UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

(Mark One)

For the Fiscal Year Ended December 31, 2003

OR

For the transition period from            to           

Commission File Number 000-31523

IXIA

26601 West Agoura Road, Calabasas, CA 91302
(Address of principal executive offices, including zip code)

Registrant’s telephone number, including area code: (818) 871-1800

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, without par value

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x  No o

The aggregate market value of the shares of the Registrant’s Common Stock held by nonaffiliates of the Registrant, computed by reference to the closing price on the Nasdaq National Market on the last business day of the Registrant’s most recently completed second fiscal quarter (June 30, 2003), was approximately $160,018,130.

As of February 20, 2004, the number of shares of the Registrant’s Common Stock outstanding was 59,799,532.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Proxy Statement to be delivered to shareholders in connection with their Annual Meeting of Shareholders to be held on May 13, 2004 are incorporated by reference into Part III of this Annual Report.

Table of Contents

IXIA

FORM 10-K

TABLE OF CONTENTS

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PART I

Item 1. Business

Overview

     We are a provider of systems that allow our customers to measure the performance of their Internet Protocol (IP) data communications equipment and networks. Our systems generate high volumes of realistic network traffic, and analyze data received from the network, exposing problems and assessing performance. The networks our systems analyze include Ethernet networks up to 10 gigabits per second in speed, which carry data traffic over optical fiber or electrical cable and are typically used within a building to form a local area network. Other networks include Packet over SONET networks up to 10 gigabits per second in speed, which transmit packets of information over high-speed optical links. Ixia equipment is also used to test Asynchronous Transfer Mode (ATM) networks, at speeds up to 622 megabits per second. In the year ended December 31, 2003, Ethernet interface cards accounted for 65.6% of our net revenues. Our systems are highly modular, scalable and easy to use.

     Since our incorporation in May 1997, we have sold our systems to a total of almost 750 customers, including over 450 existing and new customers in 2003. Based on revenues for the year ended December 31, 2003, our largest customers by category include:

•		Leading network equipment manufacturers such as Cisco Systems, Hewlett Packard, Extreme Networks and Alcatel;
•		Internet and network service providers such as NTT, UTStarcom, Sprint, SBC Communications and Verizon;
•		Communications chip manufacturers such as Broadcom and Texas Instruments; and
•		Network users such as Microsoft and Morgan Stanley.

     In late 2003, carriers and service providers announced plans to slightly increase capital spending. We intend to expand our business in this segment and on markets which exhibit healthy spending patterns such as the high-speed network, content-aware network, and virtual private network markets. High-speed networks route data traffic within a building or among multiple sites. Content-aware networks switch data traffic on higher layer protocols, and virtual private networks provide secure communications for network users. We intend to maintain our focus on technology leadership, expand and further penetrate our customer base, acquire new key technology and expand our international presence.

The Increasing Need for Network Analysis and Measurement

     The performance of the Internet and other networks such as local, metropolitan and wide area networks and the analysis and measurement of their performance are important to the following groups:

•		Equipment Manufacturers. To meet the higher standards specified by network operators and network users, equipment manufacturers who provide infrastructure equipment and systems must ensure the quality of their products during development and manufacturing and prior to shipping. Failure to ensure the consistent performance of their products may result in the loss of customers, increased research and development costs, customer service charges and losses resulting from the return of products.
•		Internet and Network Service Providers. Internet and network service providers seek to provide network users with the high quality network services they demand. Failure to provide satisfactory service can be costly and may result in the loss of customers. To ensure these desired service levels are met, Internet and network service providers must verify the performance of network equipment during the product and systems selection process prior to deployment.

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•		Communications Chip Manufacturers. Communications chip manufacturers require equipment to evaluate and analyze the performance of their chips during the design and development phase.
•		Network Users. Network users such as large businesses increasingly use specialized systems in order to verify that they are receiving the level of service that they have contracted to receive from Internet and network service providers. They also increasingly use these systems to measure the performance of their own networks before new equipment or applications are deployed in the network.

     The following characteristics and functions are used to evaluate the performance of network infrastructure equipment and systems:

•		Throughput is the maximum rate at which a network device or network can transmit distinct units of data, called packets, without loss;
•		Latency is the time that it takes a packet to travel through a network device or network;
•		Loss is the percentage of packets lost during transmission through a network device or network;
•		Jitter is the variation in the time intervals between packets transmitted through a network device or network;
•		Integrity checking confirms that the user information transmitted through a network device or network has not been corrupted;
•		Sequence checking verifies that packets are received in the same order in which they were sent through a network device or network;
•		Session setup rate is the number of individual sessions, or meaningful data conversations between computers, a network device or network can establish in one second;
•		Session tear down rate is the number of individual sessions, or meaningful data conversations between computers, a network device or network can terminate in one second; and
•		Session capacity is the maximum number of individual sessions, or meaningful data conversations between computers, a network device or network can sustain at any given time.

Characteristics Demanded of Network Performance Analysis and Measurement Equipment

     Performance requirements of network equipment and systems are becoming increasingly demanding. As a result, precise performance verification is becoming more important throughout the design, development, production, deployment and operation of network equipment and systems. Because this performance verification must take place across multiple layers of the network infrastructure and for all network protocols, network performance verification systems are required to be highly flexible and modular. In order to address multi-port switches and routers, performance verification systems must also be highly scalable and capable of generating and analyzing large amounts of data at high speeds over increasingly complex configurations. The rapid evolution of complex network technologies and protocols, including the emergence of Packet over SONET and Gigabit Ethernet, has also resulted in the need for performance verification systems that are easy to use with minimal training and setup.

The Ixia Solution

     We are a provider of multi-port traffic generation and performance analysis systems for the high-speed data communications market, including the Internet infrastructure and local, metropolitan and wide area networks. Our systems address the need for accurate and reliable performance verification of optical and electrical networks. The optical and electrical interfaces these networks use include Packet over SONET OC-192c, OC-48c, OC-12c and OC-

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3c; 10 Gigabit Ethernet, Gigabit Ethernet, and 10/100 megabits per second Ethernet; and ATM OC3c and OC12c. Our systems meet the requirements of a wide variety of customers, including network equipment manufacturers, Internet and network service providers, communications chip manufacturers and network users.

     Our systems provide the following key benefits to our customers:

     High Performance. Our systems generate and receive data traffic at wire speed, which is the maximum rate that data traffic can be transmitted over the network. Our systems provide accurate analysis across multiple layers of the overall network and of individual network components in real-time, that is, as the transmission is actually occurring. Our systems can be configured to either generate packets of data, to group those packets into sessions, or to generate pseudo random binary sequences.

     When configured to generate packets of data, our systems analyze each discrete packet of information on a packet-by-packet basis, thereby allowing our customers to precisely measure the performance of their networks and individual network components. This precision allows customers to accurately measure critical quality of service parameters such as throughput, latency, loss and jitter and check data integrity and packet sequence throughout the network, as well as to locate various network problems.

     When configured to group packets of data into meaningful sessions, or conversations between computers, our systems emulate highly complex and specialized applications such as those used to transfer electronic mail, browse the Internet and manage databases. This emulation allows our customers to accurately measure critical characteristics of their networks such as session setup rate, session tear down rate and session capacity.

     When configured to generate pseudo random bit streams, our systems analyze each individual bit to measure the bit error rate of test sequences, thereby allowing our customers to precisely measure critical physical transport characteristics of their networks. Our systems also allow users to precisely repeat complex test scenarios in order to evaluate the impact of changes made to network equipment and systems.

     Highly Scalable. Each of our interface cards provides one or more ports through which our systems generate and receive data traffic. Each physical port contains its own dedicated logic circuits, with no shared resources. Our customers can easily scale the size of their test or the amount of data traffic generated by inserting additional interface cards. By connecting multiple chassis and synchronizing up to thousands of ports to operate simultaneously, our customers can simulate large-scale networks. We believe that our systems offer our customers the highest port density and therefore the most scalable systems available. In addition, our client-server architecture allows multiple users in the same or different geographic locations to simultaneously access and operate different ports contained in the same chassis.

     Highly Customizable. Each of our current generation of interface cards includes a microprocessor for each interface port. This microprocessor uses the LINUX operating system, enabling Ixia to rapidly develop test applications and to recompile code from our partner companies or acquisitions for use on the Ixia platform. In addition, our users can run their existing software applications on their Ixia hardware, or write new software applications for it. We believe that the use of this open and well-known operating system makes it easy for our customers to customize their performance analysis system to their specific needs.

     Highly Modular. Our hardware products consist of stackable and portable chassis, which can be configured with any mix of up to 16 of our interface cards. This modular design allows our customers to quickly and easily create complex and custom test configurations. Our systems also allow for the convenient integration of additional network technologies into existing systems through the addition of specific interface cards.

     Flexibility. Our customers can easily reconfigure our systems to address changing technologies, protocols and applications without changing system hardware or replacing interface cards. For example, a customer can reconfigure our systems through software changes downloaded from our website. A customer might download these changes to test new network protocols or types of equipment.

     Ease of Use. We have designed our systems so that users can install and operate them with minimal training and setup. Our systems are easy to use and offer our customers a wide range of readily accessible pre-designed test configurations. These tests include industry standard and application-specific tests. Users can easily

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configure and operate our systems to generate and analyze data traffic over any combination of interface cards or ports through our graphical user interface that features a familiar Microsoft Windows point-and-click environment. Our systems also support the commonly used Tool Command Language (Tcl) for programming, which allows users to create custom and automated testing applications tailored to meet their specific requirements.

Strategy

     Our objective is to be the industry leader in multi-port traffic generation and performance analysis systems for the high-speed data communications market, including the Internet infrastructure and local, metropolitan and wide area networks. Key elements of our strategy to achieve this objective include the following:

     Continue to Expand Our Addressable Markets. We plan to further expand our addressable markets into areas of network growth, such as content-aware routing and switching, secure virtual private networks, networks that carry voice over IP, and next-generation SONET networks. We believe that we can leverage our core competencies in high-speed transmission protocols into leadership positions as these markets expand and mature.

     Maintain Focus on Technology Leadership. We intend to continue to focus on research and development in order to maintain our technology leadership position and to offer performance analysis systems that address new and evolving network technologies. We intend to maintain an active role in industry standards committees such as the Internet Engineering Task Force and to continue our active involvement in industry forums such as the Metro Ethernet Forum. We also plan to continue to work closely with customers who are developing emerging network technologies, including Cisco Systems, Hewlett Packard, and Intel, as well as leading edge start-up companies, to enhance the performance and functionality of our existing systems and to design future products that specifically address our customers’ needs as they evolve.

     Expand and Further Penetrate Customer Base. We plan to strengthen and further penetrate our existing customer relationships, particularly those with network equipment manufacturers and network users, and to pursue sales to new customers. For example, Microsoft and Morgan Stanley currently use our systems to verify the performance and reliability of network equipment before deployment in their networks. We believe we have the potential to increase sales to network users as they focus on optimizing their networks for use with their unique applications, as well as maximizing their return on investment from existing networks by utilizing our Real World Traffic suite of network application verification products. We plan to strengthen our customer relationships and to expand our customer base by:

•		developing and offering new and innovative systems that meet our existing and potential customers’ needs;
•		expanding our sales and marketing efforts; and
•		building our reputation and brand name recognition.

     We also plan to continue our focus on customer support by maintaining and expanding the capabilities of our highly qualified and specialized internal customer engineering group. This group of technically trained professionals provides our customers with extensive support and assistance, including assistance with customized requirements and on-site training and support.

