<PAGE>   1


                     U.S. 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)
       X      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
      ---     SECURITIES EXCHANGE ACT OF 1934

              FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998

                                    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: 0-23699

                              VISUAL NETWORKS, INC.
             (Exact Name of Registrant as Specified in Its Charter)


               DELAWARE                                   52-1837515
    (State or Other Jurisdiction of                     (IRS Employer
    Incorporation or Organization)                   Identification No.)

           2092 GAITHER ROAD                                20850   
          ROCKVILLE, MARYLAND                             (Zip Code)
(Address of Principal Executive Office)                   

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (301) 296-2300

           SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

<TABLE>
<CAPTION>
                                                   Name of Each Exchange
     Title of Each Class:                           on which Registered:
     -------------------                            -------------------
   <S>                                             <C>
   COMMON STOCK, PAR VALUE                         NASDAQ NATIONAL MARKET
       $0.01 PER SHARE                            
</TABLE>

          SECURITIES REGISTERED PURSUANT TO SECTION 12 (g) OF THE ACT:

                                      NONE


<PAGE>   2


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

       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 1999 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, 1998.

       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 [X].

       The aggregate market value of the voting stock held by non-affiliates of
the Registrant as of March 22, 1999 was approximately $677,799,065.

       The number of shares outstanding of the Registrant's Common Stock, as of
March 22, 1999 was 20,316,570 shares of Common Stock.


<PAGE>   3

                              VISUAL NETWORKS, INC.
                                    FORM 10-K


                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                              PAGE
                                                                                              ----

                                                   PART I
<S>                                                                                          <C>
Item 1.      Business.........................................................................2

             Overview.........................................................................2
             Industry Background..............................................................2
             Problems Managing Frame Relay, ATM and IP/Internet Services......................4
             The Visual Networks Solution.....................................................5
             Visual Networks' Strategy........................................................6
             Products.........................................................................7
             Visual's Selling Strategy and Visual UpTime System Deployment Models.............9
             Product Development..............................................................9
             Customers.......................................................................10
             Sales, Marketing and Support....................................................11
             Competition.....................................................................12
             Manufacturing...................................................................13
             Patents and Other Intellectual Property Rights..................................13
             Employees.......................................................................14


Item 2.      Properties......................................................................14

Item 3.      Legal Proceedings...............................................................14

Item 4.      Submission of Matters to a Vote of Security Holders.............................14


<CAPTION>
                                                  PART II

<S>                                                                                          <C>
Item 5.      Market for the Company's Common Equity and Related Stockholder Matters..........15

Item 6.      Selected Consolidated Financial Data............................................18

Item 7.      Management's Discussion and Analysis of Financial Condition and
             Results of Operations...........................................................19

Item 7A      Quantitative and Qualitative Disclosure about Market Risk.......................31


Item 8.      Financial Statements and Supplementary Data.....................................31

Item 9.      Changes in and Disagreements with Accountants on Accounting and Financial
             Disclosure......................................................................31
</TABLE>


<PAGE>   4

<TABLE>
<CAPTION>
                                                  PART III

<S>                                                                                          <C>
Item 10.     Directors and Executive Officers of the Registrant..............................32

Item 11.     Executive Compensation..........................................................32

Item 12      Security Ownership of Certain Beneficial Owners and Management..................32

Item 13.     Certain Relationships and Related Transactions..................................32


<CAPTION>
                                                  PART IV
<S>                                                                                          <C>
Item 14.     Exhibits, Financial Statement Schedules, and Reports on Form 8-K................33


Exhibit Index ...............................................................................33

Signatures...................................................................................35
</TABLE>


<PAGE>   5


                           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 1999. 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.


<PAGE>   6

                                     PART I

ITEM 1. BUSINESS.

OVERVIEW

       Visual Networks, Inc. (the "Company" or "Visual") designs, manufactures
and sells wide-area-network ("WAN") service level management systems for
statistically multiplexed technologies such as Frame Relay, Asynchronous
Transfer Mode ("ATM") and IP/lnternet. The Company's Visual UpTime system
combines WAN access functionality with innovative software for performance
monitoring, troubleshooting and network capacity planning. Visual UpTime
provides instrumentation for network performance measurement and analysis that
allows service providers to achieve the service levels required by their
customers and to lower operating costs associated with statistically multiplexed
services. The availability of performance monitoring and troubleshooting
instrumentation also allows subscribers to verify the service levels being
supplied by their service provider and monitor traffic traversing the WAN, a
requirement for many subscribers wishing to use statistically multiplexed
services to carry mission-critical data traffic. The Company believes Visual
UpTime systems are deployed in configurations managing up to 1,600 circuits and
the system is currently designed to support configurations of up to 45,000
circuits on a single managed network.

       The Company believes it is a worldwide leader in providing WAN service
level management systems and has shipped systems for deployment on an aggregate
of over 50,000 WAN circuits. The Company has developed relationships with major
service providers such as AT&T Corp. ("AT&T"), Sprint/United Management Company
("Sprint"), MCI Worldcom, Inc. ("MCI"), Ameritech Corporation ("Ameritech"),
Bell Atlantic Network Integration, Inc. ("Bell Atlantic"), BellSouth
Communications Systems, Inc. ("BellSouth"), Intermedia Communications, Inc. and
GTE Communication Systems Corporation. These service providers either resell
Visual UpTime to their subscribers or integrate Visual UpTime into their network
infrastructure to enable them to offer enhanced data transport service levels.
Visual UpTime has been deployed in Frame Relay networks utilized by over 425
subscribers, including ABN-AMRO Bank, Cargill, Inc., Delta Air Lines, Inc., EDS
Electronic Commerce Division ("EDS"), Federal Express Corporation ("FedEx"),
Household International, Inc., Marriott International, Inc. ("Marriott"),
Reynolds Metals, Inc. ("Reynolds") and Waste Management, Inc. For the year ended
December 31, 1998, the Company had revenue of approximately $50.9 million.

       Vertical Systems Group ("Vertical Systems"), a leading WAN Industry
analyst, estimates that approximately 1,000,000 Frame Relay circuits and 45,000
ATM circuits will be installed worldwide from 1999 through 2001. To take
advantage of this projected growth in these markets, the Company plans to expand
its relationships with its service provider customers which together account for
the majority of statistically-multiplexed traffic worldwide. The percentage of
revenue attributable to sales to service providers increased from approximately
40% of revenue for the year ended December 31, 1997, to approximately 65% of
revenue for the year ended December 31, 1998. Sprint, AT&T and MCI accounted for
27%, 7% and 2%, respectively, of revenue for the year ended December 31, 1997.
Sales of products or services to Sprint, AT&T and MCI accounted for 30%, 17% and
14%, respectively, of revenue for the year ended December 31, 1998.

INDUSTRY BACKGROUND

       WAN SERVICES MARKET

       The 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 or to connect the computing facilities of one enterprise to
another. The Company believes WAN data traffic volumes will continue to expand
rapidly due to three key trends driving telecommunications markets worldwide:


                                     - 2 -

<PAGE>   7

       -  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; and

       -  The 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.

       Vertical Systems forecasts that WAN traffic on leased-line, Frame Relay
and ATM services in the U.S. market will triple from 1996 to 2000, estimates the
U.S. market for these services exceeded $13 billion in 1997 and projects that it
will grow to $19.5 billion in 2000. Vertical Systems estimates that the non-U.S.
market for these services exceeded $13 billion in 1997.

       WAN NETWORK DEPLOYMENT

       A typical WAN deployment to support distributed computing environments
includes various types of customer premise equipment ("CPE") owned by the
subscriber, deployed at the subscriber's sites and interconnected by the WAN
service. The points at which the subscriber CPE connects to the WAN service are
known as service demarcations ("demarcs"). The subscribers are responsible for
network performance on the subscriber side of the demarcs, while providers are
responsible for network performance on the provider side of the demarcs.

       The equipment used for Frame Relay, ATM and IP/lnternet services
comprises both the access equipment located at the subscriber premises and the
switches located at the provider's central office. Access equipment includes
devices such as DSU/CSUs, FRADs (frame relay access devices ), frame relay cards
for routers and ATM access multiplexers. Vertical Systems projects that the
markets for this equipment will grow significantly in parallel with the
projected growth in the underlying service markets. The market for Frame Relay,
ATM and IP/lnternet access equipment is projected to grow from $353 million in
1996 to $1.4 billion in 2000.

       WAN NETWORK ARCHITECTURES

       WAN services are provided through two network architectures, time
division multiplexing ("TDM") and statistical multiplexing. TDM services, such
as leased-line and 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. Consequently,
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. By contrast, statistical multiplexing technologies and their
derivative services, such as Frame Relay, ATM, IP/Internet, X.25 and Switched
Multimegabit Data Services ( "SMDS" ), are based on the concept of 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
services can be up to 50% less expensive than WANs based on leased-line 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, often resulting in lower
quality of service more suitable for non-mission-critical distributed computing
applications where the traffic is highly variable and unpredictable.

       WAN services are undergoing a significant shift from TDM architectures to
statistically multiplexed architectures. Vertical Systems estimates that
worldwide revenues for Frame Relay service, the most widely used service, grew
at a compound annual growth rate of 117% between 1995 and 1997 and will grow at
a compound annual growth rate of 41% through the year 2000. The worldwide number
of installed Frame Relay circuits is projected to grow from approximately
580,000 in 1997 to more than 1.5 million in 2000. ATM services, which are


                                     - 3 -
<PAGE>   8

characterized by higher capacities and higher speeds, are less widely offered
today but also are projected to experience rapid growth. The worldwide number of
installed ATM circuits is projected by Vertical Systems to grow from
approximately 4,000 in 1997 to more than 33,000 in 2000. Accordingly, the U.S.
market for Frame Relay and ATM services is expected to shift from 12% of WAN
bandwidth in 1996 to nearly 40% in 2000 (with the majority of growth attributed
to Frame Relay services) while the U.S. market for leased-line services is
expected to decrease from approximately 88% of WAN bandwidth to 60% from 1996 to
2000.

       The growth of statistically multiplexed services has resulted in
increased focus by subscribers on WAN service levels, defined by parameters such
as service availability, throughput and delay. Subscribers have historically
been able to tolerate the lower reliability and quality of service of
statistically multiplexed services because most of the distributed computing
applications supported by these services, including E-mail and file transfer,
were not mission-critical. Today, however, the importance of distributed
computing applications is increasing as enterprises implement newer
mission-critical applications for enterprise resource planning, transaction
processing, work group collaboration, remote telecommuting, sales force
automation and electronic order entry. Subscribers, therefore, are demanding
that their providers offer, achieve and, increasingly, guarantee higher service
levels.

       The proliferation of statistically multiplexed services has also resulted
in increased administrative costs for subscribers as more network managers
manage multiple networks consisting of leased-line services supporting
mission-critical legacy applications and statistically-multiplexed services
supporting recently-deployed, distributed computing applications. The high cost
of administering multiple networks coupled with the attractive pricing of
statistically-multiplexed services is driving the need for subscribers to
consolidate their applications onto a single statistically-multiplexed WAN. The
migration of mainframe computing environments running mission-critical
host-centric applications onto lower cost statistically multiplexed services has
highlighted the need to provide higher service levels with such services. This
migration and the proliferation of distributed computing applications have also
generated subscriber demand for providers to offer multiple classes of service
levels. Multiple service levels enable subscribers to deploy statistically
multiplexed WANs that have service characteristics commensurate with the
performance requirements of their differing computing applications, thereby
optimizing price and performance. Subscriber demand for multiple, guaranteed and
verified WAN service levels presents challenges to providers, which must be able
to offer these service levels while maintaining profitability.

       The WAN services segment of deregulated telecommunications markets is
intensely competitive and price sensitive, and cost leadership tends to drive
competitive strategies. Providers can only achieve cost leadership if they can
realize economies of scale. They must also avoid a costly dependence on highly
skilled personnel for service provisioning and maintenance, a dependence that
has historically existed for statistically multiplexed services. Therefore,
providers face the challenge of increasing the manageability of statistically
multiplexed services while simultaneously developing service deployment and
operational models that can satisfy rapid growth requirements and achieve
economies of scale.

PROBLEMS MANAGING FRAME RELAY, ATM AND IP/LNTERNET SERVICES

       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. Accordingly, the diagnostic and measurement capabilities required
to sufficiently maintain these services are fairly simplistic and are focused
largely on physical transmission characteristics such as bit error rates or line
coding violations. These capabilities are widely available within the providers'
facilities and work in conjunction with simple DSU/CSUs deployed by the
subscribers. By contrast, the performance, quality and maintainability of
statistically multiplexed services are highly dependent on the volume and type
of traffic running over the service. This extensive interplay between the
subscriber application traffic and the provider service dictates the need for
sophisticated diagnostic and measurement capabilities which not only analyze
physical transmission characteristics but can also analyze the traffic itself.
Historically, this level of measurement and analysis capability has generally
required the use of expensive portable protocol analyzers, which are typically
not deployed on a continuous basis at the demarc. This inability to measure
service performance and quality has created difficulties for both subscribers
and providers including the following:


                                     - 4 -
<PAGE>   9

       SUSPECT SERVICE LEVELS INHIBIT SUBSCRIBER ACCEPTANCE OF SERVICE.
Subscribers generally view statistically multiplexed services as offering
deficient service levels and are therefore reluctant to run mission-critical
applications across statistically multiplexed WANs. As the demand for higher
service levels and multiple service levels has increased, subscribers and
providers need a mechanism to measure, verify and improve service levels at the
demarc.

       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 providers requiring
many highly skilled personnel to provision and operate statistically multiplexed
services. This cost is exacerbated by the gap between the demand for and supply
of such personnel. The implication of this model is that operating costs are
driven up and providers' WAN service businesses are not scaleable to the levels
required to generate the economies of scale necessary for cost leadership. The
specific areas of concern are:

       -  INEFFICIENT SERVICE PROVISIONING. It is difficult for the provider to
          ascertain if 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 for the WAN service. At the same time, the
          provider is typically restricted from billing the subscriber for the
          service until the subscriber's applications are working properly over
          the WAN service.

