##### Table of Contents






UNITED STATES

SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549




---

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS

PURSUANT TO SECTIONS 13 OR 15(d) OF THE


SECURITIES EXCHANGE ACT OF 1934


|           |  |                                                                                                 
|---------- |  | ------------------------------------------------------------------------------------------------
|(MARK ONE) |  |                                                                                                 
|           |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
        THE SECURITIES EXCHANGE ACT OF 1934    
|          
|           |  | FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
        OR                                          
|          
|           |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
        THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM
            TO

Commission File Number: 000-23699

VISUAL NETWORKS, INC.

(Exact Name of Registrant as Specified in Its
Charter)


|                                                                                        |  |                                                             
|--------------------------------------------------------------------------------------- |  | ------------------------------------------------------------
|Delaware
        (State or Other Jurisdiction of
        Incorporation or Organization) |  | 52-1837515
        (IRS Employer
        Identification No.)
|2092 Gaither Road, Rockville, Maryland
        (Address of Principal Executive Office)  |  | 20850
        (Zip Code)                                    

Registrants telephone number, including area code:
(301) 296-2300

Securities Registered Pursuant to Section 12(b) of the
Act:

NONE

Securities Registered Pursuant to Section 12(g) of the
Act:

Common Stock, par value $0.01 per share

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 
  No

Documents incorporated by reference: Specified
portions of the Definitive Proxy Statement to be filed with the
Commission pursuant to Regulation 14A in connection with
the 2001 Annual Meeting are incorporated herein by reference
into Part III of this Report. Such proxy statement will be filed
with the Securities and Exchange Commission not later than
120 days after the Registrants fiscal year ended
December 31, 2000.

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of Regulation S-K is
not contained herein, and will 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.

The aggregate market value of the voting stock
held by non-affiliates of the Registrant as of March 31,
2001 was approximately $112,138,000.

The number of outstanding shares of the
Registrants common stock as of March 31, 2001 was
33,398,785 shares, including 2,000,000 shares held in
escrow.



---






---

TABLE OF CONTENTS



|                                                  |                                                                                                |  |  |  |  |  |  | 
|------------------------------------------------- | ---------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I                                           
|                                                  | Item 1. Business.                                                                             
|                                                  | Item 2. Properties.                                                                           
|                                                  | Item 3. Legal Proceedings.                                                                    
|                                                  | Item 4. Submission of Matters to a Vote of Security Holders.                                  
|PART II                                          
|                                                  | Item 5. Market for Our Common Stock and Related Stockholder Matters.                          
|                                                  | Item 6. Selected Consolidated Financial Data.                                                 
|                                                  | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations.
|                                                  | Item 7A. Quantitative and Qualitative Disclosure About Market Risk.                           
|                                                  | Item 8. Financial Statements and Supplementary Data.                                          
|                                                  | Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. 
|                                                  | Item 10. Our Directors and Executive Officers.                                                
|                                                  | Item 11. Executive Compensation.                                                              
|                                                  | Item 12. Security Ownership of Certain Beneficial Owners and Management.                      
|                                                  | Item 13. Certain Relationships and Related Transactions.                                      
|PART IV                                          
|                                                  | Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.                     
|SIGNATURES                                       
|EXHIBIT INDEX                                    
|EX-10.24 Loan and Security Agreement             
|EX-10.25 Accounts Receivable Financing Agreement 
|EX-10.26 Intellectual Property Security Agreement
|EX-10.27 Purchase of Equip & Services Agreement  
|EX-21.1 List of Subsidiaries of the Company      
|EX-23.1 Consent of Arthur Andersen LLP           



---



VISUAL NETWORKS, INC. FORM 10-K

TABLE OF CONTENTS

|           |  |                                                                                        |    |      |    | 
|---------- |  | -------------------------------------------------------------------------------------- | -- | ---- | -- | 
|           |  |                                                                                        |    | Page
|           |  |                                                                                        |    |     
|          
|          
|          
|          
|PART I    
|          
|          
|          
|          
|Item  1.   |  | Business                                                                               |    |      | 1  | 
|          
|          
|          
|          
|           |  | Overview                                                                               |    |      | 1  | 
|          
|          
|          
|          
|           |  | Industry Background                                                                    |    |      | 2  | 
|          
|          
|          
|          
|           |  | Problems Managing Networks Based on IP and the Internet                                |    |      | 4  | 
|          
|          
|          
|          
|           |  | The Visual Networks Solution                                                           |    |      | 6  | 
|          
|          
|          
|          
|           |  | The Visual Networks Strategy                                                           |    |      | 7  | 
|          
|          
|          
|          
|           |  | Products                                                                               |    |      | 8  | 
|          
|          
|          
|          
|           |  | The Visual Networks Selling Strategy                                                   |    |      | 11 | 
|          
|          
|          
|          
|           |  | Product Development                                                                    |    |      | 12 | 
|          
|          
|          
|          
|           |  | Customers                                                                              |    |      | 12 | 
|          
|          
|          
|          
|           |  | Competition                                                                            |    |      | 13 | 
|          
|          
|          
|          
|           |  | Manufacturing                                                                          |    |      | 14 | 
|          
|          
|          
|          
|           |  | Patents and Other Intellectual Property Rights                                         |    |      | 14 | 
|          
|          
|          
|          
|           |  | Employees                                                                              |    |      | 15 | 
|          
|          
|          
|          
|Item  2.   |  | Properties                                                                             |    |      | 15 | 
|          
|          
|          
|          
|Item  3.   |  | Legal Proceedings                                                                      |    |      | 15 | 
|          
|          
|          
|          
|Item  4.   |  | Submission of Matters to a Vote of Security Holders                                    |    |      | 16 | 
|          
|          
|          
|          
|PART II   
|          
|          
|          
|          
|Item  5.   |  | Market for Our Common Stock and Related Stockholder Matters                            |    |      | 16 | 
|          
|          
|          
|          
|Item  6.   |  | Selected Consolidated Financial Data                                                   |    |      | 17 | 
|          
|          
|          
|          
|Item  7.   |  | Managements Discussion and Analysis of Financial Condition
	and Results of Operations |    |      | 18 | 
|          
|          
|          
|          
|Item  7A.  |  | Quantitative and Qualitative Disclosure about Market Risk                              |    |      | 33 | 
|          
|          
|          
|          
|Item  8.   |  | Financial Statements and Supplementary Data                                            |    |      | 33 | 
|          
|          
|          
|          
|Item  9.   |  | Changes in and Disagreements with Accountants on Accounting and
	Financial Disclosure  |    |      | 33 | 
|          
|          
|          
|          
|PART III  
|          
|          
|          
|          
|Item  10.  |  | Our Directors and Executive Officers                                                   |    |      | 34 | 
|          
|          
|          
|          
|Item  11.  |  | Executive Compensation                                                                 |    |      | 34 | 
|          
|          
|          
|          
|Item  12.  |  | Security Ownership of Certain Beneficial Owners and Management                         |    |      | 34 | 
|          
|          
|          
|          
|Item  13.  |  | Certain Relationships and Related Transactions                                         |    |      | 34 | 
|          
|          
|          
|          
|PART IV   
|          
|          
|          
|          
|Item  14.  |  | Exhibits, Financial Statement Schedules and Reports on
	Form  8-K                      |    |      | 34 | 
|          
|          
|          
|          
|Signatures |  |                                                                                        | 37 |     

i



---



##### Table of Contents



FORWARD LOOKING STATEMENTS

IN ADDITION TO HISTORICAL INFORMATION, THIS ANNUAL REPORT ON
FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS
AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER
MATERIALLY. FACTORS THAT MIGHT CAUSE OR CONTRIBUTE TO SUCH
DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN
THE SECTION ENTITLED MANAGEMENTS DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
READERS SHOULD CAREFULLY REVIEW THE RISKS DESCRIBED IN OTHER
DOCUMENTS THE COMPANY FILES FROM TIME TO TIME WITH THE
SECURITIES AND EXCHANGE COMMISSION, INCLUDING THE QUARTERLY
REPORTS ON FORM 10-Q TO BE FILED BY THE COMPANY IN 2001.
READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THE
FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE OF
THIS ANNUAL REPORT ON FORM 10-K. THE COMPANY UNDERTAKES NO
OBLIGATION TO PUBLICLY RELEASE ANY REVISIONS TO THE
FORWARD-LOOKING STATEMENTS OR REFLECT EVENTS OR CIRCUMSTANCES
AFTER THE DATE OF THIS DOCUMENT.

ii



---



##### Table of Contents






PART I




Item  1.  Business.

Overview

We design, manufacture, sell and support comprehensive service
management systems for providers and users of new world
connectivity services and out-sourced Web services. Our systems
combine software components, or agents, installed at key places
in a network with centralized software applications designed for
performance monitoring, real-time troubleshooting, fault
management, network resource discovery and network capacity
planning. Visual UpTime, Visual IP InSight and Visual eWatcher
provide network performance measurement and analysis that allow
network and Web-hosting service providers to achieve the service
levels required by their subscriber customers and to lower
operating costs associated with new world networks. The
availability of performance monitoring and troubleshooting
software agents also allows customers to verify service levels
supplied by their service providers and monitor traffic
traversing their networks, a requirement for many enterprises
wishing to use public telecommunications services to carry
mission-critical data. Visual Trinity enhances the availability
and performance of an e-business network infrastructure by
automating the discovery of network resources, correlating
events and determining root-cause and business impact. These
applications are essential to both service provider and
enterprise customers in generating revenue, attracting and
retaining customers, and maintaining a competitive position. We
believe that our systems are deployed in configurations managing
up to 4,500 transport circuits and Internet access for up to
1.5 million desktop computers.

We believe that we are a worldwide leader in providing service
management systems, having shipped systems for deployment on an
aggregate of over 155,000 transport circuits and over
40 million desktops. We have developed relationships with
major service providers including AT&T, British
Telecommunications, Earthlink Network, Prodigy Communications,
SBC Communications, Sprint, Verizon and WorldCom. These service
providers either resell our systems to their subscribers or
integrate our systems into their network infrastructure to
enable them to offer enhanced network services. Customers
deploying our systems for the purposes of root-cause fault
determination and business impact analysis include AT&T,
Bouygues Telecom, Chase, Everest Broadband Networks,
HypoVereinsbank and Verizon. For the year ended
December 31, 2000, we had consolidated revenue of
approximately $89.0 million, of which 70% was attributable
to service providers.

Vertical Systems Group, a leading industry analyst, estimates
that approximately 533,000 frame relay circuits and 37,000 ATM
circuits will be installed worldwide from 2001 through 2002.
International Data Corporation, or IDC, a leading industry
analyst, estimates that the number of Internet capable devices
in the United States will grow from 100 million in 2000 to
more than 1 billion by 2003. The Yankee Group, another
leading industry analyst, estimates that the annual market for
e-commerce and Web site implementation and management services
will grow from $370 million in 2000 to $850 million in
2003. Vertical Systems estimates that worldwide frame relay and
ATM service revenue will grow from $12.3 billion in 2000 to
$19.9 billion in 2002. To support these applications and
services, networks are growing in size and complexity. We plan
to apply our comprehensive product portfolio for
troubleshooting, service level performance monitoring, fault
management and root-cause and business impact analysis to
improve the quality and performance of these networks so that
they are suitable for mission critical applications. To take
advantage of the projected growth in these markets, we plan to
expand our relationships with our service provider customers
which together account for the majority of Internet Protocol, or
IP, network traffic worldwide.

Our company was incorporated in Maryland in August 1993
under the name Avail Networks, Inc. and reincorporated in
Delaware in December 1994 as Visual Networks, Inc. Our
principal executive offices are located at 2092 Gaither Road,
Rockville, Maryland 20850. Our telephone number is
(301) 296-2300. On May 15, 1998, we acquired Net2Net
Corporation. On September 30, 1999, we acquired Inverse
Network Technology. On May 24, 2000, we acquired Avesta
Technologies, Inc. The Net2Net and Inverse acquisitions were
accounted for as pooling of interests transactions. The Avesta
acquisition was accounted for as a purchase business combination.

1



---



##### Table of Contents



Industry Background

Wide Area Network Services Market

The Wide Area Network, or WAN, services market has grown rapidly
with the increase in computing and the associated data traffic
volumes carried over WANs. WAN services are used to interconnect
the computing facilities of geographically dispersed sites
within an enterprise, to connect the computing facilities of one
enterprise to another and to allow remote users to utilize the
enterprise computing facilities. Businesses and other
organizations are becoming ever more dependent on data
communications and the myriad of computers and devices that
facilitate data communications. We believe that WAN data traffic
volumes will continue to expand rapidly due to four key trends
driving telecommunications markets worldwide:



| |   |                                                                                                                                                                                                                     
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | proliferation of distributed computing applications such as
	electronic mail, electronic transaction processing, enterprise
	resource planning and inter-enterprise information transfer
	based on Web technologies;
|
| |  | deregulation of the telecommunications services industry, which
	has intensified competition and resulted in decreasing prices of
	WAN services;                                                                    
|
| |  | continued deployment of high capacity fiber-optic networks and
	the emergence of high bandwidth network access technologies that
	increase the ability to transfer large volumes of electronic
	information; and    
|
| |  | rapid growth of remote applications that access enterprise
	resources such as telecommuting and e-commerce, and the
	availability of broadband access technologies that enable them.                                

Todays networks are deployed using a supply chain of
various wholesale and retail network service providers for
network access, backbone transport and hosting, including
traditional telephone companies and new world broadband network
providers. These service providers may either be competing or
cooperating with one another to provide the complete
connectivity service solution to the ultimate customer, the
enterprise. In this environment, a high premium has been placed
on network performance and availability. This results in the
need for tools that offer a consistent, reliable way to measure
service quality, end-to-end, across many ownership boundaries,
vendors and types of access media.

WAN Service Management Market Dynamics

Frame relay and ATM are the generally accepted technologies for
corporate backbone WANs. However, the use of IP networks to
support mission critical applications is increasing.
Telecommuters and field sales and support people are dependent
on remote access Virtual Private Networks, or VPNs, to perform
their jobs. In addition, mission critical corporate applications
and e-commerce are being provided by corporate intranets and
Internet technologies.

The rapid proliferation of new technologies to deliver IP
services adds to the complexity of these services. For example,
the Yankee Group predicts that the number of business and
residential Digital Subscriber Line, or DSL, subscribers will
grow from 1.1 million in 2000 to 6.2 million in 2002.
The combination of mission criticality and the increased
complexity of managing multiple technologies causes difficulties
for network providers and their subscribers alike. The scarcity
of skilled labor strains enterprise information technology, or
IT, staffs, causing the need for solutions that can help to
manage the complexity.

As a result, enterprises are delegating more responsibility to
their service providers. Both the service providers and their
enterprise IT customers need solutions to manage their
out-sourced relationships. Service providers need service
management solutions for the myriad of new technologies that
they are deploying. IDC predicts that between 2001 and 2003
products explicitly focused on managing IP services will
experience an increase in popularity as service providers seek
to get the most out of their IP equipment investments.

The simultaneous increase in complexity and mission criticality
and the dependence on service providers lead to opportunities
for creating new value-added services. Service providers, in a
constant quest to protect margins and retain customers, are
aggressively competing on quality and other high value services
such as

2



---



##### Table of Contents





WAN Network Deployment

A typical WAN deployment supporting mission critical
applications includes various types of customer premises
equipment, or CPE, owned by the subscriber, deployed at the
subscribers site and interconnected by the WAN service. It
may also include Web servers and applications that may be hosted
at the customer site or in a service providers Web data
center. The point at which the subscriber CPE connects to the
WAN service is known as the service demarcation (the
demarc), or the point where the service provider
hands off the service to the subscriber, and ultimately, is the
point where the services are defined. The subscriber is
responsible for network performance on its side of the demarc
while the service provider is responsible for network
performance on its side of the demarc.

The equipment used for frame relay, ATM and IP/ Internet
services includes both the access equipment located at the
subscriber premises and the switches located at the service
providers central office. Vertical Systems projects that
the market for this equipment will grow from approximately
$9.4 billion in 2000 to approximately $13.0 billion in
2002. IDC estimates that in 2001 commercial and other entities
around the world will invest $700 billion in their online
activities including expenditures for not only improving
technology infrastructures but also business infrastructures.
These investments will drive much of the growth in spending on
IT hardware, software and services that will surpass $1.0
trillion for the first time in 2001. The equipment used for
hosted services includes firewalls, routers, content caches,
servers and databases. IDC projects that Web hosted services
will grow to be a $2.0 billion market in 2001.

WAN Network Architectures

WAN services are provided through two network architectures,
time division multiplexing, or TDM, and statistical
multiplexing. TDM services, such as leased-line and integrated
services digital network, or ISDN, rely on architectures which
provide dedicated circuits between computing facilities and
provide fixed bandwidth regardless of traffic flow. Unless
information is continuously transmitted, the dedicated bandwidth
is often idle resulting in the inefficient use of expensive
bandwidth. The use of dedicated bandwidth does, however, provide
guaranteed throughput and fixed delay, ensuring high quality of
service for all network traffic. TDM services are suitable for
the large installed base of mainframe computing environments
running mission-critical, host-centric applications where the
variability in traffic volume is low and the traffic volume is
relatively predictable. Statistical multiplexing technologies
and their derivative services are based on the concept of
logical connectivity and shared bandwidth which is dynamically
allocated in real time according to prevailing traffic patterns.
As a result of this shared bandwidth, WANs based on these
statistical multiplexing services can be up to 50% less
expensive than WANs based on TDM services for distributed
computing applications. Because bandwidth in the WAN is shared
among multiple subscribers, however, these services are
generally characterized by best efforts throughput
and variable delay. The challenge is to provide network
performance and availability suitable for mission critical
applications.

Logical connectivity is provided via frame relay, ATM and IP, or
IP running over frame relay and ATM. Frame relay and ATM are the
predominant technologies used today for mission critical
applications. IP is rapidly emerging to broaden the scope of
coverage. Vertical Systems estimates that worldwide revenues for
frame relay service, the most widely used service, will grow at
a compound annual growth rate of 25% from 1998 through 2002. The
worldwide number of installed frame relay ports is projected to
grow from approximately 1.5 million in 2000 to more than
2.0 million in 2002. The worldwide number of installed ATM
circuits is projected by Vertical Systems to grow from
approximately 28,000 in 2000 to approximately 65,000 in 2002.

There are many established and emerging technologies for
accessing the service providers logical network. The
predominant access technologies facilitate dedicated service as
well as traditional dial-up access over traditional telephone
networks. More recently, broadband access technologies such as
DSL, cable and

3



---



##### Table of Contents





When the complexity of the network supply chain is added to the
complexity of multiple technologies and derived service
offerings, the result is the new world of wide area networking,
and it is often characterized by confusion and chaos. The goal
of new world service management solutions is to bring order to
the chaos while meeting the requirements of both the service
providers and their enterprise customers.

The growth of logical connectivity services has resulted in
increased focus by subscribers on WAN service levels defined by
parameters such as service availability, throughput and delay.
Because of the importance of mission-critical applications such
as enterprise resource planning, transaction processing, work
group collaboration, remote telecommuting, sales force
automation and electronic order entry, subscribers are demanding
that their service providers offer, guarantee and achieve higher
service levels.

The proliferation of logical connectivity services has also
resulted in increased administrative costs for subscribers as
network managers are responsible for multiple networks
consisting of older leased-line services as well as multiple
access and logical connectivity options. The high cost of
administering multiple networks coupled with the attractive
pricing of logical connectivity services is driving the need for
subscribers to outsource some of the service management to their
service provider, without forfeiting control or visibility of
performance. Subscriber demand for multiple, guaranteed and
verified WAN service levels presents challenges to service
provider firms that must be able to offer these service levels
while maintaining profitability.

Where Service Provider and Enterprise Requirements Meet

Service providers want solutions that will enable the delivery
of higher performing services to the enterprise customers.
Service providers want to differentiate themselves by the
quality and breadth of their service offerings. They want to
rapidly provision network services and troubleshoot network
problems without the costly effort of dispatching technicians.
In this highly competitive industry, service providers must be
able to get services up and running quickly. By being alerted to
degradations of services before their customers are affected,
service providers ensure customer satisfaction with the
services, thereby reducing customer turnover. Subscribers demand
high network performance and want the appropriate tools to hold
their respective service providers accountable.

Both parties want returns on their network investments. Service
providers want to charge more for enhanced services and save on
operations costs. Enterprises want to optimize the performance
of their network and minimize their IT expenses. By optimizing
network resources, service providers and enterprises will be
able to reduce the cost of downtime.

The requirements of the service provider and the enterprise meet
at the point of service delivery, the service demarc. Service
Level Agreements, or SLAs, are defined in terms of performance
attributes such as average and peak throughput, availability and
delay. Service management solutions must provide a
representation of the service performance against their defining
SLAs. In cases where a service is not performing as defined,
service level management becomes the tool set for rapidly
isolating problem conditions and enabling the restoration of
service performance to required levels. It is important to
understand that service-affecting conditions can arise in either
the service providers or the subscribers
infrastructure. Effective service level management software must
be able to distinguish between the two and monitor the
performance of the network at the point of service delivery.

Problems Managing Networks Based on IP and the Internet

In leased-line environments, the performance, quality and
maintainability of the service are independent of the volume and
type of traffic running over the service. The diagnostic and
measurement capabilities required to sufficiently maintain these
services are fairly simple and are focused largely on physical
transmission characteristics such as bit error rates or line
coding violations. These capabilities are widely available
within the service providers facilities and work in
conjunction with simplistic devices deployed by the subscribers.
By contrast, the performance, quality and maintainability of
logical connectivity services are

4



---



##### Table of Contents





Suspect service levels inhibit subscriber acceptance of
services. Subscribers want to be continuously assured that
logical connectivity services are performing sufficiently to
support mission-critical applications. As the demand for higher
service levels and multiple service levels has increased,
subscribers and their service providers need a mechanism to
measure, verify and improve service levels.

Operational cost models are not scaleable. The inability
to cost-effectively measure performance at the demarc, and
thereby demonstrate to subscribers the WAN service level being
provided, results in service providers requiring many highly
skilled personnel to provision and operate logical connectivity
services. This cost is exacerbated by the gap between the demand
for and supply of personnel. The implication of this model is
that operating costs are driven up and service providers
WAN service businesses are not scaleable to the levels required
to generate the necessary economies of scale. The specific areas
of concern are:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Inefficient service provisioning. The service provider
	has difficulty determining whether the WAN service is properly
	deployed until the subscribers network has been connected
	to the service and the subscribers applications are
	operational. This often results in multiple dispatches of
	personnel to the subscriber site and extensive interaction with
	the subscriber for its equipment and applications to be
	configured properly. The service provider is typically
	restricted from billing the subscriber for the service until the
	subscribers applications are working properly over the
	service.                                                                                                                                                                                                                                                      
|
| |  | Extensive troubleshooting and high maintenance. When
	subscribers experience degraded network performance, they
	generally assume there is a problem with the service supplied by
	their service provider. It can often take days, weeks or even
	months to diagnose the causes of degraded performance requiring
	highly skilled personnel with sophisticated instrumentation and
	diagnostic tools. Although these degraded performance conditions
	are frequently caused by faulty or misconfigured subscriber
	equipment or applications, the service provider is forced to
	expend significant time and effort without reimbursement to help
	diagnose the problem.                                                                                                                                                                                                        
|
| |  | Inaccurate network engineering and planning. The shared
	bandwidth nature of WAN services coupled with subscriber demand
	for many classes of service levels increases the importance of
	accurate network planning and design to ensure that the network
	architecture is optimized for performance and cost. If the
	network is engineered with excess capacity, it may improve the
	performance of subscriber applications, but it will tend to
	negate the inherent bandwidth efficiencies of logical
	connectivity technologies. By contrast, if the network is
	designed with inadequate capacity, performance will suffer.
	Successful network engineering and planning is dependent on
	accurate historical usage information which, because of the
	inability of traditional equipment to measure traffic at the
	demarc, is difficult to ascertain for these services.

We believe that an essential element of logical connectivity
services being demanded by subscribers is the ability to manage
and verify service levels. We believe that service providers
will experience difficulty meeting the increasing demand for
logical connectivity services without having systems for
managing service levels. The labor-intensity of provisioning and
maintaining the service inhibits the service providers
ability to scale the WAN services profitably without service
level management capability. As the service providers
focus shifts to profitability, the growth in frame relay, ATM
and IP/ Internet services will depend, in part, on the ability
of service providers to implement systems that can manage
service levels, lower operational costs and increase scalability.

5



---



##### Table of Contents



The Visual Networks Solution

We offer a market-leading family of WAN service level management
systems that combine WAN access functionality with planning,
monitoring and troubleshooting capabilities that enable
customers to implement required service levels while
simultaneously decreasing the costs and complexity of achieving
the levels. Our systems measure and analyze network performance
at the demarc through innovative software applications that
address the historical problems of managing service levels. Our
service management systems apply to services that account for
90% of wide area connectivity. Our systems also provide service
management for hosted application services. We believe that our
systems offer customers the following benefits:

Increased confidence in service levels. Our systems
enable service providers and their subscribers to accurately
measure, report on and improve service levels. These abilities
serve to clarify the relationship between subscriber and service
provider, resulting in increased subscriber confidence in
running mission-critical computing applications on these
services.

Increased scalability and lower costs of service
providers and subscribers operational models.
Our systems can reduce the labor-intensive nature of deploying
logical connectivity services, thereby decreasing both service
providers and subscribers costs and increasing their
ability to generate revenues, by enabling:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Rapid and cost-effective service provisioning. Our
	systems allow the service provider to verify that its service is
	properly provisioned without waiting for the subscriber network
	or applications to be connected and configured. This tends to
	reduce customer support costs during initiation of service and
	allows the service provider to begin billing for the service
	earlier than was previously possible.                                                                                                                                                                                                                                                                                                                                                                                                    
|
| |  | Reduced need for reactive troubleshooting. Our systems
	reduce the need for service providers to perform troubleshooting
	after the fact, by continuously monitoring network performance
	at the demarc and proactively alerting the service provider and
	subscriber to anomalous performance characteristics. These early
	warnings allow the network operator to take corrective action
	before the performance of any application on the network is
	impaired. Because many of the anomalous characteristics are
	subscriber-related, the subscriber is more likely to take
	corrective action without involving the service provider. The
	net result is that fewer maintenance personnel are required to
	solve fewer problems, thereby increasing service provider
	efficiency and subscriber satisfaction.           
|
| |  | More rapid and less costly troubleshooting. Because our
	systems provide information that enables isolation of problems
	between the service provider network and subscriber equipment
	and applications, the service provider can more quickly diagnose
	the cause of faulty or degraded performance. Many problems that
	would otherwise last for days and require on-site visits of
	highly skilled personnel can be diagnosed remotely within
	minutes by our systems. Because our systems are designed to
	allow both the service provider and the subscriber to access the
	same reports and analyses simultaneously, more problem
	conditions can be resolved collaboratively. Our systems provide
	fault consolidation and root-cause analysis that are
	capabilities that can be used to reduce mean time to repair.
|
| |  | Reduced impact of problem conditions. Our systems
	automatically identify applications and users that are effected
	by problem conditions. This enables maintenance personnel to
	attack those problems that have the largest business impact
	first, thus reducing the overall business impact of faults.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|
| |  | More accurate network engineering and planning. Our
	systems continuously provide an accurate and detailed view of
	historical WAN service usage patterns along with automated
	guidance regarding the need to change circuit capacities. This
	allows subscribers and service providers to implement a network
	design optimized for cost and performance.                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

6



---



##### Table of Contents



The Visual Networks Strategy

Our overall strategy is to maintain and build upon our market
leadership in the deployment of WAN service level management
systems for networks based on IP and the Internet. Key elements
of our strategy include:

Embedding agent technology in the equipment of other
manufacturers. In order to fully instrument the network, we
will partner with leading manufacturers of access equipment to
embed our agent technology into their systems.

Deploying our systems as part of service provider
networks. We believe that service providers will become the
predominant means for the deployment of service management
systems. Although these systems can be deployed by either
service providers or subscribers, we believe that maximum
benefit is achieved when the systems are deployed by the service
providers supplying subscribers with access to performance data.
In this deployment model, service providers can employ
collaborative fault and performance management techniques that
lead to greater network quality. More important, we believe the
benefits of lower provisioning and maintenance costs may be most
effectively captured if the system is deployed by the service
provider.

Capitalizing on our strong incumbency position with major
service providers. We have an outstanding customer list of
top-tier service providers, including AT&T, British
Telecommunications, Earthlink, Prodigy, SBC, Sprint, Verizon and
WorldCom. These service providers have standardized many of
their offerings around our service management solutions. The
Visual brand is well recognized and highly respected in this
community. As the financial condition of many of the emerging
carriers has weakened, we have seen a flight to quality and
stability in the communications services market that will
benefit our traditional customer base. Because of the
requirement to provide complete services solutions regardless of
the underlying technology, we believe that these
well-capitalized service providers are in the best position for
long-term success and will be the driving force behind converged
service offerings. We intend to capitalize on these
relationships to expand market coverage and introduce new
features and functions.

Deploying our systems to support e-commerce and application
hosting. We believe that our systems for e-commerce and
Web-hosting applications will be deployed predominantly for the
discovery of network resources, fault consolidation, root-cause
analysis and business impact analysis, as well as fault and
performance management for Intranet and Web-based services. Used
in conjunction with other types of management systems, our
systems can significantly improve network availability for key
business users and applications.

Extending our technology leadership. We believe a
combination of technological competencies have been crucial to
our success. These competencies include network analysis
technology and its application to the effective operation of
WANs, the integration of network analysis with WAN access
technology, collaborative subscriber/service provider system
architectures, auto-discovery of network resources, and
root-cause and business impact analysis technology. We continue
to invest in our core competencies by focusing on feature
development, architectural enhancements and cost reductions. We
intend to continue to invest in the development of our systems,
with particular emphasis on features and architectural
improvements designed to accommodate large-scale deployment by
service providers. This includes leveraging our current remote
access, frame relay, ATM and IP/ Internet technologies to
provide customers with a single vender solution for end-to-end
service level management as well as to address emerging
opportunities such as VPNs over the Internet.

Expanding our sales and support functions globally. Many
of our largest service provider and subscriber customers are
multinational corporations. We intend to develop a presence
outside of the U.S. with particular focus on the service
providers that have the largest share of the worldwide markets
for remote access, frame relay, ATM and IP/ Internet services,
and on enterprises that have a need for for e-commerce
management and Web hosting services. To that end, in
November 2000, we entered into a joint venture with a
customer to form a new German company. The new company provides
end-to-end service management solutions based on our products.

7



---



##### Table of Contents



Products

Visual UpTime

Visual UpTime is the de facto standard for service management of
frame relay and ATM networks. This complete service management
system helps users optimize network performance and reduce
overall costs of network ownership. Visual UpTime won Network
Worlds Best of the Test Award for the best WAN
management product of 2000. The award was based on customer
reviews conducted throughout the year.

Visual UpTime is a service level management system consisting of
analysis service elements, or ASEs, performance archive
managers, or PAMs, and platform applicable clients, or PACs,
that perform data collection, data interpretation and
presentation. By intelligently monitoring network-wide
performance, Visual UpTime enables users to track and solve
service level problems either on the subscriber or service
provider side of the demarc.