     Perform Key Technology Acquisitions. We plan to continue our strategy of acquiring key technologies that expand our product offering, address customer needs, and fill gaps in our evolving product portfolio. Any such acquisitions may be made in the form of partnering with industry leaders, acquiring assets associated with product lines, or merging with or acquiring other companies. In 2003 we acquired the assets of the Chariot application emulation testing product line from NetIQ. In February 2004 we acquired all of the outstanding capital stock of G3 Nova Technology which develops and sells Voice over IP test tools.

     Expand International Market Presence. We plan to pursue sales in key international markets, including Europe and the Asia Pacific region. In order to pursue sales in these markets, we intend to continue to develop and

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expand our relationships with key customers and distributors. In 2003, we expanded our presence in Japan through our Japanese subsidiary in Tokyo, Japan promotes and sells our products in Japan. Additionally, we expanded our sales and support team in China.

Products

     Our product line is made up of network traffic generation and performance analysis systems that simulate large-scale networks and of stand-alone software products to allow our customers to verify conformance of their products to industry standards. Our systems consist of interchangeable interface cards, multi-slot chassis, which are metal cases that incorporate a computer, a power supply and a backplane, which is a hardware component used to connect the interface cards to the computer. The interface cards generate, receive and analyze data traffic. The software for these systems includes management software and application-specific test suites.

     The operator can utilize our analysis systems in either test labs or within networks. Our systems are operated through standard computer peripheral devices. These devices include a monitor, keyboard and mouse. The operator of our systems establishes test parameters for the performance analysis by inputting data using the keyboard and mouse. The operator observes the results of the performance analysis using the monitor and may log results to files for post-analysis or archival.

     The operator configures our systems based on the specific interfaces of the network equipment being tested. For example, if the operator wanted to analyze the performance of a router with Ethernet interfaces, the operator would insert Ethernet interface cards into our system.

Chassis

     Our primary chassis, the IXIA 1600T and the IXIA 400T, are highly scalable and can be configured with any combination of interface cards. Any mix of up to 256 IXIA 1600Ts and IXIA 400Ts can be linked together and time-synchronized to support a diverse range of complex test configurations. The IXIA 1600T is a 19-inch rack-mountable 16-slot chassis, and the IXIA 400T is a compact portable four-slot chassis.

     Our highest port density chassis, the Optixia, can be configured with Gigabit Ethernet interface cards and can be similarly linked together and time-synchronized with other chassis. The Optixia is a 19-inch rack-mountable 10-slot chassis which can support up to 240 ports of 10/100/1000 megabits per second Ethernet.

     We also offer the IXIA 100 and Ixia 250 chassis. The IXIA 100 chassis features an integrated global positioning system (GPS) receiver that provides a precise time stamp for each packet that it generates. Internet service providers are able to deploy IXIA 100 chassis in multiple geographic locations in their networks and to synchronize all of the chassis by utilizing the GPS-provided time stamp. By doing so, they are able to accurately validate network performance and measure the quality of service parameters specified in service level agreements with their customers. The Ixia 250 is an integrated system offering complete laptop computer functionality, including an integrated keyboard, mouse and monitor, with slots to accommodate up to two of our interface cards and an additional built-in 10/100/1000 megabits per second Ethernet test port.

Interface Cards

     Each one of our interface cards contains from one to eight independent traffic generation and analysis ports. These ports operate at wire speed, the maximum rate that data traffic can be transmitted over the network. Each port on each interface card has a unique transmit stream engine that is used to generate either packets of information or pseudo random bit streams, and a real-time receive analysis engine capable of analyzing the packets or bit streams as they are being received. The transmit stream engine generates millions of Internet protocol data packets or continuous test sequences at wire speed that are transmitted through the network and received by the analysis engine. When data packets have been generated, the analysis engine then measures throughput, latency, loss and jitter, and checks data integrity and packet sequence on a packet-by-packet basis. When bit streams have been generated, the analysis engine measures the bit error rate of test sequences. In addition, our systems measure the effectiveness of

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networks in prioritizing different types of traffic. Each of our current generation interface cards also includes a microprocessor per port to generate and analyze sophisticated routing protocols, such as BGP and OSPF, as well as application traffic such as TCP/IP, HTTP and SSL.

     The following tables describe our optical and electrical interface cards. The “Physical Interface Type” column distinguishes between optical interface cards capable of transmitting data traffic over fiber optic cables and electrical interface cards capable of transmitting data over copper cables. The “Transmission Speed” column identifies the speed at which data is sent out of and received by each port on the interface cards, and the “Number of Ports per Interface Card” column identifies how many ports are contained on a single card.

Interface Cards

System Management Software

     Our systems are managed through graphical user interfaces which consist of two proprietary applications and the commonly used Tool Command Language (Tcl) programming environment. Our graphical user interfaces allow users to configure our chassis and interface cards in order to generate and analyze traffic. In addition, our graphical user interfaces allow our users to execute a variety of industry standard and application-specific tests provided by Ixia. Tcl allows users to create custom and automated test applications tailored to meet their specific requirements.

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Application Specific Test Suites

     We have a large suite of software applications that measure equipment and network performance, including throughput, latency, loss, jitter, integrity checking and sequence checking. These measurements enable network equipment manufacturers, network users and Internet and network service providers to evaluate the performance of their equipment before the equipment is deployed in a network. These performance measurements also allow network users and Internet and network service providers to validate network performance and to verify that the requirements of service level agreements, or SLAs, are being met. Our application-specific test suites include the following:

     Internet Backbone Router Tester. Our Internet Backbone Router Tester offers a complete system for validation of advanced routers that direct data traffic throughout the Internet and are being deployed by Internet service providers. It provides the ability to generate and receive data traffic at wire speed. The Internet Backbone Router Tester provides an integrated mix of ATM, Packet over SONET, 10 Gigabit Ethernet, Gigabit Ethernet and 10/100 megabits per second Ethernet interfaces. Utilizing routing protocol emulation software based on IP version 4 and IP version 6 RIP, IS-IS, OSPF, and BGP-4, as well as MPLS, LDP, RSVP-TE, Layer 2 VPNs, VPLS, and Layer 3 VPNs, all standard industry routing protocols, our tester can simulate the data traffic of millions of users to automatically configure the routing table within a single router or within a network of routers. Our system thereby provides performance and reliability testing of the router or network of routers in realistic conditions.

     Benchmarking Methodology for Network Interconnect Devices (RFC-2544) Test Suite. Our RFC-2544 Test Suite offers the complete benchmarking validation tests defined by the Internet Engineering Task Force’s Request for Comments 2544. These tests include throughput, latency and loss tests. These tests can be readily applied to any device or network utilizing any mix of ATM, Packet over SONET, 10 Gigabit Ethernet, Gigabit Ethernet or 10/100 megabits per second Ethernet interfaces. These tests provide the basic industry accepted benchmarking metrics to qualify a router or switch before network deployment.

     LAN Switching Devices (RFC-2889) Test Suite. Our RFC-2889 Test Suite complements our RFC-2544 Test Suite by offering a number of additional tests to qualify the behavior of switching devices for local area networks. These tests can be readily applied to any device or network utilizing any mix of 10 Gigabit Ethernet, Gigabit Ethernet and 10/100 megabits per second Ethernet interfaces.

     Quality of Service (QoS) Test Suite. Our Quality of Service, or QoS, Test Suite offers a comprehensive set of tools designed to verify how effectively a router distinguishes between different types of data traffic and then routes the traffic through the network based on those distinctions. The QoS routing technique assigns a higher priority to some traffic types and a lower priority to other traffic types, which networks to forward high priority traffic ahead of low priority traffic. This test suite supports many combinations of ATM, Packet Over SONET, 10 Gigabit Ethernet, Gigabit Ethernet and 10/100 megabits per second Ethernet interfaces.

     IP Multicast Test Suite. IP Multicast is a set of protocols that allow a single computer to distribute data traffic to multiple recipients. For example, a single web server could transmit an audio or video broadcast to millions of users simultaneously. Our IP Multicast Test Suite provides a comprehensive set of tests designed to evaluate the behavior of Internet Protocol multicast routers, switches and networks. This test suite supports ATM, Packet over SONET, 10 Gigabit Ethernet, Gigabit Ethernet and 10/100 megabits per second Ethernet interfaces.

     IxWeb Web Stress Test Suite. The IxWeb Web Stress Test Suite offers large scale traffic generation and analysis designed to verify the behavior and performance of content-aware routers, web switches and server load balancers by establishing millions of concurrent Transmission Control Protocol, or TCP, sessions, from thousands of simulated users and servers. This test suite provides metrics such as session setup rate, session tear down rate and session capacity. This test suite is supported on the current generation of our Gigabit Ethernet and 10/100 megabits per second Ethernet interface cards.

     IxANVL – Automated Network Validation Library. The IxANVL test suite validates the protocol implementations and operational robustness of networking devices by determining how well a network device’s protocol implementation adheres to the specifications of a specific protocol. This stand-alone test suite provides functional tests that follow individual statements within protocol specifications to assess conformance, as well as

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negative tests that check how a product handles badly formatted packets or packets sent in an order other than the specified one.

     IxChariot Product Family. The IxChariot product family offers traffic pattern analysis and decision support tools which emulate real world application data. IxChariot offers application assessment and device testing by emulating hundreds of protocols across thousands of network endpoints as well as providing the ability to predict the expected performance characteristics of application running on wired and wireless networks.

Products in Development

     We are currently developing a number of new products which we plan to introduce to the market during the first half of 2004. These new products include:

•		enhanced versions of our 10 Gigabit Ethernet interface cards supporting improved routing protocol performance and the ability to run our Real World Traffic Suite of application software;
•		an Application Load Module, consisting of eight 10/100/1000 megabit per second Ethernet ports optimized for high-performance operation when running our Real World Traffic Suite of application software;
•		a new Gigabit Ethernet interface card supporting both electrical and optical connections on each port, eliminating the need to purchase separate electrical and optical interfaces;
•		an automated test suite for Virtual Private LAN Services (VPLS) that will speed and simplify the configuration and testing of routers supporting this new protocol;
•		a new mode of operation for our OC-3/OC-12 ATM interface card enabling it to function as a Packet over SONET tester;
•		a new multicast protocol emulation for Protocol Independent Multicast, Sparse Mode, for IPv6 (PIM-SMv6);
•		a 10 Gigabit per second interface card supporting G.709 Forward Error Correction;
•		an enhancement for our OC-48 Packet over SONET interface card to enable testing of Generic Framing Procedure (GFP) in support of next-generation SONET networks; and
•		new, enhanced versions of our Real World Traffic Suite of applications, including IxChariot, IxVPN, and IxWeb.

     We may delay or cancel the introduction of these, or any other, new products to the market as a result of a number of factors, some of which are beyond our control. For more information regarding these factors, see “Business — Research and Development” on page 13 and “Risk Factors — If we are unable to successfully introduce new products to keep pace with the rapid technological changes that characterize our market, our results of operations will be significantly harmed” on page 26.

Technology

     The design of all of our systems requires a combination of sophisticated technical competencies, including design of field programmable gate arrays, or FPGAs, which are integrated circuits that can be repeatedly reprogrammed to perform different sets of functions as required. The design of all of our systems also requires high-speed digital hardware design, software engineering and optical and mechanical engineering. We have built an organization of professional staff with skills in all of these areas. The integration of these technical competencies

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enables us to design and manufacture performance analysis systems which are highly scalable to meet the needs of our customers.