       -  EXTENSIVE TROUBLESHOOTING AND HIGH MAINTENANCE. When the subscriber
          applications experience degraded performance, subscribers generally
          assume there is a problem with the WAN service supplied by the
          provider. It can often take days, weeks or even months to diagnose the
          causes of degraded performance and require 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 provider is
          forced to expend significant time and effort without reimbursement to
          help the subscriber diagnose the problem.

       -  INACCURATE NETWORK ENGINEERING AND PLANNING. The shared bandwidth
          nature of these 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 statistically multiplexed 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.

       The Company believes that the potential subscriber demand for
statistically multiplexed services has been constrained by the inability to
manage and verify service levels. Additionally, the Company believes that it
will be difficult for providers to meet the increasing demand for statistically
multiplexed services without systems for managing service levels because the
labor-intensity of provisioning and maintaining the service inhibits the
providers' ability to scale these WAN services profitably. As the providers'
focus shifts to profitability, the growth in Frame Relay, ATM and IP/lnternet
services will depend, in part, on the ability of providers to implement systems
that can manage service levels, lower operational costs and increase
scaleabllity.

THE VISUAL NETWORKS SOLUTION

       The Company's Visual UpTime offering is a leading WAN service level
management system that combines WAN access functionality with planning,
monitoring and troubleshooting capabilities and enables the implementation of
required service levels while simultaneously decreasing the costs and complexity
of achieving such levels. Visual UpTime deploys instrumentation for measurement
and analysis at the demarc and provides innovative software applications that
address the historical problems of managing service levels.


                                     - 5 -
<PAGE>   10

       INCREASED CONFIDENCE IN SERVICE LEVELS. By instrumenting the demarc,
Visual UpTime enables providers and subscribers to accurately measure, report on
and improve service levels. These abilities serve to clarify the relationship
between subscriber and provider, resulting in increased subscriber confidence in
running mission-critical computing applications on statistically multiplexed
services.

       INCREASED SCALEABILITY AND LOWER COSTS OF PROVIDERS' OPERATIONAL MODEL.
Visual UpTime can reduce the labor-intensive nature of deploying statistically
multiplexed services, decreasing providers' costs and increasing their ability
to generate revenues:

    -  RAPID AND COST-EFFECTIVE SERVICE PROVISIONING. Visual UpTime allows the
       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. Additionally, it positions the provider to begin billing for
       the service earlier than was previously possible.

    -  REDUCED NEED FOR TROUBLESHOOTING. Visual UpTime reduces the need for
       providers to perform troubleshooting by continuously monitoring the
       service performance at the demarc and proactively alerting the provider
       and subscriber to anomalous performance characteristics. Such early
       warnings allow the network operator to take corrective action before the
       performance of any computing application on the network is impaired.
       Furthermore, since many of the anomalous characteristics are
       subscriber-related, the subscriber is more likely to take corrective
       action without involving the provider. The net result of this early
       warning system is that fewer maintenance personnel are required to solve
       fewer problems, thereby increasing provider efficiency and subscriber
       satisfaction.

    -  MORE RAPID BUT LESS COSTLY TROUBLESHOOTING. Because Visual UpTime
       provides information which enables isolation of problems between provider
       network and subscriber equipment and applications, the provider can more
       quickly diagnose the cause of faulty or degraded performance. With Visual
       UpTime, many problems that would otherwise last for days and require
       on-site visits of highly skilled personnel can be diagnosed remotely
       within minutes. Because Visual UpTime is architected to allow both the
       provider and the subscriber to access the same reports and analyses
       simultaneously, more problem conditions can be resolved collaboratively.

    -  MORE ACCURATE NETWORK ENGINEERING AND PLANNING. Visual UpTime
       continuously provides 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 providers to
       implement a network design optimized for cost and performance.

VISUAL NETWORKS' STRATEGY

       The Company's strategy is to maintain and build upon its market
leadership in the deployment of WAN service level management systems for
statistically multiplexed WAN services. Key elements of the Company's strategy
include:

       EMBED SERVICE LEVEL MANAGEMENT FUNCTIONALITY INTO NETWORK INFRASTRUCTURE.
Visual UpTime provides an innovative integration of service level management
functionality with WAN access equipment. The Company believes that this
integration substantially enhances the cost effectiveness of deploying Visual
UpTime.

       VISUAL UPTIME AS PART OF PROVIDER NETWORKS. The Company believes
providers will become the predominant vehicle for the deployment of service
level management systems such as Visual UpTime. Although these systems can be
deployed by either providers or subscribers, the Company believes the maximum
benefit is achieved when the systems are deployed by the providers and access to
performance data is provided by the providers to their subscribers. In this
deployment model, providers can employ collaborative fault and performance
management techniques that lead to greater network quality. More importantly,
the Company believes the benefits of lower provisioning and maintenance costs
may be most effectively captured if the system is deployed by the


                                     - 6 -
<PAGE>   11

provider.

       EXTEND TECHNOLOGY LEADERSHIP. The Company believes a combination of
technological competencies have been crucial to its 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, and collaborative subscriber/provider system architectures. Since
introducing Visual UpTime in mid-1995, the Company has continued to invest in
its core competencies by focusing on feature development, architectural
enhancements and cost reductions. The Company intends to continue to invest in
the development of Visual UpTime, with particular emphasis on features and
architectural improvements designed to accommodate large scale deployment by
providers. This includes leveraging its current Frame Relay, ATM and IP/lnternet
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
virtual private networks ( "VPN" ) over the Internet.

       ACHIEVE COST LEADERSHIP. The Company believes its sales levels represent
a volume advantage over any other systems being used to manage statistically
multiplexed WAN services. The Company intends to leverage this volume advantage
with investments in cost reduction to continue to provide the lowest cost WAN
service level management system.

       EXPAND SALES AND SUPPORT FUNCTIONS GLOBALLY. Although over 70% of the
worldwide circuits for Frame Relay and ATM are deployed in the U.S., many of the
Company's largest provider and subscriber customers are multinational
corporations. The Company intends to develop a presence outside of the U.S. with
particular focus on the providers which have the largest share of the worldwide
markets for Frame Relay, ATM and IP/lnternet services.

       LEVERAGE OUTSOURCED MANUFACTURING MODEL. The Company believes scaleable
and flexible manufacturing will be critical to its growth. The Company believes
it can best meet these requirements by outsourcing the majority of its
manufacturing, allowing the Company to focus on its core competencies in product
development and sales and marketing.

PRODUCTS

       VISUAL UPTIME SYSTEM

       Visual UpTime is a service level management system consisting of analysis
service elements ("ASEs"), performance archive managers ("PAMs") and platform
applicable clients ("PACs") that perform data collection, data interpretation
and presentation, respectively. By intelligently monitoring network-wide
performance, Visual UpTime enables users to track and solve service level
problems either on the subscriber or 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. The analysis results are organized in accordance with the structure of
standard management information bases ("MlBs") as defined by the Internet
Engineering Task Force ("IETF"). These MlBs are compatible with simple network
management protocol ("SNMP") and include relevant parts of industry standard
MlBs such as MIB 1, MIB II and the remote monitoring ("RMON" ) MIB.
Additionally, the ASEs include proprietary MIB extensions that provide added
value for WAN service level management. Depending on customer requirements, the
Company's 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 subscriber local area network environment.


                                     - 7 -
<PAGE>   12

       PAM. The PAM is the system database and request broker between the PACs
and either the database or ASEs. The PAM runs the Company's proprietary software
on Microsoft's WindowsNT Server and SQL Server database. The PAM communicates
with the PACs using a proprietary application programming interface ("API"). The
PAM communicates with the ASEs using either SNMP or trivial file transfer
protocol ( "TFTP" ). Unlike traditional SNMP 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. Current versions of the PAC run on Windows95, WindowsNT and
major versions of UNIX.

       The PAC includes three integrated toolsets:

             PERFORMANCE MONITORING. This toolset is an early warning system,
       alerting 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 which 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
       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. The system
architecture currently supports configurations with up to 45,000 circuits. The
Company believes the system is currently deployed in configurations managing
more than 1,600 circuits. System pricing varies by size of deployment and
relative mix between circuit speeds. The Company expects its average selling
price to decrease significantly as its sales to providers increase.

       ANALYZER

       The Company's analyzer (the "Analyzer") 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. The Analyzer 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, the Analyzer can be utilized in a number of
configurations based on physical circuit speed, access line type and monitoring
application. The Company distributes the Analyzer through a number of channels,
including VARs, resellers and OEM arrangements. The Company expects that it will
utilize the OEM channel for future sales.


                                     - 8 -
<PAGE>   13

VISUAL'S SELLING STRATEGY AND VISUAL UPTIME SYSTEM DEPLOYMENT MODELS

       The Company has deployed a long-term, multi-stage selling strategy.
Initially, the Company sold Visual UpTime to subscribers, with the objective of
creating demand among subscribers for higher service levels for statistically
multiplexed WAN services and stimulating demand among providers for the
infrastructure necessary to provide and maintain such service levels. In 1995
and 1996, the majority of the Company's sales were made to subscribers directly
or through value-added resellers. At the same time, the Company commenced
marketing Visual UpTime to providers for resale or lease as value-added CPE in
conjunction with their service offerings. In furtherance of this stage of the
Company's selling strategy, the Company has executed reseller agreements with
Sprint and MCI. The portion of the Company's revenue derived from these and
other provider relationships has grown from approximately 40% for the year ended
December 31, 1997 to approximately 65% for the year ended December 31, 1998.

       Substantially all Visual UpTime systems sold to date have been deployed
by subscribers and are configured so that only the subscriber has access to the
WAN service performance data collected and presented by the system ("subscriber
deployment model"). The Company recently has focused on demonstrating to
providers the incremental value of provisioning and operating cost savings
arising from wide scale deployment by the provider. The Company's selling
strategy contemplates an evolution of the deployment model so that sales of
Visual UpTime systems will be made directly to providers and the providers will
deploy the systems as a part of their network infrastructure ("provider
deployment model").

       SUBSCRIBER DEPLOYMENT MODEL

       In the subscriber deployment model, a subscriber deploys an ASE instead
of conventional WAN access equipment on each circuit to be managed, thus
providing instrumentation on every circuit. The PAM is deployed at the
subscriber's network operations center. PACs are deployed wherever there are
subscriber network operators who need to access the system.

       PROVIDER DEPLOYMENT MODEL

       In the provider deployment model, the WAN access equipment is similarly
replaced by an ASE. The ASE is then owned by the provider and represents a
critical element of the provider's network infrastructure, thereby extending the
WAN service demarc to include the functionality of the WAN access equipment. By
extending WAN service level management capabilities to the subscriber's site,
the providers will be in a position to offer a new class of "intelligent"
service levels, which can effectively increase revenue, increase quality of
service levels and decrease cost at the same time. The provider can scale the
service by adding additional ASEs. In the provider deployment model, the PAM is
deployed within the provider's network operations center and one PAM typically
supports multiple subscribers, yielding significant economies of scale for the
provider. PACs are deployed at the provider network operations center and at the
subscriber network operations centers, enabling simultaneous access for
providers and subscribers to the information generated by Visual UpTime.

PRODUCT DEVELOPMENT

       The Company has 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 and collaborative
subscriber/provider system architectures.

       The Company has made significant investments in Visual UpTime
architecture and feature development. Through the acquisition of Net2Net, the
Company has accelerated the development of ATM functionality into Visual UpTime
to provide customers with a single-vendor solution for end-to-end service level
management, encompassing Frame Relay, ATM and IP/Internet. In addition, the
Company will continue to expand the functionality of Visual UpTime to address
emerging opportunities such as VPNs over the Internet. The Company is focused on
the further enhancement and refinement of Visual UpTime, including the
development of the architectural scaleability that will be required for
wide-scale implementation through the provider deployment 


                                     - 9 -
<PAGE>   14

model. Additionally, the Company expects to invest in system refinements which
increase the economic benefit of deployments outside North America. The
Company's success will depend to a substantial degree on its ability to bring to
market in a timely fashion new products and enhancements to Visual UpTime that
meet changing market requirements. The Company expects to employ a combined
strategy of developing products internally and acquiring products and technology
to meet evolving market requirements.

       As of December 31, 1998, there were 82 persons working in the Company's
research and development area. The Company's research and development
expenditures were $5.4 million, $7.3 million and $10.4 million for the years
ended December 31, 1996, 1997 and 1998, respectively.

CUSTOMERS

       Visual UpTime has been shipped to more than 425 subscribers. Subscriber
deployments represent the majority of deployments to date. The following
subscribers each have generated, either directly or through resellers,
cumulative revenue of more than $250,000:

     ABN-AMRO Bank                           Federal Express Corporation
     Cargill, Inc.                           Household International, Inc.
     Columbia Gas System Inc.                Marriott International, Inc.
     Delta Air Lines, Inc.                   Waste Management, Inc.
     EDS, Electronic Commerce Division

       Sprint, AT&T and MCI accounted for 27%, 7% and 2%, respectively, of
revenue for the year ended December 31,1997. Sales of products or services to
Sprint, AT&T and MCI accounted for 30%, 17% and 14%, respectively, of revenue
for the year ended December 31, 1998. See "Risk Factors--We are Dependent on
Certain Major Customers".

       Since mid-1996, the Company has developed business relationships with a
number of providers, including AT&T, MCI, Sprint, Ameritech, Bell Atlantic and
BellSouth. These providers supply approximately 50% of worldwide Frame Relay and
ATM services. While these relationships are at different levels of business
maturity, the portion of the Company's revenue derived from these relationships
has grown from approximately 40% in the year ended December 31, 1997, to
approximately 65% in the year ended December 31, 1998. The Company expects to
expend substantial additional effort to evolve these business partners to the
provider deployment model. See "Risk Factors--Our Success Depends on Service
Providers Incorporating Our Product Into Their Infrastructure" and "Risk
Factors--We Are Subject To Lengthy Sales Cycles."