ASE. The ASE is a combination of embedded proprietary
software and hardware that performs detailed analysis of network
performance at the demarc. Most versions of the ASE provide the
functionality of WAN access equipment, such as a DSU/ CSU.
Visual UpTime ASEs use sophisticated proprietary software in
conjunction with networking-specific microprocessors and
integrated circuits to perform detailed analysis of every bit,
frame and packet traversing the demarc. The ASEs generally store
the analysis results locally in memory and wait for the PAM to
request the results. When the ASE detects an anomalous
condition, it sends an unsolicited alert to the PAM so that
network operators can take prompt action. Depending on customer
requirements, our core ASE technology can be deployed in a
number of configurations based on physical circuit speed, number
of virtual circuits supported, type of access functionality and
the local area network environment.

PAM. The PAM is the system database and request broker
between the PACs and either the database or ASEs. Unlike
traditional data transfer management architectures which depend
on continuous polling between the manager (PAM) and agents
(ASEs), a bandwidth consuming process, Visual UpTime distributes
most of the processing burden to the ASE, allowing the PAM-ASE
data sharing to take place less frequently, typically once a
day. This feature is critical in WAN environments where costly
bandwidth makes continuous management polling impractical.

PAC. The PAC is Visual UpTimes client software for
packaging and presenting information stored in the PAM and ASE.
Multiple PACs may access a single PAM or ASE. The PAC includes
three integrated toolsets:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Performance monitoring. This toolset is an early warning
	system, alerting network operators to impending service
	degradation that allows corrective action to be taken before the
	subscribers application performance degrades. This toolset
	displays network performance related events and alarms. The
	performance monitoring toolset is tightly linked to the
	troubleshooting toolset, allowing an operator to evaluate
	quickly and precisely the conditions that caused the event or
	alarm.    
|
| |  | Troubleshooting. This toolset enables an operator to
	rapidly perform detailed diagnostics to identify the cause of
	service level problems. This toolset displays real-time and
	historical network performance statistics. The troubleshooting
	toolset includes a protocol capture and analysis capability used
	by network operators to isolate problems arising from the
	interplay between a subscribers CPE or applications and
	the WAN service.                                                   
|
| |  | Planning and reporting. This toolset is a report
	generation tool that creates a wide variety of reports from the
	network performance data stored in the PAM. This toolset is used
	primarily for capacity planning and network engineering,
	management of service level agreements between service provider
	and subscriber and executive reporting from the network
	operations staff to senior management personnel. The planning
	and reporting toolset is accessible through a PAC or a
	Web-browser.

The Visual UpTime components are sold as a complete system which
requires at least one PAC/ PAM per deployment along with one ASE
deployed at the demarc of each circuit on which service level
management is required. We believe the system is currently
deployed in configurations managing up to 4,500 transport
circuits. System pricing varies by size of deployment and
relative mix between circuit speeds.

8



---



##### Table of Contents



Visual IP InSight

Visual IP InSight is a WAN service management system for remote
access network technologies utilizing IP and the Internet. It
helps both service providers and enterprises provide the highest
quality IP services to their customers. Visual IP InSight helps
operations managers, network managers and customer care (help
desk) personnel proactively manage the complete service
experience whether it is for a service subscriber or an internal
enterprise user. Visual IP InSight has also become a cornerstone
for credible SLA offerings of ISPs. The product includes three
software applications:



| |   |                                                                                                                                                                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | IP InSight Service Operations. This function provides
	information regarding problems in real-time and monitors
	performance of IP applications, such as e-mail and domain name
	system using metrics such as availability, throughput, latency
	and packet loss.
|
| |  | IP InSight Customer Care. This feature allows customer
	care personnel to call up a customers history of network
	connections and PC configurations.                                                                                                            
|
| |  | IP InSight Service Level Manager. This function makes it
	easy to define, monitor and administer SLAs. Its unique tools
	also map users to their specific services, service providers and
	SLAs.                                                                 

System components for Visual IP InSight include PC client
agents, stand-alone test points, data collectors and a data
repository. These components communicate with each other over an
IP network providing a steady stream of real-time information.
Visual IP InSights architecture is distributed and
fault-tolerant, and it scales to carrier class networks.

The systems client agent is the origin of
quality-of-service and test data. The client agent can passively
monitor user activity on the network or perform active tests
when requested by the network manager. The client agent can be
deployed in any remote access environment  dial modem,
Digital Subscriber Line ISDN or cable modem.

The systems client agent runs transparently until end-user
help is required. Context-sensitive online help suggests
solutions to more than 150 dial-access problems and keeps a
descriptive error log that customer care personnel can use to
solve problems that end users cannot resolve on their own.

Visual IP InSight also offers service agents that are deployed
at test points within the network (such as the network edge) and
perform active tests as directed by the network manager.

Visual IP InSight Collectors collect data from client agents and
service agents and send it to the back-end database. A collector
can be deployed either behind a firewall or in key points in the
public IP network, and a single collector can handle hundreds of
thousands of active clients.

Visual IP InSight Aggregators are servers positioned at key
locations in the network or data center. Collectors pass the
client agent and service agent data they have collected to one
or more aggregators for data validation and loading into various
data repositories. All of the performance data gathered is
stored in a high performance relational database. Data is
presented using a secure web interface, allowing detailed
information on the performance of the network and applications
to be quickly distributed throughout an organization or between
customers and partners.

Visual Trinity

Visual Trinity increases service availability across the entire
IT organization while simultaneously providing a service view of
the entire IT infrastructure, including rules-free, real-time
root-cause and impact analysis and service reporting. Visual
Trinity incorporates data collection agents that continuously
pass information gathered from routers, bridges, servers,
computers, Web sites and many types of applications to the Model
Server that tracks in real-time the inter-relationships among
different streams of information. This allows the Model Server
to automatically isolate the root-cause and business impact of
service disruptions. Visual Trinity enables an
organizations IT staff to focus on quickly restoring
services based on business priority.

9



---



##### Table of Contents



Visual Trinity has a three-tier architecture:

Data collection  agent managers. Agent
managers provide scalability for discovery and monitoring. They
can be distributed to fit the size, complexity and bandwidth
limitations of the network. Customers can add different agents
to the agent managers for various methods of collecting event
information. Visual Trinity agents detect and continuously
monitor business resources.

Data interpretation  servers. There are
four types of Visual Trinity servers:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The Visual Trinity Model Server containing the enterprise
	service model lies at the core of the Visual Trinity
	architecture. Visual Trinity discovers and creates managed
	objects to represent most types of business resources. The model
	is a dynamically built and self-updating model of the
	infrastructure resources and the relationships between them. The
	model server processes events from the agent manager and
	performs all root-cause and impact analysis.
|
| |  | The Visual Trinity Data Server stores events, alarms, and
	long-term service availability information. This information is
	used for service availability reporting and investigating
	historical alarms.                                                                                                                                                                                                                                                                     
|
| |  | The Visual Trinity Reporting Server provides the ability to view
	information about individual outages and service disruptions.
	Utilizing Trinitys embedded online analytical processing
	technology, the Reporting Server can generate standardized or
	completely customizable reports viewable through a Web browser.
	These reports illustrate service performance and availability
	over time, as well as by individual outage and business impact.                    
|
| |  | The Visual Trinity Object Server acts as a data cache between
	the Model Server and the Service Manager by allowing many users
	to view, monitor and manage the information simultaneously.                                                                                                                                                                                                                                                                                   

Data representation  Service Manager/
Client. The Visual Trinity Service Manager provides four
applications that allow the user to interact with the business
resources and services represented in the model.



| |   |                                                                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The alarm manager allows users to monitor alarms continuously by
	displaying real-time and historical alarms for a selected set of
	managed objects.                 
|
| |  | The map manager allows users to visualize and manage the
	network, using a set of dynamic maps that graphically depict
	individual resources and their relationships.
|
| |  | The enterprise explorer manages the managed objects and workflow
	objects in the model. It allows users to directly identify and
	manipulate resources.              
|
| |  | The administration utility allows the administrator to use and
	customize Visual Trinitys discovery, resource monitoring,
	and event definition features.           

Visual eWatcher

Visual eWatcher is our Web management solution. It delivers a
secure 24×7 monitoring of the Web
environment  the Web site and the underlying
infrastructure. Visual eWatcher monitors availability, verifies
integrity and tests performance. It ensures the integrity of Web
sites as well as the availability of internal Web infrastructure
components. It can also act as a Visual Trinity agent for the
Web by enhancing Visual Trinitys ability to discover,
monitor and test business services based on the Web.

Visual eWatcher automatically discovers all Web
resources  from routers to internal business
services to URLs on a Web site. Once those network components
are discovered, they can be added to Visual eWatchers
database for testing. Visual eWatcher can then monitor and test
for availability, responsiveness and accuracy of Web page
content. When faults are detected, thresholds are exceeded or
applications fail, Visual eWatcher alerts IT personnel in real
time. Visual eWatcher includes an escalated notification system
that communicates network problems in a variety of methods,
including e-mail, on-screen interrupt and pager. Visual eWatcher
allows for proactive Web site management, accessible from any
browser. Visual eWatcher is installed on dedicated servers and
can be placed at any point in the network.

10



---



##### Table of Contents



Visual Internet Benchmark

Visual Internet Benchmark provides an industry benchmark for the
quality of service provided by ISPs. The service provides
standardized, comparative reports of Internet access and
performance statistics for more than 50 service providers.
Visual Internet Benchmark reports are available for the U.S.,
U.K., and Canada. Enterprises use this data when selecting
service providers. Service providers use this data and the
expertise behind it to improve their networks, as well as for
marketing purposes. Visual Internet Benchmark collects
comprehensive statistics on such key metrics as call failure
rates, dial-up connection speeds, log-in elapsed time, Web
access failures, domain name system lookup times, Web server
access times, and Web server transfer rates.

Cell Tracer

Our network analyzer product, Cell Tracer, is a combination of
embedded proprietary software and hardware and Microsoft Windows
presentation software that performs detailed analysis of network
performance on ATM circuits. The Windows software, running on a
Pentium-based computer, connects either locally or remotely to
the hardware to perform detailed analysis of every bit, cell and
packet traversing the ATM circuit. Cell Tracer is designed to
meet both the network monitoring and troubleshooting needs of
field support personnel and the centralized operational needs
for supporting remote ATM circuits. Depending on customer
requirements, Cell Tracer can be utilized in a number of
configurations based on physical circuit speed, access line type
and monitoring applications. Generally, we have distributed Cell
Tracer through original equipment manufacturers and expect
future sales of this product to continue to be made
substantially through Network Associates.

The Visual Networks Selling Strategy

We implement a push  pull sales strategy where
market demand is generated by marketing programs, cultivated by
the direct sales force and fulfilled by channel partners. The
channel partners are traditional service providers, such as
AT&T, WorldCom, Sprint, and the traditional local telephone
companies; emerging service providers, including ISPs and
competitive telecommunications providers; value added resellers,
or VARs; and system integrators.

In our sales model, marketing activities generate subscriber
demand through a variety of focused marketing programs. The
result of this demand generation activity is a set of qualified
leads that are cultivated by our direct field sales force or our
inside sales force depending on the size and complexity of the
opportunity. Direct sales drives the opportunity towards closure
by applying Visual systems to the prospective customers
network environment and describing the associated value
proposition, typically a lengthy process. Upon completion of
these steps, direct sales will determine the prospects
preferred fulfillment channel and steer the opportunity through
that channel. Direct sales will remain engaged until the demand
is satisfied.

We have several fulfillment channels. Customer requirements may
be met through the subscription to a service providers
managed service that embeds our technology, or by the
acquisition of our products from a service provider or VAR.
Demand could also be fulfilled by a system integrator or service
provider partner who provides out-sourced, or hosted, management
services using Visual Networks technology.

The development of a service provider service based on Visual
Networks technology is a complex sale to multiple
departments within a service providers organization. We
work with the service provider to develop a service definition
and business plan for the integration of Visual products into
the service providers existing service.

We provide pre-sale technical support to each of our channels.
The time required to develop a relationship with a channel
partner can take from two to 12 months for VARs and system
integrators, and from 12 to 24 months for service
providers. The sales cycle for subscriber deployment through an
established channel is typically four to six months long.

11



---



##### Table of Contents



We have sales and technical support teams assigned to each major
service provider account. In addition, our senior management
team devotes significant time furthering the business
relationships with these service providers and we invest
significant marketing resources to stimulate sales with these
service providers.

As of December 31, 2000, we employed 123 people in sales
and marketing. Our expenditures for sales and marketing
activities were approximately $19.8 million in 1998,
$24.4 million in 1999 and $41.9 million in 2000.

Product Development

We have developed core competencies in network analysis
technology and its application to the effective operation of
WANs, the integration of network analysis with WAN access
technology, collaborative subscriber/service provider system
architectures, network auto discovery, and root-cause and
business impact analysis.

We have made significant investments in system architecture and
feature development. Through the acquisitions of Net2Net,
Inverse and Avesta, we accelerated the pace of product
development in order to provide customers with a single vendor
solution for end-to-end service and fault management,
encompassing frame relay, ATM and IP/ Internet. We will continue
to expand Visual UpTime for managing frame relay, ATM or IP
connectivity over broadband access services. We will continue to
expand IP InSight for broadband access technologies as well. We
anticipate that we will utilize Visual Trinity technology for
correlating fault and performance management in the WAN services
market. We are focused on the further enhancement and refinement
of our systems, including the development of the architectural
scalability that will be required for wide-scale implementation
through the service provider deployment model. Additionally, we
expect to invest in system refinements, which increase the
economic benefit of deployments outside North America.

As of December 31, 2000, there were 98 persons working in
our research and development area. Our research and development
expenditures were approximately $13.8 million in 1998,
$16.7 million in 1999 and $27.3 million in 2000.

Customers

Since mid-1996, we have developed business relationships,
currently at different levels of maturity, with a number of
service providers, including AT&T, British
Telecommunications, Earthlink, Prodigy, SBC, Sprint, Verizon and
WorldCom. Sales of products or services to Sprint, AT&T and
WorldCom accounted for 18%, 20% and 14%, respectively, of
consolidated revenue for 2000.

AT&T Relationship. In December 1997, we entered
into a non-exclusive procurement agreement with AT&T. The
agreement had an initial term of three years and has
automatically renewed with the right by either party to
terminate the agreement upon 30 days notice. Prices
and discounts for all equipment purchased by AT&T are fixed,
except in certain limited circumstances. The equipment carries a
five-year warranty. If we offer more favorable prices and terms
to any other customer for the same quantity of products during
the term of the agreement, we will amend the agreement to
provide AT&T with the same or comparable overall terms. The
agreement does not obligate AT&T to make any minimum
purchases from us. We also provide certain support services to
AT&T.

WorldCom Relationship. In August 1997, we entered
into a non-exclusive three-year reseller agreement with
WorldCom, which has automatically renewed for a one-year term.
Prices and discounts for all equipment purchased by WorldCom are
fixed. The equipment carries a five-year warranty. If we offer
more favorable prices to any other customer for the same
quantity of products purchased over a similar period of time,
the prices charged to WorldCom will be adjusted to the more
favorable price. The reseller agreement does not obligate
WorldCom to make any minimum purchases from us. We also provide
certain support services to WorldCom.

Sprint Relationship. In May 2000, we entered into a
new non-exclusive three-year reseller agreement with Sprint, in
effect extending the basic terms of our earlier agreement with
Sprint made in August 1996. Prices for all equipment
purchased by Sprint are fixed for the term. The equipment
carries a five-year

12



---



##### Table of Contents





Competition

The markets for telecommunications equipment and software are
intensely competitive. Our products integrate key functionality
traditionally found in six distinct market segments: the WAN
access equipment market; the network test and analysis market;
the market for operational support systems, or OSSs; the market
for client-based network management and Internet infrastructure
testbeds; the Web hosting performance and management market; and
the root-cause fault management market. We believe that our
products are the only systems that integrate functional
attributes from all these market segments to cost-effectively
provide WAN service level management. Because of the size and
growth opportunity associated with the WAN service level
management market, we expect to encounter increased competition
from current and potential participants in each of these
segments. Increased competition may result in price reductions,
reduced profitability and loss of market share, any of which
would have a material adverse effect on our business, financial
condition and results of operations.

WAN access equipment. The WAN access equipment market is
highly fragmented. Leading vendors in this segment include ADC
Telecommunications, Paradyne and Adtran. These companies may
partner with companies offering network test and analysis
products in order to compete in the WAN service level management
market. We are aware of such an arrangement between Paradyne and
NetScout Systems. Internetworking providers, like Cisco Systems,
may integrate WAN access functionality with routers, which may
adversely affect Visual UpTimes cost justification.

Network test and analysis. An essential element of a WAN
service level management system is technology and expertise
associated with network test and analysis. Products in this
market include portable and distributed protocol analyzers and
transmission test instruments. The major suppliers in this
market segment are Network Associates, Agilent Technologies,
Acterna and NetScout.

Telecommunications operational support systems. OSSs
encompass all of the systems related to service deployment
including provisioning systems, billing systems,
trouble-ticketing systems, and fault and performance management
systems. Historically, OSSs have been developed by the
in-house staffs of the service providers and have sometimes been
a source of competitive advantage to service providers. Visual
UpTime provides a significant portion of the functionality that
might otherwise be found in a fault and performance management
system for statistically multiplexed WAN services. However, in
some cases, a service provider may consider in-house development
as an alternative to deployment of Visual UpTime.

Client-based network management and Internet infrastructure
test-beds. An emerging trend in network management is
increased emphasis on visibility of actual user experience.
Installing clients on end user desktops is a particularly
effective way to gather this type of data. This technology can
be deployed either as a service offering using simulated
desktops or sold as standalone software. Major suppliers of
standalone software include Lucent Technologies, Ganymede
Software, First Sense Software, Jyra Research and NextPoint
Networks. Major suppliers of service based solutions include
Keynote Software, Freshwater Software, Exodus Communications and
MDIS Group.

Application hosting performance and management. With the
increased importance of Web sites, Web applications, and their
underlying infrastructure, comes competition from companies in
surrounding industries. There are a wide variety of solutions in
the market offered as either stand alone products, out-sourced
services, or both. Major competitors in this market space are
Mercury Interactive, Keynote and Freshwater Software. Though the
current market is highly fragmented, we expect near term
consolidation of point product companies leaving those companies
who offer full end-to-end solutions as the market leaders.

Root-cause fault management. Root-cause fault management
competition comes from system management companies that have
added root-cause fault management capability to their product
portfolio and root-cause fault management companies who have
entered into partnership arrangements with system management

13



---



##### Table of Contents





We intend to compete by offering superior features, performance,
reliability and flexibility at competitive prices. We also
intend to compete on the strength of our relationships with
service providers. As competition in the WAN service level
management market intensifies, we believe that the industry may
be characterized by price competition similar to that present in
the broader networking market. In response to competitive
trends, we expect to continue to reduce the cost of our systems
in order to avoid a deterioration of gross margins.

Manufacturing

We have moved to a predominately out-sourced manufacturing model
in order to achieve significant scalability. We are ISO 9001
certified for design, development and manufacturing of WAN
Service Management Systems (hardware and software) in our
Rockville, Maryland facility. We have not experienced any
significant delays or material unanticipated costs resulting
from the use of subcontractors; however, such a strategy
involves certain risks, including the potential absence of
adequate capacity and reduced control over delivery schedules,
manufacturing yields, quality and costs. Although we attempt to
maintain appropriate back-up suppliers, in the event that any
significant subcontractor was to become unable or unwilling to
continue to manufacture and/or test our products in required
volumes, we would have to identify and qualify acceptable
replacements. This qualification process could be lengthy and no
assurance could be given that any additional sources would
become available to us on a timely basis. A delay or reduction
in component shipments, or a delay or increase in costs in the
assembly and testing of products by third party subcontractors,
could materially and adversely affect our business, financial
condition and results of operations.

Although we generally use standard parts and components for our
products, several key components are currently purchased only
from sole, single or limited sources. Any interruption in the
supply of these components or the inability to procure these
components from alternate sources at acceptable prices and
within a reasonable time could have a material adverse effect
upon our business, financial condition and results of operations.

Patents and Other Intellectual Property Rights

We presently have four patents in the United States: (i) a
Method and Apparatus for Non-Intrusive Measurement of
Round Trip Delay in Communications Networks, which expires
in May 2015; (ii) a Method and Apparatus for
Measurement of Peak Throughput in Packetized Data
Networks, which expires in November 2016;
(iii) a Method and Apparatus for Performing Service
Level Analysis of Communications Network Performance
Metrics, which expires in November 2018; and
(iv) a Method and Apparatus for Performing In-Service
Quality of Service Testing, which expires in
December 2017. We also have a number of patent applications
pending in the United States and our key foreign markets. No
assurance can be given that competitors will not successfully
challenge the validity or scope of our patents or that such
patents will provide a competitive advantage to us.

We expect that software and communications product developers
will increasingly be subject to claims of infringement of
patents as the number of products and competitors in our
industry segment grows and the functionality of products in the
industry segment overlaps. We are not aware that any of our
products infringe the property rights of third parties. We have
pending patent litigation including allegations that two of our
patents infringe those of System Management ARTS (see
Item 3 below). There can be no assurance, however, that
additional third parties will not claim infringement by us with
respect to current or future products. Any claims, with or
without merit, could result in costly litigation that could
absorb significant management time, which could have a material
adverse effect on our business, financial condition and results
of operations. These claims might require us to enter into
license or royalty agreements. License or royalty

14



---



##### Table of Contents





As part of our confidentiality procedures, we generally enter
into non-disclosure agreements with our employees, business
partners and customers with respect to our software,
documentation and other proprietary information. Despite these
precautions, it may be possible for a third party to copy or
otherwise obtain and use our products or technology without
authorization, or to develop similar technology independently.
Policing unauthorized use of our products is difficult.
Effective protection of intellectual property rights is
unavailable or limited in certain foreign countries. There can
be no assurance that protection of our proprietary rights will
be adequate or that our competitors will not independently
develop similar technology, duplicate our products or design
around any of our patents or other intellectual rights.

Employees

As of December 31, 2000, we had 325 full-time employees,
including 98 in product development, 108 in sales, 15 in
marketing, 11 in manufacturing, 33 in customer service and 60 in
finance, centralized services and administration.

Our future success will depend in significant part on the
continued service of our key technical, sales and senior
management personnel. Competition for such personnel is intense
and there can be no assurance that we can retain our key
managerial, sales and technical employees, or that we can
attract, assimilate or retain other highly qualified technical,
sales and managerial personnel in the future. None of our
employees are represented by a labor union. We have not
experienced any work stoppages and consider our relations with
our employees to be good.




Item  2.  Properties.

Our principal administrative, sales and marketing, research and
development and customer support facilities are located in
approximately 75,000 square feet of office space in Rockville,
Maryland, that we occupy under leases that expire in
December 2006. We also occupy approximately 32,000 square
feet of space in Sunnyvale, California under a sublease that
expires in July 2003, approximately 34,000 square feet of
space in New York, New York under a lease that expires in
June 2008, and 2,021 square feet of space in Ottawa, Canada
under a lease that expires in May 2001. By June 30,
2001, we intend to sublease a portion of the office space that
we lease in Maryland, and we intend to exit the facility in
California and a portion of our leased space in New York because
our revised strategic focus and reorganization reduced the need
for office space.




Item  3.  Legal Proceedings.

In July, August and September 2000, several purported class
action complaints were filed against us, Scott E. Stouffer, our
Chairman and CEO, and Michael Watters, our former Chief
Operating Officer, in the United States District Court for the
District of Maryland. The complaints allege that between
February 7, 2000 and August 23, 2000, the defendants
made false and misleading statements which had the effect of
inflating the market price of our stock, in violation of
Sections 10(b) and 20(a) of the Securities Exchange Act of
1934. The complaints do not specify the amount of damages
sought. We believe that the plaintiffs claims are without
merit and intend to defend these cases vigorously. We expect
that a substantial portion of the legal costs that we might
incur related to this matter will be paid by our directors
and officers insurance policy. We cannot presently
determine the ultimate outcome of this action. A negative
outcome could have a material adverse effect on our financial
position or results of operations. Failure to prevail in the
litigation could result in, among other things, the payment of
substantial monetary or punitive damages.

In October 1997, a lawsuit was filed by System Management
ARTS against Avesta and one of its employees alleging
infringement of two patents, unfair competition, breach of
contract and interference with contractual relations resulting
in unjust enrichment. Avesta answered the complaint, denying all
allegations, and also asserted counterclaims against the
plaintiff for patent misuse, unfair competition and interference
with business and patent invalidity. The plaintiff has since
dropped one of the patents from the lawsuit and certain of
Avestas counterclaims have been dismissed. Avestas
counterclaims currently seek a declaratory

15



---



##### Table of Contents








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

None.




PART II




Item  5.  Market for Our Common Stock and
Related Stockholder Matters.

Our common stock is traded on the Nasdaq National Market under
the symbol VNWK. The following table sets forth, for
the indicated periods, the range of high and low closing per
share sales prices for the common stock as reported on the
Nasdaq National Market.

|               |  |      |       |     |  |   |       | 
|-------------- |  | ---- | ----- | --- |  | - | ----- | 
|               |  | High |       | Low
|               |  |      |       |    
|1999           |  |      |       |     |  |   |       | 
|               |  |      |       |     |  |   |       | 
|First Quarter  |  | $    | 43.50 |     |  | $ | 31.50 | 
|              
|              
|              
|              
|Second Quarter |  |      | 39.50 |     |  |   | 26.25 | 
|              
|              
|              
|              
|Third Quarter  |  |      | 44.50 |     |  |   | 31.00 | 
|              
|              
|              
|              
|Fourth Quarter |  |      | 80.00 |     |  |   | 32.25 | 
|              
|              
|              
|              
|2000           |  |      |       |     |  |   |       | 
|               |  |      |       |     |  |   |       | 
|First Quarter  |  | $    | 83.50 |     |  | $ | 50.31 | 
|              
|              
|              
|              
|Second Quarter |  |      | 60.50 |     |  |   | 24.31 | 
|              
|              
|              
|              
|Third Quarter  |  |      | 26.75 |     |  |   | 5.88  | 
|              
|              
|              
|              
|Fourth Quarter |  |      | 6.94  |     |  |   | 2.03  | 
|              
|              
|              
|              
|2001           |  |      |       |     |  |   |       | 
|               |  |      |       |     |  |   |       | 
|First Quarter  |  | $    | 6.53  |     |  | $ | 2.50  | 

On April 6, 2001, the last reported sale price of our
common stock was $3.375 per share. As of March 31,
2001, we had approximately 454 stockholders of record.

We have never paid or declared any cash dividends on our common
stock. It is our present policy to retain earnings to finance
the growth and development of the business and, therefore, we do
not anticipate declaring or paying cash dividends on our common
stock in the foreseeable future. In addition, our credit
facility with Silicon Valley Bank prohibits us from paying cash
dividends without the Banks consent. See Note 2 of Notes
to Consolidated Financial Statements.

16



---



##### Table of Contents






Item  6.  Selected Consolidated Financial
Data.