     Complex Logic Design. Our systems use field programmable gate arrays that are programmed by the host personal computer and therefore can be reconfigured for different applications. Our newest products have clock frequencies, which are the timing signals that synchronize all components within our system, of up to 344 megahertz, and logic densities, which are the number of individual switching components, or gates, of more than two million gates per chip. Our customers can download new features and enhancements from our website using a web browser that runs on our system, thereby allowing rapid updates of the system. Almost all of our logic is designed in the VHDL hardware description language, which is a unique programming language tailored to the development of logic chips. This language enables the easy migration of the hardware design to application specific integrated circuits as volumes warrant. We develop VHDL code in a modular fashion for reuse in logic design, which comprises a critical portion of our intellectual property. This reusable technology allows us to reduce the time-to-market for our new and enhanced products.

     Software Technology. We devote substantial engineering resources to the development of software technology for use in our product lines. We have developed software to control our systems, analyze data collected by our systems, and monitor, maintain and self-test our hardware and field programmable gate array subsystems. A majority of our software technology and expertise is focused on the use of object-oriented development techniques to design software subsystems that can be reused across multiple product lines. These objects are client and server independent allowing for distributed network applications. This software architecture allows all of the software tools developed for our existing products to be utilized in all of our new products with very little modification. Another important component of our software technology is our graphical user interface design. Customer experience with our test products has enabled us to design a simple yet effective method to display complex configurations in clear and concise graphical user interfaces for intuitive use by engineers.

Customers

     During the period from our incorporation in May 1997 through December 31, 2003, we shipped our systems to a total of over 750 customers, including 450 existing and new customers in 2003. No customer other than Cisco Systems accounted for more than 10% of our net revenues in 2003, 2002 or 2001. Our five largest customers collectively accounted for 40.4% of our net revenues in 2003, 48.5% of our net revenues in 2002 and 37.2% of our net revenues in 2001.

     Our customers may reduce or discontinue their purchases at any time.

     Customers who purchased more than $250,000 of our products during the year ended December 31, 2003 included:

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Competition

     The market for network performance measurement and analysis systems for use in the high-speed data communications industry is highly competitive, and we expect this competition to increase in the future. We currently compete with test equipment manufacturers such as Agilent Technologies, Spirent Communications and Anritsu. We also compete with a number of small companies which are focused on network performance measurement.

     We believe that the principal competitive factors in our market include:

•		timeliness of new product introductions;
•		product quality, reliability and performance;
•		ease of installation, integration and use;
•		breadth of product offerings and features;
•		price and overall cost of product ownership;
•		customer service and technical support; and
•		company reputation and size.

     We believe that we compete favorably in the key competitive factors that impact our markets. We intend to remain competitive through ongoing research and development efforts to enhance existing systems and to develop new systems. We will also seek to expand our market presence through marketing and sales efforts. However, our market is still evolving and we may not be able to compete successfully against current or future competitors.

     We expect competition to increase significantly from existing providers of network performance measurement and analysis products and from companies that may enter our existing or future markets. These companies may develop similar or substitute solutions that may be more cost-effective or provide better performance or functionality than our systems. Also, as we broaden our product offerings, we may move into new markets in which we will have to compete against companies already established in those markets. Some of our existing and potential competitors have longer operating histories, significantly greater financial, marketing, service, support, technical and other resources, significantly greater name recognition and a larger installed base of customers than we do. In addition, many of our competitors have well established relationships with our current and potential customers and have extensive knowledge of our industry. It is possible that new competitors or alliances among competitors will emerge and rapidly acquire market share. Moreover, our competitors may consolidate with each other, or with other companies, giving them even greater capabilities with which to compete against us.

     To be successful, we must continue to respond promptly and effectively to the challenges of changing customer requirements, technological advances and competitors’ innovations. Accordingly, we cannot predict what our relative competitive position will be as the market evolves for network performance measurement and analysis systems.

Sales, Marketing and Technical Support

     Sales. Our direct sales force and manufacturers’ representatives market and sell our systems primarily in the United States and Japan. Our distributors market and sell our systems primarily outside of the United States and Japan. Our net revenues from international product shipments were $25.3 million in 2003, $14.3 million in 2002 and $13.3 million in 2001. Our direct sales force maintains close contact with our customers and provides technical support to our manufacturers’ representatives and distributors.

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     Marketing. We have a number of marketing programs to support the sale and distribution of our systems and to inform existing and potential customers and our manufacturers’ representatives and distributors about the capabilities and benefits of our systems. Our marketing efforts also include promoting our business in the following ways:

•		participating in industry trade shows and technical conferences;
•		sponsoring technical seminars that highlight our solutions;
•		advertising in trade journals; and
•		communicating through our corporate website.

     Technical Support. We maintain a technically knowledgeable and responsive customer service and support staff that is critical to our development of long-term customer relationships. This highly qualified and specialized internal customer engineering group:

•		offers our customers customized solutions for their performance validation needs;
•		develops custom applications at our company headquarters;
•		can be deployed to customer sites on short notice; and
•		provides our customers with the training necessary to optimally utilize our systems.

Manufacturing

     Our manufacturing operations consist primarily of materials planning and procurement, quality control, logistics, final assembly and testing and distribution. We outsource the manufacture and assembly of printed circuit boards to third party contract manufacturers and assembly companies. This manufacturing process enables us to operate without substantial space and personnel dedicated to manufacturing operations. As a result, we can conserve a significant portion of the working capital and capital expenditures that would be required for funding inventory and manufacturing processes.

     We are dependent upon sole or limited source suppliers for key components and parts used in our systems, including field programmable gate arrays, chips, oscillators and optical modules. We and our contract manufacturers purchase components through purchase orders and have no guaranteed or long-term supply arrangements with our respective suppliers. In addition, the availability of many components is dependent in part on our ability and the ability of our contract manufacturers and assembly companies to provide suppliers with accurate forecasts of future requirements. Any extended interruption in the supply of any of the key components currently obtained from a sole or limited source or delay in transitioning to a replacement supplier’s product or replacement component into our systems could disrupt our operations and significantly harm our business in any given period.

     Lead times for materials and components ordered by us and by our contract manufacturers vary and depend on factors such as the specific supplier, contract terms and demand for a component at a given time. We and our contract manufacturers acquire materials, complete standard subassemblies and assemble fully-configured systems based on sales forecasts and historical purchasing patterns. If orders do not match forecasts or substantially deviate from historical patterns, we and our contract manufacturers may have excess or inadequate inventory of materials and components.

Research and Development

     We believe that research and development is critical to our business. We focus our research and development efforts on developing new products and on further enhancing existing products. Our development

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efforts include anticipating and addressing the performance analysis needs of network equipment manufacturers, Internet and network service providers, communications chip manufacturers and network users and focusing on emerging high growth network technologies.

     Our future success depends on our ability to continue to enhance our existing products and to develop products that address the needs of our customers. We closely monitor changing customer needs by communicating and working directly with our customers and distributors. We also receive input from active participation in industry groups responsible for establishing technical standards.

     Development schedules for technology products are inherently difficult to predict, and we cannot assure you that we will introduce any proposed new products in a timely fashion. Also, we cannot assure you that our product development efforts will result in commercially successful products or that our products will not contain software errors or other performance problems or be rendered obsolete by changing technology or new product announcements by other companies.

     We plan to continue to make significant investments in research and development. Our research and development expenditures were $22.0 million in 2003, $20.4 million in 2002 and $19.4 million in 2001. These expenditures included stock-based compensation expense of $1.3 million in 2003, $2.9 million in 2002 and $6.1 million in 2001.

Intellectual Property and Proprietary Rights

     Our success and ability to compete is dependent in part upon our ability to protect and maintain our proprietary rights to our intellectual property. We currently rely on a combination of trademark, trade secret and copyright laws and restrictions on disclosure to establish and protect our intellectual property. We also expect to rely on patents to protect some of our proprietary technology. We have filed applications for a number patents in both the U.S. and Japan but cannot assure you that the patents will be issued or that the patents will be upheld if they are issued. We also cannot assure you that such patents, if issued, will be effective in protecting our proprietary technology. We have registered our Ixia name, the Ixia logo and other trademarks in the United States and have filed for registration of additional trademarks in the United States and other jurisdictions. We are also in the process of filing applications for registration of additional trademarks.

     We generally enter into confidentiality agreements with our officers, employees and consultants. We also generally limit access to and distribution of our source code and further limit the disclosure and use of other proprietary information. However, these measures provide only limited protection of our intellectual property rights. In addition, we may not have signed agreements containing adequate protective provisions in every case, and the contractual provisions that are in place may not provide us with adequate protection in all circumstances. Further, we have not included copyright notices on all of our copyrightable intellectual property.

     Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain or use technology that we regard as proprietary. We cannot assure you that the steps taken by us to protect our proprietary rights will be adequate to prevent misappropriation of our technology or that our competitors will not independently develop technologies that are similar or superior to our technology. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States. Any infringement of our proprietary rights could result in significant litigation costs, and any failure to adequately protect our proprietary rights could result in our competitors offering similar products, potentially resulting in loss of competitive advantage and decreased revenues. Litigation may be necessary to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation of this type could result in substantial costs and diversion of resources and could significantly harm our business.

     The data communications industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. From time to time, third parties may assert patent, copyright, trademark and other intellectual property rights to technologies that are important to our business. We have not conducted a search to determine whether the technology we have in our products infringes or misappropriates intellectual property held by third parties. In addition, because patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed which could relate to our

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products. Any claims asserting that our systems infringe or may infringe proprietary rights of third parties, if determined adversely to us, could significantly harm our business.

Employees

     As of December 31, 2003 we had 287 full-time employees. We also from time to time hire temporary and part-time employees and independent contractors. Our future performance depends, to a significant degree, on our continued ability to attract and retain highly skilled and qualified technical, sales and marketing and senior management personnel. Our employees are not represented by any labor unions. We consider our relations with our employees to be good.

Available Information

     Our website address is www.ixiacom.com. We make available free of charge through a link provided at such website our Forms 10-K, 10-Q and 8-K as well as any amendments thereto. Such reports are available as soon as reasonably practicable after they are filed with the Securities and Exchange Commission.

Business Risk Factors

     The statements that are not historical facts contained in the above “Business” discussion in this Item 1 are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and reflect the current belief, expectations or intent of the Company’s management. These statements are subject to and involve certain risks and uncertainties. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Risk Factors” in Item 7 of this Annual Report on Form 10-K.

Item 2. Properties

     Our corporate headquarters are located in Calabasas, California, where currently we lease approximately 63,500 square feet of space which houses our research and development, sales and marketing, finance and administration and manufacturing operations. The lease expires in May 2008. We also lease office space for our sales offices in Santa Clara, California, North Carolina, Illinois, the United Kingdom, Japan and China. Additionally, we have a facility in Bucharest, Romania used primarily in research and development activities. We believe that our current facilities will be adequate to meet our needs for at least the next 12 months, and that we will be able to obtain additional space when and as needed on acceptable terms.

Item 3. Legal Proceedings

     From time to time, certain legal actions may arise in the ordinary course of the Company’s business. To date, such legal actions have not had a material adverse effect on the Company’s financial position, results of operations or cash flows.

Item 4. Submission of Matters to a Vote of Security Holders

     None

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PART II

Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

     Ixia’s common stock is traded on the Nasdaq National Market under the symbol “XXIA.” The following table sets forth the high and low closing sales prices of our common stock as reported on the Nasdaq National Market for the following time periods.