       AT&T RELATIONSHIP

       In December 1997, the Company entered into a non-exclusive procurement
agreement with AT&T. The agreement is for an initial term of three years and
automatically renews until terminated by either party upon 30 days' notice.
Prices and discounts for all equipment purchased by AT&T are fixed for the term,
except in certain limited circumstances. The equipment carries a five-year
warranty. If the Company offers more favorable prices and terms to any other
customer during the term of the agreement, the Company 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 the Company. The Company
also provides certain support services to AT&T.

       MCI RELATIONSHIP

       In August 1997, the Company entered into a non-exclusive three-year
reseller agreement with MCI, which automatically renews for successive one-year
terms unless terminated by either party at least 60 days prior to expiration.
Prices and discounts for all equipment purchased by MCI are fixed for the term.
The equipment carries a five year warranty. If the Company offers more favorable
prices to any other customer for the same quantity of products purchased over a
similar period of time, the prices charged to MCI will be adjusted to the more
favorable 


                                     - 10 -
<PAGE>   15

price. The reseller agreement does not obligate MCI to make any minimum
purchases from the Company. The Company also provides certain support services
to MCI.

       SPRINT RELATIONSHIP

       In August 1996, the Company entered into a non-exclusive three-year
reseller agreement with Sprint. Prices for all equipment purchased by Sprint are
fixed for the term, unless Sprint does not purchase a certain minimum amount of
equipment and services, in which event prices for equipment and services are
subject to increase. The equipment carries a five year warranty. If the Company
offers more favorable prices and terms to any other customer during the term of
the agreement, such terms and prices will be applicable to Sprint's orders. The
reseller agreement does not obligate Sprint to make any minimum purchases from
the Company. The Company also provides certain escrow rights and support
services to Sprint.

SALES, MARKETING AND SUPPORT

       The Company's sales, marketing and support operations vary according to
the type of deployment model being targeted:

       SUBSCRIBER DEPLOYMENT

       The Company has targeted subscriber deployment opportunities through a
combination of direct sales, sales through value-added resellers and integrators
and sales through providers acting in the capacity of resellers. The Company
provides pre-sale technical support to each of its channels. The development of
relationships with the various channels varies from 2 to 12 months for value
added resellers and integrators and from 12 to 24 months in the case of
providers. The sales cycle for subscriber deployment when handled directly or
through resellers is typically 4 to 6 months, and, for this reason, a large
majority of sales to date have been subscriber deployments.

       PROVIDER DEPLOYMENT

       The Company targets provider deployment opportunities on an account by
account basis in descending order of their Frame Relay and ATM market shares.
According to Vertical Systems, AT&T, Sprint and MCI together control more than
55% of the U.S. market and 40% of the worldwide market for Frame Relay and ATM
services. Because of current levels of competition for WAN services, the Company
believes its most significant opportunities for Visual UpTime are with
U.S.-based long distance providers. The Company believes its relationships with
AT&T, Sprint and MCI will influence other providers to adopt Visual UpTime.

       The provider deployment model involves a complex sale with very large
companies. The sales cycle begins with the presentation of Visual UpTime's value
proposition to multiple departments within a provider organization followed by a
lengthy evaluation process. The Company then works with the provider to develop
a service definition and business plan for the integration of Visual UpTime into
the provider's existing services.

       The Company has sales and technical support teams assigned to each
account. In addition, the Company's senior management team devotes significant
time furthering the business relationships with these providers and the Company
invests significant marketing resources to stimulate sales to these providers.
The Company expects to increase its sales, marketing and support efforts
addressed to these providers and extend those efforts to international and
IP/lnternet providers.

       As of December 31, 1998, the Company employed 51 persons in sales and
marketing. The Company's expenditures on sales and marketing were approximately
$9.5 million, $13.2 million and 13.9 million for the years ended December 31,
1996, 1997, and 1998, respectively.


                                     - 11 -
<PAGE>   16

COMPETITION

       The markets for telecommunications equipment and software are intensely
competitive. Visual UpTime integrates key functionality traditionally found in
three distinct market segments: the WAN access equipment market; the network
test and analysis market; and the market for telecommunications OSS. The Company
believes that Visual UpTime is the only system which integrates functional
attributes from these three 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, the Company expects to encounter
increased competition from current and potential participants in each of these
segments. See "Risk Factors--We Face Intense and Evolving Competition in the WAN
Equipment Market".

       WAN ACCESS EQUIPMENt

       The WAN access equipment market is highly fragmented. This market
includes DSU/CSUs, low to mid-range time division multiplexers, Frame Relay
access devices and ATM access products. Leading vendors in this segment include
ADC Telecommunications, Inc., Paradyne Corporation, Adtran, Inc., Sync Research,
Inc. and Digital Link Corp. The Company expects that, in some cases, these
companies may partner with companies offering network test and analysis products
in order to compete in the WAN service level management market. The Company is
aware of such arrangements between Digital Link and NetScout and NetScout and
Paradyne. Furthermore, internetworking providers, such as Cisco Systems, Inc.,
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 vendors in this market segment are Network
Associates, Inc., Hewlett-Packard Company, Telecommunications Techniques Corp.
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 providers and have sometimes been a source of competitive
advantage to 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. Therefore, in some
cases, a provider may consider in-house development as an alternative to
deployment of Visual UpTime.

       The Company intends to compete by offering superior features,
performance, reliability and flexibility at competitive prices. The Company also
intends to compete on the strength of its relationships with providers. As
competition in the WAN service level management market increases, the Company
believes that the industry may be characterized by intense price competition
similar to that present in the broader networking market. In response to
competitive trends, the Company expects that it will continue to reduce the cost
of its systems to seek ways to improve upon Visual UpTime's price-to-performance
ratio. Increased competition may result in price reductions, reduced
profitability and loss of market share, any of which would have a material
adverse effect on the Company's business, financial condition and results of
operations.


                                     - 12 -
<PAGE>   17

MANUFACTURING

       The Company currently uses a combination of subcontracting and internal
manufacturing, but anticipates moving to a predominately outsourced
manufacturing model in order to achieve significant scaleability. In connection
with its outsourcing strategy and increased volumes, the Company is seeking to
secure additional sources of supply, including additional contract
manufacturers. The Company was recently ISO 9001 certified and has 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 the
Company attempts to maintain appropriate back-up suppliers, in the event that
any significant subcontractor were to become unable or unwilling to continue to
manufacture and/or test the Company's products in required volumes, the Company
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 the Company 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 the Company's business, financial condition and results of
operations.

       Although the Company generally uses standard parts and components for its
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 of the Company or its subcontractors to procure these components from
alternate sources at acceptable prices and within a reasonable time, could have
a material adverse effect upon the Company's business, financial condition and
results of operations. See "Risk Factors--We Are Dependent on Sole and Limited
Source Suppliers and May Face Fluctuations in Component Pricing".

PATENTS AND OTHER INTELLECTUAL PROPERTY RIGHTS

       The Company presently has one issued patent on the "Measurement of Round
Trip Delay", which expires in April 2015, and another issued on the "Method and
Apparatus for Measurement of Peak Throughput in Packetized Data Networks," which
expires in 2016.  It also has two patents pending. No assurance can be given 
that competitors will not successfully challenge the validity or scope of the
Company's patents or that such patents will provide a competitive advantage to
the Company. As part of its confidentiality procedures, the Company generally
enters into non-disclosure agreements with its employees and business partners
and license agreements with respect to its software, documentation and other
proprietary information. Despite these precautions, it may be possible for a
third party to copy or otherwise obtain and use the Company's products or
technology without authorization, or to develop similar technology
independently. Policing unauthorized use of the Company's products is difficult.
Effective protection of intellectual property rights is unavailable or limited
in certain foreign countries. There can be no assurance that the Company's
protection of its proprietary rights will be adequate or that the Company's
competitors will not independently develop similar technology, duplicate the
Company's products or design around any patents issued to the Company or other
intellectual rights of the Company.

       The Company expects that software and communications product developers
will increasingly be subject to claims of infringement of patents as the number
of products and competitors in the Company's industry segment grows and the
functionality of products in the industry segment overlaps. The Company is not
aware that any of its products infringe the property rights of third parties.
There can be no assurance, however, that third parties will not claim such
infringement by the Company with respect to current or future products. Any such
claims, with or without merit, could result in costly litigation that could
absorb significant management time, which could have a material adverse effect
on the Company's business, financial condition and results of operations. Such
claims might require the Company to enter into license or royalty agreements.
Such license or royalty agreements, if required, may not be available on terms
acceptable to the Company or at all, which could have a material adverse effect
on the Company's business, financial condition and results of operations. See
"Risk Factors--We Rely on Intellectual Property and Proprietary Rights".


                                     - 13 -
<PAGE>   18

       EMPLOYEES

       As of December 31, 1998, the Company had 177 full-time employees,
including 82 in product development, 43 in sales, 8 in marketing, 10 in
manufacturing, 6 in customer service and 28 in finance, centralized services and
administration.

       The Company's future success will depend in significant part on the
continued service of its key technical, sales and senior management personnel.
Competition for such personnel is intense and there can be no assurance that the
Company can retain its key managerial, sales and technical employees, or that it
can attract, assimilate or retain other highly qualified technical, sales and
managerial personnel in the future. None of the Company's employees is
represented by a labor union. The Company has not experienced any work stoppages
and considers its relations with its employees to be good.

ITEM 2. PROPERTIES

       The Company's principal administrative, sales and marketing, research and
development and customer support facility is located in approximately 49,000
square feet of office space in Rockville, Maryland that the Company occupies
under leases that expire in November 2001. The Company also occupies
approximately 14,000 square feet of space for its Hudson, Massachusetts facility
which the Company has leased through December 1999. While the Company believes
that its facilities in Rockville are adequate for its immediate needs, it may
need additional space in late 2000. The Company intends to obtain alternative
space in Hudson.

ITEM 3. LEGAL PROCEEDINGS

       The Company is involved in legal proceedings from time to time in the
ordinary course of its business. Management believes that none of these legal
proceedings will have a materially adverse effect on the Company's business,
financial condition or results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

       None.


                                     - 14 -
<PAGE>   19

                                     PART II

ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK EQUITY AND RELATED STOCKHOLDER
MATTERS.

       The Company's Common Stock is traded on the Nasdaq National Market under
the symbol "VNWK." Prior to February 6, 1998, there was no established public
trading market for any of the Company's securities.

       The following table sets forth, for the periods indicated, the range of
high and low closing sales price for the Common Stock as reported on the Nasdaq
National Market.

<TABLE>
<CAPTION>
Fiscal 1998                                                           High                Low
-----------                                                           ----                ---

<S>                                                                 <C>                 <C>    
First Quarter (from February 6, 1998 to March 31, 1998)             $26.000             $16.813
Second Quarter (ended June 30, 1998)                                 37.250              28.250
Third Quarter (ended September 30, 1998)                             37.750              17.500
Fourth Quarter (ended December 31, 1998)                             37.875              22.125

<CAPTION>
Fiscal 1999
-----------

<S>                                                                 <C>                 <C>    
First Quarter (from January 1, 1999 to March 22, 1999)               43.500              31.500
</TABLE>

       On March 22, 1999, the last reported sale price of the Common Stock was
$39.500 per share. As of March 22, 1999, the Company had approximately 236
shareholders.

       The Company has never paid or declared any cash dividends on its Common
Stock. It is the present policy of the Company to retain earnings to finance the
growth and development of the business and, therefore, the Company does not
anticipate declaring or paying cash dividends on its Common Stock in the
foreseeable future. In addition, the Company's credit facility with Silicon
Valley Bank prohibits the Company from paying cash dividends without the Bank's
consent. See Note 2 of Notes to Consolidated Financial Statements.

       On May 15, 1998, Visual Acquisitions, Inc., the Company's wholly owned
subsidiary merged into Net2Net Corporation ("Net2Net") under the terms of an
Agreement and Plan of Merger dated April 15, 1998. In connection with the
merger, the shares of capital stock of Net2Net owned by the selling stockholders
and certain obligations of Net2Net to creditors were converted, on a pro rata
basis, into shares of the Company's Common Stock, and Net2Net became the
Company's wholly owned subsidiary. The selling stockholders and creditors of
Net2Net received, in the aggregate, 2,075,277 shares of Common Stock in
connection with the merger. The non-cash consideration for the shares issued to
the selling stockholders of Net2Net was an aggregate of $64,256,375 and the
non-cash consideration for the shares issued to creditors of Net2Net subsequent
to the merger was an aggregate of $604,895. All such shares were issued by the
Company in reliance upon the exemption contained in Section 506 of Regulation D.

       The following table represents all securities sold by the Company during
1998 in connection with the Net2Net merger, which were not registered under the
Securities Act of 1933, as amended.