The selected consolidated financial data below should be read in
conjunction with Managements Discussion and Analysis
of Financial Condition and Results of Operations and the
consolidated financial statements, notes thereto and other
financial information included elsewhere in this Form 10-K.
The selected consolidated financial data as of and for the years
ended December 31, 1998, 1999 and 2000, are derived from our
consolidated financial statements which have been audited by
Arthur Andersen LLP, independent public accountants. The
selected consolidated financial data for the years ended
December 31, 1996 and 1997, are derived from audited
consolidated financial statements not included in this
Form 10-K.

|                                                      |                                                    |                                       |         |       |        |      |         |        |        |      |        |        |        |   |        |        |        |   |          |         |         | 
|----------------------------------------------------- | -------------------------------------------------- | ------------------------------------- | ------- | ----- | ------ | ---- | ------- | ------ | ------ | ---- | ------ | ------ | ------ | - | ------ | ------ | ------ | - | -------- | ------- | ------- | 
|                                                      |                                                    |                                      
|                                                      |                                                    | Years Ended December 31,             
|                                                      |                                                    |                                      
|                                                      |                                                    | 1996                                  |         | 1997  |        | 1998 |         | 1999   |        | 2000
|                                                      |                                                    |                                       |         |       |        |      |         |        |        |     
|                                                      |                                                    |                                      
|                                                      |                                                    | (in thousands, except per share data)
|                                                     
|                                                     
|                                                     
|                                                     
|Consolidated Statement of Operations Data:            |                                                    |                                       |         |       |        |      |         |        |        |      |        |        |        |   |        |        |        |   |          |        
|                                                     
|                                                     
|                                                     
|                                                     
|Revenue                                               |                                                    | $                                     | 8,762   |       |        | $    | 29,300  |        |        | $    | 56,088 |        |        | $ | 91,719 |        |        | $ | 89,041   |        
|                                                     
|                                                     
|                                                     
|                                                     
|Cost of revenue                                       |                                                    |                                       | 3,715   |       |        |      | 11,179  |        |        |      | 20,829 |        |        |   | 30,888 |        |        |   | 32,515   |        
|                                                      |                                                    |                                       |         |       |        |      |         |        |        |      |        |        |        |   |        |        |        |   |          |        
|                                                      | Gross profit                                       |                                       |         | 5,047 |        |      |         | 18,121 |        |      |        | 35,259 |        |   |        | 60,831 |        |   |          | 56,526  |        
|                                                      |                                                    |                                       |         |       |        |      |         |        |        |      |        |        |        |   |        |        |        |   |          |        
|Operating expenses:                                   |                                                    |                                       |         |       |        |      |         |        |        |      |        |        |        |   |        |        |        |   |          |        
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Research and development                           |                                       |         | 5,880 |        |      |         | 9,148  |        |      |        | 13,771 |        |   |        | 16,677 |        |   |          | 27,277  |        
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Write-off of purchased research and development(1) |                                       |         |      |        |      |         |       |        |      |        |       |        |   |        |       |        |   |          | 39,000  |        
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Sales and marketing                                |                                       |         | 9,605 |        |      |         | 14,555 |        |      |        | 19,759 |        |   |        | 24,447 |        |   |          | 41,907  |        
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | General and administrative                         |                                       |         | 2,281 |        |      |         | 3,798  |        |      |        | 5,528  |        |   |        | 7,928  |        |   |          | 11,247  |        
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Merger-related costs(2)                            |                                       |         |      |        |      |         |       |        |      |        | 4,318  |        |   |        | 6,776  |        |   |          |        |        
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Restructuring and impairment charges(3) (4)        |                                       |         |      |        |      |         |       |        |      |        | 751    |        |   |        |       |        |   |          | 335,810 |        
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Amortization of acquired intangibles(1)            |                                       |         |      |        |      |         |       |        |      |        |       |        |   |        |       |        |   |          | 53,426  |        
|                                                      |                                                    |                                       |         |       |        |      |         |        |        |      |        |        |        |   |        |        |        |   |          |        
|                                                      |                                                    | Total operating expenses              |         |       | 17,766 |      |         |        | 27,501 |      |        |        | 44,127 |   |        |        | 55,828 |   |          |         | 508,667 | 
|                                                      |                                                    |                                       |         |       |        |      |         |        |        |      |        |        |        |   |        |        |        |   |          |        
|Income (loss) from operations                         |                                                    |                                       | (12,719 | )     |        |      | (9,380  | )      |        |      | (8,868 | )      |        |   | 5,003  |        |        |   | (452,141 | )      
|                                                     
|                                                     
|                                                     
|                                                     
|Interest income, net                                  |                                                    |                                       | 217     |       |        |      | 165     |        |        |      | 2,413  |        |        |   | 2,270  |        |        |   | 2,598    |        
|                                                      |                                                    |                                       |         |       |        |      |         |        |        |      |        |        |        |   |        |        |        |   |          |        
|Income (loss) before income taxes                     |                                                    |                                       | (12,502 | )     |        |      | (9,215  | )      |        |      | (6,455 | )      |        |   | 7,273  |        |        |   | (449,543 | )      
|                                                     
|                                                     
|                                                     
|                                                     
|Benefit (provision) for income taxes                  |                                                    |                                       |        |       |        |      |        |        |        |      |       |        |        |   | (3,722 | )      |        |   | 34,058   |        
|                                                      |                                                    |                                       |         |       |        |      |         |        |        |      |        |        |        |   |        |        |        |   |          |        
|Net income (loss)                                     |                                                    |                                       | (12,502 | )     |        |      | (9,215  | )      |        |      | (6,455 | )      |        |   | 3,551  |        |        |   | (415,485 | )      
|                                                     
|                                                     
|                                                     
|                                                     
|Dividends and accretion on preferred stock            |                                                    |                                       | (1,012  | )     |        |      | (1,457  | )      |        |      | (171   | )      |        |   |       |        |        |   |         |        
|                                                      |                                                    |                                       |         |       |        |      |         |        |        |      |        |        |        |   |        |        |        |   |          |        
|Net income (loss) attributable to common stockholders |                                                    | $                                     | (13,514 | )     |        | $    | (10,672 | )      |        | $    | (6,626 | )      |        | $ | 3,551  |        |        | $ | (415,485 | )      
|                                                      |                                                    |                                       |         |       |        |      |         |        |        |      |        |        |        |   |        |        |        |   |          |        
|Basic income (loss) per share                         |                                                    | $                                     | (2.36   | )     |        | $    | (1.44   | )      |        | $    | (0.30  | )      |        | $ | 0.14   |        |        | $ | (14.46   | )      
|                                                      |                                                    |                                       |         |       |        |      |         |        |        |      |        |        |        |   |        |        |        |   |          |        
|Diluted income (loss) per share                       |                                                    | $                                     | (2.36   | )     |        | $    | (1.44   | )      |        | $    | (0.30  | )      |        | $ | 0.13   |        |        | $ | (14.46   | )      
|                                                      |                                                    |                                       |         |       |        |      |         |        |        |      |        |        |        |   |        |        |        |   |          |        
|Basic weighted-average shares(5)                      |                                                    |                                       | 5,715   |       |        |      | 7,431   |        |        |      | 21,946 |        |        |   | 24,583 |        |        |   | 28,733   |        
|                                                      |                                                    |                                       |         |       |        |      |         |        |        |      |        |        |        |   |        |        |        |   |          |        
|Diluted weighted-average shares(5)                    |                                                    |                                       | 5,715   |       |        |      | 7,431   |        |        |      | 21,946 |        |        |   | 26,547 |        |        |   | 28,733   |        
|                                                      |                                                    |                                       |         |       |        |      |         |        |        |      |        |        |        |   |        |        |        |   |          |        
|Consolidated Balance Sheet Data:                      |                                                    |                                       |         |       |        |      |         |        |        |      |        |        |        |   |        |        |        |   |          |        
|                                                     
|                                                     
|                                                     
|                                                     
|Cash and cash equivalents                             |                                                    | $                                     | 7,551   |       |        | $    | 9,601   |        |        | $    | 51,655 |        |        | $ | 54,629 |        |        | $ | 17,369   |        
|                                                     
|                                                     
|                                                     
|                                                     
|Working capital                                       |                                                    |                                       | 3,458   |       |        |      | (782    | )      |        |      | 43,146 |        |        |   | 50,353 |        |        |   | (2,482   | )      
|                                                     
|                                                     
|                                                     
|                                                     
|Total assets                                          |                                                    |                                       | 13,253  |       |        |      | 21,036  |        |        |      | 71,780 |        |        |   | 83,154 |        |        |   | 70,664   |        
|                                                     
|                                                     
|                                                     
|                                                     
|Long-term debt, net of current portion                |                                                    |                                       | 286     |       |        |      | 138     |        |        |      | 1,011  |        |        |   | 782    |        |        |   | 243      |        
|                                                     
|                                                     
|                                                     
|                                                     
|Redeemable convertible preferred stock                |                                                    |                                       | 13,398  |       |        |      | 14,855  |        |        |      |       |        |        |   |       |        |        |   |         |        
|                                                     
|                                                     
|                                                     
|                                                     
|Stockholders equity (deficit)                        |                                                    |                                       | (8,563  | )     |        |      | (13,251 | )      |        |      | 48,322 |        |        |   | 58,252 |        |        |   | 26,085   |        




|    |                                                                                                                                                                                                                                                                                                                                                                                                                         
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | In 2000, we acquired Avesta in a purchase business combination.
	The purchase price allocation included $39.0 million of
	in-process technology which was expensed as of the acquisition
	date. The amortization of acquired intangibles in 2000 relates
	to goodwill and other intangible assets recorded in connection
	with the Avesta acquisition. See Notes 1 and 6 of Notes to
	Consolidated Financial Statements.
|   
|(2) | During 1998, we incurred certain merger-related costs in
	connection with our acquisition of Net2Net. During 1999, we
	incurred certain merger-related costs in connection with our
	acquisition of Inverse. See Note 1 of Notes to Consolidated
	Financial Statements.                                                                                                                                                 

17



---



##### Table of Contents





|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(3) | In 2000, we recorded a restructuring charge that consisted
	primarily of severance and other termination benefits related to
	a workforce reduction and lease costs and related leasehold
	improvement write-offs related to the closure of certain
	facilities. In 1998, we recorded a restructuring charge related
	to the consolidation of certain functions and the
	discontinuation of certain product development efforts. See
	Notes 1 and 7 of Notes to Consolidated Financial Statements.
|   
|(4) | In 2000, we recorded an impairment charge of $328.8 million
	for the write-off of goodwill and other intangibles related to
	the acquisition of Avesta. See Notes 1, 6 and 7 of Notes to
	Consolidated Financial Statements.                                                                                                                                                                                                                                                                      
|   
|(5) | For an explanation of the determination of the weighted-average
	number of shares used in computing income (loss) per share
	amounts, see Note 1 of Notes to Consolidated Financial
	Statements.                                                                                                                                                                                                                                                                                                  




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

The following discussion of our financial condition and results
of operations should be read in conjunction with our
consolidated financial statements, the related notes thereto,
and other financial information included elsewhere in this
Form 10-K. References to we, us or
our refer to Visual Networks, Inc. on a consolidated
basis unless the context suggests otherwise.

Overview

From our incorporation in August 1993 through
December 1996, our principal objective was to secure
sufficient equity financing to enable us to accelerate product
development efforts of Visual UpTime for frame relay deployment
and to develop sales and marketing functions and general and
administrative infrastructure. Visual UpTime was first shipped
in mid-1995. We began generating significant revenue from sales
of Visual UpTime during 1996. In August 1996, we entered
into a master reseller agreement with Sprint, resulting in our
products being sold through Sprint to subscribers. In
October 1997, we entered into a similar master reseller
agreement with WorldCom, which also resulted in our shipping of
products through WorldCom to subscribers. In December 1997,
we entered into an agreement with AT&T, which provides for
the sale of our products to AT&T for deployment as part of
AT&Ts infrastructure. During 1998, 1999 and 2000, we
continued to focus on selling Visual UpTime, and added the
following products to our product portfolio as a result of a
series of acquisitions  the Cell Tracer product in
1998; the Inverse products, Visual IP InSight and Visual
Internet Benchmark, in 1999; and the Avesta products, Visual
Trinity and Visual eWatcher, in 2000.

On May 15, 1998, we acquired Net2Net in a merger accounted
for as a pooling of interests. On September 30, 1999, we
acquired Inverse in a merger accounted for as a pooling of
interests. See Note 1 of Notes to Consolidated Financial
Statements. On May 24, 2000, we acquired Avesta in a merger
accounted for using the purchase method of accounting. See
Notes 1 and 6 of Notes to Consolidated Financial Statements.

We realize revenue from sales of hardware, software, benchmark
services, professional services and technical support. We
generally recognize revenue from the sale or license of our
products upon delivery of the product and passage of title to
the customer. Where the agreements provide for evaluation or
customer acceptance, we recognize revenue upon the completion of
the evaluation process and acceptance of the product by the
customer. Maintenance contracts call for us to provide technical
support and software updates to customers. We recognize
maintenance revenue, including maintenance revenue that is
bundled with product sales, ratably over the term of the
maintenance contracts, which currently range from one to five
years. Revenue recognized from multiple-element software
arrangements is allocated to each element of the arrangement
based on the relative fair values of the elements. The fair
values of professional services, technical support and training
have been determined based on the Companys specific
objective evidence of fair value. Revenue from services is
recognized when the services are performed. Subscription fees
for our benchmark reports are deferred and recognized upon
delivery of the reports. We currently contract with third party
subcontract manufacturers for most of the assembly, testing and
shipping of our products. We anticipate maintaining a portion of
our internal manufacturing function for the foreseeable future
at our Rockville, Maryland facility.

18



---



##### Table of Contents



Recent Developments

Our revenue decreased from 1999 while our operating expenses
increased resulting in significant losses from operations. With
the acquisition of Avesta, we allowed our business strategy to
become less focused, which increased the complexity of our
business and adversely affected our results of operations. In an
attempt to refocus our efforts, we announced a plan in the
fourth quarter of 2000 to realign our product portfolio,
streamline our operations and devote resources to the markets
and products that offer us the greatest growth opportunities.

We believe that our comprehensive plan will strengthen our
business by:



| |   |                                                                                                                                           
| | - | ------------------------------------------------------------------------------------------------------------------------------------------
| |  | targeting our product portfolio  Visual UpTime,
	Visual IP InSight, Visual Trinity and Visual eWatcher to
	broadband and Web outsourcing;
|
| |  | strengthening our senior management team; and                                                                                             
|
| |  | concentrating our sales, marketing, research and product
	development initiatives around service providers and their
	end-user customers. 

As a result of these initiatives, we are:



| |   |                                                                                                                                                                                                                        
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | consolidating our four research and development centers into two
	main centers in Rockville, Maryland and New York, New York;                                                                                          
|
| |  | searching for a president and other executives to focus on
	day-to-day execution; and                                                                                                                                  
|
| |  | reducing our workforce by approximately 140 employees, closing
	our facilities in Ottawa, Canada and Sunnyvale, California, and
	reducing the size of our facilities in Rockville, Maryland and
	in New York, New York.

In connection with this plan, we recorded a restructuring charge
of $7.0 million in the fourth quarter of 2000. The failure
to successfully implement our plans in a timely manner or
achieve the anticipated reductions in operating expenses derived
from any portion of our plan would have a material adverse
effect on our business, financial condition and results of
operations. We anticipate that our plan will be fully executed
by the end of 2001.

By adding Avestas fault management and applications
monitoring capabilities to our product portfolio in
May 2000 and offering these products to our traditional
service provider customer base, we expected to be able to
respond to the trend among companies to outsource their networks
and applications to service providers. The expanded product
portfolio gives customers the ability to manage real-time and
historical availability and performance on an end-to-end basis
across all service definitions, from base transport services
through and including hosted applications services. The
acquisition also expanded our market opportunity to include
large IT organizations as well as the emerging applications
service provider market. However, despite the addition of these
new products and the introduction of new markets, we did not,
and we do not currently expect to experience the growth in
revenue that we had anticipated at the time of the Avesta
acquisition.

Our historical trend of increasing revenue each quarter began to
reverse with a modest decrease in revenue to $28.6 million
in the second quarter from $30.5 million in the first
quarter. During the third and fourth quarters of 2000, however,
revenue decreased significantly to $14.6 million and
$15.3 million, respectively. These revenue decreases were
due to lower than expected revenue related to the Visual Trinity
and Visual eWatcher products (the products added through the
Avesta acquisition) as well as decreases in the revenue provided
by our other products. Despite these revenue decreases, our
operating expenses increased significantly in the corresponding
periods due, in large part, to the addition of the Avesta
operations. In response to these trends and as discussed above,
we initiated a restructuring plan in the fourth quarter to
realign our product portfolio and streamline our operations.

Due to the significance of these developments, we performed an
evaluation of the recoverability of our long-lived assets in
accordance with SFAS No. 121, including those assets
related to the Avesta acquisition. Based upon this evaluation,
we concluded that the remaining values of the goodwill and other
intangible assets

19



---



##### Table of Contents





Results of Operations

The following table presents certain consolidated statement of
operations data as a percentage of our revenue:

|                                      |                                                 |                          |       |      |      |      |       |      |      |  |        |       |       | 
|------------------------------------- | ----------------------------------------------- | ------------------------ | ----- | ---- | ---- | ---- | ----- | ---- | ---- |  | ------ | ----- | ----- | 
|                                      |                                                 |                         
|                                      |                                                 | Years Ended December 31,
|                                      |                                                 |                         
|                                      |                                                 | 1998                     |       | 1999 |      | 2000
|                                      |                                                 |                          |       |      |      |     
|Revenue                               |                                                 |                          | 100.0 | %    |      |      | 100.0 | %    |      |  | 100.0  | %    
|                                     
|                                     
|                                     
|                                     
|Cost of revenue                       |                                                 |                          | 37.1  |      |      |      | 33.7  |      |      |  | 36.5   |      
|                                      |                                                 |                          |       |      |      |      |       |      |      |  |        |      
|                                      | Gross profit                                    |                          |       | 62.9 |      |      |       | 66.3 |      |  |        | 63.5  |      
|                                      |                                                 |                          |       |      |      |      |       |      |      |  |        |      
|Operating expenses:                   |                                                 |                          |       |      |      |      |       |      |      |  |        |      
|                                     
|                                     
|                                     
|                                     
|                                      | Research and development                        |                          |       | 24.6 |      |      |       | 18.2 |      |  |        | 30.6  |      
|                                     
|                                     
|                                     
|                                     
|                                      | Write-off of purchased research and development |                          |       |     |      |      |       |     |      |  |        | 43.8  |      
|                                     
|                                     
|                                     
|                                     
|                                      | Sales and marketing                             |                          |       | 35.2 |      |      |       | 26.7 |      |  |        | 47.1  |      
|                                     
|                                     
|                                     
|                                     
|                                      | General and administrative                      |                          |       | 9.9  |      |      |       | 8.6  |      |  |        | 12.6  |      
|                                     
|                                     
|                                     
|                                     
|                                      | Merger-related costs                            |                          |       | 7.7  |      |      |       | 7.3  |      |  |        |      |      
|                                     
|                                     
|                                     
|                                     
|                                      | Restructuring and impairment charges            |                          |       | 1.3  |      |      |       |     |      |  |        | 377.2 |      
|                                     
|                                     
|                                     
|                                     
|                                      | Amortization of goodwill and other intangibles  |                          |       |     |      |      |       |     |      |  |        | 60.0  |      
|                                      |                                                 |                          |       |      |      |      |       |      |      |  |        |      
|                                      |                                                 | Total operating expenses |       |      | 78.7 |      |       |      | 60.8 |  |        |       | 571.3 | 
|                                      |                                                 |                          |       |      |      |      |       |      |      |  |        |      
|Income (loss) from operations         |                                                 |                          | (15.8 | )    |      |      | 5.5   |      |      |  | (507.8 | )    
|                                     
|                                     
|                                     
|                                     
|Interest income, net                  |                                                 |                          | 4.3   |      |      |      | 2.4   |      |      |  | 2.9    |      
|                                      |                                                 |                          |       |      |      |      |       |      |      |  |        |      
|Net income (loss) before income taxes |                                                 |                          | (11.5 | )    |      |      | 7.9   |      |      |  | (504.9 | )    
|                                     
|                                     
|                                     
|                                     
|Benefit (provision) for income taxes  |                                                 |                          |      |      |      |      | (4.0  | )    |      |  | 38.3   |      
|                                      |                                                 |                          |       |      |      |      |       |      |      |  |        |      
|Net income (loss)                     |                                                 |                          | (11.5 | )%   |      |      | 3.9   | %    |      |  | (466.6 | )%   
|                                      |                                                 |                          |       |      |      |      |       |      |      |  |        |      

The following table presents the revenue by product (in
thousands):

|                              |               |                          |        |        |  |      |        |        |  |   |        |        | 
|----------------------------- | ------------- | ------------------------ | ------ | ------ |  | ---- | ------ | ------ |  | - | ------ | ------ | 
|                              |               |                         
|                              |               | Years Ended December 31,
|                              |               |                         
|                              |               | 1998                     |        | 1999   |  | 2000
|                              |               |                          |        |        |  |     
|Visual UpTime and Cell Tracer |               | $                        | 50,883 |        |  | $    | 84,546 |        |  | $ | 67,700 |       
|                             
|                             
|                             
|                             
|Visual IP InSight             |               |                          | 1,913  |        |  |      | 4,557  |        |  |   | 9,466  |       
|                             
|                             
|                             
|                             
|Visual Internet Benchmark     |               |                          | 3,292  |        |  |      | 2,616  |        |  |   | 4,607  |       
|                             
|                             
|                             
|                             
|Visual Trinity and eWatcher   |               |                          |       |        |  |      |       |        |  |   | 7,268  |       
|                              |               |                          |        |        |  |      |        |        |  |   |        |       
|                              | Total revenue |                          | $      | 56,088 |  |      | $      | 91,719 |  |   | $      | 89,041 | 
|                              |               |                          |        |        |  |      |        |        |  |   |        |       

2000 Compared with 1999

Revenue. We recognized $89.0 million in revenue for
2000, a 2.9% decrease from revenue of $91.7 million for
1999. The decline was due primarily to a decrease in Visual
UpTime revenue of $16.8 million, primarily from service
providers, offset by increases in revenue related to Visual IP
InSight and Visual Internet Benchmark and the effect of the
acquisition of the Avesta Trinity and eWatcher products. The
decrease in sales of Visual UpTime was primarily attributable to
a change in purchasing behavior of two major

20



---



##### Table of Contents





Gross profit. Cost of revenue consists of subcontracting
costs, component parts, direct compensation costs, communication
costs, warranty and other contractual obligations, royalties,
license fees and other overhead expenses related to
manufacturing operations and to support our software products
and benchmark services. Gross profit was $56.5 million for
2000, as compared to $60.8 million for 1999, a decrease of
$4.3 million. Gross margin was 63.5% of revenue for 2000,
as compared to 66.3% of revenue for 1999. The decrease in gross
margin percentage was due primarily to higher fixed costs
supporting a lower revenue base and approximately
$1.9 million in inventory write-downs offset, in part, by
the addition of higher-margin software sales of Trinity and
eWatcher. Our future gross margins may be affected by a number
of factors, including product mix, the proportion of sales to
service providers, competitive pricing, manufacturing volumes
and an increase in the cost of component parts.

Research and development expense. Research and
development expense consists of compensation for research and
development staff, depreciation of test and development
equipment, certain software development costs and costs of
prototype materials. Research and development expense was
$27.3 million for 2000 as compared to $16.7 million
for 1999, an increase of $10.6 million. The increase in
research and development expense was due primarily to the costs
of the Avesta research and development staff subsequent to the
date of acquisition, increased staffing levels and related
support costs, and purchases of materials and services used in
the development of new or enhanced products. Research and
development expense was 30.6% and 18.2% of revenue for 2000 and
1999, respectively. We expect that research and development
expenditures may decrease in absolute dollars during 2001 as a
result of our reduction in workforce and office space, and may
decrease as a percentage of revenue during 2001 and thereafter.

Write-off of purchased research and development. A
write-off of purchased research and development costs of
$39.0 million was recorded in 2000. We recorded this
expense in the second quarter of 2000 in connection with the
acquisition of Avesta. At the date of acquisition, Avesta had
in-process technology which represented research and development
projects of Avesta that had not reached technological
feasibility and that had no alternative future use in research
and development activities or otherwise. Amounts assigned to
in-process research and development (IPR&D)
meeting the above criteria must be charged to expense at the
date of consummation of the purchase business combination.

The evaluated projects were future releases of the Trinity,
eWatcher and other products. The products in process included
both upgrades to existing products as well as major
modifications for future releases. Additional products that had
been started but not yet assigned a numerical designation and
were considered to be only 1% complete were excluded from the
evaluation. The Trinity related projects represented the
majority of the value assigned to the IPR&D projects. We
valued the acquired IPR&D based upon an independent
appraisal of the projects under development. The values of the
IPR&D projects were determined by estimating the future cash
flows from the projects, once commercially feasible, discounting
the net cash flows back to their present values and then
applying a percentage of completion to the calculated values to
reflect the uncertainty of technical success of the projects.
The rates used to discount the net cash flows to their present
values were based on Avestas weighted average cost of
capital. The percentage of completion was based on
managements estimates of the amount of resources spent to
date and on the expected use of future resources.

As of the valuation date, Avesta was offering version 1.3
of the Trinity product. Versions 2.0, 2.1 and 3.0 were
considered IPR&D projects and were estimated to be 95%, 15%
and 5% complete, respectively. The eWatcher product had been
acquired by Avesta in 1998 and versions 2.0 and 2.5 were
considered IPR&D projects and were estimated to be 25% and
4% complete, respectively. Certain risks and uncertainties are
associated with the completion of the development of these
products within a reasonable projected period of time. Each of
the acquired IPR&D projects had not demonstrated
technological feasibility as of the acquisition date. Failure to
bring these products to market in a timely manner may adversely
affect our future revenue and profitability.

21



---



##### Table of Contents



Sales and marketing expense. Sales and marketing expense
consists of compensation for the sales and marketing staff,
commissions, pre-sales support, travel and entertainment
expense, trade shows and other marketing programs. Sales and
marketing expense was $41.9 million for 2000, as compared
to $24.4 million for 1999, an increase of $17.5 million.
The increase in sales and marketing expense was due primarily to
the costs of Avesta sales and marketing staff and programs
subsequent to the date of acquisition and continued growth in
staffing, commissions and marketing programs. Sales and
marketing expense was 47.1% and 26.7% of revenue for 2000 and
1999, respectively. We expect that sales and marketing
expenditures may decrease in absolute dollars during 2001 as a
result of our reduction in workforce and office space, and may
decrease as a percentage of revenue during 2001 and thereafter.

General and administrative expense. General and
administrative expense consists of the costs of finance,
administration, and general management activities. General and
administrative expense was $11.2 million for 2000 as
compared to $7.9 million for 1999, an increase of
$3.3 million. The increase in general and administrative
expense was due primarily to the additional costs of the Avesta
staff and professional services incurred subsequent to the date
of acquisition and increased staffing, professional services and
corporate facilities and network infrastructure costs. General
and administrative expense was 12.6% and 8.6% of revenue for
2000 and 1999, respectively. We expect that general and
administrative expenditures may decrease in absolute dollars
during 2001 as a result of our reduction in workforce and office
space, and may decrease as a percentage of revenue during 2001
and thereafter.

Restructuring and impairment charges. We recorded a
restructuring charge of $7.0 million in the fourth quarter
of 2000 that consisted primarily of severance and other
termination benefits related to a workforce reduction of
approximately 140 employees and lease costs and leasehold
improvement write-offs related to the closure of facilities in
Ottawa, Canada and Sunnyvale, California and the reduction in
size of our facilities in Rockville, Maryland and New York, New
York. We also recorded an impairment charge of
$328.8 million for the write-off of goodwill and other
intangibles related to the Avesta acquisition (see Note 7
of Notes to Consolidated Financial Statements).

Amortization of acquired intangibles. We recorded
$53.4 million in amortization of goodwill and other
intangibles related to the Avesta acquisition in 2000.

Interest income, net. Interest income, net, for 2000 was
approximately $2.6 million as compared to $2.3 million
for 1999. The increase of $0.3 million was primarily due to
decreased interest expense related to capital leases and other
borrowings.

Income taxes. The benefit for income taxes for 2000 was
$34.1 million. The effective tax rate of 8% differed from
the statutory rates primarily due to the income tax effect of
the Avesta acquisition and increases in the valuation allowance.

Net income (loss). Net loss for 2000 was
$415.5 million as compared to net income for 1999 of
$3.6 million, an increase of $419.1 million. The
decrease was due primarily to decreases in revenue and gross
profit, increased operating expenses, the write-off of purchased
research and development, the amortization of goodwill and other
intangible assets and the restructuring and impairment charges.

1999 Compared with 1998

Revenue. We recognized $91.7 million in revenue for
1999, a 63.5% increase over revenue of $56.1 million for
1998. The increase was due primarily to the continued acceptance
of Visual UpTime, Visual IP InSight and Visual Internet
Benchmark products with an increase in sales to service
providers, particularly AT&T and Sprint. Sales to service
providers accounted for approximately 72% of revenue for 1999 as
compared to approximately 67% for 1998.

22



---



##### Table of Contents



Gross profit. Gross profit was $60.8 million for
1999, as compared to $35.3 million for 1998, an increase of
$25.5 million. Gross margin was 66.3% of revenue for 1999,
as compared to 62.9% of revenue for 1998. The increase in gross
margin percentage was due primarily to product cost reductions
and to product sales mix.

Research and development expense. Research and
development expense was $16.7 million for 1999 as compared
to $13.8 million for 1998, an increase of
$2.9 million. The increase in research and development
expense was due primarily to increased staffing levels and
related support costs, and purchases of materials and services
used in the development of new or enhanced products. Research
and development expense was 18.2% and 24.6% of revenue for 1999
and 1998, respectively.

Sales and marketing expense. Sales and marketing expense
was $24.4 million for 1999, as compared to
$19.8 million for 1998, an increase of $4.6 million.
The increase in sales and marketing expense was due primarily to
increased staffing levels during the year and related
commissions, and marketing programs. Sales and marketing expense
was 26.7% and 35.2% of revenue for 1999 and 1998, respectively.

General and administrative expense. General and
administrative expense was $7.9 million for 1999 as
compared to $5.5 million for 1998, an increase of
$2.4 million. The increase in general and administrative
expense was due primarily to increased staffing levels,
professional services and continued growth in corporate
facilities and network infrastructure. General and
administrative expense was 8.6% and 9.9% of revenue for 1999 and
1998, respectively.

Merger-related costs. In connection with the Inverse
acquisition, we recorded merger-related costs of approximately
$6.8 million. Transaction costs totaled approximately
$6.4 million and consisted primarily of fees for investment
bankers, attorneys, accountants and other direct transaction
costs. The remaining $0.4 million in non-recurring costs
consisted primarily of the write-off of certain assets as a
result of the merger and the accrual of certain employee
benefits to conform the policies of Inverse with our policies.
In connection with the acquisition of Net2Net, we recorded
merger-related costs of approximately $4.3 million.
Transaction costs totaled approximately $4.1 million and
consisted primarily of fees for investment bankers, attorneys,
accountants and other direct transaction costs. Integration
expenses totaled approximately $0.2 million and consisted
of incremental and non-recurring costs necessary to integrate
Visual and Net2Net.

Restructuring charge. We recorded a restructuring charge
of $0.8 million in connection with the acquisition of
Net2Net that related to the consolidation of Visual and
Net2Nets manufacturing, sales, marketing and
administration functions as well as the discontinuance of
certain Net2Net product development efforts.

Interest income, net. Interest income, net, for 1999 was
approximately $2.3 million as compared to $2.4 million
for 1998. The decrease of $0.1 million was primarily due to
the increase in interest expense related to capital leases and
other borrowings.

Income taxes. Income taxes for 1999 were
$3.7 million, reflecting an effective tax rate of 51%. The
effective tax rate differed from statutory rates due to the
effect of certain non-deductible merger-related costs and the
effect of our net operating loss carryforwards.

Net income (loss). Net income for 1999 was
$3.6 million as compared to a net loss of $6.5 million
for 1998, an increase of $10.1 million. The increase was
due primarily to increases in revenue and gross profit, which
offset the increased operating, merger-related expenses and
restructuring costs described above.

Liquidity and Capital Resources

At December 31, 2000, our combined balance of cash and cash
equivalents was $17.4 million as compared to
$54.6 million as of December 31, 1999, a decrease of
$37.2 million. The decrease is primarily attributable to
$16.9 million in cash used in operating activities,
$10.2 million in cash used in connection with the
acquisition of Avesta, $7.6 million in capital
expenditures, $3.9 million in net purchases of investments,
and $2.8 million in net repayments under credit agreements
and capital lease obligations, offset by $4.2 million in
proceeds from the exercise of stock options.

23



---



##### Table of Contents



We require substantial working capital to fund our core
business, particularly to finance inventories, accounts
receivable, research and development activities and capital
expenditures. To date, we have financed our operations and
capital expenditures with the proceeds from our initial public
offering completed in February 1998 and from our income
from operations generated through the first quarter of 2000. We
currently anticipate that capital expenditures for 2001 will not
exceed $4.0 million. Our future capital requirements will
depend on many factors, including the rate of revenue growth, if
any, the timing and extent of spending to support product
development efforts and sales and marketing, the timing of
introductions of new products and enhancements to existing
products and market acceptance of our products.

In addition to our cash, cash equivalents and investments,
another potential source of liquidity is our bank credit
facility. The credit facility, as amended, includes an
asset-based arrangement providing for borrowings up to the
lesser of $10.0 million or 80% of eligible accounts
receivable (as defined in the credit facility) with a maximum of
$5.0 million available for issuing standby letters of
credit, provided that we either maintain a minimum of
$10.0 million cash on deposit with the bank, secure with
cash any outstanding letters of credit, or treat any unsecured
letters of credit as borrowings. This credit facility also
includes an equipment financing arrangement. The credit facility
matures on February 28, 2002 and borrowings under the
credit facility bear interest at prime plus 2%. Borrowings under
the equipment financing agreement cannot be made after
March 31, 2001, are repayable over 36 months and bear
interest at prime plus 2%. The bank credit facility contains
restrictive financial covenants, including, but not limited to,
requirements related to liquidity and operating results as well
as restrictions related to other borrowings, acquisitions,
dispositions of assets, distributions and investments. The
credit facility also provides for certain administrative and
facility fees. As of December 31, 2000, there were no
borrowings outstanding under the bank credit facility. We
borrowed approximately $450,000 under the equipment financing
arrangement in March 2001. In December 2000, our bank issued a
standby letter of credit that expires on March 31, 2002 in
the amount of $5.0 million with us satisfying the minimum
deposit requirement.

We incurred a net loss of $415.5 million in 2000 that
included several significant non-cash charges related to the
acquisition of Avesta, including the write-off of purchased
research and development of $39.0 million, an impairment
charge of $328.8 million related to write-off of goodwill
and other intangibles, and the amortization of goodwill and
other intangibles of $53.4 million. We reported losses from
operations for the second, third and fourth quarters of
$46.6 million, $39.1 million and $373.3 million,
respectively, in 2000. Excluding the non-cash Avesta-related
charges and the $7.0 million restructuring charge recorded
in the fourth quarter, operating income was $1.2 million for the
second quarter of 2000 and operating losses were
$17.2 million and $14.9 million for the third and
fourth quarters, respectively. We generated income from
operations in 1999 and for the quarter ended March 31, 2000.

The deterioration of our operating results in 2000, excluding
the effects of the non-cash Avesta-related charges and the
restructuring charge, was due primarily to decreased revenue and
increased operating expenses. During 2000, revenue decreased
from $30.5 million in the first quarter to
$28.6 million in the second quarter to $14.6 million
in the third quarter. Despite the decline in the level of
quarterly revenue during 2000, our operating expenses, excluding
the non-cash Avesta-related charges, increased from
$14.3 million in the first quarter to $17.9 million in
the second quarter to $24.3 million in the third quarter.
In response to these trends, as discussed above, we initiated a
restructuring plan in the fourth quarter. Revenue increased to
$15.3 million in the fourth quarter of 2000 and the
operating expenses, excluding the non-cash Avesta-related
charges and the restructuring charge, decreased to
$24.0 million in the fourth quarter.