     On March 1, 2004 the closing sales price reported for our common stock was $12.37 per share, and as of that date there were approximately 49 shareholders of record.

     We have never declared or paid cash dividends on our common stock and do not anticipate paying any dividends in the foreseeable future.

Item 6. Selected Financial Data

     The following selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the notes to those consolidated financial statements. The statement of income data set forth below for the years ended December 31, 2003, 2002 and 2001 and the balance sheet data as of December 31, 2003 and 2002 are derived from, and are qualified by reference to, the Company’s audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The statement of income data for the years ended December 31, 2000 and 1999 and the balance sheet data as of December 31, 2001, 2000 and 1999 are derived from audited financial statements not included herein, but which were previously filed with the SEC.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of many factors. The results of operations for the years ended December 31, 2003, 2002 and 2001 are not necessarily indicative of the results that may be expected for any future period. The following discussion should be read in conjunction with the consolidated financial statements and the notes thereto included in Item 8 of this Annual Report on Form 10-K and in conjunction with the “Risk Factors” described below.

Overview

     We develop, market and sell systems that allow our customers to measure the performance of their data communications equipment and networks. Our systems generate and analyze data traffic, including business transaction and Voice over IP traffic, which sends voice communication over data networks using a protocol known as the Internet Protocol, or IP. In addition, our products allow customers to analyze the performance, accuracy and reliability of equipment and systems that they either manufacture for sale to others or purchase for use in their own networks. The networks our systems analyze include advanced Ethernet networks, which carry data traffic over optical fiber as well as over electrical cable and are typically used within a single building or a group of buildings. Other networks include Packet Over SONET networks which transmit packets of information over high-speed optical links. Our customers include manufacturers of network equipment, Internet and network service providers, communications chip manufacturers and network users.

     Our product offerings include a variety of interface cards, chassis that can hold up to 16 interface cards each and related software products. Our interface cards can generate traffic over a variety of optical and electrical interfaces such as Gigabit Ethernet and Packet Over SONET. The following table sets forth, for the periods indicated, our net revenues by principal product category in dollars and as a percentage of total net revenues:

     Over the last two years, revenue from Ethernet interface cards has increased while revenue from SONET interface cards has decreased. Generally, Ethernet interface cards are used to test equipment that is used at edge of the Internet and in enterprise applications, where demand has been increasing over the last two years. SONET interface cards are used to test equipment that is used in core of the Internet and in telecommunications applications, where demand has weakened over the past two years. Looking forward, we expect demand for our Ethernet interface cards to remain strong and we expect demand for our SONET interface cards to remain sluggish. Over the same time period, software revenues have increased both in dollar terms and as a percentage of revenue. This increase in software revenues is the result of our strategy to use specialized software applications to drive demand for our proprietary hardware platform. Software revenues should continue to increase both in dollar terms and as a percentage of revenue.

     Sales to our five largest customers collectively accounted for approximately $33.7 million, or 40.4%, of our net revenues in 2003, $32.8 million, or 48.5%, in 2002 and $28.7 million, or 37.2%, in 2001. To date, we have sold our systems primarily to network equipment manufacturers. While we expect that we will continue to have some customer concentration for the foreseeable future, we have sold our systems to a wide variety of customers. Through December 31, 2003, we had shipped our systems to a total of over 750 customers, including over 450 existing and new customers in 2003. To the extent we develop a broader and more diverse customer base, we anticipate that our reliance on any one customer will diminish.

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     Net Revenues. Our revenues consist primarily of hardware and software product sales. In some instances our software products are installed on and used in conjunction with our hardware products. At other times our software products are installed and run on other companies’ hardware. Our software does not require significant modification or customization, and our sales do not involve any significant future obligations or customer acceptance terms. Accordingly, product revenue from product sales is recognized upon shipment. We warrant the hardware and software components of our products for up to one year after sale. At the time of sale we defer the portion of our revenues that relates to our post-contract support and recognize it ratably over the service period. Revenues from maintenance contracts are deferred and recognized ratably over the term of the contracts.

     Cost of Revenues. Our cost of revenues consists of materials, payments to third party manufacturers, salaries and related expenses for manufacturing personnel and the warranty cost of hardware to be replaced during the one-year warranty period. We outsource the majority of our manufacturing operations, and we conduct final assembly, supply chain management, quality assurance, documentation control and shipping at our facility. Accordingly, a significant portion of our cost of revenues consists of payments to our contract manufacturers. Beginning in July 2003, cost of revenues also included royalty and amortization of purchased technology expenses in connection with the rights acquired from NetIQ Corporation related to the Chariot product (for additional information, see Note 4 to the Consolidated Financial Statements). In addition, cost of revenues includes a non-cash component related to the amortization of deferred stock-based compensation allocated to manufacturing personnel.

     Gross Margins. Excluding the effects of stock-based compensation, the gross margins of our various interface cards have generally been consistent and have exceeded the gross margins of our chassis. In general, our gross margins are primarily affected by the following factors:

•		the pricing we are able to obtain from our component suppliers and contract manufacturers;
•		the mix of our products sold, including the mix of software versus hardware sales;
•		new product introductions by us and by our competitors;
•		changes in our pricing policies and those of our competitors;
•		demand for our products;
•		expenses related to acquired technologies, such as royalties and amortization of intangible assets;
•		production volume; and
•		the mix of sales channels through which our products are sold.

     In the near term we anticipate gross margins as a percentage of revenue to increase slightly due to reductions of royalty expense expected in the future.

     Operating Expenses. We generally recognize our operating expenses as we incur them in three major operational categories: research and development, sales and marketing and general and administrative.

     Research and development expenses consist primarily of salaries and related personnel and consulting costs related to the design, development, testing and enhancements of our systems. We expense our research and development costs as they are incurred. We also capitalize and depreciate over a two-year period some costs of our systems used for internal purposes. We expect research and development expenses to increase as we seek to attain our strategic product development objectives and to meet changing customer requirements and technological advances.

     Sales and marketing expenses consist primarily of salaries, commissions and related expenses for personnel engaged in sales and marketing and customer support functions, as well as costs associated with promotional and other marketing activities. We expect sales and marketing expenses to increase in line with revenue increases.

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     General and administrative expenses consist primarily of salaries and related expenses for executive, finance, human resources, information technology and administrative personnel, as well as recruiting and professional fees, insurance costs and other general corporate expenses, including rent. We expect modest sequential increases in general and administrative expenses as the Company continues to grow and implement procedures and policies to comply with regulations introduced by the recently enacted Sarbanes-Oxley Act of 2002.

     Amortization of intangible assets consists of the amortization of the purchase price of the various intangible assets over their useful lives.

     Periodically we review goodwill and other intangible assets for impairment. An impairment charge is recorded to the extent that the carrying value exceeds the fair value.

     Deferred stock-based compensation, recorded in the shareholders’ equity section of the balance sheet, represents the difference between the deemed fair value of our common stock for accounting purposes and (1) the exercise price of the options or warrants at the date of grant or (2) the purchase price of the restricted stock. Deferred stock-based compensation is presented as a reduction of shareholders’ equity, with amortization recorded over the vesting period which is typically four years.

     Interest income represents interest on cash and a variety of securities, including commercial paper, money market funds and government and corporate debt securities.

     Income tax expense is determined based on the amount of earnings and enacted federal, state and foreign tax rates, adjusted for allowable credits and the effect of stock option transactions.

Critical Accounting Policies and Estimates

     Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, allowance for doubtful accounts, allowance for obsolete inventory, deferred taxes, impairment of long-lived assets and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

     We apply the following critical accounting policies in the preparation of our consolidated financial statements:

•		Revenue Recognition Policy. We recognize revenue as discussed in the “Overview” section.
•		Allowance for Doubtful Accounts. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
•		Write Down of Obsolete Inventory. We write down inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual future demand is less favorable than as projected by management, additional inventory write-downs may be required.
•		Deferred Taxes. Deferred taxes are determined based on the differences between the financial statement and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to

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		reduce deferred tax assets to the amounts expected to be realized. In assessing the need for a valuation allowance we consider estimates of future taxable income and ongoing prudent and feasible tax planning strategies.
•		Acquisition Purchase Price Allocation. When we have acquired a business, product line or rights to a product or technology, we allocate the purchase price, including related transaction fees, to the various tangible and intangible assets acquired and the liabilities assumed, based on their estimated fair value. Determining the fair value of certain assets and liabilities acquired is subjective in nature and often involves the use of significant estimates and assumptions. To assist in this process, we may obtain appraisals from valuation specialists for certain intangible assets. Most of the assumptions used to determine fair value are made based on forecasted information. The useful lives of amortizable intangible assets are reviewed for reasonableness periodically by management in light of current conditions.
•		Impairment of Long-Lived Assets. We evaluate the recoverability of our identifiable definite life intangible assets and other long-lived assets in accordance with Statement of Financial Accounting Standards (“SFAS”) 144 which generally requires that we assess these assets for recoverability when events or circumstances indicate a potential impairment by estimating the undiscounted cash flows to be generated from the use and ultimate disposition of these assets. To the extent that the estimated undiscounted cash flows fall below the carrying value of the intangible or other long lived assets we write down the assets to fair value. Fair value is generally determined based on discounted cash flows. We evaluate the recoverability of our goodwill in accordance with SFAS 142 which requires us to assess our goodwill annually for impairment. Impairment losses are recorded to the extent that the carrying value of the goodwill exceeds the fair value.
•		Contingencies and Litigation. We evaluate contingent liabilities, including threatened or pending litigation, in accordance with SFAS 5, “Accounting for Contingencies,” and we record accruals when the outcome of these matters is deemed probable and the liability can reasonably be estimated. We make these assessments based on the facts and circumstances of each situation and in some instances based in part on the advice of outside legal counsel.

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Results of Operations

     The following table sets forth certain statement of income data as a percentage of net revenues for the periods indicated:

Comparison of the Years Ended December 31, 2003 and 2002

     Net Revenues. In 2003, net revenues increased 23.6% to $83.5 million from the $67.6 million recorded in 2002. This increase in net revenues in 2003 was largely a result of increased sales of our Ethernet products, especially our 10/100 Mbps & Gigabit Ethernet Load Modules and growth in sales of our software products. In addition, this growth was from a combination of both existing and new customers. Sales to our five largest customers collectively accounted for approximately $33.7 million or 40.4% of our net revenues in 2003 compared to $32.8 million or 48.5% of net revenues in 2002.

     Gross Profit. Gross profit increased 22.7% to $66.6 million in 2003 from $54.3 million in 2002. Our gross profit margin decreased to 79.7% in 2003 from 80.3% in 2002. This decrease in the gross profit margin was primarily a result of royalties and amortization of purchased technology associated with certain rights acquired from NetIQ Corporation in July 2003. We will pay minimum royalties of at least $500,000 each quarter through December 31, 2004. This decrease was partially offset by an increase in sales of high margin software products and decreasing component costs during 2003 as compared to 2002.

     Research and Development Expenses. Research and development expenses increased to $22.0 million in 2003 from $20.4 million in 2002. This increase was primarily due to higher compensation and related benefit costs due to the addition of engineering personnel through internal hiring and acquisitions and to the costs associated with the increased use of third party consultants. This increase was partially offset by a reduction in the amortization of deferred stock-based compensation related to individuals engaged in research and development activities and decreased prototype costs as a result of the timing of the development cycle of our hardware products.

