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 three and nine months ended September 30, 2009 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2009, or for any other future period. The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in Item 1 of this Quarterly Report and in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2008 ("2008 Form 10-K"), including the "Risk Factors" section and the consolidated financial statements and notes included therein.
OVERVIEW
We were incorporated on May 27, 1997 as a California corporation. We are a leading provider of converged test systems and services for wireless and wired infrastructures and services. Our hardware and software allow our customers to test and measure the performance, functionality, service quality and conformance of wireless and wired Internet Protocol (IP) equipment and networks, and the applications that run over them. Our solutions generate, capture, characterize and analyze high volumes of realistic network and application traffic, identifying problems, assessing performance, ensuring functionality and interoperability, and verifying conformance to industry specifications. We offer hardware platforms with interchangeable media interfaces, utilizing a common set of applications and Application Programming Interfaces (APIs) that allow our customers to create integrated, easy-to-use automated test environments. The networks that our systems analyze primarily include Ethernet networks operating at speeds of up to 100 gigabits per second and wireless networks that carry data traffic over optical fiber, electrical cable and airwaves. We also offer hardware platforms and equipment that test wireless equipment, especially those associated with 3G (third generation) and 4G (fourth generation or Long-Term Evolution (LTE)) networks. Customers also use our suite of software applications to test and verify web, Internet, security and business applications.
Acquisition of Catapult Communications Corporation. On June 23, 2009, we completed our acquisition of all of the outstanding shares of common stock of Catapult Communications Corporation ("Catapult"). Catapult provides advanced wireless test systems to network equipment manufacturers and service providers worldwide. Catapult's 3G and 4G wireless networking test solutions complement our IP performance test systems and service verification platforms. With this acquisition, we will be able to broaden our product portfolio and provide a single source solution for testing converged multiplay IP services over wireless and wireline networks to new and existing customers. The purchase price for Catapult totaled $106.6 million, or $65.4 million net of Catapult's existing cash and investments. The Catapult acquisition was funded from our existing cash and cash equivalents. The results of operations of Catapult have been included in the condensed consolidated statements of income and cash flows since the date of the acquisition.
Acquisition of Agilent Technologies' N2X Data Network Testing Product Line. On October 30, 2009, we completed our acquisition from Agilent Technologies, Inc. ("Agilent") of its N2X Data Network Testing Product Line business ("N2X Business") for $44.1 million in cash, subject to a post-closing working capital adjustment, and the assumption of certain liabilities of the N2X Business. In return for the consideration paid, we acquired certain assets and liabilities of Agilent's N2X Business, including inventory, accounts receivables, fixed assets, accounts payable, customer relationships, certain intellectual property rights, and other assets required to run the business. The N2X Business provides network equipment manufacturers and service providers with solutions to validate the performance and scalability characteristics of next-generation network equipment for voice, video and data (multiplay) services. The acquisition was funded from our existing cash and investments. In the fourth quarter of 2009, the result of operations of the N2X Business acquisition will be included in our consolidated statements of income and cash flows from the date of acquisition, which we expect will result in a significant increase in revenues, cost of goods sold and operating expenses.
Revenues. Our revenues are principally derived from the sale and support of our test systems. Product revenues primarily consist of sales of our hardware and software products. Our service revenues primarily consist of the provision of post contract customer support and maintenance ("PCS") related to the initial period provided with the product purchase (generally for 90-day or 12-month periods) and separately purchased extended PCS