Our ability to generate operating income in the future is, in
large part, dependent upon our success in increasing revenue
over the third and fourth quarter 2000 levels and reducing
operating expenses from the third and fourth quarter 2000
levels. While we believe that our restructuring plan will result
in a growth in revenue, due to market conditions, competitive
pressures and other factors beyond our control, there can be no
assurances that we will be able to adequately increase revenue
in the future. We also believe that our restructuring will
result in a reduction in operating expenses that, when combined
with the anticipated revenue growth, will result in a return to
profitability. In the event that the anticipated cost reductions
are not realized or revenue does not increase, we may be
required to further reduce our cost structure. There can be no
assurance that we will become profitable.

24



---



##### Table of Contents



Our success is also dependent on our ability to generate
adequate cash for operating and capital needs. In 2000, we used
$16.9 million in operating activities and
$21.8 million in investing activities. The cash was used
primarily to fund our operating losses, to purchase property and
equipment and to pay the transaction costs related to the Avesta
acquisition. At December 31, 2000, we had $26.1 million in
cash, cash equivalents and investments. We are relying on our
existing cash, cash equivalents, investments and credit facility
together with future sales and the collection of the related
accounts receivable to meet our future cash requirements. If
cash provided by these sources is not sufficient to fund future
operations, we will be required to further reduce our
expenditures for operations or to seek additional capital
through other means that may include the sale of assets, the
sale of equity securities or additional borrowings. Although we
believe that we have the ability to generate additional cash
through such actions, the results of such actions may be
dilutive. There can be no assurance that additional capital will
be available, or available on terms that are reasonable or
acceptable to us. If we are unable to generate additional cash,
our business and financial condition would be materially and
adversely affected such that we may need to consider other
alternatives for the future of the Company.

Substantially all of our product sales to date have been made to
customers in the United States. We plan to sell our products to
foreign customers at prices denominated in U.S. dollars.
However, if we commence selling material volumes of product to
such customers at prices not denominated in U.S. dollars, we
intend to adopt a strategy to hedge against fluctuations in
foreign currency.

Risk Factors

In addition to the other information provided or incorporated by
reference in this document, stockholders should also consider
the following factors carefully in evaluating whether to make an
investment decision. Stockholders should also refer to the
section entitled Forward Looking Statements.

We have a history of losses and an accumulated deficit and we
may not be profitable in the future.

Our limited history, operating losses and accumulated deficit
make predicting our future operating results difficult. Our
company was organized in 1993 and we introduced Visual UpTime in
mid-1995. Accordingly, we have only a limited operating history
upon which an evaluation of our product and prospects can be
based. As of December 31, 2000, we had an accumulated
deficit of approximately $446.9 million. Although we
reported net income of $3.6 million for 1999, we incurred a
substantial consolidated net loss in the year ended
December 31, 2000 of approximately $415.5 million. The
loss in 2000 related to the year-end write-down of impaired
intangible assets recorded in the Avesta acquisition, the
write-off of purchased research and development related to the
Avesta acquisition, the amortization of the acquired intangibles
including goodwill prior to the write-down, the restructuring
charge recorded in the fourth quarter as well as reduced revenue
and increased operating expenses. We also experienced a loss of
$6.5 million in 1998. The loss in 1998 related primarily to the
effect of merger-related and restructuring costs and the effect
of the Net2Net and Inverse operating losses prior to the
respective dates of acquisition.

Failure to successfully implement our new business strategic
initiatives will harm our future business prospects.

During 2000, we allowed our business strategy to become less
focused, which increased the complexity of our business and
adversely affected our results of operations. In an attempt to
refocus our efforts, we adopted the comprehensive plan described
above. The failure to successfully implement our new strategy in
a timely manner or achieve the anticipated reductions in
operating expenses derived from any portion of our plan would
have a material adverse effect on our business, financial
condition and results of operations. We anticipate that these
plans will be fully executed by the end of 2001.

Failure of broadband access services to achieve significant
market penetration could impact the effectiveness of our new
strategic business initiatives.

Part of the new strategic business initiatives is to provide
comprehensive service management for new world networks running
over broadband access facilities such as DSL, fixed wireless,
and cable. There is no

25



---



##### Table of Contents





Failure to achieve expected revenue levels may adversely
affect future operating results.

Our revenue in any period depends primarily on the volume and
timing of orders received during the period, which are difficult
to predict. Our expense levels are based, in part, on the
expectation of future revenue. If revenue levels are below
expectations due to delays associated with customers
decision-making processes or for any other reason, operating
results are likely to be materially and adversely affected.
Results of operations may be affected disproportionately by a
reduction in revenue because a large portion of our expenses are
fixed and cannot be easily reduced without adversely affecting
our business. In addition, we currently intend to sustain
funding of research and product development efforts and sales,
marketing and customer support operations and to expand
distribution channels. To the extent such expenses precede or
are not promptly followed by increased revenue, our business,
financial condition and results of operations could be adversely
affected.

Failure of service provider companies to incorporate our
products into their infrastructure may adversely affect the
level of future revenue.

Network service provider companies have not typically offered
products and services that enable their customers to measure and
test the level of service they receive on their communications
networks. If these companies do not want to offer this type of
service, our future revenue could be significantly lower than
anticipated. Our sales and marketing strategy depends on sales
of Visual UpTime, Visual IP InSight, Visual Trinity and Visual
eWatcher to service provider companies for them to deploy as
part of their network infrastructure. Although we expect that
for 2001, a significant portion of our revenue will be
attributable to sales of Visual UpTime, Visual IP InSight,
Visual Trinity and Visual eWatcher to service providers, we
cannot be sure that we will be successful in demonstrating the
value of our products to service provider companies. We believe
that the success of the service provider deployment strategy
depends on a number of factors over which we may have little or
no control, including:



| |   |                                                                                                                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | acceptance of and satisfaction with our systems by service
	provider companies and their customers;                                                                                                 
|
| |  | the realization of operating cost efficiencies upon the
	deployment of Visual Uptime, Visual IP InSight, Visual Trinity
	and/or Visual eWatcher;                                                    
|
| |  | our ability to convince the service providers of the operational
	benefits of Visual UpTime, Visual IP InSight, Visual Trinity and
	Visual eWatcher;                                                
|
| |  | the demand generation for these systems from customers and
	support for the systems by the service provider companies
	sales forces;                                                               
|
| |  | the competitive dynamics between service provider companies that
	provide communication networks for wide area use and the
	development of service for new world networks overall;                  
|
| |  | our successful development of systems and products that address
	the requirements for systems deployed as part of a service
	provider companys infrastructure;                                     
|
| |  | the timing and successful completion of integration development
	work by service provider companies to incorporate our service
	management functionality into their operational infrastructure;
	and
|
| |  | the absence of new technologies that make our products and
	systems obsolete before they become standardized in network
	systems.                                                                   

The failure of our products to become an accepted part of the
service provider companies infrastructure or a slower than
expected increase in the volume of sales by us to these
companies could have a material adverse effect on our business,
financial condition and results of operations.

26



---



##### Table of Contents



Our long sales cycle requires us to expend significant
resources on potential sales opportunities that may never be
consummated.

If we do not generate additional revenue from our sales and
marketing efforts, the expended resources and lack of increased
revenues could have a material adverse affect on our business,
financial condition and results of operations. Our future
business prospects depend on growing the sales of our products
and services. The incorporation of our products into the
infrastructure of service providers is characterized by a long
sales cycle to turn opportunities into sales. The risks inherent
in the long sales cycle for Visual UpTime, Visual IP InSight,
Visual Trinity and Visual eWatcher, many of which we have little
or no control over, include:



| |   |                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------
| |  | service provider companies internal acceptance reviews;                                                                                    
|
| |  | service provider companies budgetary constraints and
	technology assessment;                                                               
|
| |  | service provider companies lengthy decision-making
	processes;                                                                             
|
| |  | the attendant delays frequently associated with service provider
	companies internal procedures to approve large capital
	expenditures; and
|
| |  | the substantial commitment of capital from service provider
	companies.                                                                     

Sales of Visual UpTime, Visual IP InSight, Visual Trinity and
Visual eWatcher generally involve significant testing by and
education of both service provider companies and their customers
as well as a substantial commitment of our sales and marketing
resources. As a result, we may expend significant resources
pursuing potential sales opportunities that will not be
consummated. Even if service providers do deploy our products,
the curtailment or termination of service provider company
marketing programs, the reduction in demand by service provider
customers, decreases in service provider company capital budgets
or the reduction in the purchasing priority assigned to products
such as Visual UpTime, Visual IP InSight and Visual Trinity,
particularly if significant and unanticipated by us, could have
a material adverse effect on our business, financial condition
and results of operations.

The loss of Sprint, AT&T or WorldCom as a customer could
harm our business.

Our service provider deployment strategy depends predominantly
on sales to service provider companies. The loss of any one of
Sprint, AT&T or WorldCom, which have historically provided a
majority of our revenue, would result in a substantial loss of
revenue that could have a material adverse effect on our
business, financial condition and results of operations. For
2000, Sprint, AT&T and WorldCom accounted for 18%, 20% and
14%, respectively, of our consolidated revenue. This
concentration should continue as our customer base will consist
predominantly of service provider companies. Existing service
provider company customers are not easily replaced because of
the relatively few participants in that market. High barriers to
entry due to extraordinary capital requirements and the
likelihood that mergers of existing service providers may
further reduce their number mean that replacing a significant
network provider company customer will be even more difficult in
the future. Furthermore, the small number of customers means
that the reduction, delay or cancellation of orders or a delay
in shipment of our products to any one service provider company
customer could have a material adverse effect on our business,
financial condition and results of operations. Our anticipated
dependence on sizable orders from a limited number of service
provider companies will make the relationship between us and
each service provider company critically important to our
business. As our relationships with these service provider
companies evolve over time, we will make adjustments to product
specifications, forecasts and delivery timetables in response to
service provider company demands and expectations. Further,
because none of our agreements contain minimum purchase
requirements, there can be no assurance that the issuance of a
purchase order will result in significant recurring business.
Any inability to manage our service provider company
relationships successfully could have a material adverse effect
on our business, financial condition and results of operations.

27



---



##### Table of Contents



The pending break-up of AT&T could lengthen sales cycles
and adversely affect our business.

Potential disruption caused by the pending break-up of AT&T
could result in delays by AT&Ts customers in ordering
services based on our equipment and delays in installation of
services by AT&T. Both of these conditions could adversely
affect our business, financial condition and results of
operations. The separation by AT&T of its Business unit,
Broadband unit and Wireless unit into three different companies
could impact adversely the potential synergies realized from
integrated service management across multiple broadband access
technologies, resulting in a reduction in the demand for our
products which would have a material adverse effect on our
business, financial condition and results of operations.

The consolidation of the telecommunications industry could
result in a lengthened sales cycle.

Many companies in the telecommunications industry, particularly
Internet service providers, DSL providers and competitive local
exchange carriers, are consolidating with each other. As a
result, the managements of these companies are focused on
internal integration and other issues and are less likely to
focus on the purchasing of additional equipment and services.
This is likely to affect our business by lengthening our sales
cycle, which could adversely effect our business, financial
condition and results of operations.

We face growing competition that could make it difficult for
us to acquire and retain customers.

The market for service management systems for new world
connectivity services and out-sourced Web services is new and
rapidly evolving. We expect competition in this market to
intensify in the future. Our competitors vary in size and in the
scope and breadth of the products and services that they offer.
Many of these competitors have greater financial, technical,
marketing and other resources than us, and some have well
established relationships with our current and potential
customers. As a result, these competitors may be able to respond
to new or emerging technologies and changes in customer
requirements more effectively than us, or devote greater
resources than us to the development, promotion and sale of
products. Increased competition may result in price reductions,
reduced profitability and loss of market share, any of which
could have a material adverse effect on our business, financial
condition and results of operations. We may experience
competition from less expensive products and services that
provide only a portion of the functionality provided by our
products and services. In particular, as prices for network
equipment components such as data service units/channel service
units decrease, customers may decide to purchase these less
expensive products even though they lack certain features
offered by our products, particularly when these units are
integrated in customer routers and switches. For example, we
expect that participants with strong capabilities in these
various segments could partner with each other to offer products
that supply functionality approaching that provided by Visual
UpTime. The success of such products could have a material
adverse effect on our business, financial condition and results
of operations. If we expand the scope of our products and
services, we may encounter many additional, market-specific
competitors. These potential competitors include companies that
sell network management software such as Lucent
Technologies  OneVision Division and Telecordia
Technologies, each of which has announced products that could
potentially compete with us in the future. The success of such
products could have a material adverse effect on our business,
financial condition and results of operations. We may experience
competition from fault management companies, such as Micromuse,
that provide only a portion of the functionality provided by our
products and services. If the functionality of these systems is
sufficient to meet customer requirements, or these companies add
functionality to match our products and services, the success of
such products could have a material adverse effect on our
business, financial condition and results of operations.

Our defense of the litigation relating to our alleged false
and misleading statements in addition to a competitors
patent infringement claim may result in costly litigation,
divert the efforts and attention of our management, and be
unsuccessful.

We are defending ourselves against the claims discussed in
Item 3. Legal Proceedings. We believe that the
plaintiffs claims are without merit and intend to defend
these cases vigorously. We may, however, incur significant legal
costs related to this litigation. We cannot presently determine
the ultimate outcomes of these

28



---



##### Table of Contents







| |   |                                                                                                                         
| | - | ------------------------------------------------------------------------------------------------------------------------
| |  | the payment of substantial monetary and punitive damages;                                                               
|
| |  | the reimbursement of the plaintiffs legal costs;                                                                       
|
| |  | the requirement to stop selling one of our major products in its
	current form;                                         
|
| |  | the redesign of that product;                                                                                           
|
| |  | the requirement to license certain technology from the
	plaintiff, which could include significant royalty payments; and
|
| |  | the indemnification of certain customers against the losses they
	may incur due to the alleged infringement.            

Failure to adapt to rapid technological change could
adversely affect our ability to compete effectively.

The market for our products is characterized by rapid changes,
including continuing advances in technology, frequent new
product introductions, changes in customer requirements and
preferences and changes in industry standards. If we are unable
to develop and introduce new products and product enhancements
in a timely fashion that accommodate these changes, we will
likely lose customers and business which could have a material
adverse effect on our business, financial condition and results
of operations. The introduction of new technologies or advances
in techniques for network services or the integration of service
level management functionality into other network hardware
components could render our products obsolete or unmarketable.
There can be no assurance that (i) our existing products
will continue to compete successfully; (ii) our future
product offerings will keep pace with the technological changes
implemented by our competitors; (iii) our products will
satisfy evolving industry standards or preferences of existing
or prospective customers; or (iv) we will be successful in
developing and marketing products for any future technology.
Failure to achieve any one of these objectives could have a
material adverse effect on our business, financial condition and
results of operations.

Failure of the market to accept new world network services
would reduce the demand for our products.

Because our systems are deployed predominantly on new world
networks such as frame relay, ATM, IP, remote access and VPNs,
our near term success will depend on the continued market
acceptance of these technologies as preferred networking
solutions. If these services do not maintain widespread market
acceptance, the market for our products will be substantially
reduced which could have a material adverse effect on our
business, financial condition and results of operations.
Although we are currently devoting significant resources to the
development of additional products, there can be no assurance
that we will complete the development of these or any future
products in a timely fashion, that we will successfully manage
the transition from existing products, that our future products
will achieve market acceptance, or if market acceptance is
achieved, that we will be able to maintain such acceptance for a
significant period of time. If we are unable to develop products
on a timely basis that address changing customer needs and
technologies, we may lose market share to competitors or be
required to substantially increase development expenditures.
Such an increase in research and development expenditures may
have a material adverse effect on our business, financial
condition and results of operations. There also can be no
assurance that products or technologies developed by others will
not adversely affect our competitive position or render our
products or technologies noncompetitive or obsolete.

29



---



##### Table of Contents



Failure of businesses to use the Internet for corporate
networking purposes would reduce the demand for our products.

Because our service management products and services are based
on providing performance measurement and diagnostics for the
Internet and corporate IP networks, the Internet must be widely
adopted, in a timely manner, as a means of electronic commerce,
or e-commerce, and communications. If such adoption should not
occur, our business, financial condition and results of
operations could be adversely affected. Because e-commerce and
communications over the Internet are new and evolving, it is
difficult to predict the size of this market and its sustainable
growth rate. In addition, we believe that the use of the
Internet for conducting business transactions could be hindered
for a number of reasons, including, but not limited to:



| |   |                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------
| |  | security concerns including the potential for fraud or theft of
	stored data and information communicated over the Internet;
|
| |  | inconsistent quality of service, including well-publicized
	outages of popular web sites;                                   
|
| |  | lack of availability of cost-effective, high-speed service;                                                                 
|
| |  | limited numbers of local access points for corporate users;                                                                 
|
| |  | delay in the development of enabling technologies or adoption of
	new standards;                                            
|
| |  | inability to integrate business applications with the Internet;                                                             
|
| |  | the need to operate with multiple and frequently incompatible
	products; and                                                
|
| |  | a lack of tools to simplify access to and use of the Internet.                                                              

Improvements to the infrastructure of the Internet could
reduce or eliminate demand for our Internet performance
measurement products and services.

The demand for our service management products and services
could be reduced or eliminated if future improvements to the
infrastructure of the Internet lead companies to conclude that
measuring and evaluating the performance of their networks is no
longer important to their business. The Internet is a complex,
heterogeneous network of communications networks with multiple
operators and vendors supplying and managing the underlying
infrastructure as well as connections to this infrastructure.
Because the inherent complexity of the Internet currently causes
significant e-commerce quality-of-service problems for
companies, the vendors and operators that supply and manage the
underlying infrastructure are continuously seeking to improve
the speed, availability, reliability and consistency of the
Internet. If these vendors and operators succeed in
significantly improving the performance of the Internet, which
would result in corresponding improvements in the performance of
companies networks, demand for our products and services
would likely decline which could have a material adverse effect
on our business, financial condition and results of operations.

Errors in our products or services could discourage customers
and damage our reputation.

If our existing or future products or services contain errors
that are not detected before shipment, we could experience a
loss of or delay in market acceptance of our products, diversion
of development resources, damage to our reputation or increases
in service or warranty costs, any of which could have a material
adverse effect upon our business, financial condition and
results of operations. Products and services as complex as those
we offer may contain undetected errors or failures when first
introduced or as new versions are released. There can be no
assurance that, despite testing by us and by current and
potential customers, errors will not be found in new products
and services until commercial shipments have commenced.

Our dependence on sole and limited source suppliers makes the
price we pay for important components in our products more
volatile.

Many key components used in the manufacture of our products are
purchased only from sole or limited sources. If a sole or
limited source supplier raises their prices, delays shipments or
becomes unable or

30



---



##### Table of Contents







| |   |                                                                                                                                                                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | we have not identified alternative suppliers for all of our key
	components and we may not be able to find alternative suppliers,
	if necessary, or find alternative components of comparable
	quality;                                                                                                      
|
| |  | we will have to qualify alternative suppliers before components
	are purchased from them which will, even if successful,
	necessarily delay the process of procuring the replacement
	components;                                                                                                            
|
| |  | most of our suppliers do not have long-term agreements with us,
	so these suppliers could suddenly increase component prices;                                                                                                                                                                                
|
| |  | even minor delays in shipments of key components from suppliers,
	which we have experienced in the past, could delay the shipment
	of our products;                                                                                                                                                          
|
| |  | although all of our sole or limited source suppliers are based
	in the United States, some of them may manufacture or acquire
	components from outside of the United States and thus they may
	be unable to deliver their components if their own supplies are
	interrupted by events in other countries; and
|
| |  | some of the components, including dynamic random access memories
	and embedded communications processors, are subject to
	significant price fluctuations.                                                                                                                                                    

Sole-source components presently include framers, certain
semiconductors, embedded communications processors,
communication controllers and line interface components.

We may face difficulties assimilating and may incur costs
associated with any future acquisitions.

We may seek to acquire or invest in businesses, products or
technologies that we feel could complement or expand our
business, augment our market coverage, enhance our technical
capabilities or that may otherwise offer growth opportunities.
Acquisitions could create risks for us, including:



| |   |                                                                                                                              
| | - | -----------------------------------------------------------------------------------------------------------------------------
| |  | difficulties in assimilation of acquired personnel, operations
	and technologies;                                            
|
| |  | unanticipated costs associated with the acquisition;                                                                         
|
| |  | diversion of managements attention from our core business;                                                                  
|
| |  | adverse effects on existing business relationships with channel
	partners of our products and services and our customers; and
|
| |  | use of substantial portions of our available cash to consummate
	the acquisition.                                            

Our failure to successfully assimilate companies or technologies
acquired by us or the occurrence of unanticipated costs that may
arise in connection with such acquisitions could have a material
adverse effect on our business, financial condition and results
of operations.

Expansion of our international activities will expose our
business to additional risks.

We believe we must expand the sales and marketing activities for
our products and services outside the United States and hire
additional international personnel. Therefore, we expect to
commit significant resources to expand our international sales
and marketing activities, which were less than 10% of our
consolidated revenue for 2000 and prior periods. Conducting
international operations would subject us to risks we do not
face in the United States. These include, but are not limited to:



| |   |                                              
| | - | ---------------------------------------------
| |  | currency exchange rate fluctuations;         
|
| |  | seasonal fluctuations in purchasing patterns;

31



---



##### Table of Contents





| |   |                                                                                               
| | - | ----------------------------------------------------------------------------------------------
| |  | unexpected changes in regulatory requirements;                                                
|
| |  | maintaining and servicing computer hardware in distant locations;                             
|
| |  | longer accounts receivable payment cycles and difficulties in
	collecting accounts receivable;
|
| |  | difficulties in managing and staffing international operations;                               
|
| |  | potentially adverse tax consequences, including restrictions on
	the repatriation of earnings;
|
| |  | the burdens complying with a wide variety of foreign laws; and                                
|
| |  | reduced protection for intellectual property rights in some
	countries.                       

The Internet and other IP services, such as frame relay and ATM,
may not be used as widely in other countries and the adoption of
public data service for transporting mission-critical
applications may evolve slowly or may not evolve at all. As a
result, we may not be successful in selling our products and
services to customers in markets outside the United States.
Failure to expand our international activities successfully
could have a material adverse effect on our business, financial
condition and results of operations.

The loss of key people could jeopardize our growth
prospects.

The loss of the services of Scott E. Stouffer, our
Chairman, President and Chief Executive Officer, and
Peter J. Minihane, our Chief Financial Officer, or any
other key employees could adversely affect our ability to
execute our business plan and could have a material adverse
effect on our business, financial condition and results of
operations. Our success depends to a significant degree upon the
continuing contributions of our key management and technical
employees, particularly Messrs. Stouffer and Minihane.

Our inability to recruit and retain employees may hurt our
growth prospects.

We are actively seeking to fill a number of executive management
positions. If we fail to recruit and retain personnel, it could
damage our ability to grow and expand our business. Our future
success depends on our ability to retain highly skilled
managerial, sales, marketing, customer support and product
development personnel. Intense competition for technically
trained sales and product development personnel makes recruiting
qualified personnel difficult. There can be no assurance that we
will be successful in retaining our key employees. Failure to
retain key personnel could have a material adverse effect on our
business, financial condition and results of operations.

Claims by others that we infringe their intellectual property
rights may harm our business.

If others claim that our products infringe on their intellectual
property rights, whether the claims are valid or not, we may be
forced to spend significant sums in litigation, pay damages,
delay product shipments, reengineer our products or acquire
licenses to the claimants intellectual property. We expect
that these claims may become more common as the number of
products in the network management industry increases and the
functionality of these products further overlaps. If a claimant
is successful in a lawsuit arising from such a claim, it could
have a material adverse effect on our business, financial
condition and results of operations.

Failure to protect our own intellectual property rights may
harm our business.

Our success is dependent on our proprietary technology and
intellectual property rights. We hold four patents and also rely
on copyright and trade secret laws, trademarks, confidentiality
procedures and contractual provisions to protect our proprietary
software, documentation and other proprietary information. These
protection methods may not be adequate to prevent competitors
from developing similar technology. Moreover, in the absence of
patent protection, our business may be adversely affected by
competitors that develop functionally equivalent technology.
Litigation to enforce our intellectual property rights,
regardless of its success or failure, could be burdensome and
expensive and could involve a high degree of uncertainty. In
addition, legal proceedings may divert managements
attention from growing our business. We may be subject to
additional risk as we enter into transactions in countries where
intellectual property laws are not well

32



---



##### Table of Contents





We have anti-takeover protections that may delay or prevent a
change in control that could benefit our stockholders.

Terms of our certificate of incorporation and bylaws make it
more difficult for another individual or company to acquire
control of our company, even if a change of control would
benefit our stockholders. These terms include:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                     
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | our board of directors, without stockholder approval, may issue
	up to 5,000,000 shares of preferred stock on terms that they
	determine. This preferred stock could be issued quickly with
	terms that delay or prevent the change in control of our
	company, make removal of management more difficult or depress
	the price of our stock;                                                                                       
|
| |  | certain provisions of our certificate of incorporation and
	bylaws and of Delaware law could delay or make more difficult a
	merger, tender offer or proxy contest;                                                                                                                                                                                                                                                                 
|
| |  | we are subject to the anti-takeover provisions of
	Section 203 of the Delaware General Corporation Law which
	prohibits a publicly held Delaware corporation from engaging in
	a business combination with an interested
	stockholder for a period of three years after the date of
	the transaction in which the person became an interested
	stockholder, unless the business combination is approved in a
	prescribed manner;
|
| |  | our board of directors is staggered so that only a
	portion of its members are elected each year;                                                                                                                                                                                                                                                                                                                                 
|
| |  | only our board of directors, our chairman of the board, our
	president or stockholders holding a majority of our stock can
	call special stockholder meetings; and                                                                                                                                                                                                                                                                  
|
| |  | special procedures must be followed in order for stockholders to
	present proposals at stockholder meetings.                                                                                                                                                                                                                                                                                                                        

In addition, our credit facility with Silicon Valley Bank
prohibits us from engaging in a merger with or being acquired by
another entity without their consent, unless we are the
surviving entity and the transaction does not otherwise create
an event of default.




Item  7A.  Quantitative and Qualitative
Disclosure About Market Risk.

We are exposed to market risk from changes in interest rates.
Our investment policy restricts us to investing only in
investment-grade securities. A failure of these investment
securities to perform at their historical levels could reduce
the interest income realized by us. We do not have significant
cash flow exposure to changing interest rates on our long-term
debt that consists primarily of capital lease obligations for
which the interest rates are fixed. However, the estimated fair
value of such debt is subject to market risk. As of
December 31, 2000, the fair value of our long-term debt did
not differ materially from its carrying value. Any borrowings
under our credit facility are also sensitive to changes in
interest rates. As of December 31, 2000, there were no
borrowings outstanding under our credit facility.




Item  8.  Financial Statements and
Supplementary Data.

The information required by Item 8 of Part II is
incorporated herein by reference to the Consolidated Financial
Statements and financial statement schedule filed with this
report; see Item 14 of Part IV.




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

None.

33



---



##### Table of Contents



PART III




Item  10.  Our Directors and Executive
Officers.

The information required by Item 10 is hereby incorporated
by reference from the Proxy Statement for our 2001 Annual
Meeting of Stockholders.




Item  11.  Executive Compensation.

The information required by Item 11 is hereby incorporated
by reference from the Proxy Statement for our 2001 Annual
Meeting of Stockholders.




Item  12.  Security Ownership of Certain
Beneficial Owners and Management.

The information required by Item 12 is hereby incorporated
by reference from the Proxy Statement for our 2001 Annual
Meeting of Stockholders.




Item  13.  Certain Relationships and Related
Transactions.

The information required by Item 13 is hereby incorporated
by reference from the Proxy Statement for our 2001 Annual
Meeting of Stockholders.




PART IV




Item  14.  Exhibits, Financial Statement
Schedules and Reports on Form 8-K.

|                                                                                                                 |                                              |                              |     |     |     | 
|---------------------------------------------------------------------------------------------------------------- | -------------------------------------------- | ---------------------------- | --- | --- | --- | 
|                                                                                                                 |                                              | Page                        
|                                                                                                                 |                                              | Number                      
|                                                                                                                 |                                              |                             
|(a) Documents filed as part of the report:                                                                       |                                              |                              |     |    
|                                                                                                                
|                                                                                                                
|                                                                                                                
|                                                                                                                
|                                                                                                                 | (1) Report of Independent Public Accountants |                              |     | F-2 |    
|                                                                                                                
|                                                                                                                
|                                                                                                                
|                                                                                                                
|Consolidated Balance Sheets as of December 31, 1999 and 2000                                                     |                                              |                              | F-3 |    
|                                                                                                                
|                                                                                                                
|                                                                                                                
|                                                                                                                
|Consolidated Statements of Operations for the years ended
	December 31, 1998, 1999 and 2000                      |                                              |                              | F-4 |    
|                                                                                                                
|                                                                                                                
|                                                                                                                
|                                                                                                                
|Consolidated Statements of Changes in Stockholders Equity
	for the years ended December 31, 1998, 1999 and 2000 |                                              |                              | F-5 |    
|                                                                                                                
|                                                                                                                
|                                                                                                                
|                                                                                                                
|Consolidated Statements of Cash Flows for the years ended
	December 31, 1998, 1999 and 2000                      |                                              |                              | F-7 |    
|                                                                                                                
|                                                                                                                
|                                                                                                                
|                                                                                                                
|Notes to Consolidated Financial Statements                                                                       |                                              |                              | F-8 |    
|                                                                                                                
|                                                                                                                
|                                                                                                                
|                                                                                                                
|                                                                                                                 | (2) Report of Independent Public Accountants |                              |     | S-1 |    
|                                                                                                                
|                                                                                                                
|                                                                                                                
|                                                                                                                
|                                                                                                                 |                                              | Financial Statement Schedule |     |     | S-2 | 
|                                                                                                                
|                                                                                                                
|                                                                                                                
|                                                                                                                
|                                                                                                                 | (3) Exhibits                                 |                              |     |     |    

The following exhibits are filed or incorporated by reference as
stated below:

|            |  |                                                                                                                                                                          
|----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit     |  |                                                                                                                                                                          
|Number      |  | Description                                                                                                                                                              
|            |  |                                                                                                                                                                          
|3.1$        |  | Amended and Restated Certificate of Incorporation of the Company.                                                                                                        
|3.1.1@      |  | Certificate of Amendment to Amended and Restated Certificate of
	Incorporation.                                                                                          
|10.1*       |  | 1994 Stock Option Plan.                                                                                                                                                  
|10.2*       |  | 1997 Omnibus Stock Plan, as amended.                                                                                                                                     
|10.3*       |  | Amended and Restated 1997 Directors Stock Option Plan.                                                                                                                  
|10.4!!      |  | 2000 Stock Incentive Plan, as amended.                                                                                                                                   
|10.5*      |  | Reseller/ Integration Agreement, dated August 29, 1997, by
	and between the Company and MCI Telecommunications Corporation.                                              
|10.5.1$$$ |  | Second Amendment, dated November 4, 1998, to the Reseller/
	Integration Agreement between the Company and MCI
	Telecommunications Corporation (relating to Exhibit 10.5).