                                     - 15 -
<PAGE>   20


<TABLE>
<CAPTION>
                                                   NUMBER OF
                        NAME                        SHARES
                        ----                        ------

<S>                                                <C>   
Richard J. Arena..............................      98,740
Michael Barza.................................      18,092
Ralph L. Beck.................................      54,118
Jeffrey Bellanger.............................         634
Clark Bernard.................................      18,513
Margaret and Nicholas Bik.....................       4,451
Columbia Ventures Trust.......................       7,935
Commonwealth Capital Ventures, L.P............      14,897
Nicholas Cooke................................         857
Robert M. and Carol M. Cotter.................       7,829
Frederick R. Cronin...........................      23,805
Cutler Associates Investments, Inc............      15,870
Tetsuko De La Vega............................         126
Dextra Holdings Ltd...........................     180,207
Laurence W. Duclos, Jr........................       7,300
Peter W. Dumas................................       4,166
Thomas Dungan.................................         800
Roberta Farrell...............................         126
David H. Feinberg.............................       3,967
Mark Galvin...................................       3,650
Abbott Gilman.................................      15,870
Independence Trust............................      28,884
Kathleen Jacobelli............................       1,269
Paul W. Kelley................................      98,714
Dennis A. Kirshy..............................      51,579
Allan M. Kline................................       4,364
Richard A. Kline..............................         317
Alexander E. Kukielka.........................      52,531
Jeffrey S. Lang...............................       7,935
Herbert A. and Rose Lerner....................       2,777
Le Serre......................................       3,615
Kevin C. Little...............................      34,915
Litton Master Trust...........................      60,069
Stuart P. MacEachern..........................       5,395
Nigel C. Machin
      (Custodian for Carey
        Machin under UGMA)....................       1,745
Nigel C. Machin
      (Custodian for Haley
        Machin under UGMA)....................       1,745
Nigel C. Machin...............................      10,791
Ernest Magaro.................................       7,300
Lauren Maschio................................         634
Arnold M. McCalmont...........................      15,394
James A. and Regina M. McCalmont..............      15,870
</TABLE>


                                     - 16 -
<PAGE>   21

<TABLE>
<CAPTION>
                                                   NUMBER OF
                        NAME                        SHARES
                        ----                        ------

<S>                                                <C>   
Jennifer N. McCalmont.........................       7,935
Rebekah R. McCalmont..........................      23,329
Stephen A. McCalmont..........................     197,429
Norman B. Meisner.............................       7,935
MHF Sylvan Fund...............................      33,853
NMS Services (Cayman), Inc....................     183,730
Charles J. and Virginia R. Nagle..............       8,259
Fred S. and Nancee J. Nixdorf.................       7,776
Rodger Nordblom...............................      19,995
The Ocean Fund(1)   ..........................     358,784
Vincent M. O'Reilly...........................       9,124
Raymond E. Palmer.............................       3,650
Pioneer Capital Corporation...................      32,361
Pioneer Ventures Limited Partnership II.......     164,337
David Robbins.................................       1,904
Howard Salwen.................................       4,761
Howard Salwen
      (1986 Children's Trust FBO
        Andre Salwen).........................       4,761
Howard Salwen
      (1986 Children's Trust FBO
       David Salwen)..........................       4,761
Larry S. and Eileen Samburg...................       2,380
Morey Schapira................................         991
Nathaniel P. Schildbach.......................          95
Keith Schofield...............................         253
Peter K. Schofield............................       7,935
Silicon Valley Bank(2)  ......................       2,225
William L. and Esther M. Steele...............       1,587
Richard Steinberg.............................       8,463
Technical Communications
      Corporation.............................      36,184
Waterline Capital LLC.........................      39,676
Lars Widstrand................................         158
Worcester Venture Group Trust.................      12,850
</TABLE>

(1) The Ocean Fund received 16,848 of these shares upon repayment of a note
issued by Net2Net.

(2) Silicon Valley Bank received 2,225 shares of the Company upon exercise of a
warrant issued by Net2Net.

        In addition, from January 1, 1998 through May 1, 1998, the Company
issued an aggregate of 191,946 shares of Common Stock in the aggregate amount
of $95,718, upon exercise of stock options. The shares were issued at prices
ranging from $0.07 to $7.00 per share and were issued in reliance upon the
exemption contained in Rule 701 of the Securities Act of 1933, as amended.


                                     - 17 -
<PAGE>   22


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, 1996, 1997 and 1998, are derived from consolidated financial statements of
the Company which have been audited by Arthur Andersen LLP, independent public
accountants. The selected consolidated financial data for the years ended
December 31, 1994 and 1995, are derived from audited consolidated financial
statements not included in this Form 10-K.

<TABLE>
<CAPTION>

                                                                              YEARS ENDED DECEMBER 31,
                                                     ---------------------------------------------------------------------------
                                                         1994            1995           1996           1997             1998
                                                     ------------     ----------     ----------     -----------     ------------
                                                                   (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

CONSOLIDATED STATEMENT OF
    OPERATIONS DATA:

<S>                                                    <C>            <C>            <C>            <C>             <C>      
Revenue.............................................    $     -        $     567      $   8,279      $   27,345      $  50,863
Cost of goods sold..................................          -              242          3,687          10,754         19,010
                                                       ----------     ----------     ----------     -----------     ----------
      Gross profit..................................          -              325          4,592          16,591         31,853
                                                       ----------     ----------     ----------     -----------     ----------
Operating expenses:
      Research and development......................          163          2,038          5,432           7,321         10,396
      Sales and marketing...........................          -            1,187          9,483          13,182         13,899
      General and administrative....................          276            566          2,036           3,211          4,256
      Merger-related costs (1)......................          -              -              -               -            5,069
                                                       ----------     ----------     ----------     -----------     ----------
                        Total operating expenses....          439          3,791         16,951          23,714         33,620
                                                       ----------     ----------     ----------     -----------     ----------
Loss from operations................................         (439)        (3,466)       (12,359)         (7,123)        (1,767)
Interest income, net................................            1             63            166              93          2,275
                                                       ----------     ----------     ----------     -----------     ----------
Net income (loss)...................................         (438)        (3,403)       (12,193)         (7,030)           508
Dividends and accretion on preferred stock..........          -             (250)        (1,012)         (1,457)          (171)
                                                       ----------     ----------     ----------     -----------     ----------

Net income (loss) attributable to common shareholders   $    (438)     $  (3,653)     $ (13,205)     $   (8,487)     $     337
                                                       ==========     ==========     ==========     ===========     ==========
Basic and diluted income (loss) per share...........    $   (0.14)     $   (1.04)     $   (2.97)     $    (1.72)     $    0.02
                                                       ==========     ==========     ==========     ===========     ==========
Basic weighted-average shares (2)...................    3,113,327      3,524,681      4,439,522       4,926,802     18,228,982
                                                       ==========     ==========     ==========     ===========     ==========

Diluted weighted-average shares (2).................    3,113,327      3,524,681      4,439,522       4,926,802     21,145,216
                                                       ==========     ==========     ==========     ===========     ==========
Pro forma basic and diluted income (loss) per
    share ..........................................                                                 $    (0.45)     $    0.02
                                                                                                    ===========     ==========
Pro forma basic and diluted weighted-average shares (2)                                              15,532,537     21,145,216
                                                                                                    ===========     ==========

CONSOLIDATED BALANCE SHEET DATA:

Cash and cash equivalents...........................       $1,424        $ 3,548       $  7,551      $    8,902        $50,531
Working capital.....................................        1,319          3,632          7,031            (271)        44,187
Total assets........................................        1,489          5,091         13,344          18,611         66,848
Long-term debt, net of current portion..............          -               86            148             -              -
Redeemable convertible preferred stock..............        1,170          3,385         13,398          14,855            -
Stockholders' equity (deficit)......................          205            678         (4,980)        (13,302)        48,665
</TABLE>

(1) During the year ended December 31, 1998, the Company incurred certain
    merger-related costs in connection with its acquisition of Net2Net. See
    Notes 1 and 6 of Notes to Consolidated Financial Statements.

(2) 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.


                                     - 18 -
<PAGE>   23


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

       The following discussion of the financial condition and results of
operations of the Company should be read in conjunction with the Company's
Consolidated Financial Statements, the related notes thereto, and other
financial information included elsewhere in this Form 10-K.

OVERVIEW

       The Company was incorporated in Maryland in August 1993 as Avail
Networks, Inc. and reincorporated in Delaware in December 1994 as Visual
Networks, Inc. From incorporation through December 1994, the Company's principal
objective was to secure sufficient equity financing to enable the Company to
accelerate product development efforts. The Company secured its initial round of
equity financing in December 1994.

       During 1995 and 1996, the Company devoted substantial resources to
developing Visual UpTime for Frame Relay deployment and to developing sales and
marketing functions and general and administrative infrastructure. Visual UpTime
was first shipped in mid-1995. The Company began generating significant revenue
from sales of Visual UpTime during 1996.

       During 1995 and 1996, most of the Company's sales were to subscribers. In
August 1996, the Company entered into a master reseller agreement with Sprint,
resulting in the Company's products shipping through Sprint to subscribers. In
October 1997, the Company entered into a similar master reseller agreement with
MCI, which also resulted in shipments of the Company's products through MCI to
subscribers. During 1997 and 1998, the Company has focused on selling Visual
UpTime directly to providers as part of their network infrastructure. In
December 1997, the Company entered into an agreement with AT&T, which provides
for the sale of the Company's products to AT&T for deployment as part of AT&T's
infrastructure.

       The Company realizes revenue from sales of hardware, from the licensing
of related software and from maintenance contracts. The Company generally
recognizes revenue upon shipment or delivery of the product and passage of title
to the customer. Where the 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
call for the Company to provide technical support and software updates to
customers. The Company recognizes maintenance revenue, including maintenance
revenue that is bundled with product sales, ratably over the contract period,
which currently ranges from one to three years.

       The Company currently contracts with third parties for board assembly and
other production processes and has manufacturing operations that perform final
assembly, testing and shipping of its product at its facilities in Rockville,
Maryland and Hudson, Massachusetts. The Company anticipates maintaining a
portion of its internal manufacturing function for the foreseeable future at its
Rockville, Maryland facility.

       On May 15, 1998, the Company acquired Net2Net in a merger accounted for
as a pooling of interests. The combination with Net2Net will affect the future
results of the operations reported by the Company. See Note 1 of Notes to
Consolidated Financial Statements.


                                     - 19 -
<PAGE>   24

RESULTS OF OPERATIONS

       The following table presents for the periods indicated certain
consolidated statement of operations data as a percentage of the Company's
revenue:

<TABLE>
<CAPTION>
                                                              YEARS ENDED DECEMBER 31,
                                                       -----------------------------------
                                                         1996          1997         1998
                                                       --------      --------     --------
<S>                                                     <C>           <C>          <C>   
Revenue..............................................    100.0%        100.0%       100.0%
Cost of goods sold...................................     44.5          39.3         37.4
                                                       --------      --------     --------
      Gross profit...................................     55.5          60.7         62.6
                                                       --------      --------     --------
Operating expenses:
      Research and development.......................     65.6          26.8         20.4
      Sales and marketing............................    114.6          48.2         27.3
      General and administrative.....................     24.6          11.7         8.4
      Merger-related costs...........................    -             -             10.0
                                                       --------      --------     --------
                        Total operating expenses.....    204.8          86.7         66.1
                                                       --------      --------     --------
Loss from operations.................................   (149.3)        (26.0)        (3.5)
Interest income, net.................................      2.0           0.3          4.5
                                                       --------      --------     --------
Net income (loss)....................................   (147.3)%       (25.7)%        1.0%
                                                       ========      ========     ========
</TABLE>

YEAR ENDED DECEMBER 31, 1998 COMPARED WITH YEAR ENDED DECEMBER 31, 1997

       REVENUE. The Company recognized $50.9 million in revenue for the year
ended December 31, 1998, an 86.0% increase over revenue of $27.3 million for the
year ended December 31, 1997. The increase was due primarily to the continued
acceptance of Visual UpTime in the Frame Relay market, with a significant
increase in sales to providers and, to a lesser extent, to the increase in sales
of the Company's network analysis tools. Sales to providers accounted for
approximately 65% of revenue for the year ended December 31, 1998 as compared to
approximately 40% for the year ended December 31, 1997.

       GROSS PROFIT. Cost of goods sold consists of component parts, direct
compensation costs, warranty and other contractual obligations, royalties,
license fees and other overhead expenses related to manufacturing operations.
Gross profit was $31.9 million for the year ended December 31, 1998, as compared
to $16.6 million for the year ended December 31, 1997, an increase of $15.3
million. Gross margin was 62.6% of revenue for the year ended December 31, 1998,
as compared to 60.7% of revenue for the year ended December 31, 1997. The
increase in gross margin percentage was due primarily to product cost reductions
and to product sales mix. The Company's future gross margins may be adversely
affected by a number of factors, including product mix, the proportion of sales
to 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 $10.4 million for the
year ended December 31, 1998 as compared to $7.3 million for the year ended
December 31, 1997, an increase of $3.1 million. The increase in research and
development expense was due primarily to increased staffing levels and, to a
lesser extent, purchases of materials used in the development of new or enhanced
products. Research and development expense was 20.4% and 26.8% of revenue for
the years ended December 31, 1998 and 1997, respectively. The Company expects
that research and development expenditures will increase in absolute dollars,
and may decrease as a percentage of revenue, during 1999 and thereafter. The
increase in absolute dollars will support continued development of new enhanced
products and the exploration of new or complementary technologies.

       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 $13.9 million for the year ended December 31,
1998, as compared to $13.2 million for the year ended December 31, 1997, an
increase of $0.7 million. The increase in sales and marketing expense 


                                     - 20 -
<PAGE>   25

was due primarily to increased staffing levels during the year and related 
costs, such as commissions. Sales and marketing expense was 27.3% and 48.2% of
revenue for the years ended December 31, 1998 and 1997, respectively. The
Company expects that sales and marketing expenditures will increase in absolute
dollars, and may decrease as a percentage of revenue, during 1999 and
thereafter. This increase in absolute dollars is expected to be incurred as
additional personnel are hired, field offices are opened and promotional
expenditures increase to allow the Company to increase its market penetration
and to pursue market opportunities.

       GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense
consists of the costs of finance, administration, and general management
activities. General and administrative expense was $4.3 million for the year
ended December 31, 1998 as compared to $3.2 million for the year ended December
31, 1997, an increase of $1.1 million. The increase in general and
administrative expense was due primarily to increased staffing levels and costs
incurred related to a planned secondary public offering that was canceled in
1998. General and administrative expense was 8.4% and 11.7% of revenue for the
years ended December 31, 1998 and 1997, respectively. The Company expects that
general and administrative expenditures will increase in absolute dollars, and
may decrease as a percentage of revenue, during 1999 and thereafter. The
increase in absolute dollars is expected to be required for the expansion of the
Company's administrative staff and internal systems to support expanding
operations.

       MERGER-RELATED COSTS. In connection with the Net2Net acquisition, the
Company recorded merger-related charges for transaction costs, integration
expenses and restructuring charges of approximately $5.1 million. Transaction
costs totaled approximately $4.2 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.
These costs were expensed as incurred. In the second quarter, the Company
recorded a restructuring charge of approximately $2.7 million primarily 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 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 $0.7
million was charged against the restructuring reserve. This amount included
approximately $0.5 million related to employee termination costs and
approximately $0.2 million related to contractual obligations. In the fourth
quarter, the Company reversed the remaining $2.0 million of the restructuring
accrual. 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 contractual obligations have been paid and
all of the employee terminations have been completed and the related benefits
have been paid.  