contracts, and to our implied PCS obligations. Service revenues also include separately purchased extended hardware warranty support for certain of our products, training and other professional services. PCS on our software products includes unspecified software upgrades and customer technical support services. Our hardware products primarily consist of chassis and interface cards, and during the three years ended September 30, 2009, our Ethernet interface cards have represented the majority of our revenues. In general, our Ethernet interface cards are used to test equipment and advanced IP services in the core and at the edge of the Internet and in enterprise applications. Looking forward, we expect that the sale of our Ethernet interface cards will continue to represent a significant portion of our revenues. We have also seen year-over-year declines in our overall revenues over the past several quarters, due in part to the global business environment and our customers' constraints in their capital expenditure and operating budgets. These factors also limit our ability to accurately forecast the future demand and revenue trends for our products and services.
Sales to our largest customer, Cisco Systems, accounted for approximately $6.4 million, or 13.7%, and $20.3 million, or 16.7%, of our total revenues for the three and nine months ended September 30, 2009, respectively, and $9.2 million, or 19.5%, and $29.0 million, or 21.5%, of our total revenues for the three and nine months ended September 30, 2008, respectively. To date, we have sold the majority of our products to network equipment manufacturers. While we expect that we will continue to have customer concentration for the foreseeable future, we continue to sell our products to a wider variety and increasing number of customers. To the extent that we continue to develop a broader and more diverse customer base, our reliance on any one customer or customer type should diminish. From a geographic perspective, we generate a majority of our revenues from product shipments to customer locations within the United States. We generated revenues from product shipments to international locations of $19.1 million, or 41.3%, and $49.3 million, or 40.5%, of our total revenues for the three and nine months ended September 30, 2009, respectively, and $16.6 million, or 35.1%, and $47.4 million, or 35.2%, of our total revenues for the three and nine months ended September 30, 2008, respectively. We intend to continue increasing our sales efforts internationally with specific focus on Europe and the Asia Pacific regions. Looking forward, and given the recent acquisitions of Catapult and the N2X Business, we expect our international revenues to continue to grow on an annualized basis as a percentage of our total revenues.
In some instances our software products may be installed and operated independently from our hardware products. At other times, our software products are installed on and work with our hardware products to enhance the functionality of the overall test system. As our software is generally more than incidental to the sale of our test systems, we recognize revenue by applying software revenue recognition guidance.
Our test systems are generally fully functional at the time of shipment and do not require us to perform any significant production, modification, customization or installation after shipment. As such, revenue from hardware and software product sales is recognized upon shipment provided that (i) an arrangement exists, which is typically in the form of a customer purchase order;
(ii) delivery has occurred (i.e., transfer of title (as applicable) and risk of loss to the customer); (iii) the sales price is fixed or determinable; and
(iv) collectibility is deemed probable. When a sale involves multiple elements, or multiple products, and we have vendor-specific objective evidence ("VSOE") of fair value for each element in the arrangement, we recognize revenue based on the relative fair value of all elements within the arrangement. We determine VSOE based on sales prices charged to customers when the same element is sold separately or based upon stated PCS renewal rates for certain arrangements. Many of our products, such as our software products, typically include an initial period (generally 90-day or 12-month periods) of free PCS, which is not sold separately. Accordingly, we are unable to establish VSOE for these products. In cases where VSOE only exists for the undelivered elements such as PCS, we apply the residual method to recognize revenue. Under the residual method, a portion of the total arrangement fee is allocated first to the undelivered elements, typically PCS, based on their VSOE, and the residual portion of the fee is allocated to the delivered elements, typically our hardware and software products, and is recognized as revenue assuming all other revenue recognition criteria as described above have been met. If VSOE cannot be determined for all undelivered elements of an arrangement, we defer revenue until the earlier of (i) the delivery of all elements or
(ii) the establishment of VSOE for all undelivered elements, provided that if the only undelivered element is PCS or a service, the total arrangement fee is recognized as revenue over the PCS or service term.

Services revenues from our initial and separately purchased extended contractual PCS arrangements (generally offered for 12-month periods) are recognized ratably over the contractual coverage period. In addition, for implied PCS obligations we defer revenues from product sales and allocate these amounts to PCS revenues to account for the circumstances in which we provide PCS after the expiration of the customer's contractual PCS period. Deferred revenues for these implied PCS obligations are recognized ratably over the implied PCS period, which is typically based on the expected economic life of our software products of four years. To the extent we determine that implied PCS is no longer being provided after the expiration of the customer's contractual PCS period, the remaining deferred revenue balance related to the implied PCS obligation is reversed and recognized as revenue in the period of cessation of the implied PCS obligation. The implied PCS obligation for our software products ceases upon
(i) the license management of our software upgrades and (ii) our determination not to provide PCS after the expiration of the contractual PCS period. Our implied PCS obligation also ceases for products that are not license managed provided we have discontinued development, sales activities and support for those specific products. Our license management system locks a software license to a specific computer or Ixia hardware product on which our software resides. The system then manages and controls the provision of software upgrades to ensure that the upgrades are only provided to customers that are entitled to receive such upgrades during an initial or extended PCS period. For software products that are not controlled under a license management system and for certain customers where we provide implied PCS outside of the contractual PCS period, we allocate and defer revenue for these implied PCS obligations and recognize this revenue ratably over the implied PCS periods as described above. For the three months ended September 30, 2009 and 2008, services revenues related to our implied PCS obligations approximated $923,000 and at $1.0 million, respectively. For the nine months ended September 30, 2009 and 2008, services revenues related to our implied PCS obligations approximated $3.0 million and $3.1 million, respectively. For the three and nine months ended September 30, 2009, $0 and $576,000, respectively, of deferred revenue relating to implied PCS was reversed and recognized as product revenues as a result of a certain product that is no longer developed, sold or supported. There were no such reversals for the three and nine months ended September 30, 2008. Future reversals of implied PCS deferred revenue may occur over the next 12 months as a result of the future license management of additional products and our determination not to provide PCS to certain customers after the expiration of the contractual PCS period. Revenues from our separately purchased extended hardware warranty arrangements are recognized ratably over the contractual coverage period. We recognize revenues from training and other professional services at the time the services are provided or completed, as applicable. We use distributors to complement our direct sales and marketing efforts in certain international markets. Due to the broad range of features and options available with our hardware and software products, distributors generally do not stock our products and typically place orders with us after receiving an order from an end customer. These distributors receive business terms of sale generally similar to those received by our other customers. Stock-Based Compensation. Share-based payments, including grants of stock options, restricted stock units and employee stock purchase rights, are recognized in the financial statements based on the estimated fair values for accounting purposes on the grant date. The estimated fair value for accounting purposes of each share-based award is estimated on the date of grant using an option pricing model that meets certain requirements. We use the Black-Scholes option pricing model to estimate the fair value for accounting purposes of our share-based awards. The determination of the fair value for accounting purposes of share-based awards using the Black-Scholes model is affected by our stock price and a number of assumptions, including expected volatility, expected life and risk-free interest rate. The expected life and expected volatility of a share-based award are based on historical and other data trended into the future. The risk-free interest rate assumption is based on observed interest rates appropriate for the terms of our share-based awards. Stock-based compensation expense recognized in our consolidated financial statements is based on awards that are ultimately expected to vest. The amount of stock-based compensation expense is reduced for estimated forfeitures based on historical experience as well as future expectations. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if estimated and actual forfeitures differ from these initial estimates. We evaluate the assumptions used to value share-based awards on a periodic basis. If factors change and we employ different assumptions, stock-based compensation expense may differ significantly from what we have recorded in the past. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Consistent with our past practice, we attribute the value of stock-based compensation to expense based on the graded, or accelerated multiple-option, approach.