34



---



##### Table of Contents



|          |  |                                                                                                                                                                                                       
|--------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit   |  |                                                                                                                                                                                                       
|Number    |  | Description                                                                                                                                                                                           
|          |  |                                                                                                                                                                                                       
|10.7*    |  | General Agreement for the Procurement of Equipment, Services and
	Supplies between the Company and AT&T Corp.                                                                                         
|10.8*     |  | Lease Agreement, dated December 12, 1996, by and between
	the Company and The Equitable Life Assurance Society of The
	United States.                                                                 
|10.8.1*   |  | Lease Amendment, dated September 2, 1997, by and between
	the Company and The Equitable Life Assurance Society of The
	United States (relating to Exhibit 10.8).                                      
|10.8.2$$$ |  | Second Lease Amendment, dated February 8, 1999, by and
	between the Company and
	TA/ Western, LLC, successor to The Equitable Life Assurance
	Society of The United States (relating to Exhibit 10.8).
|10.8.3*** |  | Third Lease Amendment, dated January 10, 2000, by and
	between the Company and
	TA/ Western, LLC (relating to Exhibit 10.8).                                                                          
|10.8.4!!  |  | Fourth Lease Amendment, dated May 17, 2000, by and between
	the Company and
	TA/ Western LLC (relating to Exhibit 10.8).                                                                              
|10.9***   |  | Sublease, dated October 1, 1999, between the Company and
	Micron Technology, Inc.                                                                                                                     
|10.10*    |  | Employment Agreement, dated December 15, 1994, by and
	between the Company and Scott E. Stouffer, as amended.                                                                                         
|10.11!!   |  | Lease Agreement, dated April 7, 2000, by and between Visual
	Networks, Inc. and
	TA/ Western, LLC.                                                                                                    
|10.12*    |  | Terms of Employment, dated June 11, 1997, by and between
	the Company and Peter J. Minihane, as amended.                                                                                              
|10.17**   |  | Net2Net 1994 Stock Option Plan.                                                                                                                                                                       
|10.20$$   |  | 1999 Employee Stock Purchase Plan.                                                                                                                                                                    
|10.22%%   |  | Inverse Network Technology 1996 Stock Option Plan.                                                                                                                                                    
|10.23@    |  | Merger Agreement, dated February 7, 2000, by and among the
	Company, Visual Acquisitions Three, Inc. and Avesta
	Technologies, Inc.                                                                   
|10.23.1!! |  | Avesta Technologies, Inc. 1996 Stock Option Plan.                                                                                                                                                     
|10.24     |  | Loan and Security Agreement, dated February 28, 2001, by
	and between Silicon Valley Bank and the Company.                                                                                            
|10.25     |  | Accounts Receivable Financing Agreement, dated February 28,
	2001, by and between Silicon Valley Bank and the Company.                                                                                
|10.26     |  | Intellectual Property Security Agreement, dated February 28,
	2001, by and between Silicon Valley Bank and the Company.                                                                               
|10.27   |  | Master Purchase of Equipment and Services Agreement, dated May
	22, 2000, between the Company and Sprint/ United Management
	Company.                                                                 
|16.1*     |  | Letter regarding change in certified accountants.                                                                                                                                                     
|16.2@     |  | Letter regarding change in certified accountants.                                                                                                                                                     
|21.1      |  | List of subsidiaries of the Company.                                                                                                                                                                  
|23.1      |  | Consent of Arthur Andersen LLP.                                                                                                                                                                       
|24.1      |  | Powers of Attorney (included in signature pages).                                                                                                                                                     

35



---



##### Table of Contents






| |     |  |  |                                                                                                                                                                                                                                                                                
| | --- |  |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | *   |  |  | Incorporated herein by reference to the Companys
	Registration Statement on Form S-1, No. 333-41517.                                                                                                                                                                          
| | **  |  |  | Incorporated herein by reference to Exhibit 10.1 to the
	Companys Registration Statement on Form S-8,
	No.  333-53153.                                                                                                                                                        
| | *** |  |  | Incorporated herein by reference to the Companys Annual
	Report on Form 10-K for the year ended December 31, 1999.                                                                                                                                                            
| | %   |  |  | Incorporated herein by reference to the Companys
	Registration Statement on Form S-3, No. 333-90105.                                                                                                                                                                          
| | %%  |  |  | Incorporated herein by reference to Exhibit 10.1 to the
	Companys Registration Statement on Form S-8,
	No.  333-88719.                                                                                                                                                        
| | @   |  |  | Incorporated herein by reference to the Companys
	Registration Statement on Form S-4, No. 333-33946.                                                                                                                                                                          
| | $   |  |  | Incorporated herein by reference to Exhibit 3.1 to the
	Companys Quarterly Report on Form 10-Q for the three
	months ended June 30, 1999.                                                                                                                                     
| | $$  |  |  | Incorporated herein by reference to the Companys
	Definitive Proxy Statement on Schedule 14A filed
	April 30, 1999.                                                                                                                                                           
| | $$$ |  |  | Incorporated herein by reference to the Companys Annual
	Report on Form 10-K for the year ended December 31,
	1998.                                                                                                                                                           
| |    |  |  | Portions of these Exhibits were omitted and have been filed
	separately with the Secretary of the SEC pursuant to the
	Companys Applications Requesting Confidential Treatment
	under Rule 406 of the Act, filed on December 22, 1997,
	January 28, 1998 and February 4, 1998.
| |   |  |  | Portions of these Exhibits were omitted and have been filed
	separately with the Secretary of the SEC pursuant to the
	Companys Application Requesting Confidential Treatment
	under Rule 24b-2 of the Exchange Act of 1934.                                                  
| | !!  |  |  | Incorporated herein by reference to the Companys Quarterly
	Report on Form 10-Q for the three months ended
	June 30, 2000.                                                                                                                                                    

(b) Reports on Form 8-K

None.

(c) Exhibits

The exhibits required by this Item are listed under
Item 14(a)(3).

(d) Financial Statement Schedules

The consolidated financial statement schedules required by this
Item are listed under Item 14(a)(2).

36



---



##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, as amended, the Company has
duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of
Rockville, Maryland, on the 11th day of April, 2001.



| |                      
| | ---------------------
| | VISUAL NETWORKS, INC.



| |     |                      
| | --- | ---------------------
| | By: | /s/ SCOTT E. STOUFFER

| |                                      
| | -------------------------------------
| |                                      
| | Scott E. Stouffer                    
| | President and Chief Executive Officer



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

Each person whose signature
appears below in so signing also
makes, constitutes and appoints Scott E. Stouffer, Peter J.
Minihane and Nancy A. Spangler, and each of them acting alone,
his true and lawful attorney-in-fact, with full power of
substitution, for him in any and all capacities, to execute and
cause to be filed with the Securities and Exchange Commission
any and all amendments to this Report, with exhibits thereto and
other documents in connection therewith, and hereby ratifies and
confirms all that said attorney-in-fact or his substitute or
substitutes may do or cause to be done by virtue hereof.

|                                       |  |                                                                                                                                |  |      |         | 
|-------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------ |  | ---- | ------- | 
|Signature                              |  | Title                                                                                                                          |  | Date
|                                       |  |                                                                                                                                |  |     
|/s/ SCOTT E. STOUFFERScott E. Stouffer |  | President, Chief Executive Officer and Director (Principal
        Executive Officer)                                          |  |      | 4/11/01 | 
|/s/ PETER J. MINIHANEPeter J. Minihane |  | Executive Vice President, Chief Financial Officer, Treasurer and
        Director (Principal Financial and Accounting Officer) |  |      | 4/11/01 | 
|Grant G. Behrman                       |  | Director                                                                                                                       |  |      |         | 
|/s/ MARC F. BENSONMarc F. Benson       |  | Director                                                                                                                       |  |      | 4/11/01 | 
|/s/ TED H. MCCOURTNEYTed H. McCourtney |  | Director                                                                                                                       |  |      | 4/11/01 | 
|/s/ THOMAS A. SMITHThomas A. Smith     |  | Director                                                                                                                       |  |      | 4/11/01 | 
|/s/ WILLIAM J. SMITHWilliam J. Smith   |  | Director                                                                                                                       |  |      | 4/11/01 | 

37



---



##### Table of Contents



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|                                                                                                                 |  |      |     | 
|---------------------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                                                 |  | Page
|                                                                                                                 |  |     
|Report of Independent Public Accountants                                                                         |  |      | F-2 | 
|                                                                                                                
|                                                                                                                
|                                                                                                                
|                                                                                                                
|Consolidated Balance Sheets as of December 31, 1999 and 2000                                                     |  |      | F-3 | 
|                                                                                                                
|                                                                                                                
|                                                                                                                
|                                                                                                                
|Consolidated Statements of Operations for the years ended
	December 31, 1998, 1999 and 2000                      |  |      | F-4 | 
|                                                                                                                
|                                                                                                                
|                                                                                                                
|                                                                                                                
|Consolidated Statements of Changes in Stockholders Equity
	for the years ended December 31, 1998, 1999 and 2000 |  |      | F-5 | 
|                                                                                                                
|                                                                                                                
|                                                                                                                
|                                                                                                                
|Consolidated Statements of Cash Flows for the years ended
	December 31, 1998, 1999 and 2000                      |  |      | F-7 | 
|                                                                                                                
|                                                                                                                
|                                                                                                                
|                                                                                                                
|Notes to Consolidated Financial Statements                                                                       |  |      | F-8 | 

F-1



---



##### Table of Contents



REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Visual Networks, Inc.:

We have audited the accompanying consolidated balance sheets of
Visual Networks, Inc. (a Delaware corporation) and subsidiaries
as of December 31, 1999 and 2000, and the related
consolidated statements of operations, changes in
stockholders equity and cash flows for each of the three
years in the period ended December 31, 2000. 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 in accordance with auditing standards
generally accepted in the United States. Those standards 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. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial position
of Visual Networks, Inc. and subsidiaries as of
December 31, 1999 and 2000, and the results of their
operations and their cash flows for each of the three years in
the period ended December 31, 2000, in conformity with
accounting principles generally accepted in the United States.



| |                    
| | -------------------
| | ARTHUR ANDERSEN LLP

Vienna, Virginia



F-2



---



##### Table of Contents



VISUAL NETWORKS, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share and per share data)


|                                        |                                                                                                                                                                      |                                            |       |         |        |  |        |          |        | 
|--------------------------------------- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ----- | ------- | ------ |  | ------ | -------- | ------ | 
|                                        |                                                                                                                                                                      |                                           
|                                        |                                                                                                                                                                      | December 31,                              
|                                        |                                                                                                                                                                      |                                           
|                                        |                                                                                                                                                                      | 1999                                       |       | 2000   
|                                        |                                                                                                                                                                      |                                            |       |        
|Assets                                  |                                                                                                                                                                      |                                            |       |         |        |  |        |         
|                                       
|                                       
|                                       
|                                       
|Current assets:                         |                                                                                                                                                                      |                                            |       |         |        |  |        |         
|                                       
|                                       
|                                       
|                                       
|                                        | Cash and cash equivalents                                                                                                                                            |                                            | $     | 54,629  |        |  | $      | 17,369   |       
|                                       
|                                       
|                                       
|                                       
|                                        | Short-term investments                                                                                                                                               |                                            |       |        |        |  |        | 3,700    |       
|                                       
|                                       
|                                       
|                                       
|                                        | Accounts receivable, net of allowance of $754 and $1,103,
	respectively                                                                                              |                                            |       | 9,374   |        |  |        | 4,222    |       
|                                       
|                                       
|                                       
|                                       
|                                        | Inventory                                                                                                                                                            |                                            |       | 7,998   |        |  |        | 13,474   |       
|                                       
|                                       
|                                       
|                                       
|                                        | Other current assets                                                                                                                                                 |                                            |       | 2,472   |        |  |        | 3,089    |       
|                                        |                                                                                                                                                                      |                                            |       |         |        |  |        |         
|                                        |                                                                                                                                                                      | Total current assets                       |       |         | 74,473 |  |        |          | 41,854 | 
|                                       
|                                       
|                                       
|                                       
|Property and equipment, net             |                                                                                                                                                                      |                                            | 8,566 |         |        |  | 10,738 |         
|                                       
|                                       
|                                       
|                                       
|Goodwill and intangible assets          |                                                                                                                                                                      |                                            |      |         |        |  | 8,510  |         
|                                       
|                                       
|                                       
|                                       
|Other assets                            |                                                                                                                                                                      |                                            | 115   |         |        |  | 9,562  |         
|                                        |                                                                                                                                                                      |                                            |       |         |        |  |        |         
|                                        |                                                                                                                                                                      | Total assets                               |       | $       | 83,154 |  |        | $        | 70,664 | 
|                                        |                                                                                                                                                                      |                                            |       |         |        |  |        |         
|Liabilities and Stockholders Equity    |                                                                                                                                                                      |                                            |       |         |        |  |        |         
|                                       
|                                       
|                                       
|                                       
|Current liabilities:                    |                                                                                                                                                                      |                                            |       |         |        |  |        |         
|                                       
|                                       
|                                       
|                                       
|                                        | Accounts payable and accrued expenses                                                                                                                                |                                            | $     | 11,754  |        |  | $      | 27,912   |       
|                                       
|                                       
|                                       
|                                       
|                                        | Deferred revenue                                                                                                                                                     |                                            |       | 11,798  |        |  |        | 15,818   |       
|                                       
|                                       
|                                       
|                                       
|                                        | Current portion of long-term debt                                                                                                                                    |                                            |       | 568     |        |  |        | 606      |       
|                                        |                                                                                                                                                                      |                                            |       |         |        |  |        |         
|                                        |                                                                                                                                                                      | Total current liabilities                  |       |         | 24,120 |  |        |          | 44,336 | 
|                                       
|                                       
|                                       
|                                       
|Long-term debt, net of current portion  |                                                                                                                                                                      |                                            | 782   |         |        |  | 243    |         
|                                        |                                                                                                                                                                      |                                            |       |         |        |  |        |         
|                                        |                                                                                                                                                                      | Total liabilities                          |       |         | 24,902 |  |        |          | 44,579 | 
|                                        |                                                                                                                                                                      |                                            |       |         |        |  |        |         
|Commitments and contingencies (Note 10) |                                                                                                                                                                      |                                            |       |         |        |  |        |         
|                                       
|                                       
|                                       
|                                       
|Stockholders equity:                   |                                                                                                                                                                      |                                            |       |         |        |  |        |         
|                                       
|                                       
|                                       
|                                       
|                                        | Common stock, $.01 par value; 50,000,000 shares authorized,
	24,833,609 and 31,296,383 shares issued and outstanding as of
	December 31, 1999 and 2000, respectively |                                            |       | 248     |        |  |        | 313      |       
|                                       
|                                       
|                                       
|                                       
|                                        | Additional paid-in capital                                                                                                                                           |                                            |       | 90,169  |        |  |        | 473,108  |       
|                                       
|                                       
|                                       
|                                       
|                                        | Deferred compensation                                                                                                                                                |                                            |       | (705    | )      |  |        | (402     | )     
|                                       
|                                       
|                                       
|                                       
|                                        | Accumulated other comprehensive income                                                                                                                               |                                            |       |        |        |  |        | 11       |       
|                                       
|                                       
|                                       
|                                       
|                                        | Accumulated deficit                                                                                                                                                  |                                            |       | (31,460 | )      |  |        | (446,945 | )     
|                                        |                                                                                                                                                                      |                                            |       |         |        |  |        |         
|                                        |                                                                                                                                                                      | Total stockholders equity                 |       |         | 58,252 |  |        |          | 26,085 | 
|                                        |                                                                                                                                                                      |                                            |       |         |        |  |        |         
|                                        |                                                                                                                                                                      | Total liabilities and stockholders equity |       | $       | 83,154 |  |        | $        | 70,664 | 
|                                        |                                                                                                                                                                      |                                            |       |         |        |  |        |         

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

F-3



---



##### Table of Contents



VISUAL NETWORKS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)


|                                                      |                                                 |                          |        |        |        |      |        |        |        |   |          |         |         | 
|----------------------------------------------------- | ----------------------------------------------- | ------------------------ | ------ | ------ | ------ | ---- | ------ | ------ | ------ | - | -------- | ------- | ------- | 
|                                                      |                                                 |                         
|                                                      |                                                 | Years Ended December 31,
|                                                      |                                                 |                         
|                                                      |                                                 | 1998                     |        | 1999   |        | 2000
|                                                      |                                                 |                          |        |        |        |     
|Revenue                                               |                                                 | $                        | 56,088 |        |        | $    | 91,719 |        |        | $ | 89,041   |        
|                                                     
|                                                     
|                                                     
|                                                     
|Cost of revenue                                       |                                                 |                          | 20,829 |        |        |      | 30,888 |        |        |   | 32,515   |        
|                                                      |                                                 |                          |        |        |        |      |        |        |        |   |          |        
|                                                      | Gross profit                                    |                          |        | 35,259 |        |      |        | 60,831 |        |   |          | 56,526  |        
|                                                      |                                                 |                          |        |        |        |      |        |        |        |   |          |        
|Operating expenses:                                   |                                                 |                          |        |        |        |      |        |        |        |   |          |        
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Research and development                        |                          |        | 13,771 |        |      |        | 16,677 |        |   |          | 27,277  |        
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Write-off of purchased research and development |                          |        |       |        |      |        |       |        |   |          | 39,000  |        
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Sales and marketing                             |                          |        | 19,759 |        |      |        | 24,447 |        |   |          | 41,907  |        
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | General and administrative                      |                          |        | 5,528  |        |      |        | 7,928  |        |   |          | 11,247  |        
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Merger-related costs                            |                          |        | 4,318  |        |      |        | 6,776  |        |   |          |        |        
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Restructuring and impairment charges            |                          |        | 751    |        |      |        |       |        |   |          | 335,810 |        
|                                                     
|                                                     
|                                                     
|                                                     
|                                                      | Amortization of goodwill and other intangibles  |                          |        |       |        |      |        |       |        |   |          | 53,426  |        
|                                                      |                                                 |                          |        |        |        |      |        |        |        |   |          |        
|                                                      |                                                 | Total operating expenses |        |        | 44,127 |      |        |        | 55,828 |   |          |         | 508,667 | 
|                                                      |                                                 |                          |        |        |        |      |        |        |        |   |          |        
|Income (loss) from operations                         |                                                 |                          | (8,868 | )      |        |      | 5,003  |        |        |   | (452,141 | )      
|                                                     
|                                                     
|                                                     
|                                                     
|Interest income, net                                  |                                                 |                          | 2,413  |        |        |      | 2,270  |        |        |   | 2,598    |        
|                                                      |                                                 |                          |        |        |        |      |        |        |        |   |          |        
|Income (loss) before income taxes                     |                                                 |                          | (6,455 | )      |        |      | 7,273  |        |        |   | (449,543 | )      
|                                                     
|                                                     
|                                                     
|                                                     
|Benefit (provision) for income taxes                  |                                                 |                          |       |        |        |      | (3,722 | )      |        |   | 34,058   |        
|                                                      |                                                 |                          |        |        |        |      |        |        |        |   |          |        
|Net income (loss)                                     |                                                 |                          | (6,455 | )      |        |      | 3,551  |        |        |   | (415,485 | )      
|                                                     
|                                                     
|                                                     
|                                                     
|Dividends and accretion on preferred stock            |                                                 |                          | (171   | )      |        |      |       |        |        |   |         |        
|                                                      |                                                 |                          |        |        |        |      |        |        |        |   |          |        
|Net income (loss) attributable to common stockholders |                                                 | $                        | (6,626 | )      |        | $    | 3,551  |        |        | $ | (415,485 | )      
|                                                      |                                                 |                          |        |        |        |      |        |        |        |   |          |        
|Basic income (loss) per share                         |                                                 | $                        | (0.30  | )      |        | $    | 0.14   |        |        | $ | (14.46   | )      
|                                                      |                                                 |                          |        |        |        |      |        |        |        |   |          |        
|Diluted income (loss) per share                       |                                                 | $                        | (0.30  | )      |        | $    | 0.13   |        |        | $ | (14.46   | )      
|                                                      |                                                 |                          |        |        |        |      |        |        |        |   |          |        
|Basic weighted-average shares outstanding             |                                                 |                          | 21,946 |        |        |      | 24,583 |        |        |   | 28,733   |        
|                                                      |                                                 |                          |        |        |        |      |        |        |        |   |          |        
|Diluted weighted-average shares outstanding           |                                                 |                          | 21,946 |        |        |      | 26,547 |        |        |   | 28,733   |        
|                                                      |                                                 |                          |        |        |        |      |        |        |        |   |          |        

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

F-4



---



##### Table of Contents



VISUAL NETWORKS, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS
EQUITY

(in thousands, except share data)


|                           |                                                               |                 |           |                      |   |              |        |         |   |        |         |          |   |   |   |     |   |  |            |            |   |   |     |     |  
|-------------------------- | ------------------------------------------------------------- | --------------- | --------- | -------------------- | - | ------------ | ------ | ------- | - | ------ | ------- | -------- | - | - | - | --- | - |  | ---------- | ---------- | - | - | --- | --- | -
|                           |                                                               |                 |           |                      |   |              |        |         |   |       
|                           |                                                               | Redeemable      |           |                      |   |              |        |        
|                           |                                                               | Convertible     |           | Series A Convertible |   |             
|                           |                                                               | Preferred Stock |           | Preferred Stock      |   | Common Stock
|                           |                                                               |                 |           |                      |   |             
|                           |                                                               | Shares          |           | Amount               |   | Shares       |        | Amount  |   | Shares |         | Amount  
|                           |                                                               |                 |           |                      |   |              |        |         |   |        |         |         
|Balance, December 31, 1997 |                                                               |                 | 7,228,473 |                      |   | $            | 14,855 |         |   |        | 347,070 |          |   | $ | 3 |     |   |  | 7,525,270  |            |   | $ | 75  |    
|                          
|                          
|                          
|                          
|                           | Accretion on preferred stock                                  |                 |           |                     |   |              |        | 16      |   |        |         |         |   |   |   |    |   |  |            |           |   |   |     |    |  
|                          
|                          
|                          
|                          
|                           | Accrued dividends on preferred stock                          |                 |           |                     |   |              |        | 125     |   |        |         |         |   |   |   | 30  |   |  |            |           |   |   |     |    |  
|                          
|                          
|                          
|                          
|                           | Conversion of preferred stock and payment of dividend         |                 |           | (7,228,473           | ) |              |        | (14,996 | ) |        |         | (347,070 | ) |   |   | (33 | ) |  |            | 10,605,735 |   |   |     | 106 |  
|                          
|                          
|                          
|                          
|                           | Issuance of common stock                                      |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            | 5,325,849  |   |   |     | 53  |  
|                          
|                          
|                          
|                          
|                           | Repurchase of common stock                                    |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            | (75,073    | ) |   |     |    |  
|                          
|                          
|                          
|                          
|                           | Exercise of stock options and warrants                        |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            | 785,274    |   |   |     | 8   |  
|                          
|                          
|                          
|                          
|                           | Issuance of common stock for services                         |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            | 6,316      |   |   |     |    |  
|                          
|                          
|                          
|                          
|                           | Settlement of note for common stock                           |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            | 16,848     |   |   |     |    |  
|                          
|                          
|                          
|                          
|                           | Deferred compensation                                         |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            |           |   |   |     |    |  
|                          
|                          
|                          
|                          
|                           | Amortization of deferred compensation                         |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            |           |   |   |     |    |  
|                          
|                          
|                          
|                          
|                           | Net loss                                                      |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            |           |   |   |     |    |  
|                           |                                                               |                 |           |                      |   |              |        |         |   |        |         |          |   |   |   |     |   |  |            |            |   |   |     |    
|Balance, December 31, 1998 |                                                               |                 |          |                      |   |              |       |         |   |        |        |          |   |   |  |     |   |  | 24,190,219 |            |   |   | 242 |    
|                          
|                          
|                          
|                          
|                           | Exercise of stock options and warrants                        |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            | 699,266    |   |   |     | 7   |  
|                          
|                          
|                          
|                          
|                           | Income tax benefit from exercise of stock options             |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            |           |   |   |     |    |  
|                          
|                          
|                          
|                          
|                           | Issuance of common stock under employee stock purchase plan   |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            | 4,182      |   |   |     |    |  
|                          
|                          
|                          
|                          
|                           | Repurchase of common stock                                    |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            | (60,058    | ) |   |     | (1  | )
|                          
|                          
|                          
|                          
|                           | Repayment of shareholder notes                                |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            |           |   |   |     |    |  
|                          
|                          
|                          
|                          
|                           | Deferred compensation                                         |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            |           |   |   |     |    |  
|                          
|                          
|                          
|                          
|                           | Amortization of deferred compensation                         |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            |           |   |   |     |    |  
|                          
|                          
|                          
|                          
|                           | Net income                                                    |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            |           |   |   |     |    |  
|                           |                                                               |                 |           |                      |   |              |        |         |   |        |         |          |   |   |   |     |   |  |            |            |   |   |     |    
|Balance, December 31, 1999 |                                                               |                 |          |                      |   |              |       |         |   |        |        |          |   |   |  |     |   |  | 24,833,609 |            |   |   | 248 |    
|                          
|                          
|                          
|                          
|                           | Issuance of common stock, options and warrants in acquisition |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            | 5,413,530  |   |   |     | 54  |  
|                          
|                          
|                          
|                          
|                           | Exercise of stock options and warrants                        |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            | 866,366    |   |   |     | 9   |  
|                          
|                          
|                          
|                          
|                           | Issuance of common stock under employee stock purchase plan   |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            | 182,878    |   |   |     | 2   |  
|                          
|                          
|                          
|                          
|                           | Deferred compensation                                         |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            |           |   |   |     |    |  
|                          
|                          
|                          
|                          
|                           | Amortization of deferred compensation                         |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            |           |   |   |     |    |  
|                          
|                          
|                          
|                          
|                           | Foreign currency translation adjustment                       |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            |           |   |   |     |    |  
|                          
|                          
|                          
|                          
|                           | Net loss                                                      |                 |           |                     |   |              |        |        |   |        |         |         |   |   |   |    |   |  |            |           |   |   |     |    |  
|                           |                                                               |                 |           |                      |   |              |        |         |   |        |         |          |   |   |   |     |   |  |            |            |   |   |     |    
|Balance, December 31, 2000 |                                                               |                 |          |                      |   | $            |       |         |   |        |        |          |   | $ |  |     |   |  | 31,296,383 |            |   | $ | 313 |    
|                           |                                                               |                 |           |                      |   |              |        |         |   |        |         |          |   |   |   |     |   |  |            |            |   |   |     |    

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

F-5



---



##### Table of Contents



VISUAL NETWORKS, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS
EQUITY  (continued)

(in thousands, except share data)


|                           |                                                               |            |         |              |   |              |      |               |   |             |      |       |   |   |    |    |  |   |          |          |   |   |         |          |  
|-------------------------- | ------------------------------------------------------------- | ---------- | ------- | ------------ | - | ------------ | ---- | ------------- | - | ----------- | ---- | ----- | - | - | -- | -- |  | - | -------- | -------- | - | - | ------- | -------- | -
|                           |                                                               |            |         | Notes        |   |              |      | Accumulated   |   |             |      |      
|                           |                                                               | Additional |         | Receivable   |   |              |      | Other         |   |             |      |      
|                           |                                                               | Paid-In    |         | from         |   | Deferred     |      | Comprehensive |   | Accumulated |      |      
|                           |                                                               | Capital    |         | Stockholders |   | Compensation |      | Income        |   | Deficit     |      | Total
|                           |                                                               |            |         |              |   |              |      |               |   |             |      |      
|Balance, December 31, 1997 |                                                               | $          | 15,303  |              |   | $            |     |               |   | $           | (247 | )     |   | $ |   |    |  | $ | (28,385  | )        |   | $ | (13,251 | )       
|                          
|                          
|                          
|                          
|                           | Accretion on preferred stock                                  |            |         |             |   |              |      |              |   |             |      |      |   |   |    |   |  |   |          | (16      | ) |   |         | (16      | )
|                          
|                          
|                          
|                          
|                           | Accrued dividends on preferred stock                          |            |         |             |   |              |      |              |   |             |      |      |   |   |    |   |  |   |          | (155     | ) |   |         | (125     | )
|                          
|                          
|                          
|                          
|                           | Conversion of preferred stock and payment of dividend         |            |         | 14,923       |   |              |      |              |   |             |      |      |   |   |    |   |  |   |          |         |   |   |         | 14,996   |  
|                          
|                          
|                          
|                          
|                           | Issuance of common stock                                      |            |         | 51,800       |   |              |      |              |   |             |      |      |   |   |    |   |  |   |          |         |   |   |         | 51,853   |  
|                          
|                          
|                          
|                          
|                           | Repurchase of common stock                                    |            |         | (1           | ) |              |      |              |   |             |      |      |   |   |    |   |  |   |          |         |   |   |         | (1       | )
|                          
|                          
|                          
|                          
|                           | Exercise of stock options and warrants                        |            |         | 804          |   |              |      | (147          | ) |             |      |      |   |   |    |   |  |   |          |         |   |   |         | 665      |  
|                          
|                          
|                          
|                          
|                           | Issuance of common stock for services                         |            |         |             |   |              |      |              |   |             |      |      |   |   |    |   |  |   |          |         |   |   |         |         |  
|                          
|                          
|                          
|                          
|                           | Settlement of note for common stock                           |            |         | 542          |   |              |      |              |   |             |      |      |   |   |    |   |  |   |          |         |   |   |         | 542      |  
|                          
|                          
|                          
|                          
|                           | Deferred compensation                                         |            |         | 606          |   |              |      |              |   |             |      | (606  | ) |   |    |   |  |   |          |         |   |   |         |         |  
|                          
|                          
|                          
|                          
|                           | Amortization of deferred compensation                         |            |         |             |   |              |      |              |   |             |      | 114   |   |   |    |   |  |   |          |         |   |   |         | 114      |  
|                          
|                          
|                          
|                          
|                           | Net loss                                                      |            |         |             |   |              |      |              |   |             |      |      |   |   |    |   |  |   |          | (6,455   | ) |   |         | (6,455   | )
|                           |                                                               |            |         |              |   |              |      |               |   |             |      |       |   |   |    |    |  |   |          |          |   |   |         |         
|Balance, December 31, 1998 |                                                               |            | 83,977  |              |   |              | (147 | )             |   |             | (739 | )     |   |   |   |    |  |   | (35,011  | )        |   |   | 48,322  |         
|                          
|                          
|                          
|                          
|                           | Exercise of stock options and warrants                        |            |         | 2,047        |   |              |      |              |   |             |      |      |   |   |    |   |  |   |          |         |   |   |         | 2,054    |  
|                          
|                          
|                          
|                          
|                           | Income tax benefit from exercise of stock options             |            |         | 3,722        |   |              |      |              |   |             |      |      |   |   |    |   |  |   |          |         |   |   |         | 3,722    |  
|                          
|                          
|                          
|                          
|                           | Issuance of common stock under employee stock purchase plan   |            |         | 132          |   |              |      |              |   |             |      |      |   |   |    |   |  |   |          |         |   |   |         | 132      |  
|                          
|                          
|                          
|                          
|                           | Repurchase of common stock                                    |            |         |             |   |              |      |              |   |             |      |      |   |   |    |   |  |   |          |         |   |   |         | (1       | )
|                          
|                          
|                          
|                          
|                           | Repayment of shareholder notes                                |            |         |             |   |              |      | 147           |   |             |      |      |   |   |    |   |  |   |          |         |   |   |         | 147      |  
|                          
|                          
|                          
|                          
|                           | Deferred compensation                                         |            |         | 291          |   |              |      |              |   |             |      | (291  | ) |   |    |   |  |   |          |         |   |   |         |         |  
|                          
|                          
|                          
|                          
|                           | Amortization of deferred compensation                         |            |         |             |   |              |      |              |   |             |      | 325   |   |   |    |   |  |   |          |         |   |   |         | 325      |  
|                          
|                          
|                          
|                          
|                           | Net income                                                    |            |         |             |   |              |      |              |   |             |      |      |   |   |    |   |  |   |          | 3,551    |   |   |         | 3,551    |  
|                           |                                                               |            |         |              |   |              |      |               |   |             |      |       |   |   |    |    |  |   |          |          |   |   |         |         
|Balance, December 31, 1999 |                                                               |            | 90,169  |              |   |              |     |               |   |             | (705 | )     |   |   |   |    |  |   | (31,460  | )        |   |   | 58,252  |         
|                          
|                          
|                          
|                          
|                           | Issuance of common stock, options and warrants in acquisition |            |         | 378,793      |   |              |      |              |   |             |      |      |   |   |    |   |  |   |          |         |   |   |         | 378,847  |  
|                          
|                          
|                          
|                          
|                           | Exercise of stock options and warrants                        |            |         | 3,173        |   |              |      |              |   |             |      |      |   |   |    |   |  |   |          |         |   |   |         | 3,182    |  
|                          
|                          
|                          
|                          
|                           | Issuance of common stock under employee stock purchase plan   |            |         | 1,047        |   |              |      |              |   |             |      |      |   |   |    |   |  |   |          |         |   |   |         | 1,049    |  
|                          
|                          
|                          
|                          
|                           | Deferred compensation                                         |            |         | (74          | ) |              |      |              |   |             |      | 74    |   |   |    |   |  |   |          |         |   |   |         |         |  
|                          
|                          
|                          
|                          
|                           | Amortization of deferred compensation                         |            |         |             |   |              |      |              |   |             |      | 229   |   |   |    |   |  |   |          |         |   |   |         | 229      |  
|                          
|                          
|                          
|                          
|                           | Foreign currency translation adjustment                       |            |         |             |   |              |      |              |   |             |      |      |   |   |    | 11 |  |   |          |         |   |   |         | 11       |  
|                          
|                          
|                          
|                          
|                           | Net loss                                                      |            |         |             |   |              |      |              |   |             |      |      |   |   |    |   |  |   |          | (415,485 | ) |   |         | (415,485 | )
|                           |                                                               |            |         |              |   |              |      |               |   |             |      |       |   |   |    |    |  |   |          |          |   |   |         |         
|Balance, December 31, 2000 |                                                               | $          | 473,108 |              |   | $            |     |               |   | $           | (402 | )     |   | $ | 11 |    |  | $ | (446,945 | )        |   | $ | 26,085  |         
|                           |                                                               |            |         |              |   |              |      |               |   |             |      |       |   |   |    |    |  |   |          |          |   |   |         |         