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     Sales and Marketing Expenses. Sales and marketing expenses increased to $25.1 million in 2003 from $20.8 million in 2002. This increase was primarily due to increases in the number of direct sales and marketing personnel and their associated commissions and benefits. This increase was partially offset by a reduction in the amortization of deferred stock-based compensation related to individuals engaged in sales and marketing activities and a reduction in depreciation on demonstration and evaluation equipment used by our sales force. The reduction in depreciation was a result of fully depreciated demonstration and evaluation equipment meeting the needs of our sales force and to the timing of the introduction of new hardware products which require new capital expenditures for demonstration and evaluation equipment.

     General and Administrative Expenses. General and administrative expenses increased to $9.2 million in 2003 from $7.9 million in 2002. This increase was primarily due to increases in employee compensation, recruiting expenses, insurance and accounting expenses. This increase was partially offset by a reduction in the amortization of deferred stock-based compensation related to individuals engaged in general and administrative activities.

     Amortization of Intangible Assets. Amortization of intangible assets increased to $1.1 million in 2003 from $941,000 in 2002. This increase was primarily due to amortization of the purchase price of certain rights acquired in July 2003 related to the Chariot product and a full year of amortization of intangible assets related to the ANVL product line that were written down in 2002. These increases were partially offset by a reduction in the amortization of the Caimis intangible assets.

     Impairment of Goodwill and Other Intangible Assets. Due to the decline in business conditions in 2002, we restructured our business and realigned resources to focus on profit contribution, high-growth markets and core opportunities. As a result, in 2002, we recorded an impairment charge of $1.7 million related to the impairment of goodwill and purchased intangible assets related to the acquisition of Caimis, Inc., measured as the amount by which the carrying amount exceeded the present value of the estimated future cash flows for goodwill and purchased intangible assets. In 2003, we recorded a further impairment charge of $410,000 for the remaining Caimis, Inc. intangible assets based on revised estimates of the present value of future cash flows because of a decline in potential customer interest for this product.

     Interest Income, Net. Net interest income increased to $3.1 million in 2003 from $2.7 million in 2002. This increase was primarily the result of an increase in the amount investments in marketable securities in 2003 as compared to 2002. This increase was partially offset as a result of a decline in interest rates. We incurred minimal interest expense in 2003 and 2002.

     Income Tax Expense. Income tax expense increased to $3.3 million in 2003 from $1.9 million in 2002. Income tax expense resulted in an annual effective tax rate of 27.2% in 2003 and 36.3% in 2002. The annual effective tax rate in 2003 and 2002 differs from the statutory rate primarily due to research and development tax credits and the tax benefit from the disqualifying disposition of stock options to the extent that stock-based compensation expense had previously been reflected in the our financial statements offset by nondeductible stock-based compensation charges.

Comparison of the Years Ended December 31, 2002 and 2001

     Net Revenues. In 2002, net revenues decreased 12.4% to $67.6 million from the $77.2 million recorded in 2001. This decrease in net revenues in 2002 was largely a result of significant reductions in SONET customer orders due to the slowdown in the economy and in telecommunications spending. These reductions were partially offset primarily by sales to new customers and the introduction of new Ethernet and software products during the year. Sales to our five largest customers collectively accounted for approximately $32.8 million or 48.5% of our net revenues in 2002 compared to $28.7 million or 37.2% of net revenues in 2001.

     Gross Profit. Gross profit decreased 10.3% to $54.3 million in 2002 from $60.5 million in 2001. Our gross profit margin increased to 80.3% in 2002 from 78.5% in 2001. This increase in the gross profit margin was primarily a result of decreasing component costs and, to a lesser extent, to an increase in sales of high margin software products during 2002 as compared to 2001.

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     Research and Development Expenses. Research and development expenses increased to $20.4 million in 2002 from $19.4 million in 2001. This increase was primarily due to higher compensation and related benefit costs due to the addition of engineering personnel through internal hiring and acquisitions and to the costs associated with the increased use of third party consultants. This increase was partially offset by a reduction in the amortization of deferred stock-based compensation related to individuals engaged in research.

     Sales and Marketing Expenses. Sales and marketing expenses increased to $20.8 million in 2002 from $19.6 million in 2001. This increase was primarily due to increases in the number of direct sales and marketing personnel and depreciation on demonstration and evaluation equipment used by our sales force. This increase was partially offset by a reduction in the amortization of deferred stock-based compensation related to individuals engaged in sales and marketing activities.

     General and Administrative Expenses. General and administrative expenses decreased to $7.9 million in 2002 from $8.6 million in 2001. Stock-based compensation included in general and administrative expenses decreased to $658,000 in 2002 from $2.2 million in 2001. Excluding stock-based compensation, general and administrative expenses increased to $7.2 million in 2002 from $6.5 million in 2001. This increase was primarily due to increases in insurance, utilities and rent expenses. This increase was partially offset by a reduction in the amortization of deferred stock-based compensation related to individuals engaged in general and administrative activities.

     Impairment of Goodwill and Other Intangible Assets. Due to the decline in business conditions in 2002, we restructured our business and realigned resources to focus on profit contribution, high-growth markets and core opportunities. As a result, we recorded an impairment charge of $1.7 million related to the impairment of goodwill and purchased intangible assets related to the acquisitions of Caimis, Inc., measured as the amount by which the carrying amount exceeded the present value of the estimated future cash flows for goodwill and purchased intangible assets.

     Interest Income, Net. Net interest income decreased to $2.7 million in 2002 from $4.0 million in 2001. This decrease was primarily the result of a decline in short-term interest rates. We incurred minimal interest expense in 2002 and 2001.

     Income Tax Expense. Income tax expense decreased to $1.9 million in 2002 from $7.2 million in 2001. Income tax expense was based on an annual effective tax rate of 36.3% in 2002 and 42.6% in 2001. The annual effective tax rate in 2002 and 2001 differs from the statutory rate primarily due to nondeductible stock-based compensation charges and state taxes offset by research and development tax credits.

Liquidity and Capital Resources

     As of December 31, 2003 we had cash and cash equivalents of $41.7 million, compared to $58.9 million as of December 31, 2002. Our cash, cash equivalents and short and long term investments when viewed as a whole, totaled $121.9 million as of December 31, 2003 compared to $122.2 million as of December 31, 2002.

     Net cash provided by operating activities was $17.7 million in 2003, $14.2 million in 2002 and $26.1 million in 2001. Net cash generated from operations in 2003, 2002 and 2001 was primarily provided by net income adjusted for significant non-cash expenses and changes in working capital requirements.

     Cash used in investing activities was $39.7 million in 2003, $73.4 million in 2002 and $8.1 million in 2001. Cash used in investing activities in 2003 consisted of $16.9 million for the net purchase of investment securities, $18.2 million in connection with rights acquired from NetIQ associated with the Chariot product in July 2003 and $4.2 million related to the purchase of property and equipment. Cash used in investing activities in 2002 consisted of approximately $63.4 million for the net purchase of investment securities, $5.2 million in connection with the acquisition in February 2002 of the assets of the ANVL (Automated Network Validation Library) product line from Empirix, Inc. and $4.7 million related to the purchase of property and equipment. Cash used in investing activities in 2001 consisted of approximately $2.0 million in connection with the acquisition in November 2001 of the outstanding capital stock of Caimis, Inc. and $6.1 million of capital expenditures for property and equipment. In February 2004, we paid $5.5 million in cash in connections with the purchase of all of the outstanding capital stock

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of G3 Nova Technology. In addition, a contingent payment of up to $2.5 million may be paid based upon sales of G3 Nova products in 2004 and 2005.

     Financing activities provided net cash of $4.8 million in 2003, $1.4 million in 2002 and $2.6 million in 2001. Financing activities in 2003 and 2002 consisted exclusively of proceeds from the exercise of stock options. Financing activities in 2001 consisted of proceeds from the exercise of stock options and of proceeds from the payment of related party notes receivables.

     We believe that our existing balances of cash and cash equivalents and cash flow expected to be generated from our operations will be sufficient to meet our cash needs for at least the next 12 months, although we could be required, or could elect, to seek additional funding prior to that time, however, financing may not be available on favorable terms, if at all. Our capital requirements will depend on many factors, including the growth rate of our net revenues, our profitability, our capital expenditures, acquisition of key technology, working capital requirements, the timing and extent of spending to support product development efforts and the expansion of our sales, marketing and technical support efforts.

Financial Commitments

     Our financial commitments at December 31, 2003 are as follows (in thousands):

     Contractual Obligations

Recent Accounting Pronouncements

     In July 2002, the FASB issued SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS 146 requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS 146 has not had a material impact on the Company’s financial statements.

     In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that certain guarantees be recognized as liabilities at fair value at their inception date and requires certain disclosures by the guarantor in its financial statements about its obligations. The provisions of FIN 45, which were effective for qualifying guarantees entered into or modified after December 31, 2002, did not have a material impact on the Company’s financial statements. The disclosure requirements were effective for the quarter ended March 31, 2003.

     In December 2002, the FASB issued SFAS 148, “Accounting for Stock-Based Compensation – Transition and Disclosure – an amendment of FASB Statement No. 123.” This Statement amends SFAS 123 to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The provisions of SFAS 148 are effective for financial statements for fiscal years ending after December 15, 2002, and disclosure requirements are effective for interim periods beginning after December 15, 2002. The Company continues to account for stock-based compensation to its employees and directors using the intrinsic value method prescribed by APB Opinion No. 25, and related interpretations. The Company started making the disclosures required by SFAS 148 in the consolidated financial statements for the year ended December 31, 2002. Accordingly, adoption of SFAS 148 does not impact the Company’s financial position or results of operations.

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     In May 2003, the FASB issued SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” SFAS 150 changes the accounting for certain financial instruments that under previous guidance issuers could account for as equity. It requires that those instruments be classified as liabilities in balance sheets. The guidance in SFAS 150 is generally effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective on July 1, 2003. The adoption of SFAS 150 did not impact the Company’s financial position, cash flows or results of operations.

     In December 2003, the SEC issued SAB 104. This staff accounting bulletin revises or rescinds certain sections of SAB 101, which gives interpretation guidance about revenue recognition. SAB 104 makes the interpretive guidance of SAB 101 consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The adoption of SAB 104 in December 2003 did not impact the Company’s financial position, cash flows or results of operations.

Risk Factors

     The statements that are not historical facts contained in this Annual Report on Form 10-K are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements reflect the current belief, expectations or intent of the Company’s management and are subject to and involve certain risks and uncertainties. Many of these risks and uncertainties are outside of our control and are difficult for us to forecast or mitigate. In addition to the risks described elsewhere in this Annual Report on Form 10-K and in certain of our other Securities and Exchange Act Commission filings, the following important factors, among others, could cause our actual results to differ materially from those expressed or implied by us in any forward-looking statements contained herein or made elsewhere by or on behalf of the Company.

Our quarterly and annual operating results may fluctuate significantly as a result of new product introductions and other factors which could cause our stock price to decline significantly

     Our quarterly and annual operating results have fluctuated and may fluctuate significantly due to a variety of factors, most of which are outside of our control. Some of the factors that could cause our quarterly and annual operating results to fluctuate include the other risks discussed in this “Risk Factors” section.

     We may experience a shortfall or delay in generating or recognizing revenues for a number of reasons. Orders on hand at the beginning of a quarter and orders generated in a quarter do not always result in the shipment of products and the recognition of revenues for that quarter. Failure to ship products by the end of the quarter in which they are ordered may adversely affect our operating results for that quarter. Our customer agreements typically provide that the customer may delay scheduled delivery dates and cancel orders within specified time frames without penalty. Because we incur operating expenses based on anticipated revenues trends and a high percentage of our expenses are fixed in the short term, any delay in generating or recognizing forecasted revenues could significantly harm our quarterly results of operations.