For the three and nine months ended September 30, 2009, stock-based compensation expense was $1.6 million and $8.0 million, respectively. Stock-based compensation for the three and nine months ended September 30, 2008 was $2.4 million and $7.7 million, respectively. The aggregate balance of gross unearned stock-based compensation to be expensed in the remainder of 2009 and through 2013 related to unvested share-based awards as of September 30, 2009 was approximately $9.9 million. In October 2009, we granted annual share-based awards to our employees which increased our aggregate balance of gross unearned stock-based compensation by an estimated $8.6 million. To the extent that we grant additional share-based awards, future expense may increase by the additional unearned compensation resulting from those grants. We anticipate that we will continue to grant additional share-based awards in the future as part of our long-term incentive compensation programs. The impact of future grants cannot be estimated at this time because it will depend on a number of factors, including the amount of share-based awards granted and the then current fair values of such awards for accounting purposes.
Cost of Revenues. Our cost of revenues related to the sale of our hardware and software products includes materials, payments to third party contract manufacturers, royalties, and salaries and other expenses related to our manufacturing, operations, technical support and professional service personnel. We outsource the majority of our manufacturing operations, and we conduct supply chain management, quality assurance, documentation control, shipping and some final assembly at our facilities in Calabasas, California and Mountain View, California. Accordingly, a significant portion of our cost of revenues related to our products consists of payments to our contract manufacturers.
In January 2009, we entered into an agreement with Plexus Services Corp ("Plexus"), a major electronic manufacturing services company, to improve our manufacturing process and supply chain management. The term of the agreement is five years, and the agreement provides for Plexus to manufacture and manage our supply chain for many of our chassis and interface cards. In February 2009, we began transitioning some of our manufactured products to Plexus, and expect to fully transition all of our high volume manufactured products to Plexus by the end of 2009. We are currently evaluating the manufacturing process and supply chain related to our acquisitions.
Cost of revenues related to the provision of services includes salaries and other expenses associated with customer and technical support services, professional services and the warranty cost of hardware that is replaced or repaired during the warranty coverage period. Cost of revenues does not include an allocation of the amortization of intangible assets related to our acquisitions of certain businesses, product lines and technologies, which are discussed below and included on a separate line item within our consolidated statements of income.
Our cost of revenues as a percentage of total revenues is primarily affected by the following factors:
• our pricing policies and those of our competitors;

• the pricing we are able to obtain from our component suppliers and contract manufacturers;

• the mix of customers and sales channels through which our products are sold;

• the mix of our products sold, such as the mix of software versus hardware product sales;

• new product introductions by us and by our competitors;

• demand for our products; and

• production volume.

In the near term, although we anticipate that our cost of revenues as a percentage of total revenues will remain relatively flat, we expect to continue to experience pricing pressure on larger transactions and from larger customers as a result of competition and the current global business environment.