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

F-6



---



##### Table of Contents



VISUAL NETWORKS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)


|                                                                                                    |                                                               |                                       |        |        |        |      |        |        |        |   |          |         |        |  
|--------------------------------------------------------------------------------------------------- | ------------------------------------------------------------- | ------------------------------------- | ------ | ------ | ------ | ---- | ------ | ------ | ------ | - | -------- | ------- | ------ | -
|                                                                                                    |                                                               |                                      
|                                                                                                    |                                                               | Years Ended December 31,             
|                                                                                                    |                                                               |                                      
|                                                                                                    |                                                               | 1998                                  |        | 1999   |        | 2000
|                                                                                                    |                                                               |                                       |        |        |        |     
|Cash Flows From Operating Activities:                                                               |                                                               |                                       |        |        |        |      |        |        |        |   |          |        
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|Net income (loss)                                                                                   |                                                               | $                                     | (6,455 | )      |        | $    | 3,551  |        |        | $ | (415,485 | )      
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|Adjustments to reconcile net income (loss) to net cash
	provided by (used in) operating activities: |                                                               |                                       |        |        |        |      |        |        |        |   |          |        
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    | Depreciation and amortization                                 |                                       |        | 1,912  |        |      |        | 4,033  |        |   |          | 59,666  |       
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    | Write-off of purchased research and development               |                                       |        |       |        |      |        |       |        |   |          | 39,000  |       
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    | Non-cash restructuring and impairment charges                 |                                       |        |       |        |      |        |       |        |   |          | 329,910 |       
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    | Deferred taxes                                                |                                       |        |       |        |      |        |       |        |   |          | (34,058 | )     
|                                                                                                    | Changes in assets and liabilities                            |                                       |        |        |        |      |        |        |        |   |          |         |       
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    |                                                               | Accounts receivable                   |        |        | (1,422 | )    |        |        | (3,426 | ) |          |         | 5,152  |  
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    |                                                               | Inventory                             |        |        | (1,362 | )    |        |        | (2,912 | ) |          |         | (5,476 | )
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    |                                                               | Other assets                          |        |        | (1,384 | )    |        |        | (312   | ) |          |         | (113   | )
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    |                                                               | Accounts payable and accrued expenses |        |        | 1,365  |      |        |        | 6,235  |   |          |         | 8,312  |  
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    |                                                               | Customer deposits                     |        |        | 1,545  |      |        |        | (4,613 | ) |          |         |       |  
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    |                                                               | Deferred revenue                      |        |        | 1,222  |      |        |        | 3,841  |   |          |         | (3,834 | )
|                                                                                                    |                                                               |                                       |        |        |        |      |        |        |        |   |          |        
|                                                                                                    | Net cash provided by (used in) operating activities           |                                       |        | (4,579 | )      |      |        | 6,397  |        |   |          | (16,926 | )     
|                                                                                                    |                                                               |                                       |        |        |        |      |        |        |        |   |          |        
|Cash Flows From Investing Activities:                                                               |                                                               |                                       |        |        |        |      |        |        |        |   |          |        
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    | Net (purchases) sales/maturities of short-term investments    |                                       |        | (1,002 | )      |      |        | 1,002  |        |   |          | (3,145  | )     
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    | Proceeds from sale leaseback transactions                     |                                       |        |       |        |      |        | 750    |        |   |          |        |       
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    | Expenditures for property and equipment                       |                                       |        | (5,234 | )      |      |        | (5,828 | )      |   |          | (7,623  | )     
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    | Investment in joint venture                                   |                                       |        |       |        |      |        |       |        |   |          | (797    | )     
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    | Merger-related transaction costs, net of cash acquired        |                                       |        |       |        |      |        |       |        |   |          | (10,234 | )     
|                                                                                                    |                                                               |                                       |        |        |        |      |        |        |        |   |          |        
|                                                                                                    | Net cash used in investing activities                         |                                       |        | (6,236 | )      |      |        | (4,076 | )      |   |          | (21,799 | )     
|                                                                                                    |                                                               |                                       |        |        |        |      |        |        |        |   |          |        
|Cash Flows From Financing Activities:                                                               |                                                               |                                       |        |        |        |      |        |        |        |   |          |        
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    | Series A Convertible Preferred Stock dividend                 |                                       |        | (30    | )      |      |        |       |        |   |          |        |       
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    | Proceeds from issuance of common stock, net of issuance costs |                                       |        | 51,853 |        |      |        |       |        |   |          |        |       
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    | Exercise of stock options and warrants                        |                                       |        | 652    |        |      |        | 2,185  |        |   |          | 4,231   |       
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    | Repayments of notes receivable from stockholders              |                                       |        |       |        |      |        | 147    |        |   |          |        |       
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    | Net borrowings (repayments) under credit agreements           |                                       |        | 764    |        |      |        | (1,079 | )      |   |          | (1,658  | )     
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    | Principal payments on capital lease obligations               |                                       |        | (370   | )      |      |        | (600   | )      |   |          | (1,119  | )     
|                                                                                                    |                                                               |                                       |        |        |        |      |        |        |        |   |          |        
|                                                                                                    | Net cash provided by financing activities                     |                                       |        | 52,869 |        |      |        | 653    |        |   |          | 1,454   |       
|                                                                                                    |                                                               |                                       |        |        |        |      |        |        |        |   |          |        
|Effect of exchange rate changes                                                                     |                                                               |                                       |       |        |        |      |       |        |        |   | 11       |        
|                                                                                                    |                                                               |                                       |        |        |        |      |        |        |        |   |          |        
|Net Increase (Decrease) in Cash and Cash Equivalents                                                |                                                               |                                       | 42,054 |        |        |      | 2,974  |        |        |   | (37,260  | )      
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|Cash and Cash Equivalents, Beginning of Year                                                        |                                                               |                                       | 9,601  |        |        |      | 51,655 |        |        |   | 54,629   |        
|                                                                                                    |                                                               |                                       |        |        |        |      |        |        |        |   |          |        
|Cash and Cash Equivalents, End of Year                                                              |                                                               | $                                     | 51,655 |        |        | $    | 54,629 |        |        | $ | 17,369   |        
|                                                                                                    |                                                               |                                       |        |        |        |      |        |        |        |   |          |        
|Supplemental Cash Flow Information:                                                                 |                                                               |                                       |        |        |        |      |        |        |        |   |          |        
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    | Cash paid for interest                                        |                                       | $      | 241    |        |      | $      | 232    |        |   | $        | 211     |       
|                                                                                                    |                                                               |                                       |        |        |        |      |        |        |        |   |          |        
|                                                                                                    | Cash paid for income taxes                                    |                                       | $      | 513    |        |      | $      |       |        |   | $        |        |       
|                                                                                                    |                                                               |                                       |        |        |        |      |        |        |        |   |          |        
|Supplemental disclosure of non-cash investing and financing
	activities:                            |                                                               |                                       |        |        |        |      |        |        |        |   |          |        
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                   
|                                                                                                    | Issuance of common stock, options and warrants in acquisition |                                       | $      |       |        |      | $      |       |        |   | $        | 378,847 |       
|                                                                                                    |                                                               |                                       |        |        |        |      |        |        |        |   |          |        

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

F-7



---



##### Table of Contents



VISUAL NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.  Nature of Operations and Summary of Significant
Accounting Policies:

Visual Networks, Inc. (Visual or the
Company) designs, manufactures, sells and supports
comprehensive service management systems for providers and users
of new world connectivity services and out-sourced Web services.

Risks and Other Important Factors

The Company incurred a net loss of $415.5 million for the
year ended December 31, 2000. The deterioration of the
operating results in 2000 was due, in part, to decreased revenue
and increased operating expenses. The Companys ability to
generate operating income in the future is, in large part,
dependent on its success in increasing revenue and reducing
operating expenses. Due to market conditions, competitive
pressures, and other factors beyond its control, there can be no
assurances that the Company will be able to adequately increase
revenue in the future. The Company also believes that its plans
will result in a reduction in operating expenses that, when
combined with the anticipated revenue growth, will result in a
return to profitability. In the event that the anticipated cost
reductions are not realized or revenue does not increase, the
Company may be required to further reduce its cost structure.
There can be no assurance that the Company will become
profitable.

The success of the Company is also dependent on its ability to
generate adequate cash for operating and capital needs. The
Company is relying on its existing cash and cash equivalents,
investments and credit facility together with future sales and
the collection of the related accounts receivable to meet its
future cash requirements. If cash provided by these sources is
not sufficient to fund future operations, the Company will be
required to further reduce its expenditures for operations or to
seek additional capital through other means which may include
the sale of assets, the sale of equity securities or additional
borrowings. There can be no assurances that additional capital
will be available, or available on terms that are reasonable or
acceptable to the Company.

The Companys operations are subject to certain other risks
and uncertainties, including among others, successful
incorporation of the Companys products into service
provider company infrastructure, long sale cycles, dependence on
significant customers, rapidly changing technology, current and
potential competitors with greater financial, technological,
production, and marketing resources, dependence on sole and
limited source suppliers, dependence on key management
personnel, ability to recruit and retain employees, defense
against pending litigation, limited protection of intellectual
property and proprietary rights, integration of acquisitions,
uncertainty of future profitability and possible fluctuations in
financial results.

Business Combinations and Basis of Presentation

On May 15, 1998, Visual acquired Net2Net Corporation
(Net2Net) in a merger transaction accounted for as a
pooling of interests. Net2Net was engaged in developing,
manufacturing and marketing Asynchronous Transfer Mode
(ATM) wide-area-network management and analysis
systems. Visual issued 2,056,204 shares of its common stock in
exchange for all of the outstanding preferred and common stock
of Net2Net. In addition, outstanding Net2Net stock options were
converted into options to purchase 189,733 shares of Visual
common stock, a note payable by Net2Net was settled with 16,848
shares of the Companys common stock, and the exercise of a
warrant resulted in the issuance of 2,225 shares of the
Companys common stock. In connection with the Net2Net
acquisition, the Company recorded merger-related costs of
approximately $4.3 million. Transaction costs totaled
approximately $4.1 million and consisted primarily of fees
for investment bankers, attorneys, accountants and other direct
transaction costs. Integration costs totaled approximately
$207,000 and consisted of incremental and non-recurring costs
necessary to integrate Visual

F-8



---



##### Table of Contents



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

and Net2Net. These costs were expensed as incurred. The Company
also recorded a restructuring charge of approximately $751,000
in connection with the Net2Net merger(see Note 7).

On September 30, 1999, Visual acquired Inverse Network
Technology (Inverse) in a merger transaction
accounted for as a pooling of interests. Inverse was a provider
of service level management software solutions and Internet
measurement services. Visual issued 4,096,429 shares of its
common stock in exchange for all of the outstanding preferred
and common stock of Inverse. In addition, outstanding Inverse
stock options and warrants were converted into options and
warrants to purchase 425,088 shares of Visual common stock. In
connection with the Inverse acquisition, the Company recorded
merger-related costs of approximately $6.8 million.
Transaction costs totaled approximately $6.4 million and
consisted primarily of fees for investment bankers, attorneys,
accountants and other direct transaction costs. The remaining
$376,000 in non-recurring costs consisted primarily of the
write-off of certain assets as a result of the merger and the
accrual of certain employee benefits to conform the policies of
Inverse with those of the Company.

The accompanying consolidated financial statements have been
retroactively restated to reflect the combined financial
position and combined results of operations and cash flows for
all periods presented, giving effect to the acquisitions of
Net2Net and Inverse as if they had occurred at the beginning of
the earliest period presented.

Results of operations for the separate and combined companies
prior to the pooling transactions are as follows (in thousands):

|                   |                 |                   |        |                  |   |   |        |        |  
|------------------ | --------------- | ----------------- | ------ | ---------------- | - | - | ------ | ------ | -
|                   |                 |                   |        | Six Months Ended
|                   |                 | Year Ended        |        | June 30, 1999   
|                   |                 | December 31, 1998 |        | (unaudited)     
|                   |                 |                   |        |                 
|Revenue:           |                 |                   |        |                  |   |   |        |       
|                  
|                  
|                  
|                  
|                   | Visual          |                   | $      | 49,699           |   |   | $      | 36,005 |  
|                  
|                  
|                  
|                  
|                   | Pooled entities |                   |        | 6,389            |   |   |        | 3,793  |  
|                   |                 |                   |        |                  |   |   |        |       
|                   |                 | $                 | 56,088 |                  |   | $ | 39,798 |       
|                   |                 |                   |        |                  |   |   |        |       
|Net Income (Loss): |                 |                   |        |                  |   |   |        |       
|                  
|                  
|                  
|                  
|                   | Visual          |                   | $      | 3,145            |   |   | $      | 6,178  |  
|                  
|                  
|                  
|                  
|                   | Pooled entities |                   |        | (9,600           | ) |   |        | (5,074 | )
|                   |                 |                   |        |                  |   |   |        |       
|                   |                 | $                 | (6,455 | )                |   | $ | 1,104  |       
|                   |                 |                   |        |                  |   |   |        |       

On May 24, 2000, Visual acquired Avesta Technologies, Inc.
(Avesta) in a merger transaction accounted for using
the purchase method of accounting. Avesta was a provider of
fault management and application performance monitoring software
systems to e-business customers (see Note 6). The results
of operations of Avesta have been included in the accompanying
consolidated statements of operations from the date of
acquisition (hereafter, Visual, Net2Net, Inverse and Avesta are
collectively referred to as the Company).

Principles of Consolidation

The consolidated financial statements include the accounts of
Visual Networks, Inc. and its wholly owned subsidiaries. All
significant intercompany account balances and transactions have
been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts
of assets and liabilities, and disclosure of contingent assets
and liabilities at the date of the financial statements and the

F-9



---



##### Table of Contents



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.

Cash and Cash Equivalents

The Company considers all highly liquid instruments with an
original maturity of three months or less at the time of
purchase to be cash equivalents. The Company maintains its cash
and cash equivalents with high credit quality financial
institutions. The Companys cash equivalents consist
primarily of investments in money market funds that invest in
U.S. Treasury obligations, repurchase agreements
collateralized by U.S. Treasury securities, and high
quality corporate obligations. The Company had approximately
$52.6 million and $10.8 million, respectively,
invested in money market funds as of December 31, 1999 and
2000 and approximately $2.0 million invested in a bond fund
as of December 31, 1999.

Investments

Investments in marketable securities are classified as
available-for-sale and are reported at fair value in accordance
with Statement of Financial Accounting Standards
(SFAS) No. 115, Accounting for Certain
Investments in Debt and Equity Securities. The fair values
are based on quoted market prices. Unrealized gains and losses
on marketable securities are reported as a separate component of
comprehensive income, if significant. As of December 31,
2000, the Company held short-term investments in
U.S. Treasury obligations that mature within one year. The
Company also held a $5.0 million certificate of deposit
that matures on March 31, 2002 and has been included in
other assets in the accompanying balance sheet as of
December 31, 2000. As of December 31, 2000, unrealized
gains and losses were not material.

The Company has an investment in an entity in which the Company
has less than a majority ownership interest but over which the
Company can exercise significant influence. The Company uses the
equity method to account for this investment and its carrying
value of $747,000 is included in other assets in the
accompanying balance sheet as of December 31, 2000. Under
the equity method, investments originally recorded at cost are
adjusted to recognize the Companys share of net earnings
or losses of the affiliates as they occur, rather than as
dividends or other distributions are received, limited to the
extent of the Companys investment in, advances to and
guarantees for the investment entity. The Company also has an
investment in an entity in which the Company exercises no
control or significant influence. Such investment is accounted
for under the cost method and its carrying value of
approximately $3.7 million is included in other assets in
the accompanying balance sheet as of December 31, 2000. The
Company periodically reviews its investments for permanent
impairments.

Inventory

Inventory is stated at the lower of average cost or market, and
consists of the following (in thousands):

|                 |  |              |       |      |  |   |        | 
|---------------- |  | ------------ | ----- | ---- |  | - | ------ | 
|                 |  |             
|                 |  | December 31,
|                 |  |             
|                 |  | 1999         |       | 2000
|                 |  |              |       |     
|Raw materials    |  | $            | 764   |      |  | $ | 4,301  | 
|                
|                
|                
|                
|Work-in-progress |  |              | 2,230 |      |  |   | 151    | 
|                
|                
|                
|                
|Finished goods   |  |              | 5,004 |      |  |   | 9,022  | 
|                 |  |              |       |      |  |   |        | 
|                 |  | $            | 7,998 |      |  | $ | 13,474 | 
|                 |  |              |       |      |  |   |        | 

Property and Equipment

Property and equipment is carried at cost and depreciated over
its estimated useful life, ranging from three to five years,
using the straight-line method. Equipment held under capital
leases is recorded at the

F-10



---



##### Table of Contents



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

present value of the future minimum lease payments and is
amortized on a straight-line basis over the shorter of the
assets useful lives or the relevant lease term, ranging
from three to seven years. Property and equipment consists of
the following (in thousands):

|                              |  |              |        |      |  |   |         |  
|----------------------------- |  | ------------ | ------ | ---- |  | - | ------- | -
|                              |  |             
|                              |  | December 31,
|                              |  |             
|                              |  | 1999         |        | 2000
|                              |  |              |        |     
|Equipment and software        |  | $            | 10,170 |      |  | $ | 17,480  |  
|                             
|                             
|                             
|                             
|Furniture and fixtures        |  |              | 3,043  |      |  |   | 2,370   |  
|                             
|                             
|                             
|                             
|Leasehold improvements        |  |              | 1,684  |      |  |   | 2,942   |  
|                              |  |              |        |      |  |   |         |  
|                              |  |              | 14,897 |      |  |   | 22,792  |  
|                             
|                             
|                             
|                             
|Less-Accumulated depreciation |  |              | (6,331 | )    |  |   | (12,054 | )
|                              |  |              |        |      |  |   |         |  
|                              |  | $            | 8,566  |      |  | $ | 10,738  |  
|                              |  |              |        |      |  |   |         |  

Intangible Assets

Intangible assets consist of identifiable intangibles related to
the acquisition of Avesta. Such intangibles are amortized using
the straight-line method over the following estimated useful
lives. Goodwill arising from the Avesta acquisition was
amortized over its estimated useful life of four years (see
Notes 6 and 7). Intangible assets consist of the following
(in thousands):

|                      |  |              |       |        |  |        
|--------------------- |  | ------------ | ----- | ------ |  | -------
|                      |  | December 31, |       | Useful
|                      |  | 2000         |       | Life  
|                      |  |              |       |       
|Assembled workforce   |  | $            | 224   |        |  | 3 years
|                     
|                     
|                     
|                     
|Trademarks/tradenames |  |              | 1,064 |        |  | 7 years
|                     
|                     
|                     
|                     
|Completed technology  |  |              | 7,222 |        |  | 5 years
|                      |  |              |       |        |  |        
|                      |  | $            | 8,510 |        |  |        
|                      |  |              |       |        |  |        

Long-Lived Assets

The Company reviews its long-lived assets, including property
and equipment, identifiable intangibles, and goodwill whenever
events or changes in circumstances indicate that the carrying
amount of the assets may not be fully recoverable. To determine
recoverability of its long-lived assets, the Company evaluates
the probability that future estimated undiscounted net cash
flows will be less than the carrying amount of the assets. If
future estimated undiscounted net cash flows are more likely
than not to be less than the carrying amount of the long-lived
assets, then such assets are written down to their fair value.
As part of the $335.8 million restructuring and impairment
charges recorded during the year ended December 31, 2000,
the Company recorded an impairment charge of $328.8 million
against long-lived assets (see Note 7). The Companys
estimates of anticipated revenues and profits and the remaining
estimated lives of tangible and intangible assets, or both,
could be reduced significantly in the future. As a result, the
carrying amount of long-lived assets, including intangibles,
could be reduced materially in the future.

F-11



---



##### Table of Contents



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Accounts Payable and Accrued Expenses

Accounts payable and accrued expenses consist of the following
(in thousands):

|                       |  |              |        |      |  |   |        | 
|---------------------- |  | ------------ | ------ | ---- |  | - | ------ | 
|                       |  |             
|                       |  | December 31,
|                       |  |             
|                       |  | 1999         |        | 2000
|                       |  |              |        |     
|Accounts payable       |  | $            | 2,908  |      |  | $ | 5,836  | 
|                      
|                      
|                      
|                      
|Accrued compensation   |  |              | 3,640  |      |  |   | 6,936  | 
|                      
|                      
|                      
|                      
|Accrued restructuring  |  |              |       |      |  |   | 4,306  | 
|                      
|                      
|                      
|                      
|Other accrued expenses |  |              | 5,206  |      |  |   | 10,834 | 
|                       |  |              |        |      |  |   |        | 
|                       |  | $            | 11,754 |      |  | $ | 27,912 | 
|                       |  |              |        |      |  |   |        | 

Revenue Recognition

The Companys service management products and services
include hardware, software, benchmark services, professional
services and technical support. The Company generally recognizes
revenue from the sale or license of its products upon delivery
and passage of title to the customer. Where agreements provide
for evaluation or customer acceptance, the Company recognizes
revenue upon the completion of the evaluation process and
acceptance of the product by the customer. Maintenance contracts
require the Company to provide technical support and software
updates to customers. The Company recognizes product support and
maintenance revenue, including maintenance revenue that is
bundled with product sales, ratably over the term of the
contract period, which generally ranges from one to five years.
Revenue recognized from multiple-element software arrangements
is allocated to each element of the arrangement based on the
relative fair values of the elements. The fair values of
professional services, technical support and training have been
determined based on the Companys specific objective
evidence of fair value. Revenue from services is recognized when
the services are performed. Subscription fees for the
Companys benchmark reports are recognized upon delivery of
the reports.

The Company adopted the American Institute of Certified Public
Accountants (the AICPA) Statement of Position
(SOP) 97-2, Software Revenue
Recognition, in 1998. In 1999, the Company adopted SOP
98-9, Modification of SOP 97-2, Software Revenue
Recognition, with Respect to Certain Transactions, which
amends SOP 98-4, Deferral of Effective Date of a Provision
of SOP 97-2, to provide additional guidance regarding the
accounting for multiple element software sales. The Company
recognizes software revenue in accordance with these SOPs.

The Company has agreements with certain resellers that provide
price protection in the event that more favorable prices and
terms are granted to any other customer. Reserves for estimated
price protection credits are established by the Company
concurrently with the recognition of revenue. The Company
monitors the factors that influence the pricing of its products
and reseller inventory levels and makes adjustments to these
reserves when management believes that actual price protection
credits may differ from established estimates.

In December 1999, the SEC issued Staff Accounting Bulletin
No. 101 (SAB No. 101), Revenue
Recognition in Financial Statements. SAB No. 101
provides guidance on applying generally accepted accounting
principles to revenue recognition, presentation and disclosure
in financial statements. The Company adopted SAB No. 101 in
the fourth quarter of 2000 without a material effect on the
Companys results of operations or financial position.

Credit Risk and Significant Customers

Financial instruments that potentially subject the Company to
significant concentrations of credit risk consist principally of
cash and cash equivalents, investments and accounts receivable.
The Company sells its

F-12



---



##### Table of Contents



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

products to large telecommunications and Internet service
providers primarily in the United States. The Company grants
credit terms without collateral to its customers and has not
experienced any significant credit related losses. Accounts
receivable include allowances to record receivables at their
estimated net realizable value. For the year ended
December 31, 1998, three customers individually represented
27%, 16% and 13% of revenue, respectively. For the year ended
December 31, 1999, two customers each represented 25% of
revenue. For the year ended December 31, 2000, three
customers individually represented 20%, 18% and 14% of revenue.

Warranty

The Company warrants its hardware products for periods of up to
five years. Estimated warranty costs are charged to cost of
revenue in the period in which revenue from the related product
sale is recognized.

Research and Development

Research and development costs are expensed as incurred.

The Company accounts for software development costs in
accordance with SFAS No. 86, Accounting for the Costs
of Computer Software to be Sold, Leased, or Otherwise
Marketed. Costs incurred prior to establishment of
technological feasibility are expensed as incurred and reflected
as research and development costs in the accompanying
consolidated statements of operations. For the years ended
December 31, 1998, 1999, and 2000, the Company did not
capitalize any costs related to software development. During
these periods, the time between the establishment of
technological feasibility and general release of products was
very short. Consequently, costs otherwise capitalizable after
technological feasibility were expensed as they were immaterial.

Income Taxes

The Company accounts for income taxes in accordance with SFAS
No. 109 Accounting for Income Taxes. Under SFAS
No. 109, deferred tax assets and liabilities are computed
based on the difference between the financial statement and
income tax bases of assets and liabilities using the enacted
marginal tax rate. SFAS No. 109 requires that the net
deferred tax asset be reduced by a valuation allowance if, based
on the weight of available evidence, it is more likely than not
that some portion or all of the net deferred tax asset will not
be realized.

Fair Value of Financial Instruments

SFAS No. 107, Disclosures about Fair Value of
Financial Instruments, requires disclosures of fair value
information about financial instruments, whether or not
recognized in the balance sheet, for which it is practicable to
estimate that value. In cases where quoted market prices are not
available, fair values are based on estimates of future cash
flows. In that regard, the derived fair value estimates cannot
be substantiated by comparison to independent markets and, in
many cases, could not be realized in immediate settlement of the
instrument. The carrying values of current assets and current
liabilities approximate fair value because of the relatively
short maturities of these instruments. The fair value of the
Companys long-term debt, which is comprised primarily of
capital lease obligations, is estimated using a discounted cash
flow analysis based on the Companys borrowing cost for
similar credit facilities. The Company estimates that as of
December 31, 2000, the fair value of its long-term debt
does not differ materially from its carrying value.

Foreign Currency and International Operations

The functional currencies of certain of the Companys
subsidiaries are the respective local currencies. The financial
statements of these subsidiaries are translated to
U.S. dollars using period-end rates for assets

F-13



---



##### Table of Contents



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

and liabilities and average rates during the relevant period for
revenues and expenses. Translation gains and losses are
accumulated as a component of other comprehensive loss in
stockholders equity. Such gains and losses have not been
material.

Comprehensive Income

The Company reports comprehensive income in accordance with SFAS
No. 130, Reporting Comprehensive Income. SFAS
No. 130 establishes rules for the reporting and display of
comprehensive income and its components. SFAS No. 130
requires foreign currency translation adjustments and the
unrealized gains and losses on marketable securities to be
included in other comprehensive income. Because the Company has
not had any significant components of other comprehensive
income, the reported net income (loss) does not differ
materially from comprehensive income (loss) for the years ended
December 31, 1998, 1999 and 2000.

Segment Reporting

SFAS No. 131, Disclosure about Segments of an
Enterprise and Related Information, establishes standards
for the way that public business enterprises report information
about operating segments in annual financial statements and
requires that these enterprises report selected information
about operating segments in interim financial reports. SFAS 131
also establishes standards for related disclosures about
products and services, geographic areas and major customers. The
revenue and assets of the Companys foreign subsidiaries
have not been significant. Management has concluded that the
Companys operations occur in one segment only based upon
the information used by management in evaluating the performance
of the business.

Basic and Diluted Income (Loss) per Share

SFAS No. 128, Earnings Per Share, requires dual
presentation of basic and diluted income per share. Basic income
(loss) per share includes no dilution and is computed by
dividing net income (loss) available to common stockholders
by the weighted-average number of common shares outstanding for
the period.

Diluted income (loss) per share includes the potential
dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common
stock. Options to purchase 2,600,019 shares of common stock that
were outstanding at December 31, 1998 were not included in
the computation of diluted loss per share as their effect would
be anti-dilutive. The effect of preferred stock convertible into
10,605,735 shares of common stock outstanding from
January 1, 1998 to February 11, 1998 has also not been
included in the computation of diluted loss per share. The
effect of the conversion of the preferred stock is included in
the computation of both basic and diluted loss per share from
the date of conversion on February 11, 1998. The treasury
stock effect of options to purchase 3,953,444 shares of common
stock that were outstanding as of December 31, 1999 was
included in the computation of diluted income per share for the
year ended December 31, 1999. Options and warrants to
purchase 3,121,313 shares of common stock that were outstanding
at December 31, 2000 were not included in the computation
of diluted loss per share as their effect would be anti-dilutive.