     Additionally, our operating results may vary as a result of the timing of our release of new products. The introduction of a new product in any quarter may cause an increase in revenues in that quarter that may not be sustainable in subsequent quarters.

If we are unable to successfully introduce new products to keep pace with the rapid technological changes that characterize our market, our results of operations will be significantly harmed

     The market for our products is characterized by:

•		rapid technological change such as the recent development of optical fiber and wireless technologies;
•		frequent new product introductions such as higher speed and more complex routers;

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•		evolving industry standards such as new Internet protocols;
•		changing customer needs such as the increase in the levels of service agreed to between network service providers and their customers; and
•		short product life cycles as a result of rapid changes in our customers’ products.

     We expect that new technologies will continue to emerge as the need for higher and more cost-effective bandwidth increases. Our performance will depend on our successful development, introduction and market acceptance of new and enhanced performance analysis products that address these new technologies and changes in customer requirements. If we experience any delay in the development or introduction of new products or enhancements to our existing products, our operating results may suffer. For instance, undetected software or hardware errors, which frequently occur when new products are first introduced, could result in the delay or loss of market acceptance of our products and the loss of credibility with our customers. In addition, if we are not able to develop, or license from third parties, the underlying core technologies necessary to create new products and enhancements, our existing products are likely to become technologically obsolete over time and our operating results will suffer. If the rate of development of new technologies and transmission protocols by our customers is delayed, the growth of the market for our products and therefore our sales and operating results may be harmed.

     Our ability to successfully introduce new products in a timely fashion will depend on several factors, including our ability to:

•		anticipate technological changes and industry trends;
•		properly identify customer needs;
•		innovate and develop new technologies and applications;
•		hire and retain necessary technical personnel;
•		successfully commercialize new technologies in a timely manner;
•		timely obtain key components for the manufacture of new products;
•		manufacture and deliver our products in sufficient volumes and on time;
•		price our products competitively; and
•		differentiate our offerings from our competitors’ offerings.

     The development of new, technologically advanced products is a complex and uncertain process requiring high levels of innovation and highly skilled engineering and development personnel, as well as the accurate anticipation of technology and market trends. We cannot assure you that we will be able to identify, develop, manufacture, market or support new or enhanced products successfully, if at all, or on a timely or cost-effective basis. Further, we cannot assure you that our new products will gain market acceptance or that we will be able to respond effectively to technological changes, emerging industry standards or product announcements by our competitors. If we fail to respond to technological change and the needs of our markets, we will lose revenues and our competitive position will suffer.

We depend on sales of a narrow range of products and if customers do not purchase our products, our revenues and results of operations would be significantly harmed

     Our business and products are concentrated in the market for systems that analyze and measure the performance of network equipment and systems. This market is in an evolving market and there is uncertainty regarding its size and scope. Our performance will depend on increased sales of our existing systems and the

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successful development, introduction and market acceptance of new and enhanced products. We cannot assure you that we will be successful in increasing these sales or in developing and introducing new products. Our failure to do so would significantly harm our revenues and results of operations.

Competition in our market could significantly harm our results of operations

     The market for our products is highly competitive. We face competition primarily from test equipment manufacturers such as Agilent Technologies, Spirent Communications and Anritsu. We also compete with a number of small companies which are focused on network performance analysis and measurement. Additionally, some of our network equipment manufacturer customers have developed, or may develop, in-house performance analysis products for their own use or for sale to others. For example, Cisco Systems, our largest customer, has used internally developed test products for a number of years. Although Cisco Systems has always accounted for a significant portion of our net revenues, we cannot assure you that it will continue to do so.

     As we broaden our product offerings, we may move into new markets and face additional competition. Moreover, our competitors may have more experience operating in these new markets and be better established with the customers in these new markets.

     Some of our competitors and potential competitors have greater brand name recognition and greater financial, technical, marketing, sales and distribution capabilities than we do. Moreover, our competitors may consolidate with each other, or with other companies, giving them even greater capabilities with which to compete against us.

     Increased competition in the network performance analysis and measurement market could result in increased pressure on us to reduce prices and could result in a reduction in our revenues and/or a decrease in our margins, each of which could significantly harm our results of operations. In addition, increased competition could prevent us from increasing our market share, or cause us to lose our existing market share, either of which would harm our revenues and profitability.

     We cannot predict whether our current or future competitors will develop or market technologies and products that offer higher performance or more features or are more cost-effective than our current or future products. To remain competitive, we must continue to develop cost-effective products and product enhancements which offer higher performance and more functionality. Our failure to do so will harm our revenues and results of operations.

If we do not diversify our customer base, we may not be able to grow our business or increase our profitability

     Our growth depends in part on our ability to diversify our customer base by increasing sales to enterprise network users, Internet and network service providers and communications chip manufacturers. To effectively compete for the business of these customers, we must develop new products and enhancements to existing products and expand our sales, marketing and customer support capabilities, which will result in increases in operating costs. If we cannot offset these increases in costs with an increase in our revenues, our net income and our stock price may fall. Some of our existing and potential competitors have existing relationships with many Internet and network service providers, communications chip manufacturers and network users. We cannot assure you that we will be successful in increasing our sales presence in these markets. Any failure by us to increase sales in these markets would adversely affect our growth.

Because we depend on a limited number of network equipment manufacturers for a majority of our revenues, any cancellation, reduction or delay in purchases by these customers could significantly harm our revenues and results of operations

     Historically, a small number of network equipment manufacturing customers has accounted for a significant portion of our net revenues. Sales to our five largest customers represented 40.4% of our net revenues in 2003,

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48.5% of our net revenues in 2002 and 37.2% our net revenues in 2001. Sales to Cisco Systems, our largest customer, accounted for 29.1% of our net revenues in 2003, 34.2% of our net revenues in 2002 and 24.4% of our net revenues in 2001. We expect that significant customer concentration will continue for the foreseeable future and that our operating results will continue to depend to a significant extent upon revenues from a small number of customers.

     Our dependence on large orders from a limited number of network equipment manufacturers makes our relationships with these manufacturers critical to the success of our business. We cannot assure you that we will be able to retain our largest customers, that we will be able to increase our sales to our other existing customers or that we will be able to attract additional customers. From time to time, we have experienced delays and reductions in orders from some of our major customers. In addition, our customers have sought price concessions from us and may continue to do so. We do not have long-term contracts with our customers, and our major customers can stop purchasing our products at any time without penalty and are free to purchase products from our competitors. The loss of one or more of our largest customers, any reduction or delay in sales to these customers, our inability to successfully develop and maintain relationships with existing and new customers or requirements that we make price concessions could significantly harm our revenues and results of operations.

Our business may be adversely affected by unfavorable general economic and market conditions

     Our business is subject to the effects of general economic conditions in the United States and globally and, in particular, market conditions in the communications and networking industries. Especially, during 2002 and 2001, our operating results were adversely affected as a result of unfavorable economic conditions and reduced capital spending in the United States, Europe and Asia. In particular, sales to network equipment manufacturers in North America were significantly and adversely affected during fiscal years 2002 and 2001. If there is a slowdown in the global economy and market condition, we may experience material adverse impacts on our business, operating results and financial condition.

Man-made problems such as computer viruses or terrorism may disrupt our operations and harm our operating results

     Despite our implementation of network security measures, our network is vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems. Any such event could have a material adverse effect on our business, operating results and financial condition. In addition, the effects of war or acts of terrorism could have a material adverse effect on our business, operating results and financial condition. The continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, may cause further disruption to the economy and create further uncertainties. Similarly, events such as the recent blackout in the eastern United States could have similar negative impacts. To the extent that such disruptions or uncertainties result in delays or cancellations of customer orders, or the manufacture or shipment of our products, our business, operating results and financial condition could be materially and adversely affected.

Some of our customers may not have the resources to pay for our products or to order our products as a result of unfavorable economic conditions

     With an economic slowdown, some of our customers may experience, serious cash flow problems, and may find it difficult to obtain financing on attractive terms, if at all. As a result, some of these customers may not be able to pay, or may delay payment for, the amounts that they owe us. Furthermore, they may not order as many products from us as originally forecasted or any products at all. The inability of our customers to pay us or to timely pay us for our products will adversely affect our cash flow and the timing of our revenue recognition and harm our results of operation. The failure of our customers to order product will also result in decreased revenues. In addition, customer bankruptcies could cause us to incur financial losses. In 2003, three customers filed complaints against us in United States bankruptcy courts in connection with alleged preferential payments to us prior to their bankruptcy filings. Two of the complaints have been settled and the third is expected to be resolved without materially affecting our results of operations.

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As our customers consolidate, they may reduce purchases of our products and demand more favorable terms and conditions from us, which would harm our revenues and profitability

     Consolidation of our customers could reduce the number of customers to whom our products could be sold. These merged customers could obtain products from a source other than us or demand more favorable terms and conditions from us, which would harm our revenues and profitability. In addition, our network equipment manufacturer customers may merge with or acquire our competitors and discontinue their relationships with us.

Acquisitions undertaken and any that we may undertake could be difficult to integrate, disrupt our business, dilute shareholder value and significantly harm our operating results

     Acquisitions are inherently risky and no assurance can be given that our previous or future acquisitions will be successful or will not materially and adversely affect our business, operating results or financial condition. We expect to continue to review opportunities to acquire other businesses or technologies that would complement our current products, expand the breadth of our markets, enhance our technical capabilities or otherwise offer growth opportunities. While we have no current agreements, we may acquire additional businesses, products or technologies in the future. If we make any further acquisitions, we could issue stock that would dilute existing shareholders’ percentage ownership, incur substantial debt or assume contingent liabilities. We have limited experience in acquiring other businesses and technologies. Acquisitions involve numerous risks, including the following:

•		problems assimilating the acquired operations, technologies or products;
•		unanticipated costs associated with the acquisition;
•		diversion of management’s attention from our core business;
•		adverse effects on existing business relationships with suppliers, contract manufacturers, customers and industry experts;
•		risks associated with entering markets in which we have no or limited prior experience; and
•		potential loss of the acquired organization’s or our own key employees.

     Impairment charges of $1.7 million in 2002 and $410,000 in 2003 relating to the October 2001 acquisition of Caimis, Inc. Charges recorded in 2002 resulted from the decline in business conditions in 2002 and our restructuring of our resources to focus on other higher-growth opportunities. In 2003, the continued lack of customer interest in these products resulted in the write-off of the remaining Caimis investment. We cannot assure you that we would be successful in overcoming problems in connection with our past or future acquisitions, and our inability to do so could significantly harm our assets acquired in such acquisitions, revenues and results of operations.

If we are unable to expand our sales and distribution channels or are unable to successfully manage our expanded sales organization, our revenues and results of operations will be harmed

     Historically, we have relied primarily on a limited direct sales organization, supported by third-party manufacturers’ representatives and distributors, to sell our products. Our distribution strategy focuses primarily on developing and expanding our direct sales organization and our network of manufacturers’ representatives and distributors. We may not be able to successfully expand our sales and distribution channels, and the cost of any expansion may exceed the revenues that we generate. To the extent that we are successful in expanding our sales and distribution channels, we cannot assure you that we will be able to compete successfully against the significantly larger and better-funded sales and marketing operations of many of our current or potential competitors. We have granted exclusive rights to substantially all of our distributors and manufacturers’ representatives to market our products in their specified territories. Our distributors and manufacturers’ representatives may not market our products effectively or devote the resources necessary to provide us with effective sales, marketing and technical

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support. Our inability to effectively manage the expansion of our sales and support staff, or to maintain existing or establish new relationships with successful manufacturers’ representatives and distributors, would harm our revenues and results of operations.