Operating Expenses. Our operating expenses are generally recognized when incurred and consist primarily of research and development, sales and marketing and general and administrative expenses. For the remainder of 2009, we expect our operating expenses, excluding the impact of stock-based compensation expenses discussed above, to increase significantly over the third quarter levels due to the recently completed acquisition of the N2X Business from Agilent. Our operating expenses also include the amortization of intangible assets, acquisition related costs and restructuring expenses.
Research and development expenses consist primarily of salaries and other personnel costs related to the design, development, testing and enhancement of our products. We expense our research and development costs as they are incurred. We also capitalize and depreciate over a five-year period costs of our products used for internal purposes.
Sales and marketing expenses consist primarily of compensation and related costs for personnel engaged in direct sales, sales support and marketing functions, as well as promotional and advertising expenditures. We also capitalize and depreciate over a two-year period costs of our products used for sales and marketing activities, including product demonstrations for potential customers.
General and administrative expenses consist primarily of salaries and related expenses for executive, finance, legal, human resources, information technology and administrative personnel, as well as professional fees (e.g., legal and accounting), insurance costs and other general corporate expenses.
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 would be recorded to the extent that the carrying value exceeds the fair value in the period that the impairment circumstances occurred. The future amortization of acquired intangible assets depends on a number of factors, including the extent to which we acquire additional businesses, technologies or product lines or are required to record impairment charges related to our acquired intangible assets.
Acquisition related costs are expensed as incurred and consist primarily of transaction and integration related costs such as success-based banking fees, professional fees for legal, accounting, tax, due diligence, valuation and other related services, consulting fees, required regulatory costs and other related expenses. We expect our acquisition related expenses to fluctuate over time based on the timing of our acquisitions and related integration activities.
Restructuring expenses consist primarily of employee severance costs and related charges. We expect to incur additional restructuring expenses over the near term as we complete the integrations of our recent acquisitions. For additional information, please see Note 4 of Notes to Condensed Consolidated Financial Statements.
Interest and Other Income, Net. Interest and other income, net represents interest on cash and a variety of securities, including commercial paper, money market funds, auction rate securities, and government and corporate debt securities, and certain foreign currency gains and losses.
Income Tax. Income tax is determined based on the amount of earnings and enacted federal, state and foreign tax rates, adjusted for allowable credits and deductions and for the effects of equity compensation plans.

RESULTS OF OPERATIONS
   The following table sets forth certain statement of income data as a
percentage of total revenues for the periods indicated:

                                                  Three months ended                Nine months ended
                                                    September 30,                     September 30,
                                                2009              2008            2009             2008
Revenues:
Products                                           79.9 %           84.3 %           80.1 %          84.2 %
Services                                           20.1             15.7             19.9            15.8

Total revenues                                    100.0            100.0            100.0           100.0

Costs and operating expenses:(1)
Cost of revenues - products                        22.6             17.2             21.3            18.5
Cost of revenues - services                         1.7              2.0              2.1             2.3
Research and development                           29.6             26.4             30.4            27.4
Sales and marketing                                32.9             30.6             35.2            32.8
General and administrative                         15.9             13.8             16.5            14.0
Amortization of intangible assets                   8.1              2.8              5.3             3.3
Acquisition related                                 1.9                -              2.8             0.5
Restructuring                                       5.4                -              2.9               -

Total costs and operating expenses                118.1             92.8            116.5            98.8


(Loss) income from operations                     (18.1 )            7.2            (16.5 )           1.2
Interest and other income, net                      0.7              3.0              1.3             4.4
Other-than-temporary impairment on
investments                                        (2.9 )           (9.1 )           (2.3 )          (3.2 )

(Loss) income before income taxes                 (20.3 )            1.1            (17.5 )           2.4
Income tax (benefit) expense                       (6.9 )            0.1             (6.9 )           0.6

Net (loss) income                                 (13.4 )%           1.0 %          (10.6 )%          1.8 %

(1) Stock-based compensation included in:

       Cost of revenues - products                   0.2 %     0.3 %     0.3 %     0.3 %
       Cost of revenues - services                   0.1       0.1       0.1       0.1
       Research and development                      1.3       1.8       2.7       2.0
       Sales and marketing                           0.6       1.7       1.9       1.9
       General and administrative                    1.3       1.2       1.6       1.4

Comparison of Three and Nine Months Ended September 30, 2009 and 2008 Revenues. In the third quarter of 2009, total revenues decreased 2.0% to $46.4 million from the $47.3 million recorded in the third quarter of 2008. As a result of our acquisition of Catapult in June 2009, the third quarter of 2009 included a full quarter of Catapult revenue of $7.5 million. Revenues from products decreased to $37.1 million in the third quarter of 2009 from $39.9 million in the same period in 2008. Excluding the Catapult product revenue of $5.5 million, the decrease of $8.3 million was primarily due to a $6.0 million decrease in shipments of our hardware products (primarily our Ethernet interface cards) and a $2.0 million decrease in shipments of our software products (primarily our IxLoad and IxChariot software products) in the third quarter of 2009 over the same period in 2008. Excluding the Catapult services revenues of $2.0 million, services revenues in the third quarter of 2009 were $7.3 million compared to $7.4 million in the third quarter of 2008.