F-14



---



##### Table of Contents



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following details the computation of the income
(loss) per share (in thousands, except per share data):

|                                             |                                                       |                          |        |        |   |      |        |        |  |   |          |          |  
|-------------------------------------------- | ----------------------------------------------------- | ------------------------ | ------ | ------ | - | ---- | ------ | ------ |  | - | -------- | -------- | -
|                                             |                                                       |                         
|                                             |                                                       | Years Ended December 31,
|                                             |                                                       |                         
|                                             |                                                       | 1998                     |        | 1999   |   | 2000
|                                             |                                                       |                          |        |        |   |     
|Adjustments to net income (loss):            |                                                       |                          |        |        |   |      |        |        |  |   |          |         
|                                            
|                                            
|                                            
|                                            
|Net income (loss)                            |                                                       | $                        | (6,455 | )      |   | $    | 3,551  |        |  | $ | (415,485 | )       
|                                            
|                                            
|                                            
|                                            
|Dividends and accretion on preferred stock   |                                                       |                          | (171   | )      |   |      |       |        |  |   |         |         
|                                             |                                                       |                          |        |        |   |      |        |        |  |   |          |         
|                                             | Net income (loss) attributable to common stockholders |                          | $      | (6,626 | ) |      | $      | 3,551  |  |   | $        | (415,485 | )
|                                             |                                                       |                          |        |        |   |      |        |        |  |   |          |         
|Weighted-average share calculation:          |                                                       |                          |        |        |   |      |        |        |  |   |          |         
|                                            
|                                            
|                                            
|                                            
|Basic weighted-average shares outstanding:   |                                                       |                          |        |        |   |      |        |        |  |   |          |         
|                                            
|                                            
|                                            
|                                            
|                                             | Average number of shares of common stock outstanding  |                          |        | 21,946 |   |      |        | 24,583 |  |   |          | 28,733   |  
|                                            
|                                            
|                                            
|                                            
|Diluted weighted-average shares outstanding: |                                                       |                          |        |        |   |      |        |        |  |   |          |         
|                                            
|                                            
|                                            
|                                            
|                                             | Treasury stock effect of options and warrants         |                          |        |       |   |      |        | 1,964  |  |   |          |         |  
|                                             |                                                       |                          |        |        |   |      |        |        |  |   |          |         
|Diluted weighted-average shares outstanding  |                                                       |                          | 21,946 |        |   |      | 26,547 |        |  |   | 28,733   |         
|                                             |                                                       |                          |        |        |   |      |        |        |  |   |          |         
|Income (loss) per common share:              |                                                       |                          |        |        |   |      |        |        |  |   |          |         
|                                            
|                                            
|                                            
|                                            
|                                             | Basic income (loss) per share                         |                          | $      | (0.30  | ) |      | $      | 0.14   |  |   | $        | (14.46   | )
|                                             |                                                       |                          |        |        |   |      |        |        |  |   |          |         
|                                             | Diluted income (loss) per share                       |                          | $      | (0.30  | ) |      | $      | 0.13   |  |   | $        | (14.46   | )
|                                             |                                                       |                          |        |        |   |      |        |        |  |   |          |         

Reclassifications

Certain reclassifications have been made in the 1998 and 1999
financial statements to conform to the 2000 presentation.

New Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board (the
FASB) issued SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, which
establishes accounting and reporting standards requiring every
derivative instrument to be reported on the balance sheet as
either an asset or liability measured at its fair value. It
requires that changes in the derivatives fair value be
recognized currently in earnings unless specific hedge
accounting criteria are met. SFAS No. 133, as amended, is
effective for fiscal years beginning after June 15, 2000.
The Company does not expect that adoption will have a material
effect on the Companys financial position or results of
operations.

2.  Credit Agreements and Long-Term Debt:

The Company has a credit facility, as amended, that includes an
asset-based arrangement providing for borrowings up to the
lesser of $10.0 million or 80% of eligible accounts
receivable (as defined in the credit facility) with a maximum of
$5.0 million available for issuing standby letters of
credit, provided that the Company either maintains a minimum of
$10.0 million cash on deposit with the bank, secures with
cash any outstanding letters of credit, or treats any unsecured
letters of credit as borrowings. This credit facility also
includes an equipment financing facility. The credit facility
matures on February 28, 2002, and borrowings under the
credit facility bear interest at prime plus 2%. Borrowings
under the equipment financing facility cannot be made after
March 31, 2001, are repayable over 36 months and bear
interest at prime plus 2%. The credit facility contains
restrictive financial covenants, including, but not limited to,
requirements related to liquidity and operating results as well
as restrictions related to other borrowings, acquisitions,
dispositions of

F-15



---



##### Table of Contents



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

assets, distributions, and investments. The credit facility also
provides for certain administrative and facility fees. As of
December 31, 2000, there were no borrowings outstanding
under the bank credit facility. The Company borrowed
approximately $450,000 under the equipment financing arrangement
in March 2001. In December 2000, the Companys
bank issued a standby letter of credit that expires on
March 31, 2002 in the amount of $5.0 million with the
Company satisfying the minimum deposit requirement.

In June 1999, Inverse entered into an accounts receivable
purchase agreement (Inverse Accounts Receivable
Agreement) with a bank. The Inverse Accounts Receivable
Agreement, as amended, allowed for the sale of Inverse accounts
receivable of up to $2.5 million to the bank, subject to certain
limitations. The Inverse Accounts Receivable Agreement matured
on June 25, 2000 and was not renewed. There were no
borrowings against the Inverse Accounts Receivable Agreement as
of December 31, 1999. In connection with the Inverse
Accounts Receivable Agreement, the Company issued the bank a
warrant to purchase 4,452 shares of common stock at a price of
$22.46 per share. The fair value of this warrant was immaterial.
In November 1999, the bank, in lieu of exercising the warrant,
elected to convert the warrant into 2,363 shares of common stock
in accordance with the terms of the warrant.

In January 1997, Inverse entered into an equipment
financing agreement for up to $350,000 with a leasing company.
As of December 31, 1998, Inverse had financed approximately
$350,000 in equipment purchases structured as loans under this
agreement. The equipment loans are repayable over 42 months
with interest at a rate of approximately 16% and are secured by
the related equipment. In connection with the equipment
financing agreement, the Company issued a warrant to purchase
5,799 shares of common stock at a price of $3.62 per share. The
fair value of this warrant was immaterial. In October 1999,
the leasing company, in lieu of exercising the warrant, elected
to convert the warrant into 5,280 shares of common stock in
accordance with the terms of the warrant.

In June 1998, Inverse entered into an equipment financing
agreement for up to $1.0 million with a bank. As of
December 31, 1998, Inverse had financed $1.0 million
in equipment purchases under this agreement structured as loans.
The equipment loans are repayable over 48 months at a rate
of the institutions prime lending rate plus 0.5% and are
secured by certain assets of Inverse.

During 1999, Inverse made additional principal payments on the
equipment financing agreements of approximately
$1.1 million. As of December 31, 2000, future
principal payments under the equipment financing agreements were
approximately $105,000, all of which are due during 2001.

Avestas revolving line of credit agreement with a
financial institution (the Avesta Facility), as
amended in October 1999, allowed for borrowings up to $7.5
million. The Avesta Facility matured in October 2000 and
was not renewed.

3.  Preferred Stock:

The Company had a total of 12,576,508 shares of authorized
preferred stock, 7,576,508 shares of which were designated as
Series A, B, C, D and E convertible preferred stock and
5,000,000 of which has not been designated. All of the then
outstanding shares of Series A, B, C, D and E convertible
preferred stock were converted to common stock in connection
with the Companys initial public offering in
February 1998. In connection with the conversion of the
Series A preferred stock into common stock upon completion
of the IPO, the Company declared and paid cash dividends of
approximately $30,000 to holders of the Series A preferred
stock. The series B, C, D and E preferred stock had certain
liquidation, dividend and redemption rights. The Company accrued
the cumulative dividends and recorded periodic accretion under
the interest method for the excess of the redemption value of
each series over the stated value.

F-16



---



##### Table of Contents



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

4.  Stockholders Equity:

Initial Public Offering

In February 1998, the Company completed its initial public
offering of 4,025,000 shares of the Companys common stock
resulting in net proceeds of approximately $45.4 million.
Concurrent with the offering, the Series A convertible
preferred stock and the Series B, C, D, and E redeemable
convertible preferred stock were converted into 485,890 and
10,119,845 shares of common stock, respectively.

1999 Employee Stock Purchase Plan

In May 1999, the Company adopted the 1999 Employee Stock
Purchase Plan (the 1999 Purchase Plan) which
provides for the issuance of a maximum of 400,000 shares of
common stock pursuant to options granted to participating
employees. All employees of the Company, except employees who
own 5% or more of the Companys common stock, whose
customary employment is more than 20 hours per week and
more than five months in any calendar year are eligible to
participate in the 1999 Purchase Plan. To participate, an
employee must authorize the Company to deduct an amount, subject
to certain limitations, from his or her pay during defined
six-month periods (Option Periods). Option Periods
begin on November 1 and May 1 of each year. In no case
will an employee be entitled to purchase more than the number of
whole shares determined by dividing $12,500 by the fair market
value of the common stock on the first day of the Option Period.
The purchase price for each share of common stock purchased
pursuant to an option is 85% of the closing price of the common
stock on either the first or last trading day of the applicable
Option Period, whichever price is lower. The Company issued
4,182 and 182,878 shares of common stock pursuant to the
provisions of the 1999 Purchase Plan, during 1999 and 2000,
respectively.

5.  Stock Options:

1994 Stock Option Plan

The Companys 1994 Stock Option Plan (the Option
Plan) authorizes the issuance of an aggregate of 1,975,000
shares of common stock pursuant to the exercise of stock
options. The Option Plan provides for grants of options to
employees, consultants, and directors of the Company. The Option
Plan provides for the granting of both incentive stock options
and non-statutory options. The Option Plan is administered by
the Compensation Committee of the Board of Directors, which has
sole discretion and authority, consistent with the provisions of
the Option Plan, to determine which eligible participants will
receive options, the time when options will be granted, the
terms of options granted, and the number of shares that will be
subject to options granted under the Option Plan.

For any option intended to qualify as an incentive stock option,
the exercise price must not be less than 100% of the fair market
value of the common stock on the date the option is granted
(110% of the fair market value of such common stock with respect
to any optionee who immediately before any option is granted,
directly or indirectly, possesses more than 10% of the total
combined voting power of all classes of stock of the Company
(10% Owners)). In the case of non-statutory options,
the exercise price shall not be less than 20% of the fair value
of the common stock at the time of the grant. The Compensation
Committee has the authority to determine the time or times at
which options granted under the Option Plan become exercisable
(typically up to five years); provided that, for any option
intended to qualify as an incentive stock option, such option
must expire no later than ten years from the date of grant (five
years with respect to 10% Owners). Unless terminated sooner by
the Board, the Option Plan terminates in December 2004 or
the date on which all shares available for issuance shall have
been issued pursuant to the exercise or cancellation of options
granted under the Option Plan.

F-17



---



##### Table of Contents



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Net2Net 1994 Stock Option Plan

The Net2Net 1994 Stock Plan (the Net2Net Plan)
authorizes the issuance of shares of common stock with respect
to certain Stock Rights granted under the Net2Net
Plan. In connection with the Net2Net merger, the Company assumed
the obligations of Net2Net under the Net2Net Plan. Stock Rights
under the Net2Net Plan took the form of grants of incentive and
non-statutory stock options. Subsequent to the merger,
Visuals Board of Directors adopted a resolution not to
make any future option grants under the Net2Net Plan.

Inverse 1996 Stock Option Plan

Under the 1996 Stock Option Plan (the Inverse Plan),
both incentive and non-statutory stock options were granted to
eligible employees. In connection with the Inverse merger, the
Company assumed the obligations of Inverse under the Inverse
Plan. Options granted under the Inverse Plan generally vest over
four years. Subsequent to the merger, Visuals Board of
Directors adopted a resolution not to make any future option
grants under the Inverse Plan.

Avesta 1996 Stock Option Plan

Under the 1996 Stock Option Plan (the Avesta Plan),
both incentive and non-statutory stock options were granted to
eligible employees. In connection with the Avesta merger, the
Company assumed the obligations of Avesta under the Avesta Plan.
Options granted under the Avesta Plan, generally vest over four
years. Subsequent to the merger, Visuals Board of
Directors adopted a resolution not to make any future option
grants under the Avesta Plan.

1997 Omnibus Stock Plan

The Companys 1997 Omnibus Stock Plan (the Omnibus
Plan) authorizes the issuance of an aggregate of up to
3,000,000 shares of common stock with respect to certain
Awards made under the Omnibus Plan. The Omnibus Plan
provides for grants of options to employees, officers,
directors, and consultants of the Company or any affiliate of
the Company; provided, however, that no individual may receive
an award of more than 250,000 shares in any year. Awards under
the Omnibus Plan may take the form of grants of stock options,
stock appreciation rights, restricted or unrestricted stock,
phantom stock, performance awards, or any combination thereof.
The Omnibus Plan is administered by the Board of Directors, or
by such committee or committees as may be appointed by the Board
of Directors from time to time (the Administrator).
The Administrator has sole power and authority, consistent with
the provisions of the Omnibus Plan, to determine which eligible
participants will receive Awards, the form of the Awards and the
number of shares of common stock covered by each Award, to
impose terms, limits, restrictions, and conditions upon Awards,
to modify, amend, extend, or renew Awards (with the consent of
the awardee), to accelerate or change the exercise timing of
Awards or to waive any restrictions or conditions to an Award
and to establish objectives and conditions for earning Awards.
Unless terminated sooner by the Board, the Omnibus Plan will
terminate in October 2007 or the date on which all shares
available for issuance shall have been issued pursuant to the
exercise or cancellation of Awards under the Omnibus Plan.

1997 Directors Stock Option Plan

The 1997 Directors Stock Option Plan (the Director
Plan) was adopted in October 1997. Under the terms of
the Director Plan, directors of the Company who are not
employees of the Company (the Eligible Directors)
are eligible to receive non-statutory options to purchase shares
of common stock. A total of 300,000 shares of common stock may
be issued upon exercise of options granted under the Director
Plan. Unless terminated sooner by the Board of Directors, the
Director Plan will terminate in October 2007, or the date
on which all shares available for issuance under the Director
Plan shall have been issued pursuant to the exercise of options
granted under the Director Plan.

F-18



---



##### Table of Contents



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Upon a members initial election or appointment to the
Board of Directors, such member will be granted options to
purchase 24,000 shares of common stock, vesting over four years,
with options to purchase 6,000 shares vesting at the first
anniversary of the grant and options to purchase the remaining
18,000 shares vesting thereafter, in 36 equal monthly
installments. Annual options to purchase 6,000 shares of common
stock (the Annual Options) will be granted to each
Eligible Director on the date of each annual meeting of
stockholders. Annual Options will vest at the rate of
one-twelfth of the total grant per month, and will vest in full
at the earlier of (i) the first anniversary of the date of
the grant or (ii) the date of the next annual meeting of
stockholders. The exercise price of options granted under the
Director Plan will equal the fair market value per share of the
common stock on the date of grant.

2000 Stock Incentive Plan

The Companys 2000 Stock Incentive Plan (the
Incentive Plan) authorizes the issuance of an
aggregate of 7,000,000 shares of common stock pursuant to the
exercise of stock options. The Incentive Plan provides for
grants of options to employees, consultants, and directors of
the Company. The Incentive Plan provides for the granting of
both incentive stock options and non-statutory options. The
Incentive Plan is administered by the Compensation Committee of
the Board of Directors, which has sole discretion and authority,
consistent with the provisions of the Incentive Plan, to
determine which eligible participants will receive options, the
time when options will be granted, the terms of options granted,
and the number of shares that will be subject to options granted
under the Incentive Plan.

For any option intended to qualify as an incentive stock option,
the exercise price must not be less than 100% of the fair market
value of the common stock on the date the option is granted
(110% of the fair market value of such common stock with respect
to any 10% owner). In the case of non-statutory options, the
exercise price shall not be less than 20% of the fair value of
the common stock at the time of the grant. The Compensation
Committee has the authority to determine the time or times at
which options granted under the Incentive Plan become
exercisable (typically up to five years); provided that, for any
option intended to qualify as an incentive stock option, such
option must expire no later than ten years from the date of
grant (five years with respect to 10% Owners). Unless terminated
sooner by the Board, the Incentive Plan terminates in
December 2010 or on the date that all shares available for
issuance shall have been issued pursuant to the exercise or
cancellation of options granted under the Incentive Plan.

A summary of the Companys stock option activity is
presented below:

|                                         |           |         |           |              |   |                  |              |   |       |       | 
|---------------------------------------- | --------- | ------- | --------- | ------------ | - | ---------------- | ------------ | - | ----- | ----- | 
|                                         |           |         |           | Option Price |   | Weighted-Average
|                                         |           | Options |           | Per Share    |   | Exercise Price  
|                                         |           |         |           |              |   |                 
|Options outstanding at December 31, 1997 |           |         | 2,470,395 |              |   | $0.03  $ 7.00   |              | $ | 1.67  |      
|                                        
|                                        
|                                        
|                                        
|                                         | Granted   |         |           | 1,148,862    |   |                  | 0.41  34.50 |   |       | 14.33 | 
|                                        
|                                        
|                                        
|                                        
|                                         | Canceled  |         |           | (236,292     | ) |                  | 0.17  29.00 |   |       | 12.23 | 
|                                        
|                                        
|                                        
|                                        
|                                         | Exercised |         |           | (782,946     | ) |                  | 0.07  17.50 |   |       | 1.03  | 
|                                         |           |         |           |              |   |                  |              |   |       |      
|Options outstanding at December 31, 1998 |           |         | 2,600,019 |              |   | 0.03  34.50     |              |   | 6.50  |      
|                                        
|                                        
|                                        
|                                        
|                                         | Granted   |         |           | 2,394,873    |   |                  | 0.06  59.00 |   |       | 31.48 | 
|                                        
|                                        
|                                        
|                                        
|                                         | Canceled  |         |           | (345,836     | ) |                  | 0.17  34.50 |   |       | 14.91 | 
|                                        
|                                        
|                                        
|                                        
|                                         | Exercised |         |           | (695,612     | ) |                  | 0.03  32.25 |   |       | 3.27  | 
|                                         |           |         |           |              |   |                  |              |   |       |      
|Options outstanding at December 31, 1999 |           |         | 3,953,444 |              |   | 0.03  59.00     |              |   | 21.41 |      
|                                        
|                                        
|                                        
|                                        
|                                         | Granted   |         |           | 7,248,440    |   |                  | 0.40  63.06 |   |       | 12.93 | 
|                                        
|                                        
|                                        
|                                        
|                                         | Canceled  |         |           | (7,647,979   | ) |                  | 0.29  54.45 |   |       | 18.64 | 
|                                        
|                                        
|                                        
|                                        
|                                         | Exercised |         |           | (636,326     | ) |                  | 0.07  32.25 |   |       | 4.49  | 
|                                         |           |         |           |              |   |                  |              |   |       |      
|Options outstanding at December 31, 2000 |           |         | 2,917,579 |              |   | $0.03  $63.06   |              | $ | 11.49 |      
|                                         |           |         |           |              |   |                  |              |   |       |      

F-19



---



##### Table of Contents



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

As of December 31, 2000, options to purchase 1,281,808
shares of common stock were exercisable with a weighted-average
exercise price of $12.56. The weighted-average remaining
contractual life of options outstanding at December 31,
2000 was 5.9 years.

In October 2000, the Company offered each employee an
opportunity to cancel certain stock options (the Stock
Trade-In) in exchange for the right to receive a future
stock option grant for the same number of shares six months from
the date of cancellation. Options to purchase 5,382,588 shares
were cancelled pursuant to the Stock Trade-In. The stock options
to be granted under the Stock Trade-In will have an exercise
price equivalent to the fair market value of Visuals
common stock on the date of grant. The new options will vest 20%
on the grant date. The remaining 80% will vest monthly over
36 months. The Company may, at its discretion, grant the
stock options as either incentive options or non-statutory
options, or a combination thereof, in the same proportion as the
cancelled options immediately prior to cancellation. In order to
qualify for the new options, an employee who elected to
participate in the Stock Trade-In must be employed on the date
of the new grant.

In October 1995, the FASB issued SFAS No. 123,
Accounting for Stock-Based Compensation. SFAS
No. 123 defines a fair value based method of
accounting for stock-based compensation. Under the fair value
based method, compensation cost is measured at the grant date
based on the fair value of the award and is recognized over the
service period. Prior to the issuance of SFAS No. 123,
stock-based compensation was accounted for under the
intrinsic value method as defined by Accounting
Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees. Under the
intrinsic value method, compensation is the excess, if any, of
the market price of the stock at grant date or other measurement
date over the amount an employee must pay to acquire the stock.

SFAS No. 123 allows an entity to continue to use the
intrinsic value method. However, entities electing the
accounting in APB Opinion No. 25 must make pro forma
disclosures as if the fair value based method of accounting had
been applied. The Company applies APB Opinion No. 25 and
the related interpretations in accounting for its stock-based
compensation. Under APB Opinion No. 25, the Company has
recorded deferred compensation of approximately $606,000 and
$291,000 related to stock option grants in 1998 and 1999,
respectively, of which approximately $114,000, $325,000 and
$229,000 has been amortized in the years ended December 31,
1998, 1999 and 2000, respectively.

If compensation expense had been determined based on the fair
value of the options at the grant dates consistent with the
method of accounting under SFAS No. 123, the Companys
net income or (loss) and income or (loss) per share
would have decreased or increased to the pro forma amounts
indicated below (in thousands, except per share amounts):

|                                                       |             |                          |   |        |   |      |   |        |   |  |   |          |  
|------------------------------------------------------ | ----------- | ------------------------ | - | ------ | - | ---- | - | ------ | - |  | - | -------- | -
|                                                       |             |                         
|                                                       |             | Years Ended December 31,
|                                                       |             |                         
|                                                       |             | 1998                     |   | 1999   |   | 2000
|                                                       |             |                          |   |        |   |     
|Net income (loss) attributable to common stockholders: |             |                          |   |        |   |      |   |        |   |  |   |         
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | As reported |                          | $ | (6,626 | ) |      | $ | 3,551  |   |  | $ | (415,485 | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Pro forma   |                          | $ | (8,658 | ) |      | $ | (4,620 | ) |  | $ | (435,794 | )
|                                                      
|                                                      
|                                                      
|                                                      
|Diluted income (loss) per share:                       |             |                          |   |        |   |      |   |        |   |  |   |         
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | As reported |                          | $ | (0.30  | ) |      | $ | 0.13   |   |  | $ | (14.46   | )
|                                                      
|                                                      
|                                                      
|                                                      
|                                                       | Pro forma   |                          | $ | (0.39  | ) |      | $ | (0.19  | ) |  | $ | (15.17   | )

The fair value of each option is estimated on the date of grant
using the Black-Scholes option-pricing model with the following
assumptions used for grants during the years ended
December 31, 1998, 1999 and 2000: no dividend yield,
expected volatility from zero to 100%, risk-free interest rates
from 4.0% to 6.9% and an expected term ranging from 5 to
10 years.

F-20



---



##### Table of Contents



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

6.  Avesta Acquisition:

The acquisition of Avesta was completed on May 24, 2000 and
has been accounted for as a purchase business combination. At
closing, all of the outstanding preferred and common stock of
Avesta was exchanged for 5,413,530 shares of Visual common
stock. In addition, the outstanding stock options and warrants
of Avesta were converted into options and warrants to purchase
673,338 and 445,463 shares of Visual common stock, respectively.
The equity holders of Avesta also were entitled to receive up to
an aggregate of 2,000,000 additional shares (the
Additional Shares) of Visual common stock, which
were issued into escrow, if certain sales goals of Avesta were
achieved in calendar 2000. The Company believes that none of the
Additional Shares were earned, however, the former stockholders
of Avesta have given the Company written notice that they
dispute the Companys determination and demand that such
shares be released to the equity holders. If not resolved by
negotiation, the disputes are subject to arbitration proceedings
pursuant to provisions of the merger agreement. The
determination of the aggregate purchase price includes only the
fair value of the equity securities that were issued by Visual
to the Avesta equity holders at closing. The fair value of the
Additional Shares has not been included in the determination of
the purchase price as management believes that such shares have
not been earned. For purposes of determining the purchase price,
the shares of Visual common stock issued at closing were valued
at $59.30 per share based upon the average closing price of
Visual common stock surrounding and including the date that the
merger was agreed to and announced.

Avestas outstanding options and warrants were converted to
equivalent options and warrants of Visual. The number of shares
exerciseable under these options and warrants and the exercise
prices were adjusted such that Visual options and warrants
issued for Avesta options and warrants have an equivalent
intrinsic value per option and warrant. The terms and vesting
periods of the options and warrants have not been modified.
Accordingly, the estimated fair value of these options and
warrants, based upon the Black-Scholes valuation model, has been
included in the determination of the purchase price.

The aggregate purchase price was determined as follows (in
thousands):

|                                   |                          |          |         
|---------------------------------- | ------------------------ | -------- | --------
|                                  
|                                  
|                                  
|                                  
|Fair value of common stock         |                          | $316,780
|                                  
|                                  
|                                  
|                                  
|Fair value of options and warrants |                          | 62,067  
|                                  
|                                  
|                                  
|                                  
|Transaction costs and other        |                          | 16,411  
|                                   |                          |         
|                                   | Aggregate purchase price |          | $395,258
|                                   |                          |         

The merger resulted in an allocation of purchase price to the
net tangible and intangible assets of Avesta, as well as a
write-off of the portion of the purchase price allocated to
in-process technology. Visual has allocated the purchase price
based upon the fair values of the assets and the liabilities
acquired and allocated the purchase price accordingly.

The purchase price has been allocated as follows (in thousands):

|                           |                          |   |         |         | 
|-------------------------- | ------------------------ | - | ------- | ------- | 
|                          
|                          
|                          
|                          
|Completed technology       |                          | $ | 129,000 |        
|                          
|                          
|                          
|                          
|In-process technology      |                          |   | 39,000  |        
|                          
|                          
|                          
|                          
|Assembled workforce        |                          |   | 4,000   |        
|                          
|                          
|                          
|                          
|Trademarks/tradenames      |                          |   | 19,000  |        
|                          
|                          
|                          
|                          
|Goodwill                   |                          |   | 238,723 |        
|                          
|                          
|                          
|                          
|Net liabilities assumed    |                          |   | (407    | )      
|                          
|                          
|                          
|                          
|Net deferred tax liability |                          |   | (34,058 | )      
|                           |                          |   |         |        
|                           | Aggregate purchase price |   | $       | 395,258 | 
|                           |                          |   |         |        

Of the total purchase price, $39.0 million was allocated to
in-process technology, which represented research and
development projects of Avesta that had not reached
technological feasibility as of the date of

F-21



---



##### Table of Contents



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

the acquisition and that had no alternative future use in
research and development activities or otherwise. In accordance
with SFAS No. 2, Accounting for Research and
Development Costs, as interpreted by the FASB
Interpretation No. 4, amounts assigned to in-process
research and development (IPR&D) meeting the
above criteria must be charged to expense at the date of
consummation of the purchase business combination. As a result,
the Company recorded an expense of $39.0 million during the year
ended December 31, 2000. The Company valued the acquired
IPR&D based upon an independent appraisal of the projects
under development which were related to future releases of the
Trinity, eWatcher and other products. The values of the
IPR&D projects were determined by estimating the future cash
flows from the projects, once commercially feasible, discounting
the net cash flows back to their present values and then
applying a percentage of completion to the calculated values to
reflect the uncertainty of technical success of the projects.
The rates used to discount the net cash flows to their present
values were based on Avestas weighted average cost of
capital. The percentage of completion was based on
managements estimates of the amount of resources spent to
date and on the expected use of future resources.

In connection with the Avesta acquisition, the Company
recognized approximately $900,000 in liabilities as the cost of
closing a redundant facility and terminating certain employees.
The accrual consisted primarily of severance and other employee
termination costs. These activities resulted in the termination
of approximately 20 employees in connection with a facility
closure, the elimination of duplicate positions and the
consolidation of certain operations. For the year ended
December 31, 2000, the Company charged $806,000 against the
accrual for amounts paid. The remaining accrual primarily
relates to severance costs, substantially all of which are
expected to be paid in 2001.

The pro forma information presented below (in thousands, except
per share data) reflects the Avesta acquisition as if it had
occurred on January 1, 1999 but excludes the write-off of
purchased research and development and the impairment charge of
$328.8 million (see Note 7). These results are not
necessarily indicative of future operating results or those that
would have occurred had the merger been consummated on that date.

|                                           |  |              |         |      |  |   |         |  
|------------------------------------------ |  | ------------ | ------- | ---- |  | - | ------- | -
|                                           |  |             
|                                           |  | Years Ended 
|                                           |  | December 31,
|                                           |  | (unaudited) 
|                                           |  |             
|                                           |  | 1999         |         | 2000
|                                           |  |              |         |     
|Pro forma net revenue                      |  | $            | 98,689  |      |  | $ | 94,851  |  
|                                          
|                                          
|                                          
|                                          
|Pro forma net loss                         |  |              | (88,554 | )    |  |   | (94,723 | )
|                                          
|                                          
|                                          
|                                          
|Pro forma basic and diluted loss per share |  | $            | (2.95   | )    |  | $ | (3.07   | )

In December 1999, Avesta acquired all of the outstanding
stock of Telecoms Data Systems SAS (TDS) for a
combination of cash and shares of Avesta common stock. In the
event that Avesta did not consummate an initial public offering
within eight months from the date of closing, the former
stockholder of TDS had the right to repurchase the TDS stock and
related technology. As a result of the Avesta merger, the
stockholder held 71,541 shares of Visual common stock. In
October 2000, the seller notified the Company of the intent
to exercise the repurchase option. The shares of Visual common
stock will be returned in 2001. Accordingly, the value of these
shares was not included in the determination of the purchase
price of Avesta. Because of this repurchase option, the Company
did not consolidate TDS. However, amounts paid by the Company to
fund the operations of TDS that are not expected to be repaid
were charged to expense in the accompanying statement of
operations for the year ended December 31, 2000.

7.  Restructuring and Impairment Charges:

In the second quarter of 1998, the Company recorded a
restructuring charge of approximately $2.8 million in
connection with the consolidation of Visual and Net2Nets
manufacturing, sales, marketing and administrative functions as
well as the discontinuance of certain Net2Net product
development efforts. The consolidation included a reduction in
employees that resulted in severance and other termination
benefits

F-22



---



##### Table of Contents



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

including out-placement assistance. The remaining restructuring
costs related primarily to the termination of contractual
obligations, including leases and OEM distribution agreements,
with no future benefit. During 1998, approximately $751,000 was
charged against the restructuring reserve. This amount included
approximately $546,000 related to termination costs for
approximately 15 employees including severance and other
benefits. The remaining charge to the reserve of approximately
$205,000 related primarily to amounts paid under contractual
obligations. In the fourth quarter of 1998, the Company reversed
approximately $2.0 million of the restructuring charge
previously recorded. The lower than estimated cost resulted from
fewer than planned terminations and higher than planned
attrition, along with lower than estimated costs associated with
exiting certain contractual obligations. As of December 31,
1998, all amounts due under the contractual obligations had been
paid and all of the employee terminations were completed and the
related benefits paid.