If we are unable to expand our international sales and distribution channels or manage them effectively, our results of operations would be harmed

     Historically, a significant portion of our sales have been made to customers in the United States. Sales in the United States accounted for 69.7% of our net revenues in 2003, 78.8% of our net revenues in 2002 and 82.8% of our net revenues in 2001. In the past, we have depended on distributors for the substantial majority of our international sales. In 2002, two of our distributors entered bankruptcy and were therefore terminated as distributors of our products. These terminations and additional future losses of one or more of our international distributors or their failure to sell our products would limit our ability to sustain and grow our revenues in international markets. In October 2002, we established a Japanese subsidiary in Tokyo, Japan. We intend to expand into additional international markets, including in Europe and in the Asia Pacific region, by adding distributors and international sales and support personnel. Our failure in these efforts could significantly harm our results of operations and decrease the value of our stock. We only have limited international sales experience and believe that the growth of our sales outside of the United States will be subject to a number of additional risks and uncertainties, including:

•		adoption of different local technical and regulatory standards;
•		the need to maintain and establish new relationships with distributors and the sales performance of these distributors, who may not be as effective or loyal as our employees;
•		the costs and complexity of staffing and managing more widely dispersed foreign sales activities, including the ability to identify, attract and retain qualified managers and sales personnel, overcoming cultural, linguistic and nationalistic barriers and adapting to foreign business practices;
•		longer payment cycles of foreign customers compared with customers in the United States;
•		seasonal reductions in business activities in some parts of the world, such as during the summer months in Europe;
•		legal uncertainties regarding liability, export and import restrictions, tariffs and other trade barriers;
•		potential political and economic instability; and
•		inadequate protection of intellectual property in some countries.

     Any of these factors could significantly harm our international sales or significantly impair our ability to expand into international markets.

     Our international sales, with the exception of Japan, currently are largely denominated in U.S. dollars. As a result, an increase in the value of the U.S. dollar relative to foreign currencies could increase the real cost of our products to our customers in international markets.

Changes in laws, regulations and financial accounting standards may affect our reported results of operations

     A change in accounting policies can have a significant effect on our reported results. New pronouncements and varying interpretations of pronouncements have occurred in the past and are likely to occur in the future as a result of recent Congressional and regulatory actions. New laws, regulations and accounting standards, as well as the questioning of, or changes to, currently accepted accounting practices in the technology industry may adversely affect our reported financial results, which could have an adverse effect on our stock price.

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     In particular, if we are required to record compensation expense associated with stock option grants on our income statement, our profitability will be reduced significantly. The current methodology for expensing such stock options is based on, among other things, the historical volatility of the underlying stock. Our stock price has been historically volatile. Therefore, the adoption of an accounting standard requiring companies to expense stock options would negatively impact our profitability and may adversely impact our stock price. In addition, the adoption of such a standard could limit our ability to continue to use stock options as an incentive and retention tool, which could, in turn, hurt our ability to recruit and retain employees.

     Additionally, the recently enacted Sarbanes-Oxley Act of 2002 and related regulations may result in changes in accounting standards or accepted practices within our industry and may adversely impact our stock price.

Some key components in our products come from sole or limited sources of supply, which exposes us to potential supply shortages that could disrupt the manufacture and sale of our products

     We and our contract manufacturers currently purchase a number of key components used to manufacture our products from sole or limited sources of supply for which alternative sources may not be available. From time to time, we have experienced shortages of key components, including chips, oscillators and optical modules. We and our contract manufacturers have no guaranteed or long-term supply arrangements for these or other components, including field programmable gate arrays, or FPGAs, which are integrated circuits that can be repeatedly reprogrammed to perform different sets of functions as required. Financial or other difficulties faced by our suppliers or significant changes in market demand for necessary components could limit the availability to us and our contract manufacturers of these components. Any interruption or delay in the supply of any of these components could significantly harm our ability to meet scheduled product deliveries to our customers and cause us to lose sales.

     In addition, the purchase of these components on a sole source basis subjects us to risks of price increases and potential quality assurance problems. Consolidation involving suppliers could further reduce the number of alternatives available to us and affect the cost of components. An increase in the cost of components could make our products less competitive and result in lower margins.

     There are limited substitute supplies available for many of these components, including field programmable gate arrays. All of these components are critical to the production of our products, and competition exists with other manufacturers for these key components. In the event that we can no longer obtain materials from a sole source supplier, we might not be able to qualify or identify alternative suppliers in a timely fashion, or at all.

If we fail to accurately forecast our manufacturing requirements, we could incur additional costs and experience manufacturing delays

     We provide our contract manufacturers with rolling forecasts based on anticipated product orders to determine our manufacturing requirements. Some of the components used in our products have significant lead times or lead times which may unexpectedly increase depending on factors such as the specific supplier, contract terms and the demand for components at a given time. Because of these long lead times, we are often required to forecast and order products before we know what our specific manufacturing requirements will be. If we overestimate our product orders, our contract manufacturers may have excess inventory of completed products which we would be obligated to purchase. This will lead to increased costs and the risk of obsolescence. If we underestimate our product orders, our contract manufacturers may have inadequate inventory, which could result in delays in shipments, the loss or deferral of revenues and higher costs of sales. It may also add costs to our products to expedite delivery of our products to customers or those components with long lead times to our contract manufacturers. We cannot assure you that we will be able to accurately forecast our product orders and may in the future carry excess or obsolete inventory, be unable to fulfill customer demand, or both, thereby harming our revenues, results of operations and customer relationships.

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Failure by our contract manufacturers to provide us with adequate supplies of high-quality products could harm our revenues, results of operations, competitive position and reputation

     We currently rely on a limited number of contract manufacturers to manufacture and assemble our products. We may experience delays in receiving product shipments from contract manufacturers or other problems, such as inferior quality and insufficient quantity of product. We cannot assure you that we will be able to effectively manage our contract manufacturers or that these manufacturers will meet our future requirements for timely delivery of products of sufficient quality and quantity. We intend to introduce new products and product enhancements, which will require that we rapidly achieve volume production by effectively coordinating with our suppliers and contract manufacturers. We do not have any long-term contracts with our contract manufacturers. The inability of our contract manufacturers to provide us with adequate supplies of high-quality products or the loss of any of our contract manufacturers would cause a delay in our ability to fulfill customer orders while we obtain a replacement manufacturer and would harm our revenues, results of operations, competitive position and reputation.

     We may not be able to expand our contract manufacturing capacity or our internal testing or quality assurance functions as required to keep up with demand for our products. Any such failure would in turn hinder our growth. If we do not expand these capacities and functions effectively or in a timely manner, we may experience disruptions in product flow which could limit our revenues, adversely affect our competitive position and reputation and result in additional cost, cancellation of orders or both.

Because of intense competition for technical personnel, we may not be able to recruit or retain necessary personnel on a cost-effective basis

     Our success will depend in large part upon our ability to identify, hire, retain and motivate highly skilled employees. We plan to increase the number of our research and development, marketing, sales, customer support and operations employees. In spite of the economic slowdown, competition for highly skilled employees in our industry is intense. In addition, employees may leave our company and subsequently compete against us. Our failure to attract and retain these qualified employees could significantly harm our ability to develop new products and maintain customer relationships. Volatility or lack of positive performance in our stock price may also adversely affect our ability to attract and retain highly skilled employees who may look to stock options as a key component of their compensation. The loss of the services of any of our qualified employees, the inability to attract or retain qualified personnel in the future or delays in hiring required personnel could hinder the development and introduction of new and enhanced products and harm our ability to sell our products. Moreover, companies in our industry whose employees accept positions with competitors frequently claim that those competitors have engaged in unfair hiring practices. We may be subject to such claims as we seek to retain or hire qualified personnel, some of whom may currently be working for our competitors. Some of these claims may result in material litigation. We could incur substantial costs in defending ourselves against these claims, regardless of their merits. Such claims could also discourage potential employees who currently work for our competitors from joining us.

The loss of any of our key personnel could significantly harm our results of operations and competitive position

     Our success depends to a significant degree upon the continuing contributions of our key management, technical, marketing and sales employees. There can be no assurance that we will be successful in retaining our key employees or that we can attract or retain additional skilled personnel as required. Failure to retain key personnel could significantly harm our results of operations and competitive position.

Continued rapid growth will strain our operations and require us to incur costs to maintain and upgrade our management and operational resources

     We have experienced and are continuing to experience a period of growth. Unless we manage our growth effectively, we may have difficulty in operating our business. As a result, we may inaccurately forecast sales and materials requirements, fail to integrate new personnel or fail to maintain adequate internal controls, which may result in fluctuations in our operating results and cause the price of our stock to decline. We plan to continue to

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expand our operations which may place a significant strain on our management and operational resources. In order to manage our growth effectively, we must implement and improve our operational systems, procedures and controls on a timely basis. If we cannot manage growth effectively, our profitability could be significantly harmed.

Our products may contain defects which may cause us to incur significant costs, divert our attention from product development efforts and result in a loss of customers

     Our existing products and any new or enhanced products we introduce may contain undetected software or hardware defects when they are first introduced or as new versions are released. These problems may cause us to incur significant damages or warranty and repair costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relation problems or loss of customers and reputation, all of which would harm our results of operations. A successful claim against us for an amount exceeding the limit on our product liability insurance policy would force us to use our own resources, to the extent available, to pay the claim, which could result in an increase in our expenses and a reduction of our working capital available for other uses, thereby harming our profitability and capital resources.

Our failure to protect our intellectual property may significantly harm our results of operations and reputation

     Our success and ability to compete is dependent in part on our ability to protect and maintain our proprietary rights to our intellectual property. We currently rely on a combination of trade secret, trademark and copyright laws to establish and protect our intellectual property. We also expect to rely on patents to protect some of our proprietary technology. To date, we have relied primarily on trade secret laws to protect our proprietary processes and know-how. Although we have filed applications for four U.S. patents, we cannot assure you that any of these applications will issue into patents or that, if issued, the patents will be upheld. We also cannot assure you that such patents, if issued, will be effective in protecting our proprietary technology.

     We generally enter into confidentiality agreements with our officers, employees and consultants. We also generally limit access to and distribution of our source code and further limit the disclosure and use of our other proprietary information. However, these measures provide only limited protection of our intellectual property rights. In addition, we may not have signed agreements containing adequate protective provisions in every case, and the contractual provisions that are in place may not provide us with adequate protection in all circumstances. Further, we have not included copyright notices on all of our copyrightable intellectual property. Any infringement of our proprietary rights could result in significant litigation costs, and any failure to adequately protect our proprietary rights could result in our competitors offering similar products, potentially resulting in loss of one or more competitive advantages and decreased revenues.

     Despite our efforts to protect our proprietary rights, existing trade secret, copyright, patent and trademark laws afford us only limited protection. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States. Others may attempt to copy or reverse engineer aspects of our products or to obtain and use information that we regard as proprietary. Accordingly, we may not be able to prevent misappropriation of our technologies or to deter others from developing similar technologies. Further, monitoring the unauthorized use of our products and our proprietary rights is difficult. Litigation may be necessary to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. Litigation of this type could result in substantial costs and diversion of resources and could significantly harm our results of operations and reputation.