       INTEREST INCOME, NET. Interest income, net, for the year ended December
31, 1998 was approximately $2.3 million as compared to $0.1 million for the year
ended December 31, 1997. The increase was due to the significant increase in
cash and cash equivalents between periods resulting from the proceeds of the
Company's IPO in February 1998.

       NET INCOME (LOSS). Net income for the year ended December 31, 1998 was 
$0.5 million as compared to a net loss of $7.0 million for the year ended
December 31, 1997, an increase of $7.5 million. Increased operating expenses and
the merger-related costs described above offset the increases in revenue, gross
profit, and interest income achieved in 1998.

YEAR ENDED DECEMBER 31, 1997 COMPARED WITH YEAR ENDED DECEMBER 31, 1996

       REVENUE. The Company recognized $27.3 million in revenue for the year
ended December 31, 1997, as compared to $8.3 million for the year ended December
31, 1996, an increase of $19.0 million. The increase was due primarily to
acceptance of Visual UpTime in the Frame Relay market and to sales resulting
from the reseller agreement signed with Sprint in August 1996 and, to a lesser
extent, to the increase in sales of the Company's network analysis tools.
Revenue from this reseller agreement accounted for approximately 27% of revenue
for the year ended December 31, 1997.

       GROSS PROFIT. Gross profit was $16.6 million for the year ended December
31, 1997, as compared to $4.6 million for the year ended December 31, 1996, an
increase of $12.0 million. Gross profit was 60.7% for the year ended 


                                     - 21 -
<PAGE>   26

December 31, 1997, as compared to 55.5% for the year ended December 31, 1996.
The increase in gross margin percentage was due primarily to product cost
reductions and to the mix of product sales.

       RESEARCH AND DEVELOPMENT EXPENSE. Research and development expense was
$7.3 million for the year ended December 31, 1997, as compared to $5.4 million
for the year ended December 31, 1996, an increase of $1.9 million. The increase
in research and development expense was due primarily to increased staffing
levels and, to a lesser extent, purchases of materials used in the development
of new or enhanced products.

       SALES AND MARKETING EXPENSE. Sales and marketing expense was $13.2
million for the year ended December 31, 1997, as compared to $9.5 million for
the year ended December 31, 1996, an increase of $3.7 million. The increase in
sales and marketing expense was due primarily to increased staffing levels.

       GENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expense
was $3.2 million for the year ended December 31, 1997, as compared to $2.0
million for the year ended December 31, 1996, an increase of $1.2 million. The
increase in general and administrative expense was due primarily to increased
staffing levels.

       NET LOSS. The Company's net loss was $7.0 million for the year ended
December 31, 1997, as compared to net loss of $12.2 million for the year ended
December 31, 1996, a decrease of $5.2 million. This decrease was due primarily
to the revenue and gross profit increases described above.

LIQUIDITY AND CAPITAL RESOURCES

       At December 31, 1998, the Company's combined balance of cash and cash
equivalents was $50.5 million as compared to $8.9 million as of December 31,
1997. This increase is primarily attributable to the $45.4 million in net
proceeds that the Company received from the sale of common stock in its IPO in
February 1998. Cash provided by operating activities was approximately $0.1
million for the year ended December 31, 1998. Capital expenditures were
approximately $3.9 million for the year ended December 31, 1998.

       The Company requires substantial working capital to fund its business,
particularly to finance inventories, accounts receivable, research and
development activities and capital expenditures. The Company currently
anticipates that capital expenditures for 1999 are not expected to exceed $3.5
million. The Company's 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 expansion of sales and marketing, the
timing of introductions of new products and enhancements to existing products
and market acceptance of the Company's products. There can be no assurance that
additional equity or debt financing, if required, will be available on
acceptable terms, if at all.

       In addition to the Company's cash and cash equivalents, the Company's
other principal source of liquidity is its bank credit facility. The credit
facility includes a revolving line of credit providing for borrowings up to the
lesser of $7.0 million or 80% of eligible accounts receivable (as defined in the
credit facility). The agreement entitles Silicon Valley Bank to a security
interest in the Company's inventory and accounts receivable. The agreement
contains restrictive financial covenants, including, but not limited to,
restrictions related to liquidity and net worth as well as restrictions related
to acquisitions, dispositions of assets, distributions, and investments.
Interest is payable monthly at the prime rate. As of December 31, 1998, there
were no borrowings outstanding under the bank credit facility.

       Substantially all of the Company's product sales to date have been made
to customers in the U.S. The Company intends to increase its sales efforts in
foreign markets. The Company plans to sell its products to foreign customers at
prices denominated in U.S. dollars. However, if the Company commences selling
material volumes of product to such customers at prices not denominated in U.S.
dollars, the Company intends to adopt a strategy to hedge against fluctuations
in foreign currency.

       The Company believes that the net proceeds from the IPO together with 
existing sources of liquidity will be sufficient to fund its capital
expenditures and working capital needs for the next 18 to 24 months. The Company
may consider from time to time various financing alternatives and may seek to
raise additional capital through equity or debt financing or to enter into
strategic arrangements. There can be no assurance, however, that any such
financing alternatives will be available on terms acceptable to the Company, it
at all.


                                     - 22 -
<PAGE>   27

RISK FACTORS

OUR SUCCESS DEPENDS ON SERVICE PROVIDERS INCORPORATING OUR PRODUCT INTO THEIR
INFRASTRUCTURE

       While we have begun implementation of a sales and marketing strategy to
sell Visual UpTime to service providers which will deploy the product as part of
their network infrastructure ("provider deployment model"), a significant
portion of our revenue continues to come from sales of our products to
subscribers. We expect that sales directly to subscribers will continue to
account for a significant portion of our revenue through at least the end of
1999. We anticipate that a significant portion of our future revenue will be
attributable to sales of Visual UpTime using the provider deployment model. Our
future performance will therefore be substantially dependent on incorporation of
Visual UpTime by service providers into their service offerings to subscribers.
Service providers have not typically offered solutions that enable the
subscriber to measure and test the WAN service levels offered by the service
provider, and we could encounter resistance on the part of some service
providers to offering these solutions. There can be no assurance that we will be
successful in persuading service providers to adopt the provider deployment
model. We believe the success or failure of the provider deployment model, and
the timing of success, if achieved, will depend on a number of factors over
which we may have little or no control, including: service provider and
subscriber acceptance of and satisfaction with our systems; the realization of
operating cost efficiencies for service providers when service level management
systems are deployed and our ability to demonstrate such operational benefits;
generation of demand for these systems from subscribers and support for the
systems within the service providers' sales forces; competitive dynamics between
WAN service providers and the development of the WAN services market overall;
our successful development of systems and products which address the
requirements for systems deployed as part of a service provider's
infrastructure; the timing and successful completion of integration development
work by service providers to incorporate our service level management
functionality into their operational support systems; and the absence of new
technologies which make our products and systems obsolete before they can
achieve broad acceptance. The failure of our products to become an accepted part
of the service providers' service offerings or a slower than expected increase
in the volume of sales by us to service providers would have a material adverse
effect upon our business, financial condition and results of operations.

WE ARE SUBJECT TO LENGTHY SALES CYCLES

       The provider deployment model is characterized by a lengthy sales cycle.
We expect that sales of Visual UpTime will require a substantial commitment of
capital from service providers, with the attendant delays frequently associated
with service providers' internal procedures to approve large capital
expenditures and lengthy decision-making processes. The sales cycle can also be
expected to be subject to a number of significant risks, including service
providers' budgetary constraints and technology assessment and other internal
acceptance reviews over which we have little or no control. Sales of Visual
UpTime generally involve significant testing by and education of both service
providers and subscribers 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 the provider
deployment model is implemented, curtailment or termination of service provider
marketing programs, decreases in service provider capital budgets or reduction
in the purchasing priority assigned to products such as Visual UpTime,
particularly if significant and unanticipated by us, could have a material
adverse effect on our business, financial condition and results of operations.

WE ARE DEPENDENT ON CERTAIN MAJOR CUSTOMERS

       We are dependent on a small number of customers for a substantial portion
of our revenue. For the year ended December 31, 1997, sales of products or
services to Sprint accounted for 27% of our revenue. For the year ended December
31, 1998, sales of products or services to Sprint, AT&T and MCI accounted for
30%, 17% and 14%, respectively, of our revenue. If our evolution to the provider
deployment model is successful, our customer base will consist predominantly of
large public network service providers. There are only a small number of these
service providers, and the substantial capital requirements involved in the
establishment of public networks significantly limit additional entrants into
this market. In addition, the number of these service providers may 


                                     - 23 -
<PAGE>   28

decrease if and as service providers merge or acquire one another. Accordingly,
the loss of any service provider customer, or the reduction, delay or
cancellation of orders or a delay in shipment of our products to any service
provider customer, could materially and adversely affect our business, financial
condition and results of operations.

       Our anticipated dependence on sizable orders from a limited number of
service providers will make the relationship between us and each service
provider critically important to our business. As our relationships with these
service providers evolve over time, adjustments to product specifications,
forecasts and delivery timetables may be made by us in response to service
provider 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 repeat business. Any
inability to manage our service provider relationships successfully could have a
material adverse effect on our business, financial condition and results of
operations.

OUR INDUSTRY IS CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGE AND WE ARE DEPENDENT
ON CONTINUED MARKET ACCEPTANCE OF OUR EXISTING PRODUCTS AND OUR ABILITY TO
DEVELOP NEW, MARKETABLE PRODUCTS

       Visual UpTime is focused on service level management for WANs that
utilize statistically multiplexed technologies. Accordingly, our future
financial performance will depend in large part on continued growth in the
number of enterprises adopting solutions based on Frame Relay, ATM and
IP/Internet services. The market for these services 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. The introduction of new technologies or advances in
techniques for statistically multiplexed WAN services or the integration of WAN
service level management functionality into other network hardware components
could render Visual UpTime obsolete or unmarketable. Further, we will be
required to make enhancements and refinements to the product for wide scale
implementation through the provider deployment model. There can be no assurance
that (i) Visual UpTime 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
develop and introduce new products and product enhancements in a timely fashion
could have a material adverse effect on our business, financial condition and
results of operations.

       Because Visual UpTime is deployed predominantly on Frame Relay networks,
our near-term success will depend on the continued market acceptance of Frame
Relay technology as a preferred networking solution. The failure of Frame
Relay-based services to maintain widespread market acceptance would have a
material adverse effect on our business, financial condition and results of
operations. We are currently devoting significant resources toward 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. Any inability to develop products on a timely basis that address
changing customer needs and technologies, may result in a loss of market share
to competitors or may require us 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.

       Products as complex as those offered by us 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 after commencement of commercial
shipments. The occurrence of such errors could result in the 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.


                                     - 24 -
<PAGE>   29

WE FACE INTENSE AND EVOLVING COMPETITION IN THE WAN EQUIPMENT MARKET

       The WAN equipment market is highly competitive. We face competition from
participants in three distinct market segments: the WAN access equipment market,
the network test and analysis market and the market for telecommunications
support systems. Companies participating in these market segments which compete
or can be expected to compete with us include ADC Telecommunications, Inc.,
Adtran, Inc., Concord Communications, Inc., Digital Link Corp., NetScout
Systems, Inc., Network Associates, Inc., Paradyne Corporation, Sync Research,
Inc., and Hewlett-Packard Company.

       We expect that we may experience price competition from products and
services that provide a portion of the functionality provided by Visual UpTime.
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. We expect that, in some cases, participants with strong capabilities
in these various segments may partner with each other to offer products that
supply functionality approaching that provided by Visual UpTime. We are aware of
such arrangements between Digital Link and NetScout, and NetScout and Paradyne.

       Many of our current and possible 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.

OUR QUARTERLY OPERATING RESULTS ARE SUBJECT TO POTENTIAL FLUCTUATIONS

       Our revenue and operating results may vary significantly from quarter to
quarter and from year to year as a result of a number of factors, including the
size and timing of orders, product mix and shipment of systems. The timing of
order placement, size of orders, satisfaction of contractual customer acceptance
criteria, as well as order delays or deferrals and shipment delays and
deferrals, may cause material fluctuations in revenue. Operating results may
also fluctuate on a quarterly basis based upon factors such as the continued
acceptance of Frame Relay-based products, demand for our current and future
product offerings, the introduction of product enhancements by us or our
competitors, market acceptance of new products offered by us or our competitors
and the size, timing, cancellation or delay of customer orders, including
cancellation or delay in anticipation of new product offerings. Our quarterly
operating results are also affected by the budgeting cycles of customers, the
relative percentages of products sold through our sales channels, product
pricing and competitive conditions in the industry. Any unfavorable changes in
these or other factors could have a material adverse effect on our business,
financial condition and results of operations. Accordingly, we believe that
period-to-period comparisons of our results of operations may not be meaningful
and should not be relied upon as an indication of future performance.
Furthermore, there can be no assurance that we will be able to achieve
profitability on a quarterly or annual basis.

WE HAVE A HISTORY OF LOSSES AND AN ACCUMULATED DEFICIT

       Visual was organized in 1993 and 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, 1998, we had an
accumulated deficit of approximately $25.6 million. We incurred losses from
operations for the years ended December 31, 1996, 1997 and 1998 of approximately
$12.4 million, $7.1 million and $1.8 million, respectively. The losses in 1996
and 1997 related primarily to our expenditures associated with the development
and marketing of the Visual UpTime product and the loss in 1998 related
primarily to our acquisition of Net2Net.

       There can be no assurance that our revenue will continue to grow or be
sustained in future periods. Although we have recently experienced an increase
in revenue from service providers, such growth should not be considered
indicative of future revenue growth, if any, or of 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. 


                                     - 25 -
<PAGE>   30

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 increase funding of research and
product development, sales, marketing and customer support operations and 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 materially and adversely affected. For the foregoing
reasons, there can be no assurance that we will be profitable in any future
period.