In the fourth quarter of 2000, the Company announced a plan to
realign its product portfolio, consolidate its operations and
devote resources to the markets and products that offer the
Company the greatest growth opportunities. The Companys
revised strategic focus and reorganization included a workforce
reduction of approximately 140 employees throughout the Company
and a plan to close its facilities in Ottawa, Canada and
Sunnyvale, California, and to reduce the size of its facilities
in Rockville, Maryland and New York, New York. In connection
with this plan, the Company recorded a $7.0 million
restructuring charge that consists of $4.2 million in
employee termination costs including severance and other
benefits, $1.7 million in lease obligations related to
facilities and $1.1 million in leasehold improvement
write-offs. As of December 31, 2000, $1.7 million had
been charged against the restructuring accrual. The remaining
accrual consists of severance and lease costs and is expected to
be paid substantially in 2001 and 2002.

The Company recorded approximately $390.7 million in
goodwill and other intangibles, excluding purchased research and
development, related to the acquisition of Avesta. During the
third and fourth quarters of 2000, the Companys results of
operations deteriorated. In particular, revenue decreased
significantly while operating expenses increased. The revenue
decreases were due to lower than expected revenue related to the
Avesta products as well as decreases in the revenue provided by
the Companys other products. The addition of the Avesta
products and markets did not, and is not expected to, result in
the revenue growth anticipated at the time of the acquisition.
Despite these results, the Companys operating expenses
increased significantly in the corresponding periods, due, in
large part, to the addition of the Avesta operations. In
response to these trends, the Company initiated a restructuring
plan in the fourth quarter of 2000 to realign its product
portfolio and streamline its operations. Due to the significance
of these developments, management performed an evaluation of the
recoverability of its long-lived assets, including those related
to the Avesta acquisition, in accordance with SFAS No. 121.
Based upon this evaluation, the Company concluded that the
remaining values of the goodwill and other intangible assets
related to the Avesta acquisition were impaired. This conclusion
was based upon the Companys revised estimate of the
undiscounted cash flows expected to be derived from the Avesta
operations. The estimate of such cash flows was substantially
less than the carrying values of the related long-lived assets.
As a result, the Company recorded an impairment charge of
$328.8 million in the fourth quarter of 2000. This charge
included $203.2 million related to goodwill, which
represented the entire remaining unamortized balance, and
$125.6 million related to the other acquired intangibles
including the completed technology, the assembled workforce and
the trademarks/tradenames. The fair values of the remaining
Avesta long-lived assets were determined based upon the
estimated discounted cash flows to be derived from the Avesta
operations. The discount rate used was based upon an assessment
of the risks associated with these cash flows.

8.  Employee Benefit Plans:

Effective January 1, 1996, the Company adopted a defined
contribution plan (the Visual 401(k) Plan),
available to all eligible full-time employees upon employment.
The Visual 401(k) Plan qualifies for preferential tax treatment
under the Internal Revenue Code. Employee contributions are
voluntary and are determined on an individual basis with a
maximum annual amount equal to 15% of compensation paid during

F-23



---



##### Table of Contents



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

the plan year, not to exceed the annual Internal Revenue Service
contribution limitations. All participants are fully vested in
their contributions. There have been no employer contributions
under the Visual 401(k) Plan.

During 1996, Net2Net adopted a qualified 401(k) retirement plan
(the Net2Net 401(k) Plan). The Net2Net 401(k) Plan
covered substantially all employees who satisfied a three-month
service requirement and attained the age of 21. The Net2Net
401(k) Plan provided for an optional Net2Net contribution for
any plan year at Net2Nets discretion. There were no
Net2Net contributions to the plan for the year ended
December 31, 1998.

During 1997, Inverse adopted a defined contribution retirement
plan under Internal Revenue Service Code Section 401(k)
(the Inverse 401(k) Plan). The Inverse 401(k) Plan
covered all Inverse employees, following three months of
employment. Inverses contributions were not material
during the year ended December 31, 1998 and no
contributions were made during the year ended December 31,
1999.

Prior to the acquisition, Avesta adopted a defined contribution
retirement plan under Internal Revenue Service Code
Section 401(k) (the Avesta 401(k) Plan). The
Avesta 401(k) Plan covered all Avesta employees, following three
months of employment and matching contributions are not required.

9.  Income Taxes:

No provision for income taxes was recorded as a result of the
operating loss incurred by the Company for the year ended
December 31, 1998. For the year ended December 31,
1998, the tax provision was comprised primarily of a deferred
tax benefit, which was offset by a valuation allowance of the
same amount. The components of the provision (benefit) for
income taxes consist of the following for the years ended
December 31, 1999 and 2000 (in thousands):

|                                |          |                           |   |        |       |  |   |         |         |  
|------------------------------- | -------- | ------------------------- | - | ------ | ----- |  | - | ------- | ------- | -
|                                |          |                          
|                                |          | December 31,             
|                                |          |                          
|                                |          | 1999                      |   | 2000  
|                                |          |                           |   |       
|Income tax provision (benefit): |          |                           |   |        |       |  |   |        
|                               
|                               
|                               
|                               
|                                | Current  |                           | $ | 5,902  |       |  | $ | (9,585  | )      
|                               
|                               
|                               
|                               
|                                | Deferred |                           |   | (2,180 | )     |  |   | (24,473 | )      
|                                |          |                           |   |        |       |  |   |        
|                                |          | Total provision (benefit) |   | $      | 3,722 |  |   | $       | (34,058 | )
|                                |          |                           |   |        |       |  |   |        

The tax provision for 1998 differed from the expected tax
benefit, computed by applying the Federal statutory rate,
principally due to the effect of the increase in the valuation
allowance. The provision for income taxes results in an
effective rate which differs from the Federal statutory rate as
follows for the years ended December 31, 1999 and 2000:

|                                           |                      |              |      |      |   |  |     |    |   
|------------------------------------------ | -------------------- | ------------ | ---- | ---- | - |  | --- | -- | --
|                                           |                      |             
|                                           |                      | Years Ended 
|                                           |                      | December 31,
|                                           |                      |             
|                                           |                      | 1999         |      | 2000
|                                           |                      |              |      |     
|Statutory federal income tax rate          |                      |              | 35   | %    |   |  | (35 | )%
|                                          
|                                          
|                                          
|                                          
|Effect of graduated rates                  |                      |              | (1   | )    |   |  | 1   |   
|                                          
|                                          
|                                          
|                                          
|State income taxes, net of federal benefit |                      |              | 4    |      |   |  | (4  | ) 
|                                          
|                                          
|                                          
|                                          
|Net operating loss carryforward            |                      |              | (28) |      |   |  |    |   
|                                          
|                                          
|                                          
|                                          
|Non-deductible expenses                    |                      |              | 41   |      |   |  | 21  |   
|                                          
|                                          
|                                          
|                                          
|Increase in valuation allowance            |                      |              |     |      |   |  | 9   |   
|                                           |                      |              |      |      |   |  |     |   
|                                           | Total effective rate |              |      | 51   | % |  |     | (8 | )%
|                                           |                      |              |      |      |   |  |     |   

F-24



---



##### Table of Contents



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The components of the Companys net deferred tax asset
(liability) are as follows (in thousands):

|                    |                                                       |                              |   |         |   |  |   |         |   | 
|------------------- | ----------------------------------------------------- | ---------------------------- | - | ------- | - |  | - | ------- | - | 
|                    |                                                       |                             
|                    |                                                       | December 31,                
|                    |                                                       |                             
|                    |                                                       | 1999                         |   | 2000   
|                    |                                                       |                              |   |        
|Deferred tax asset: |                                                       |                              |   |         |   |  |   |        
|                   
|                   
|                   
|                   
|                    | Net operating loss carryforwards                      |                              | $ | 9,692   |   |  | $ | 35,038  |  
|                   
|                   
|                   
|                   
|                    | Depreciation                                          |                              |   | 498     |   |  |   | 681     |  
|                   
|                   
|                   
|                   
|                    | Allowance for doubtful accounts                       |                              |   | 276     |   |  |   | 419     |  
|                   
|                   
|                   
|                   
|                    | Inventory valuation                                   |                              |   | 396     |   |  |   | 1,128   |  
|                   
|                   
|                   
|                   
|                    | Accrued liabilities                                   |                              |   | 1,208   |   |  |   | 2,658   |  
|                   
|                   
|                   
|                   
|                    | Deferred revenue                                      |                              |   | 1,248   |   |  |   | 2,558   |  
|                   
|                   
|                   
|                   
|                    | Tax credit carryforwards                              |                              |   | 1,481   |   |  |   | 2,203   |  
|                   
|                   
|                   
|                   
|                    | Basis differences attributable to purchase accounting |                              |   |        |   |  |   | (3,733  | )
|                   
|                   
|                   
|                   
|                    | Valuation allowance                                   |                              |   | (14,799 | ) |  |   | (40,952 | )
|                    |                                                       |                              |   |         |   |  |   |        
|                    |                                                       | Total net deferred tax asset |   | $       |  |  |   | $       |  | 
|                    |                                                       |                              |   |         |   |  |   |        

The Company had net operating loss carryforwards to offset
future taxable income of approximately $92.2 million as of
December 31, 2000. These net operating loss carryforwards
expire through 2020. Only a portion of the net operating loss
carryforwards are attributable to operating activities. The
remainder of the net operating loss carryforwards are
attributable to tax deductions related to the exercise of stock
options. In computing its income tax expense, the Company
recognizes the tax benefits of current and prior years
stock option deductions after the utilization of net operating
losses from operations (operating losses determined without
deductions for exercised stock options) to reduce income tax
expense. Net operating loss carryforwards, when realized related
to stock option deductions, are credited to stockholders
equity. Under the provisions of the Tax Reform Act of 1986, when
there has been a change in an entitys ownership,
utilization of net operating loss carryforwards may be limited.
Because of the changes in the ownership of Net2Net, Inverse and
Avesta, the use of the Net2Net, Inverse and Avesta net operating
losses will be limited and may not be available to offset future
taxable income.

10.  Commitments and Contingencies:

Investment in sm-end-2-end.de AG

In November 2000, the Company entered into a joint venture
agreement with a customer to form a new German company,
sm-end-2-end.de AG (end-2-end). The Company paid
approximately $797,000 for a 30% ownership interest.
Contribution of an additional Euro 825,000 by the Company is
subject to the achievement of certain contractual and financial
milestones by end-2-end by April 1, 2002. Visual also
entered into a distribution agreement with end-2-end in
November 2000 to sell the Companys products. The
Company did not have any sales to end-2-end for the year ended
December 31, 2000.

Leases

The Company leases office space and office equipment under
non-cancelable operating leases expiring through
December 2006. The Company recorded rent expense of
approximately $1.2 million, $1.7 million and
$3.3 million during 1998, 1999 and 2000, respectively.

During 1997, Visual and Net2Net entered into separate
sale-leaseback transactions in which equipment was sold and
leased back under non-cancelable capital leases. Such equipment
was sold at its net book value resulting in no gain or loss on
the transactions.

In May 1999, Inverse entered into a master lease agreement,
as amended, with a leasing company to provide up to
$1.8 million in financing to purchase furniture and
equipment through April 2000. During 1999,

F-25



---



##### Table of Contents



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Inverse purchased approximately $1.4 million of furniture
and equipment under the master lease agreement. Inverse also
entered into a sale-leaseback transaction with the leasing
company in which equipment was sold at its net book value and
leased back under non-cancelable capital leases. No gain or loss
was recognized on the transaction. In connection with the master
lease and sale-leaseback transaction, Inverse issued the leasing
company a warrant to purchase common stock. The fair value of
this warrant was not material. In November 1999, the
leasing company, in lieu of exercising the warrant, elected to
convert the warrant and receive 3,594 shares of Visual common
stock in accordance with the terms of the warrant.

Future minimum lease payments as of December 31, 2000 under
non-cancelable capital and operating leases are as follows (in
thousands):

|                                               |                              |         |      |           |  |   |       |        | 
|---------------------------------------------- | ---------------------------- | ------- | ---- | --------- |  | - | ----- | ------ | 
|                                               |                              | Capital |      | Operating
|                                               |                              | Leases  |      | Leases   
|                                               |                              |         |      |          
|2001                                           |                              | $       | 549  |           |  | $ | 3,503 |       
|                                              
|                                              
|                                              
|                                              
|2002                                           |                              |         | 249  |           |  |   | 3,260 |       
|                                              
|                                              
|                                              
|                                              
|2003                                           |                              |         |     |           |  |   | 2,645 |       
|                                              
|                                              
|                                              
|                                              
|2004                                           |                              |         |     |           |  |   | 2,166 |       
|                                              
|                                              
|                                              
|                                              
|2005                                           |                              |         |     |           |  |   | 2,095 |       
|                                              
|                                              
|                                              
|                                              
|Thereafter                                     |                              |         |     |           |  |   | 3,159 |       
|                                               |                              |         |      |           |  |   |       |       
|                                               | Total minimum lease payments |         |      | 798       |  |   | $     | 16,828 | 
|                                               |                              |         |      |           |  |   |       |       
|Interest element of lease payment              |                              |         | (54  | )         |  |   |       |       
|                                               |                              |         |      |           |  |   |       |       
|Present value of future minimum lease payments |                              |         | 744  |           |  |   |       |       
|                                              
|                                              
|                                              
|                                              
|Current portion                                |                              |         | (501 | )         |  |   |       |       
|                                               |                              |         |      |           |  |   |       |       
|Long-term portion                              |                              | $       | 243  |           |  |   |       |       
|                                               |                              |         |      |           |  |   |       |       

Litigation

In July, August and September 2000, several purported class
action complaints were filed against the Company and certain of
the Companys executives. The complaints allege that
between February 7, 2000 and August 23, 2000, the
defendants made false and misleading statements which had the
effect of inflating the market price of the Companys
stock, in violation of Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934. The complaints do not specify
the amount of damages sought. The Company believes that the
plaintiffs claims are without merit and intends to defend
against these allegations vigorously. The Company expects that a
substantial portion of the legal costs that it might incur
related to this matter will be paid by its directors and
officers insurance policy. The Company cannot presently
determine the ultimate outcome of this action. A negative
outcome could have a material adverse effect on the
Companys financial position or results of operations.
Failure to prevail in the litigation could result in, among
other things, the payment of substantial monetary or punitive
damages.

In October 1997, a lawsuit was filed against Avesta and one
of its employees alleging infringement of two patents, unfair
competition, breach of contract and interference with
contractual relations resulting in unjust enrichment. Avesta
answered the complaint, denying all allegations, and also
asserted counterclaims against the plaintiff for patent misuse,
unfair competition and interference with business and patent
invalidity. The plaintiff has since dropped one of the patents
from the lawsuit and certain of Avestas counterclaims have
been dismissed. Avestas counterclaims currently seek a
declaratory judgment (i) that its products do not infringe
the plaintiffs patents; (ii) that the remaining
patent is invalid; and (iii) that the remaining patent is
unenforceable. The Company intends to vigorously defend itself
in this matter and management believes that the plaintiffs
claims are without merit. The Company cannot presently determine
the ultimate outcome of this action. Both parties have filed
motions for partial summary judgment that have been denied. A
negative

F-26



---



##### Table of Contents



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

outcome could have a material adverse effect on the financial
position or results of operations of the Company. Failure to
prevail in the litigation could result in one or more of the
following: (i) the payment of substantial monetary and
punitive damages; (ii) the reimbursement of the
plaintiffs legal costs; (iii) the requirement to stop
selling one of our major products in its current form;
(iv) the redesign of that product; (v) the requirement
to license certain technology from the plaintiff, which could
include significant royalty payments; and (vi) the
indemnification of certain customers against the losses they may
incur due to the alleged infringement. In addition, the Company
has incurred and may continue to incur significant legal costs
related to this litigation.

11.  Revenue by Product:

The following table presents the Companys revenue by
product (in thousands):

|                              |               |                          |        |        |  |      |        |        |  |   |        |        | 
|----------------------------- | ------------- | ------------------------ | ------ | ------ |  | ---- | ------ | ------ |  | - | ------ | ------ | 
|                              |               |                         
|                              |               | Years Ended December 31,
|                              |               |                         
|                              |               | 1998                     |        | 1999   |  | 2000
|                              |               |                          |        |        |  |     
|Visual UpTime and Cell Tracer |               | $                        | 50,883 |        |  | $    | 84,546 |        |  | $ | 67,700 |       
|                             
|                             
|                             
|                             
|Visual IP InSight             |               |                          | 1,913  |        |  |      | 4,557  |        |  |   | 9,466  |       
|                             
|                             
|                             
|                             
|Visual Internet Benchmark     |               |                          | 3,292  |        |  |      | 2,616  |        |  |   | 4,607  |       
|                             
|                             
|                             
|                             
|Visual Trinity and eWatcher   |               |                          |       |        |  |      |       |        |  |   | 7,268  |       
|                              |               |                          |        |        |  |      |        |        |  |   |        |       
|                              | Total revenue |                          | $      | 56,088 |  |      | $      | 91,719 |  |   | $      | 89,041 | 
|                              |               |                          |        |        |  |      |        |        |  |   |        |       

12.  Interim Financial Data  Unaudited:

The following table of quarterly financial data has been
prepared from the financial records of the Company, without
audit, and reflects all adjustments that are, in the opinion of
management, necessary for a fair presentation of the results of
operations for the interim periods presented:

|                                |  |           |        |          |  |                                          |        |              |  |         |        |      |  |      |         |         |  |   |        |   |  |   |         |   |  |   |        |  |  |   |          |  
|------------------------------- |  | --------- | ------ | -------- |  | ---------------------------------------- | ------ | ------------ |  | ------- | ------ | ---- |  | ---- | ------- | ------- |  | - | ------ | - |  | - | ------- | - |  | - | ------ |  |  | - | -------- | -
|                                |  |           |        |          |  |                                          |        |             
|                                |  | March 31, |        | June 30, |  | September 30,                            |        | December 31,
|                                |  |           |        |          |  |                                          |        |             
|                                |  | 1999      |        | 2000     |  | 1999                                     |        | 2000(2)      |  | 1999(1) |        | 2000 |  | 1999 |         | 2000(3)
|                                |  |           |        |          |  |                                          |        |              |  |         |        |      |  |      |         |        
|                                |  |           |        |          |  |                                          |        |              |  |        
|                                |  |           |        |          |  | (in thousands, except per share amounts) |        |              |  |        
|                               
|                               
|                               
|                               
|Revenue                         |  | $         | 18,588 |          |  | $                                        | 30,494 |              |  | $       | 21,210 |      |  | $    | 28,644  |         |  | $ | 24,522 |   |  | $ | 14,607  |   |  | $ | 27,399 |  |  | $ | 15,296   |  
|                               
|                               
|                               
|                               
|Gross profit                    |  |           | 12,111 |          |  |                                          | 21,199 |              |  |         | 13,709 |      |  |      | 19,154  |         |  |   | 16,296 |   |  |   | 7,100   |   |  |   | 18,715 |  |  |   | 9,073    |  
|                               
|                               
|                               
|                               
|Income (loss) from operations   |  |           | 1,019  |          |  |                                          | 6,914  |              |  |         | 1,912  |      |  |      | (46,594 | )       |  |   | (3,222 | ) |  |   | (39,142 | ) |  |   | 5,294  |  |  |   | (373,319 | )
|                               
|                               
|                               
|                               
|Net income (loss)               |  |           | 1,075  |          |  |                                          | 5,541  |              |  |         | 1,652  |      |  |      | (42,319 | )       |  |   | (3,973 | ) |  |   | (30,709 | ) |  |   | 4,797  |  |  |   | (347,998 | )
|                               
|                               
|                               
|                               
|Basic income (loss) per share   |  |           | 0.04   |          |  |                                          | 0.22   |              |  |         | 0.07   |      |  |      | (1.54   | )       |  |   | (0.16  | ) |  |   | (0.99   | ) |  |   | 0.19   |  |  |   | (11.17   | )
|                               
|                               
|                               
|                               
|Diluted income (loss) per share |  |           | 0.04   |          |  |                                          | 0.20   |              |  |         | 0.06   |      |  |      | (1.54   | )       |  |   | (0.16  | ) |  |   | (0.99   | ) |  |   | 0.18   |  |  |   | (11.17   | )




|    |                                                                                                                                                                                             
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The net loss for the three months ended September 30, 1999
	includes approximately $6.8 million in merger-related costs
	recorded in connection with the Inverse acquisition. (see
	Note 1).
|   
|(2) | The net loss for the three months ended June 30, 2000
	includes the write-off of purchased research and development of
	$39.0 million (see Note 6).                                         





|    |                                                                                                                                                                                                                                                                                            
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(3) | The net loss for the three months ended December 31, 2000
	includes a restructuring charge of approximately
	$7.0 million and an impairment charge of approximately
	$328.8 million related to the write-off of goodwill and other
	intangibles from the Avesta acquisition. (see Note  7).

The sum of the per share amounts may not equal the annual
amounts because of the changes in the weighted-average number of
shares outstanding during the year.

F-27



---



##### Table of Contents



REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To Visual Networks, Inc.:

We have audited, in accordance with auditing standards generally
accepted in the United States, the consolidated financial
statements of Visual Networks, Inc. (a Delaware corporation) and
subsidiaries and have issued our report thereon dated
March 29, 2001. Our audits were made for the purpose of
forming an opinion on the basic financial statements taken as a
whole. The schedule included in Item 14(d) is the
responsibility of the Companys management and is presented
for purposes of complying with the Securities and Exchange
Commissions rules and is not part of the basic financial
statements. This schedule has been subjected to the auditing
procedures applied in the audits of the basic financial
statements and, in our opinion, fairly states, in all material
respects, the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.



| |                    
| | -------------------
| | ARTHUR ANDERSEN LLP

Vienna, Virginia



S-1



---



##### Table of Contents



SCHEDULE II

VISUAL NETWORKS, INC.

VALUATION AND QUALIFYING ACCOUNTS

(in thousands)


|                                      |                                  |                                   |  |                      |     |            |  |                |       |  |  |   |       |     |  |   |       | 
|------------------------------------- | -------------------------------- | --------------------------------- |  | -------------------- | --- | ---------- |  | -------------- | ----- |  |  | - | ----- | --- |  | - | ----- | 
|                                      |                                  | Balance at Beginning              |  | Additions Charged to |     |            |  | Balance at End
|Description                           |                                  | of Period                         |  | Costs and Expenses   |     | Deductions |  | of Period     
|                                      |                                  |                                   |  |                      |     |            |  |               
|For the year ended December 31, 1998: |                                  |                                   |  |                      |     |            |  |                |       |  |  |   |       |     |  |  
|                                     
|                                     
|                                     
|                                     
|                                      | Deducted from asset accounts:    |                                   |  |                      |     |            |  |                |       |  |  |   |       |     |  |   |      
|                                     
|                                     
|                                     
|                                     
|                                      |                                  | Allowance for doubtful accounts   |  | $                    | 412 |            |  | $              | 106   |  |  | $ | 25    |     |  | $ | 493   | 
|                                     
|                                     
|                                     
|                                     
|                                      | Included in current liabilities: |                                   |  |                      |     |            |  |                |       |  |  |   |       |     |  |   |      
|                                     
|                                     
|                                     
|                                     
|                                      |                                  | Reserves related to restructuring |  |                      |    |            |  |                | 2,749 |  |  |   | 2,749 | (1) |  |   |      | 
|                                     
|                                     
|                                     
|                                     
|For the year ended December 31, 1999: |                                  |                                   |  |                      |     |            |  |                |       |  |  |   |       |     |  |  
|                                     
|                                     
|                                     
|                                     
|                                      | Deducted from asset accounts:    |                                   |  |                      |     |            |  |                |       |  |  |   |       |     |  |   |      
|                                     
|                                     
|                                     
|                                     
|                                      |                                  | Allowance for doubtful accounts   |  |                      | 493 |            |  |                | 301   |  |  |   | 40    |     |  |   | 754   | 
|                                     
|                                     
|                                     
|                                     
|For the year ended December 31, 2000: |                                  |                                   |  |                      |     |            |  |                |       |  |  |   |       |     |  |  
|                                     
|                                     
|                                     
|                                     
|                                      | Deducted from asset accounts:    |                                   |  |                      |     |            |  |                |       |  |  |   |       |     |  |   |      
|                                     
|                                     
|                                     
|                                     
|                                      |                                  | Allowance for doubtful accounts   |  |                      | 754 |            |  |                | 430   |  |  |   | 81    |     |  |   | 1,103 | 
|                                     
|                                     
|                                     
|                                     
|                                      | Included in current liabilities: |                                   |  |                      |     |            |  |                |       |  |  |   |       |     |  |   |      
|                                     
|                                     
|                                     
|                                     
|                                      |                                  | Reserves related to restructuring |  |                      |    |            |  |                | 6,800 |  |  |   | 2,494 |     |  |   | 4,306 | 




|    |                                                                                                                                                                                                                                                    
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Included in these deductions were costs of $751,000 charged
	against the reserve and the reversal of $1,998,000 of the
	restructuring charges for the year ended December 31, 1998.
	See Note 7 of the Notes to Consolidated Financial
	Statements.

S-2



---



##### Table of Contents






EXHIBIT INDEX

|            |  |                                                                                                                                                                                                       
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit     |  |                                                                                                                                                                                                       
|Number      |  | Description                                                                                                                                                                                           
|            |  |                                                                                                                                                                                                       
|3.1$        |  | Amended and Restated Certificate of Incorporation of the Company.                                                                                                                                     
|3.1.1@      |  | Certificate of Amendment to Amended and Restated Certificate of
	Incorporation.                                                                                                                       
|10.1*       |  | 1994 Stock Option Plan.                                                                                                                                                                               
|10.2*       |  | 1997 Omnibus Stock Plan, as amended.                                                                                                                                                                  
|10.3*       |  | Amended and Restated 1997 Directors Stock Option Plan.                                                                                                                                               
|10.4!!      |  | 2000 Stock Incentive Plan, as amended.                                                                                                                                                                
|10.5*      |  | Reseller/ Integration Agreement, dated August 29, 1997, by
	and between the Company and MCI Telecommunications Corporation.                                                                           
|10.5.1$$$ |  | Second Amendment, dated November 4, 1998, to the Reseller/
	Integration Agreement between the Company and MCI
	Telecommunications Corporation (relating to Exhibit 10.5).                             
|10.7*      |  | General Agreement for the Procurement of Equipment, Services and
	Supplies between the Company and AT&T Corp.                                                                                         
|10.8*       |  | Lease Agreement, dated December 12, 1996, by and between
	the Company and The Equitable Life Assurance Society of The
	United States.                                                                 
|10.8.1*     |  | Lease Amendment, dated September 2, 1997, by and between
	the Company and The Equitable Life Assurance Society of The
	United States (relating to Exhibit 10.8).                                      
|10.8.2$$$   |  | Second Lease Amendment, dated February 8, 1999, by and
	between the Company and TA/ Western, LLC, successor to The
	Equitable Life Assurance Society of The United States (relating
	to Exhibit 10.8).
|10.8.3***   |  | Third Lease Amendment, dated January 10, 2000, by and
	between the Company and TA/ Western, LLC (relating to Exhibit
	10.8).                                                                          
|10.8.4!!    |  | Fourth Lease Amendment, dated May 17, 2000, by and between
	the Company and TA/ Western LLC (relating to Exhibit 10.8).                                                                               
|10.9***     |  | Sublease, dated October 1, 1999, between the Company and
	Micron Technology, Inc.                                                                                                                     
|10.10*      |  | Employment Agreement, dated December 15, 1994, by and
	between the Company and Scott E. Stouffer, as amended.                                                                                         
|10.11!!     |  | Lease Agreement, dated April 7, 2000, by and between Visual
	Networks, Inc. and TA/ Western, LLC.                                                                                                     
|10.12*      |  | Terms of Employment, dated June 11, 1997, by and between
	the Company and Peter J. Minihane, as amended.                                                                                              
|10.17**     |  | Net2Net 1994 Stock Option Plan.                                                                                                                                                                       
|10.20$$     |  | 1999 Employee Stock Purchase Plan.                                                                                                                                                                    
|10.22%%     |  | Inverse Network Technology 1996 Stock Option Plan.                                                                                                                                                    
|10.23@      |  | Merger Agreement, dated February 7, 2000, by and among the
	Company, Visual Acquisitions Three, Inc. and Avesta
	Technologies, Inc.                                                                   
|10.23.1!!   |  | Avesta Technologies, Inc. 1996 Stock Option Plan.                                                                                                                                                     
|10.24       |  | Loan and Security Agreement, dated February 28, 2001, by
	and between Silicon Valley Bank and the Company.                                                                                            
|10.25       |  | Accounts Receivable Financing Agreement, dated February 28,
	2001, by and between Silicon Valley Bank and the Company.                                                                                
|10.26       |  | Intellectual Property Security Agreement, dated February 28,
	2001, by and between Silicon Valley Bank and the Company.                                                                               
|10.27     |  | Master Purchase of Equipment and Services Agreement, dated
	May 22, 2000, between the Company and Sprint/ United
	Management Company.                                                                 
|16.1*       |  | Letter regarding change in certified accountants.                                                                                                                                                     
|16.2@       |  | Letter regarding change in certified accountants.                                                                                                                                                     



---



##### Table of Contents



|        |  |                                                  
|------- |  | -------------------------------------------------
|Exhibit |  |                                                  
|Number  |  | Description                                      
|        |  |                                                  
|21.1    |  | List of subsidiaries of the Company.             
|23.1    |  | Consent of Arthur Andersen LLP.                  
|24.1    |  | Powers of Attorney (included in signature pages).




| |     |  |  |                                                                                                                                                                                                                                                                                
| | --- |  |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | *   |  |  | Incorporated herein by reference to the Companys
	Registration Statement on Form S-1, No. 333-41517.                                                                                                                                                                          
| | **  |  |  | Incorporated herein by reference to Exhibit 10.1 to the
	Companys Registration Statement on Form S-8,
	No.  333-53153.                                                                                                                                                        
| | *** |  |  | Incorporated herein by reference to the Companys Annual
	Report on Form 10-K for the year ended December 31, 1999.                                                                                                                                                            
| | %   |  |  | Incorporated herein by reference to the Companys
	Registration Statement on Form S-3, No. 333-90105.                                                                                                                                                                          
| | %%  |  |  | Incorporated herein by reference to Exhibit 10.1 to the
	Companys Registration Statement on Form S-8,
	No.  333-88719.                                                                                                                                                        
| | @   |  |  | Incorporated herein by reference to the Companys
	Registration Statement on Form S-4, No. 333-33946.                                                                                                                                                                          
| | $   |  |  | Incorporated herein by reference to Exhibit 3.1 to the
	Companys Quarterly Report on Form 10-Q for the three
	months ended June 30, 1999.                                                                                                                                     
| | $$  |  |  | Incorporated herein by reference to the Companys
	Definitive Proxy Statement on Schedule 14A filed
	April 30, 1999.                                                                                                                                                           
| | $$$ |  |  | Incorporated herein by reference to the Companys Annual
	Report on Form 10-K for the year ended December 31,
	1998.                                                                                                                                                           
| |    |  |  | Portions of these Exhibits were omitted and have been filed
	separately with the Secretary of the SEC pursuant to the
	Companys Applications Requesting Confidential Treatment
	under Rule 406 of the Act, filed on December 22, 1997,
	January 28, 1998 and February 4, 1998.
| |   |  |  | Portions of these Exhibits were omitted and have been filed
	separately with the Secretary of the SEC pursuant to the
	Companys Application Requesting Confidential Treatment
	under Rule 24b-2 of the Exchange Act of 1934.                                                  
| | !!  |  |  | Incorporated herein by reference to the Companys Quarterly
	Report on Form 10-Q for the three months ended
	June 30, 2000.