Claims that we infringe third-party intellectual property rights could result in significant expenses or restrictions on our ability to sell our products

     From time to time, other parties may assert patent, copyright, trademark and other intellectual property rights to technologies and in various jurisdictions that are important to our business. We cannot provide assurance that others will not claim that we are infringing their intellectual property rights or that we do not in fact infringe those intellectual property rights. We have not conducted a search to determine whether the technology we have in

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our products infringes or misappropriates intellectual property held by third parties. In addition, because patent applications in the United States are not publicly disclosed until the patent is issued, applications may have been filed which could relate to our products.

     Any claims asserting that our products infringe or may infringe proprietary rights of third parties, if determined adversely to us, could significantly harm our results of operations. Any claims, with or without merit, could:

	•		be time-consuming;
	•		result in costly litigation;
	•		divert the efforts of our technical and management personnel;
	•		require us to develop alternative technology, thereby causing product shipment delays and the loss or deferral of revenues;
	•		require us to cease selling the products containing the infringing intellectual property;
	•		require us to pay substantial damage awards;
	•		damage our reputation; or
	•		require us to enter into royalty or licensing agreements which, if required, may not be available on terms acceptable to us, if at all.

     In the event a claim against us were successful and we could not obtain a license to the relevant technology on acceptable terms or license a substitute technology or redesign our products to avoid infringement, our revenues, results of operations and competitive position would be harmed.

If we fail to maintain our relationships with industry experts, our products may lose industry and market recognition and sales could decline

     Our relationships with industry experts in the field of performance analysis and measurement of networks and network equipment are critical for maintaining our industry credibility and for developing new products and testing methodologies in a timely fashion. These experts have established standard testing methodologies that evaluate new network equipment products and technologies. We provide these experts and their testing labs with our products and engineering assistance to perform tests on these new network equipment products and technologies. These industry experts refer to our products in their publications which has given our products industry recognition. In addition, these labs offer us the opportunity to test our products on the newest network equipment and technologies, thereby assisting us in developing new products that are designed to meet evolving technological needs. We cannot assure you that we will be able to maintain our relationships with industry experts or that our competitors will not obtain similar or superior relationships with industry experts. If we are unable to maintain our relationships with industry experts, our products may lose industry and market recognition which could harm our reputation and competitive position and cause our sales to decline.

Our headquarters, many of our customers and some of our contract manufacturers and suppliers are located in California where natural disasters may occur

     Currently, our corporate headquarters, many of our customers and some of our contract manufacturers and suppliers are located in California. California historically has been vulnerable to natural disasters and other risks, such as earthquakes, fires and floods, which at times have disrupted the local economy and posed physical risks to our property. We and some of our customers, contract manufacturers and suppliers do not have redundant, multiple

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site capacity. In the event of a natural disaster, our ability to conduct business could be significantly disrupted, thereby harming our results of operations.

Provisions of our articles of incorporation, bylaws and an agreement with our principal shareholder may make it difficult for a third party to acquire us, despite the possible benefits to our shareholders

     Our board of directors has the authority to issue up to one million shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the shareholders. The rights of the holders of our common stock are subject to, and may be adversely affected by, the rights of the holders of any preferred stock that we may issue. The issuance of preferred stock could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. Furthermore, some provisions of our articles of incorporation and bylaws could delay or make more difficult a merger, tender offer or proxy contest involving us.

     Technology Capital Group S.A., our principal shareholder, has agreed that for a period of three years beyond October 2001 or until any earlier time that it owns less than 25% of the outstanding shares of our common stock, it will provide us with at least 30 days advance notice before agreeing to a sale or other disposition of one percent or more of our outstanding shares in a private transaction. This notice requirement may delay a third party’s acquisition of the shares of our common stock held by Technology Capital Group and also provide us with an opportunity to propose other buyers for the shares who may be more acceptable to us, to propose to repurchase the shares proposed to be sold or to propose to register the shares for sale in an underwritten public offering. This notice requirement may also discourage third parties from attempting to acquire the shares of our common stock held by Technology Capital Group during that period.

     These provisions of our articles of incorporation and bylaws and this agreement may have the effect of delaying, deferring or preventing a change in our control despite possible benefits to our shareholders, may discourage bids at a premium over the market price of our common stock and may harm the market price of our common stock and the voting and other rights of our shareholders.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Sensitivity

     The primary objective of our investment activities is to maintain the safety of principal and preserve liquidity while maximizing yields without significantly increasing risk. Some of the securities that we have invested in may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. To minimize this risk, we maintain our portfolio of cash equivalents and investments in a variety of securities, including commercial paper, government debt securities, corporate debt securities and money market funds. We do not use any derivatives or similar instruments to manage our interest rate risk. We have the positive intent and ability to hold these securities to maturity. Currently, the carrying amount of these securities approximates fair market value. However, the fair market value of these securities is subject to interest rate risk and would decline in value if market interest rates increased. If market interest rates were to increase immediately and uniformly by 100 percent from the levels as of December 31, 2003, the decline in the fair market value of the portfolio would not be material to our financial position, results of operations or cash flows.

Exchange Rate Sensitivity

     The majority of our revenue and expenses are denominated in U.S. dollars. However, since we have sales and service operations outside of the United States, we do have some transactions that are denominated in foreign currencies, primarily the Japanese Yen and British Pound. As a result, our financial results could be affected by changes in foreign currency exchange rates. We have not engaged in foreign currency hedging to date, but we may do so in the future to decrease fluctuations in operating results due to changes in foreign currency exchange rates.

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Item 8. Financial Statements and Supplementary Data

     Our financial statements and supplementary data required by this Item are provided in the consolidated financial statements of the Company included in this Annual Report on Form 10-K as listed in Item 15(a) of this Annual Report on Form 10-K.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     None

Item 9A. Controls and Procedures

     (a) Evaluation of Disclosure Controls and Procedures

     As required by Rule 13a-15(b) under the Exchange Act, we have carried out an evaluation, under the supervision and with the participation of the Company’s management, including our President and Chief Executive Officer and our Chief Financial Officer, of the effectiveness, as of the end of the period covered by this report, of the design and operation of our “disclosure controls and procedures” as defined in Rule 13a-14 promulgated by the SEC under the Exchange Act. Based upon that evaluation, our President and Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures, as of the end of such period, were adequate and effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms.

     (b) Changes in Internal Controls over Financial Reporting

     There was no change in our internal controls over financial reporting that occurred during our fiscal quarter ended December 31, 2003 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART III

Item 10. Directors and Executive Officers of the Registrant

     Certain information required by this Item is incorporated herein by reference to information appearing in our definitive Proxy Statement for our Annual Meeting of Shareholders to be held on May 13, 2004, which information appears under the captions entitled “Election of Directors,” “Executive Officers” and “Section 16(a) Beneficial Ownership Reporting Compliance.” The Proxy Statement will be filed with the Commission within 120 days after the date of our last fiscal year-end which was December 31, 2003.

     The Registrant has adopted a Code of Ethics for its Chief Executive and Senior Financial Officers, a copy of which is filed as Exhibit 14.1 to this Annual Report on Form 10-K.

Item 11. Executive Compensation

     The information required by this Item is incorporated herein by reference to information appearing in our definitive Proxy Statement for our Annual Meeting of Shareholders to be held on May 13, 2004, which information appears under the captions “Election of Directors — Compensation of Directors,” “Executive Compensation and Other Information,” “Board of Directors and Compensation Committee Reports on Executive Compensation” and “Performance Graph.” The Proxy Statement will be filed with the Commission within 120 days after the date of our last fiscal year-end which was December 31, 2003.

37

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

     The information required by this Item is incorporated herein by reference to information appearing in our definitive Proxy Statement for our Annual Meeting of Shareholders to be held on May 13, 2004, which information appears under the captions “Common Stock Ownership of Principal Shareholders and Management” and “Equity Compensation Plan Information.” The Proxy Statement will be filed with the Commission within 120 days after the date of our last fiscal year-end which was December 31, 2003.

Item 13. Certain Relationships and Related Transactions

     The information required by this Item is incorporated herein by reference to information appearing in our definitive Proxy Statement for our Annual Meeting of Shareholders to be held on May 13, 2004, which information appears under the caption “Certain Relationships and Related Transactions.” The Proxy Statement will be filed with the Commission within 120 days after our last fiscal year-end which was December 31, 2003.

Item 14. Principal Accounting Fees and Services

     The information required by this Item is incorporated herein by reference to information appearing in our definitive Proxy Statement for our Annual Meeting of Shareholders to be held on May 13, 2004, which information appears under the caption “Principal Accountant Fees and Services.” The Proxy Statement will be filed with the Commission within 120 days after our last fiscal year-end which was December 31, 2003.

PART IV

Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

(a) The following documents are filed as part of this Report:

	(1)		Consolidated Financial Statements
			The consolidated financial statements listed in the accompanying Index to Consolidated Financial Statements are filed as part of this report.
	(2)		Financial Statement Schedule
			The financial statement schedule listed in Schedule II is filed as part of this report.

     Schedules which are not listed above have been omitted because they are not applicable or the information required to be set forth therein is included in the consolidated financial statements or notes thereto.

(3)

Exhibits

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39

(b)		Reports on Form 8-K
		Ixia filed a Current Report on Form 8-K with the Securities and Exchange Commission on October 16, 2003 with respect to its issuance of a press release announcing Ixia’s financial results for the fiscal quarter ended September 30, 2003 (furnished under Items 7 and 12 of Form 8-K).
(c)		Exhibits
		See the list of Exhibits under Item 15(a)(3) of this Annual Report on Form 10-K.
(d)		Financial Statement Schedules
		See the Schedule under Item 15(a)(2) of this Annual Report on Form 10-K.

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Report of Independent Auditors on
Financial Statement Schedule

To the Board of Directors and Shareholders of Ixia:

Our audits of the consolidated financial statements of Ixia and its subsidiaries referred to in our report dated January 28, 2004, except for the subsequent event described in Note 12 to the financial statements, as to which the date is February 20, 2004, included in this Annual Report on Form 10-K, also included an audit of the financial statement schedule listed in Item 15 of this Form 10-K. In our opinion, the financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.

/s/ PricewaterhouseCoopers LLP

Los Angeles, California
January 28, 2004

41

IXIA
SCHEDULE II – VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 2003, 2002 and 2001
(in thousands)

42

SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

     Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

43

IXIA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

44

Report of Independent Auditors

To the Board of Directors and Shareholders of Ixia:

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, shareholders’ equity and cash flows present fairly, in all material respects, the financial position of Ixia and its subsidiaries at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As described in Note 5 to the consolidated financial statements, the Company changed the manner in which it accounts for long-lived assets, goodwill and other intangible assets as of January 1, 2002.

/s/ PricewaterhouseCoopers LLP

Los Angeles, California
January 28, 2004, except for the subsequent event described in Note 12,
      as to which the date is February 20, 2004

45

IXIA
Consolidated Balance Sheets
(in thousands)

The accompanying notes are an integral part of these consolidated financial statements

46

IXIA
Consolidated Statements of Income
(in thousands, except per share data)

The accompanying notes are an integral part of these consolidated financial statements

47

IXIA
Consolidated Statements of Shareholders’ Equity
(in thousands)

The accompanying notes are an integral part of these consolidated financial statements

48

IXIA
Consolidated Statements of Cash Flows
(in thousands)