WE ARE DEPENDENT ON SOLE AND LIMITED SOURCE SUPPLIERS AND MAY FACE FLUCTUATIONS
IN COMPONENT PRICING

       Certain key components used in the manufacture of our products are
currently purchased only from sole, single or limited sources. At present,
sole-source components, where we have identified no other supplier for the
components, include framers, certain semiconductors, embedded communications
processors, communication controllers and line interface components. While
alternative suppliers have been identified for certain key components, those
alternative sources have not been qualified by us. The qualification process
could be lengthy and no assurance can be given that any additional sources would
become available to us on a timely basis, or, if such sources were to become
available, that we would not experience a degradation in the quality of
components provided by such new suppliers. We generally do not have long-term
agreements with our suppliers that guarantee the continuity of supply for sole,
single or limited source components or that provide protection against sudden
increases in component prices. We have from time to time experienced minor
delays in the receipt of key components, and any future difficulty in obtaining
sufficient and timely delivery of them could result in delays or reductions in
product shipments, which, in turn, could have a material adverse effect on our
business, financial condition and results of operations. In the event any
significant supplier becomes unable or unwilling to continue to supply required
components for our products, we would have to identify and qualify acceptable
replacements. In addition, although our sole or limited source suppliers are all
based in the United States, some of them may manufacture components, or acquire
components from, outside of the United States. If events in a country where a
key component is produced reduce or eliminate the supply of such component, and
our supplier is unable to obtain the component from another country, we would
have to identify and qualify acceptable replacements. Any interruption in the
supply of required or key 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. In the event of significant increases in
the cost of components, we would be forced either to increase the price of our
products or accept lower gross profit margins. In particular, certain of Visual
UpTime's key components, including dynamic random access memories and embedded
communications processors, are subject to fluctuations in pricing. An increase
in prices for our products resulting from such component price fluctuations
would make our products less competitive with products which do not incorporate
such components. Lower gross margins or less competitive product pricing could
have a material adverse effect on our business, financial condition and results
of operations.

WE CONTINUE TO FACE CERTAIN CHALLENGES IN INTEGRATING NET2NET INTO OUR BUSINESS

       We acquired Net2Net in May 1998. Since that time, we have been working to
integrate the two companies' businesses in an efficient and effective manner. We
continue to face challenges of integrating the Net2Net product into our product
line and expect that this will continue for some time. There can be no assurance
that such integration will be accomplished smoothly or successfully. The
difficulties of integration of the companies are increased by the necessity of
coordinating geographically separated organizations and addressing possible
differences in corporate cultures and management philosophies. The integration
of certain operations will require the dedication of management resources which
may temporarily distract attention from the day-to-day business of the combined
companies. The business of the combined companies may also be disrupted by
employee uncertainty and lack of focus during such integration. The inability of
management to successfully integrate the operations and product lines of the two
companies and, in particular to integrate and retain key engineering personnel,
could have a material adverse effect on our business, results of operations and
financial condition.


                                     - 26 -
<PAGE>   31

OUR SUCCESS DEPENDS ON OUR ABILITY TO MANAGE CHANGE AND EXPANSION

       Since our inception, we have experienced rapid and significant growth,
including a significant increase in the number of employees. This growth and
change in our operations have placed significant demands on our administrative,
operational, technical and financial resources. To compete effectively, and to
manage future growth, if any, we must continue to strengthen, on a timely basis,
our operational, financial and management information reporting systems and its
controls and procedures and to expand, train and manage our work force. There
can be no assurance that we will be able to take such actions successfully. The
failure of our management team to effectively manage growth could have a
material adverse effect on our business, financial condition and results of
operations.

WE ARE DEPENDENT ON CERTAIN KEY PERSONNEL

       Our success depends to a significant degree upon the continuing
contributions of our key management and technical employees, particularly Scott
E. Stouffer, Chairman, President and Chief Executive Officer. The loss of the
services of any key employee would adversely affect our business, financial
condition and results of operations. We maintain, and are the beneficiary under,
$2.0 million of key person life insurance on Mr. Stouffer. We believe that our
future success will depend in large part upon our ability to attract and retain
highly-skilled managerial, sales, marketing, customer support and product
development personnel. We require technically trained sales and product
development personnel, and the competition for these individuals is intense. We
have at times experienced, and continue to experience, difficulty in recruiting
qualified personnel. There can be no assurance that we will be successful in
retaining our key employees or that we can attract or retain additional skilled
personnel as required. Failure to attract and retain key personnel could have a
material adverse effect on our business, financial condition and results of
operations.

WE RELY ON INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS

       As the number of products in the network management industry increases
and the functionality of these products further overlaps, companies may
increasingly become subject to claims of infringement or misappropriation of the
intellectual property or proprietary rights of others. There can be no assurance
that third parties will not assert infringement or misappropriation claims
against us in the future with respect to current or future products, or that any
such assertion will not require us to enter into royalty arrangements or
litigation that would be costly to us. Any claims or litigation, with or without
merit, could result in a diversion of management's attention and our financial
resources, which could have a material adverse effect on our business, financial
condition and results of operations. Adverse determinations in such claims or
litigation could also have a material adverse effect on our business, financial
condition and results of operations.

       While we believe that our success will depend principally upon our
ability to develop and effectively market products that meet the requirements of
customers for service level management functionality, our ability to compete is
also dependent in part upon our proprietary technology and rights. We hold two
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. There can be no
assurance that the confidentiality agreements and other methods on which we rely
to protect our trade secrets and proprietary information and rights will 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. Furthermore, we may
be subject to additional risk as we enter into transactions in countries where
intellectual property laws are not well developed or enforced effectively. Legal
protection of our rights may be ineffective in such countries, and technology
developed or used in such countries may not be protectable in jurisdictions
where protection is ordinarily available. Litigation to defend and enforce our
intellectual property rights, regardless of the final outcome of such
litigation, could result in substantial costs and diversion of resources and
could have a material adverse effect on our business, financial condition and
results of operations. There can also be no assurance that our trade secrets or
non-disclosure agreements will provide meaningful protection of our


                                     - 27 -
<PAGE>   32

proprietary information. Our inability to protect our proprietary rights would
have a material adverse effect on our business, financial condition and results
of operations.

OUR COMMON STOCK MAY BE SUBJECT TO GREAT PRICE VOLATILITY

       Between February 1998 when our Common Stock became publicly traded and
the date hereof, the closing sales price has ranged from a low of $16.81 per
share to a high of $43.50 per share. The offering of shares of Common Stock
pursuant to this Prospectus, the limited trading history of the Common Stock,
the relatively small size of our stockholder base, announcements concerning us
or our competitors, quarterly fluctuations in operating results, announcements
of technological innovations, the introduction of new products or changes in
product pricing policies by us or our competitors, changes in proprietary rights
or changes in earnings estimates or recommendations by analysts could cause the
market price of the Common Stock to fluctuate substantially. In addition, stock
prices for many technology companies fluctuate widely for reasons which may be
unrelated to operating results. Such fluctuations in the market price of our
Common Stock may affect our visibility and credibility in the market. These
fluctuations, as well as general economic, political and market conditions such
as recessions, international instabilities or military conflicts, may materially
and adversely affect the market price of the Common Stock.

WE HAVE CERTAIN ANTITAKEOVER PROTECTIONS WHICH MAY DELAY OR PREVENT A CHANGE IN
CONTROL AND WHICH MAY ADVERSELY AFFECT YOUR RIGHTS AS A STOCKHOLDER.

       Our Board of Directors has the authority to issue up to 5,000,000 shares
of preferred stock ("Preferred Stock") and to determine the price, rights,
preferences, privileges and restrictions, including voting rights, of those
shares without any further vote or action by the stockholders. The rights of the
holders of Common Stock will be subject to, and may be adversely affected by,
the rights of the holders of any Preferred Stock that may be issued in the
future. The issuance of Preferred Stock could have the effect of making it more
difficult for a third party to acquire a majority of our outstanding voting
stock. Furthermore, 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. In general, the statute
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 Certificate of Incorporation contains other provisions that may have
the effect of delaying or preventing a change in control, including a classified
Board of Directors and a limitation on stockholder action by written consent. In
addition, our credit facility with Silicon Valley Bank prohibits us from
engaging in a merger with or being acquired by another entity without the bank's
consent, unless we are the surviving entity.

THE FAILURE OF OUR CUSTOMERS TO BE YEAR 2000 COMPLIANT COULD NEGATIVELY IMPACT
OUR BUSINESS

       Many currently installed operating systems and software products are
coded to accept only two digit entries in the date code field. These date code
fields need additional digits to distinguish accurately dates prior to January
1, 2000 and those after December 31, 1999. As a result, computer systems and
software used by many companies may need to be upgraded to comply with such
"Year 2000" requirements. Significant uncertainty exists in the software
industry concerning the potential effects associated with such compliance. We
believe that the purchasing patterns of customers and potential customers may be
significantly affected by Year 2000 issues. Many companies are expending
significant resources to correct or patch their current software systems for
Year 2000 compliance. These expenditures may result in reduced funds available
to purchase software products such as those offered by us. Conversely, Year 2000
issues may cause other companies to accelerate purchases, thereby causing an
increase in short-term demand and a consequent decrease in long-term demand for
software products.

       Additionally, Year 2000 compliance issues could cause a significant
number of companies, including our current customers, to re-evaluate their
current systems' needs and, as a result, consider switching to other systems or
suppliers. This could have a material adverse effect on our business, operating
results and financial condition.


                                     - 28 -
<PAGE>   33

OUR FAILURE TO BE YEAR 2000 COMPLIANT COULD NEGATIVELY IMPACT OUR BUSINESS

       GENERAl

       Many of the world's computer systems (including those in non-information
technology equipment and systems) currently record years in a two-digit format.
If not addressed, such computer systems will be unable to properly interpret
dates beyond the year 1999, which could lead to business disruptions. The
potential costs and uncertainties associated with the Year 2000 issue will
depend on a number of factors, including software, hardware and the nature of
the industry in which a company operates.

       We have instituted a company-wide project for addressing the Year 2000
issue (the "Project"). The Project is divided into four major sections -Product
Compliance, Oracle Implementation and System Infrastructure Upgrades, Vendor
Compliance and Customer Assessment. Each of these sections is discussed
separately below. We have engaged third party consultants to assist in program
management of the Project and in testing of critical business systems. The
Project is on schedule for completion by the end of the third quarter, 1999.

       PRODUCT COMPLIANCE

       We believe that the products that we are currently shipping have already
achieved Year 2000 compliance as defined within the requirements established by
the U.S. Government detailed in the Federal Acquisition Regulations (FAR)
Section 39 -- Final. Should a Year 2000 compliance issue arise in the future, we
will take whatever steps we deem necessary to correct it in accordance with our
Year 2000 product warranty.

       Although all previously shipped products are believed to be compliant, we
do not commit to perform tests on product versions that we are no longer
shipping. Should such non-shipping products be found non-compliant, we will not
update them to make them compliant.

       We do not guarantee and specifically disclaim any liability for the Year
2000 compliance of operating systems, hardware, software or other products not
developed by us.

       ORACLE IMPLEMENTATION & SYSTEM INFRASTRUCTURE UPGRADES

       Early in 1998, in order to improve access to business information through
scaleable, integrated computing systems across the company, we began a business
systems replacement project. The new Oracle, Enterprise Resources Planning (ERP)
application software system has replaced the core legacy systems, and is
expected to make approximately 75 percent of our systems Year 2000 compliant.
The implementation of the ERP software was substantially completed in January
1999.

       Following replacement of the core legacy systems with Oracle software, we
will seek to achieve Year 2000 compliance for other application software,
computer hardware, network equipment and miscellaneous components of our
internal business systems. We anticipate that this effort will be less
significant compared to the replacement of core applications with ERP software.

       We intend to achieve Year 2000 compliance for our remaining internal
systems as soon as possible after the Oracle implementation. Our limited number
of personal computers and application systems is anticipated to facilitate rapid
progress toward full Year 2000 compliance after ERP is successfully implemented.

       We intend to continue to work to achieve Year 2000 compliance for our
systems using a methodology that incorporates the following steps:

       Update the inventory of computer hardware, software and miscellaneous
network components,

       Evaluate application development environment compliance,


                                     - 29 -
<PAGE>   34

       Conduct overall assessment of systems infrastructure compliance,

       Complete business risk analysis,

       Take remedial actions (upgrade, repair, replace, retire or retain),

       Develop appropriate contingency plans, and develop and implement regimes
to test Year 2000 compliance for mission-critical systems.

We currently anticipate completion of this process by the end of the third
quarter 1999 in order to avoid Year 2000 impact on remaining core legacy
systems.

       VENDOR COMPLIANCE

       This section includes the process of identifying and prioritizing
critical suppliers at the direct interface level and communicating with them
about their plans and progress in addressing the Year 2000 problem. This process
will include not only component part suppliers for our products, but also
providers of insurance, financial and other services.

       Our vendor compliance program will include the following steps:

       Catalog and classify all vendors,

       On-site review and testing of out-sourced services or systems,

       Review responses from vendors to determine the level of compliance,

       Determine the timing, method and cost of vendor solutions,

       Assess vendor Year 2000 compliance and business risks, and

       Develop remedial actions or contingency plans, as necessary.

       Achievement of vendor Year 2000 compliance is anticipated to be an
on-going effort during 1999. The current target to achieve compliance or
complete contingency plans is the end of the third quarter 1999.

       CUSTOMER ASSESSMENT

       We are developing a program to assess the impact that Year 2000 issues
may have upon our customers and their purchasing decisions. We expect to
complete customer assessment by the end of the third quarter 1999.

       COSTS

       The estimated total cost of the Year 2000 compliance project, exclusive
of the ERP implementation, is approximately $300,000. These costs are expected
to be incurred throughout 1999. These costs will be incurred primarily for the
use of outside consultants, setting up Year 2000 testing environments and the
replacement of existing software and hardware.

       RISKS

       The failure to correct a material Year 2000 problem could result in an
interruption in, or a failure of, certain normal business activities or
operations. Such failures could materially and adversely affect our business,
financial condition and results of operations. Moreover, even if we successfully
remediate our Year 2000 issues, we 


                                     - 30 -
<PAGE>   35

can be materially and adversely affected by failures of third parties to
remediate their own year 2000 issues. The failure of third parties with which we
have financial or operational relationships (such as our customers and vendors)
to remediate their computer and non-information technology systems issues in a
timely manner could result in a material financial risk to us. In addition, we
believe that the purchasing patterns of customers and potential customers may be
significantly affected by Year 2000 issues. Due to the general uncertainty
inherent in the Year 2000 problem, resulting in part from the uncertainty of the
Year 2000 readiness of third-party customers and vendors, we are unable to
determine at this time whether the consequences of year 2000 failures will have
a material impact on our business, financial condition and results of
operations. Accordingly, we may experience business interruption or shutdown,
financial loss, damage to our reputation and legal liability. We believe that,
with the implementation of new business systems and completion of the Project as
scheduled, the possibility of significant interruptions of normal operations
should be reduced.

       Our expectations about future costs and the timely completion of our Year
2000 Project are subject to uncertainties that could cause actual results to
differ materially from what has been discussed above. Factors that could
influence the amount of future costs and the effective timing of remediation
efforts include our success in identifying computer programs and non-information
technology systems that contain two-digit year codes, the nature and amount of
programming and testing required to upgrade or replace each of the affected
programs and systems, the rate and magnitude of related labor and consulting
costs, and the success of our vendors and customers in addressing the Year 2000
issue.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.

       See Item 7 for discussion.

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
schedules filed with this report; see Item 14 of Part IV.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

       None.


                                     - 31 -
<PAGE>   36

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.

       The information required by Item 10 is hereby incorporated by reference
from the Proxy Statement for the 1999 Annual Meeting of Stockholders of the
Company.

ITEM 11. EXECUTIVE COMPENSATION.

       The information required by Item 11 is hereby incorporated by reference
from the Proxy Statement for the 1999 Annual Meeting of Stockholders of the
Company.

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 the 1999 Annual Meeting of Stockholders of the
Company.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

       The information required by Item 13 is hereby incorporated by reference
from the Proxy Statement for the 1999 Annual Meeting of Stockholders of the
Company.


                                     - 32 -
<PAGE>   37


                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.

<TABLE>
<CAPTION>
                                                                                              PAGE NUMBER
                                                                                              -----------

<S>                                                                                               <C>
(a)    Documents filed as part of the report:

       (1)    Report of Independent Accountants                                                   F-2
              Consolidated Balance Sheets at December 31, 1997 and 1998                           F-3
              Consolidated Statements of Operations for the years ended
                          December 31, 1996, 1997 and 1998                                        F-4
              Consolidated Statements of Changes in Stockholders' Equity (Deficit) for the
                          years ended December 31, 1995, 1996, 1997 and 1998                      F-5
              Consolidated Statements of Cash Flows for the years ended
                          December 31, 1996, 1997 and 1998                                        F-6
              Notes to Consolidated Financial Statements                                          F-7

       (2)    Financial Statement Schedule                                                        S-1

       (3)    Exhibits
</TABLE>

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

<TABLE>
<CAPTION>

  Exhibit Number       Description
  --------------       -----------

<S>                    <C>           
      3.1*             Restated Certificate of Incorporation of the Registrant.
      3.2*             Restated By-Laws of the Registrant.
      10.1*            1994 Stock Option Plan.
      10.2*            1997 Omnibus Stock Plan.
      10.3*            Amended and Restated 1997 Directors' Stock Option Plan.
      10.4*            Third Amended and Restated Stockholders and Registration
                       Rights Agreement, dated as of September 19, 1996, by and
                       among the Registrant and certain stockholders.
      10.5*+           Reseller/Integration Agreement, dated August 29, 1997 by
                       and between the Registrant and MCI Telecommunication
                       Corporation.
      10.5.1           Second Amendment, dated November 4, 1998, to the
                       Reseller/Integration Agreement between the Registrant and MCI
                       Telecommunications Corporation (relating to Exhibit 10.5).
      10.6*+           Master Reseller Agreement, dated as of August 23, 1996, between
                       Sprint/United Management Company and the Registrant.
      10.7*+           General Agreement for the Procurement of Equipment, Services
                       and Supplies between the Registrant and AT&T Corp.
      10.8*            Lease Agreement, dated December 12, 1996, by and between the
                       Registrant and The Equitable Fire Assurance Society of The
                       United States.
      10.8.1*          Lease Amendment, dated September 2, 1997, by and between the
                       Registrant 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 Registrant and TA/Western, LLC, successor to The Equitable
                       Life Assurance Society of The United States (relating to
                       Exhibit 10.8).
      10.10*           Employment Agreement dated December 15, 1994, by and between
                       the Registrant and Scott E. Stouffer, as amended.
      10.11*           Employment Agreement dated December 15, 1994, by and between
                       the Registrant and Robert Troutman, as amended.
</TABLE>


                                     - 33 -
<PAGE>   38

<TABLE>
<S>                    <C> 
      10.12*           Terms of Employment dated June 11, 1997, by and between the
                       Registrant and Peter J. Minihane, as amended.
      10.13*           Terms of Employment dated March 5, 1997, by and between the
                       Registrant and Henri A. Cheli, as amended.
      10.14*           Terms of Employment dated November 12, 1996, by and between
                       the Registrant and Gregory J. Langford, as amended.
      10.15*           Loan and Security Agreement dated January 8, 1998, by and
                       between Silicon Valley Bank and the Registrant.
      10.15.1*         Revolving Promissory Note issued by the Registrant as of
                       January 8, 1998, to Silicon Valley Bank (relating to Exhibit 10.15).
      10.15.2@         First Amendment to Loan and Security Agreement
                       dated June 30, 1998, by and between Silicon Valley Bank and the
                       Registrant (relating to Exhibit 10.15).
      10.15.3@         Amended and Restated Revolving Promissory Note issued by the
                       Registrant as of June 30, 1998 to Silicon Valley Bank (relating
                       to Exhibit 10.15).
      10.15.4@@        Second Amendment to Loan and Security Agreement dated December 28,
                       1998, by and between Silicon Valley Bank and the Registrant (relating
                       to Exhibit 10.15).
      10.15.5@@        Second Amended and Restated Revolving Promissory Note issued by the
                       Registrant on December 28, 1998 to Silicon Valley Bank (relating to
                       Exhibit 10.15).
      10.16**          Agreement and Plan of Merger dated April 15, 1998 by and among the
                       Registrant, Visual Acquisition, Inc. and Net2Net.
      10.17***         Net2Net 1994 Stock Option Plan
      10.18            Sublease Agreement, dated January 28, 1999, between Visual Networks
                       Operations, Inc. and Compus Services Corporation.
      10.19            Sublease Agreement, dated January 28, 1999, between Compus Services
                       Corporation and Visual Networks Operations, Inc.
      16.1*            Letter regarding change in certified accountants.
      23.1             Consent of Arthur Andersen LLP.
      24.1             Power of Attorney (included in signature pages).
      27               Financial Data Schedule
</TABLE>

----------

@     Incorporated herein by reference to the Company's Registration Statement
      on Form S-1, No. 333-58443.
@@    Incorporated herein by reference to the Company's Registration Statement
      on Form S-3, No. 333-73229.
*     Incorporated herein by reference to the Company's Registration Statement
      on Form S-1, No. 333-41517.
**    Incorporated herein by reference to Exhibit 2.1 to the Company's Current
      Report on Form 8-K dated May 19, 1998.
***   Incorporated herein by reference to Exhibit 10.1 to the Company's
      Registration Statement of Form S-8, No. 333-53153.
+     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 this Exhibit 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.

(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).


                                     - 34 -
<PAGE>   39

                                   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 30 day of March, 1999.

                                        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 appointed 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 and post-effective 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.

<TABLE>
<CAPTION>

      SIGNATURE                      TITLE                                     DATE
      ---------                      -----                                     ----

<S>                                  <C>                                       <C>
/s/ SCOTT E. STOUFFER                President, Chief Executive Officer        March 29, 1999
-------------------------            and Director (Principal Executive
  Scott E. Stouffer                  Officer)


/s/ PETER J. MINIHANE                Executive Vice President, Chief           March 29, 1999
-------------------------            Financial Officer and Treasurer
  Peter J. Minihane                  (Principal Financial Officer)

/s/ GRANT G. BEHRMAN
-------------------------            Director                                  March 25, 1999
  Grant G. Behrman

/s/ MARC F. BENSON
-------------------------            Director                                  March 24, 1999
       Marc F. Benson

/s/ THEODORE R. JOSEPH
-------------------------            Director                                  March 24, 1999
    Theodore R. Joseph

/s/ TED H. MCCOURTNEY
-------------------------            Director                                  March 26, 1999
     Ted H. McCourtney

/s/ THOMAS A. SMITH
-------------------------            Director                                  March 29, 1999
     Thomas A. Smith

/s/ WILLIAM J. SMITH
-------------------------            Director                                  March 24, 1999
     William J. Smith
</TABLE>


                                     - 35 -
<PAGE>   40

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                                                      PAGE
                                                                                                     ------
<S>                                                                                                   <C>
Report of Independent Public Accountants..........................................................    F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998......................................    F-3
Consolidated Statements of Operations for the years ended December 31, 1996, 1997 and 1998........    F-4
Consolidated Statements of Changes in Stockholders' Equity (Deficit) for the years
    ended December 31, 1996, 1997 and 1998........................................................    F-5
Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1997 and 1998........    F-6
Notes to Consolidated Financial Statements........................................................    F-7
</TABLE>









                                      F-1
<PAGE>   41

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Stockholders of
Visual Networks, Inc.:

We have audited the accompanying consolidated balance sheets of Visual Networks,
Inc. (a Delaware corporation) and subsidiaries as of December 31, 1997 and 1998,
and the related consolidated statements of operations, changes in stockholders'
equity (deficit) and cash flows for each of the three years in the period ended
December 31, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an 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, 1997 and 1998, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.


                                           ARTHUR ANDERSEN LLP



Washington, D.C.
January 15, 1999


                                       F-2
<PAGE>   42

                              VISUAL NETWORKS, INC.

                           CONSOLIDATED BALANCE SHEETS
                 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                                              DECEMBER 31
                                                                                      --------------------------
                                                                                         1997            1998
                                                                                      -----------     ----------
                                 ASSETS
                                 ------
<S>                                                                                   <C>             <C>     
Current assets:
      Cash and cash equivalents.......................................................$  8,902        $ 50,531
      Accounts receivable, net of allowance of $412 and $493, respectively............   3,559           5,038
      Inventory.......................................................................   3,724           5,086
      Other current assets............................................................     602           1,715
                                                                                      --------        --------
                        Total current assets..........................................  16,787          62,370
Property and equipment, net...........................................................   1,824           4,478
                                                                                      --------        --------
                        Total assets.................................................. $18,611        $ 66,848
                                                                                      ========        ========

                 LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
                 ----------------------------------------------


Current liabilities:
      Accounts payable and accrued expenses.....................................      $  5,794        $  5,575
      Accrued compensation......................................................         1,606           2,366
      Customer deposits.........................................................         3,068           4,613
      Deferred revenue..........................................................         5,211           5,246
      Bank line of credit.......................................................           126             -
      Note payable to stockholder...............................................           500             -
      Capital lease obligation..................................................           753             383
                                                                                      --------        --------
                        Total current liabilities...............................        17,058          18,183
                                                                                      --------        --------
Commitments and contingencies (Note 9)
Redeemable convertible preferred stock:
      Series B, Series C, Series D and Series E redeemable convertible
          cumulative preferred stock, $.01 par value, 7,229,438 shares
          authorized in aggregate, 7,228,473 shares issued and outstanding in
          aggregate as of December 31, 1997, and no shares outstanding as of
          December 31, 1998 (aggregate
          liquidation preference of $14,484 as of December 31, 1997)............        14,855             -
                                                                                      --------        --------
Stockholders' equity (deficit):
      Preferred stock, $.01 par value, 5,000,000 shares authorized, no shares 
          issued and outstanding................................................           -               -
      Series A convertible cumulative preferred stock, $.01 par value, 347,070
          shares authorized, issued and outstanding as of December 31, 1997 and
          no shares outstanding as of December 31, 1998 (liquidation
          preference of $149 as of December 31, 1997)...........................             3             -
      Common stock, $.01 par value, 50,000,000 shares authorized, 5,005,140 and 
          20,095,129 shares issued and outstanding as of December 31, 1997 and 
          1998, respectively....................................................            50             201
      Deferred compensation.....................................................          (247)           (197)
      Additional paid-in capital................................................        12,783          74,215
      Accumulated deficit.......................................................       (25,891)        (25,554)
                                                                                      --------        --------
                        Total stockholders' equity (deficit)....................       (13,302)         48,665
                                                                                      --------        --------
                        Total liabilities and stockholders' equity (deficit)....       $18,611         $66,848
                                                                                      ========        ========
</TABLE>


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


                                      F-3
<PAGE>   43

                              VISUAL NETWORKS, INC.

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                                   YEAR ENDED DECEMBER 31
                                                                   -----------------------------------------------
                                                                      1996              1997              1998
                                                                   -----------      ------------      ------------

<S>                                                                <C>              <C>               <C>        
Revenue....................................................        $    8,279       $    27,345       $    50,863
Cost of goods sold.........................................             3,687            10,754            19,010
                                                                   ----------       -----------       -----------
      Gross profit.........................................             4,592            16,591            31,853
                                                                   ----------       -----------       -----------
Operating expenses:
      Research and development.............................             5,432             7,321            10,396
      Sales and marketing..................................             9,483            13,182            13,899
      General and administrative...........................             2,036             3,211             4,256
      Merger-related costs.................................               -                 -               5,069
                                                                   ----------       -----------       -----------
                        Total operating expenses...........            16,951            23,714            33,620
                                                                   ----------       -----------       -----------
Loss from operations.......................................           (12,359)           (7,123)           (1,767)
Interest income, net.......................................               166                93             2,275
                                                                   ----------       -----------       -----------
Net income (loss)..........................................           (12,193)           (7,030)              508
Dividends and accretion on preferred stock.................            (1,012)           (1,457)             (171)
                                                                   ----------       -----------       -----------
Net income (loss) attributable to common shareholders......        $  (13,205)      $    (8,487)      $       337
                                                                   ==========       ===========       ===========
Basic and diluted income (loss) per share..................        $    (2.97)      $     (1.72)      $      0.02
                                                                   ==========       ===========       ===========
Basic weighted-average shares outstanding..................         4,439,522         4,926,802        18,228,982
                                                                   ==========       ===========       ===========
Diluted weighted-average shares outstanding................         4,439,522         4,926,802        21,145,216
                                                                   ==========       ===========       ===========
Pro forma basic and diluted income (loss) per share........                         $     (0.45)      $      0.02
                                                                                    ===========       ===========
Pro forma basic and diluted weighted-average shares
    outstanding............................................                          15,532,537        21,145,216
                                                                                    ===========       ===========
</TABLE>

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


                                      F-4
<PAGE>   44


                              VISUAL NETWORKS, INC.

      CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
                        (IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>


                                                               REDEEMABLE
                                                               CONVERTIBLE              SERIES A CONVERTIBLE
                                                             PREFERRED STOCK               PREFERRED STOCK
                                                        ----------------------------  ------------------------
                                                           SHARES          AMOUNT        SHARES       AMOUNT
                                                        -------------   ------------  ------------  ----------
<S>                                                        <C>            <C>            <C>          <C> 
Balance, December 31, 1995.........................        4,188,438      $  3,385       347,070      $  3
      Issuance of common stock.....................              -             -             -           -
      Issuance of Series D preferred stock.........        2,285,714         3,983           -           -
      Issuance of Series E preferred stock.........          754,321         5,018           -           -
      Accretion on preferred stock.................              -             177           -           -
      Accrued dividends on preferred stock.........              -             835           -           -
      Redemption of common stock...................              -             -             -           -
      Exercise of stock options....................              -             -             -           -
      Net loss.....................................              -             -             -           -
                                                        ------------    ----------    ----------    ------
Balance, December 31, 1996.........................        7,228,473        13,398       347,070         3
      Issuance of common stock.....................              -             -             -           -
      Exercise of stock options....................              -             -             -           -
      Deferred compensation........................              -             -             -           -
      Amortization of deferred compensation........              -             -             -           -
      Accretion on preferred stock.................              -             235           -           -
      Accrued dividends on preferred stock.........              -           1,222           -           -
      Net loss.....................................              -             -             -           -
                                                        ------------    ----------    ----------    ------
Balance, December 31, 1997.........................        7,228,473        14,855       347,070         3
      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)
      Issuance of common stock.....................              -             -             -           -
      Exercise of stock options....................              -             -             -           -
      Settlement of note for common stock..........              -             -             -           -
      Issuance and conversion of warrant...........              -             -             -           -
      Amortization of deferred compensation........              -             -             -           -
      Net loss.....................................              -             -             -           -
                                                        ------------    ----------    ----------    ------
                                                                          $
Balance, December 31, 1998.........................              -             -             -        $  -
                                                        ============    ==========    ==========    ======
</TABLE>

<TABLE>
<CAPTION>
                                                               COMMON STOCK                DEFERRED
                                                        ---------------------------
                                                           SHARES         AMOUNT         COMPENSATION
                                                        -------------  ------------   ------------------
<S>                                                      <C>            <C>                 <C> 
Balance, December 31, 1995.........................       4,032,794      $  40               $  -
      Issuance of common stock.....................         776,645          8                  -
      Issuance of Series D preferred stock.........               -          -                  -
      Issuance of Series E preferred stock.........               -          -                  -
      Accretion on preferred stock.................               -          -                  -
      Accrued dividends on preferred stock.........               -          -                  -
      Redemption of common stock...................          (8,729)         -                  -
      Exercise of stock options....................          38,785          -                  -
      Net loss.....................................               -          -                  -
                                                        -----------    -------            --------
Balance, December 31, 1996.........................       4,839,495         48                  -
      Issuance of common stock.....................          35,504          -                  -
      Exercise of stock options....................         130,141          2                  -
      Deferred compensation........................               -          -                (292)
      Amortization of deferred compensation........               -          -                  45
      Accretion on preferred stock.................               -          -                  -
      Accrued dividends on preferred stock.........               -          -                  -
      Net loss.....................................               -          -                  -
                                                        -----------    -------            --------
Balance, December 31, 1997.........................       5,005,140         50                (247)
      Accretion on preferred stock.................               -          -                  -
      Accrued dividends on preferred stock.........               -          -                  -
      Conversion of preferred stock and payment of
          dividend.................................      10,605,735        106                  -
      Issuance of common stock.....................       4,025,000         40                  -
      Exercise of stock options....................         440,181          5                  -
      Settlement of note for common stock..........          16,848          -                  -
      Issuance and conversion of warrant...........           2,225          -                  -
      Amortization of deferred compensation........               -          -                  50
      Net income...................................               -          -                  -
                                                        -----------    -------            --------
Balance, December 31, 1998.........................      20,095,129       $201               $(197)
                                                        ===========    =======            ========
</TABLE>

<TABLE>
<CAPTION>
                                                         ADDITIONAL
                                                           PAID-IN          ACCUMULATED
                                                           CAPITAL            DEFICIT             TOTAL
                                                        -------------    -----------------    -------------
<S>                                                       <C>               <C>                 <C>    
Balance, December 31, 1995.........................       $  4,745          $  (4,110)          $   678
      Issuance of common stock.....................          7,618                (89)            7,537
      Issuance of Series D preferred stock.........           -                 -                  -
      Issuance of Series E preferred stock.........           -                 -                  -
      Accretion on preferred stock.................           -                  (177)             (177)
      Accrued dividends on preferred stock.........           -                  (835)             (835)
      Redemption of common stock...................           -                 -                  -
      Exercise of stock options....................             10              -                    10
      Net loss.....................................           -               (12,193)          (12,193)
                                                        ----------       ------------         ---------
Balance, December 31, 1996.........................         12,373            (17,404)           (4,980)
      Issuance of common stock.....................             94              -                    94
      Exercise of stock options....................             24              -                    26
      Deferred compensation........................            292              -                  -
      Amortization of deferred compensation........           -                 -                    45
      Accretion on preferred stock.................           -                  (235)             (235)
      Accrued dividends on preferred stock.........           -                (1,222)           (1,222)
      Net loss.....................................           -                (7,030)           (7,030)
                                                        ----------       ------------         ---------
Balance, December 31, 1997.........................         12,783            (25,891)          (13,302)
      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.....................         45,313              -                45,353
      Exercise of stock options....................            642              -                   647
      Settlement of note for common stock..........            542              -                   542
      Issuance and Exercise of warrant.............             12              -                    12
      Amortization of deferred compensation........           -                 -                    50
      Net loss.....................................           -                   508               508
                                                        ----------       ------------         ---------

Balance, December 31, 1998.........................        $74,215           $(25,554)          $48,665
                                                        ==========       ============         =========

</TABLE>

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


                                      F-5
<PAGE>   45


                              VISUAL NETWORKS, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                                                                 YEAR ENDED DECEMBER 31
                                                                                         --------------------------------------
                                                                                             1996         1997         1998
                                                                                         ------------  ----------  ------------
<S>                                                                                       <C>          <C>          <C>
Cash flows from operating activities:
      Net income (loss)...............................................................     $(12,193)    $(7,030)     $   508
      Adjustments to reconcile net loss to net cash (used in) provided by operating
          activities -
            Depreciation and amortization.............................................          481       1,009        1,312
            Loss on disposal of property and equipment................................          323         407          -
      Changes in assets and liabilities -
            Accounts receivable.......................................................       (2,327)     (1,020)      (1,479)
            Inventory.................................................................         (675)     (2,326)      (1,362)
            Other current assets......................................................         (231)       (281)      (1,113)
            Accounts payable and accrued expenses.....................................        1,203       4,186         (135)
            Accrued compensation......................................................          702         586          760
            Customer deposits.........................................................          -         3,068        1,545
            Deferred revenue..........................................................          962       4,087           35
                                                                                         ----------    --------    ---------
                        Net cash (used in) provided by operating activities...........      (11,755)      2,686           71
                                                                                         ----------    --------    ---------
Cash flows from investing activities:
      Proceeds from sale leaseback transactions.......................................          -           544          -
      Expenditures for property and equipment.........................................       (1,509)     (1,487)      (3,916)
                                                                                         ----------    --------    ---------
                        Net cash used in investing activities.........................       (1,509)       (943)      (3,916)
                                                                                         ----------    --------    ---------
Cash flows from financing activities:
      Proceeds from issuance of preferred stock, net of issuance costs................        9,001         -            -
      Series A Convertible Preferred Stock dividend...................................          -           -            (30)
      Proceeds from issuance of common stock, net of issuance costs...................        7,537          94       45,353
      Exercise of stock options.......................................................           11          26          647
      Proceeds from note payable to stockholder.......................................          -           500          -
      Net borrowings (repayments) under credit agreements.............................          848        (722)        (126)
      Principal payments on capital lease obligations.................................         (130)       (290)        (370)
                                                                                         ----------    --------    ---------
                        Net cash provided by (used in) financing activities...........       17,267        (392)      45,474
Net increase in cash and cash equivalents.............................................        4,003       1,351       41,629
Cash and cash equivalents, beginning of period........................................        3,548       7,551        8,902
                                                                                         ----------    --------    ---------
Cash and cash equivalents, end of period..............................................     $  7,551     $ 8,902      $50,531
                                                                                         ==========    ========    =========
Supplemental cash flow information:
      Cash paid for interest..........................................................     $     71     $   143      $   168
                                                                                         ==========    ========    =========
      Cash paid for income taxes......................................................     $    -       $   -        $   513
                                                                                         ==========    ========    =========
</TABLE>

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


                                      F-6
<PAGE>   46


                              VISUAL NETWORKS, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Visual Networks, Inc. ("Visual") is engaged in developing, manufacturing and
marketing wide-area-network service level management systems. Visual's
operations are subject to certain risks and uncertainties, including among
others, successful implementation of the Visual sales and distribution model,
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, limited protection of intellectual property and
proprietary rights, integration of its acquisition of Net2Net Corporation,
uncertainty of future profitability and possible fluctuations in financial
results.

Net2Net Acquisition

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. 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 acquisition as if
it had occurred at the beginning of the earliest period presented (hereafter,
Visual and Net2Net are collectively referred to as the "Company").

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

<TABLE>
<CAPTION>


                               YEAR ENDED DECEMBER 31,
                             --------------------------
                                 1996          1997
                             -----------   ------------

<S>                            <C>           <C>    
Revenue:
      Visual............       $  6,335      $23,651
      Net2Net...........          1,944        3,694
                             ----------    ---------
                               $  8,279      $27,345
                             ==========    =========
Net Loss:
      Visual............       $ (6,983)     $  (152)
      Net2Net...........         (5,210)      (6,878)
                             ----------    ---------
                               $(12,193)     $(7,030)
                             ==========    =========
</TABLE>

In connection with the Net2Net acquisition, the Company recorded merger-related
charges for transaction costs, integration expenses and restructuring charges of
approximately $5,069,000. Transaction costs totaled approximately $4,111,000 and
consisted primarily of fees for investment bankers, attorneys, accountants and
other direct transaction costs. Integration expenses totaled approximately
$207,000 and consisted of incremental and non-recurring costs necessary to
integrate Visual and Net2Net. These costs were expensed as incurred. The
restructuring charge totaled approximately $751,000 (Note 6).



                                      F-7
<PAGE>   47

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 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.

Fair Value of Financial Instruments

The carrying values of current assets and current liabilities approximate fair
value because of the relatively short maturities of these instruments.

Revenue Recognition

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 call for 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 three years.

The Company has an agreement with one reseller that provides price protection
for units that remain in that reseller's inventory. 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.

Credit Risk

Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash and cash equivalents
and accounts receivable. 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. As of December 31, 1997 and
1998, the Company had approximately $8,650,000 and $41,914,000, respectively,
invested in money market funds.

The Company sells its hardware and licenses its software products to large
telecommunications providers and subscribers primarily in the United States. The
Company grants uncollateralized credit terms 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. During
1996, one customer individually represented 10% of revenue. During 1997, one
customer individually represented 27% of revenue. For the year ended December
31, 1998, three customers individually represented 30%, 17% and 14% of revenue,
respectively.

Warranty

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


                                      F-8
<PAGE>   48

Inventory

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

<TABLE>
<CAPTION>
                             DECEMBER 31
                         ------------------
                           1997      1998
                         --------  --------
<S>                       <C>       <C>   
Raw materials..........   $  439    $  821
Work-in-progress.......      635     1,228
Finished goods.........    2,650     3,037
                          ------    ------
                          $3,724    $5,086
                          ======    ======
</TABLE>

Property and Equipment

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

Property and equipment consists of the following (in thousands):

<TABLE>
<CAPTION>
                                             DECEMBER 31
                                        --------------------
                                          1997        1998
                                        ---------   --------
<S>                                      <C>         <C>   
Equipment and software..............     $2,659      $5,441
Furniture and fixtures..............        137       1,269
                                        -------     -------
                                          2,796       6,710
Less-Accumulated depreciation.......       (972)     (2,232)
                                        -------     -------
                                         $1,824      $4,478
                                        =======     =======
</TABLE>

Accounts Payable and Accrued Expenses

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

<TABLE>
<CAPTION>
                                         DECEMBER 31
                                      ------------------
                                        1997      1998
                                      --------  --------
<S>                                    <C>       <C>   
Accounts payable.................      $1,964    $1,744
Accrued expenses.................       3,830     3,431
Accrued restructuring costs......         -         975
                                      -------   -------
                                       $5,794    $6,150
                                      =======   =======
</TABLE>

Research and Development

Research and development costs are expensed as incurred.

The Company accounts for software development costs in accordance with Statement
of Financial Accounting Standards ("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.


                                      F-9
<PAGE>   49

For the years ended December 31, 1996, 1997 and 1998, 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.

Basic and Diluted Net Income (Loss) per Common Share

In March 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No.
128, "Earnings Per Share." SFAS No. 128 requires dual presentation of basic and
diluted earnings per share. Basic loss per share includes no dilution and is
computed by dividing net loss available to common stockholders by the
weighted-average number of common shares outstanding for the period.

Diluted 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 1,295,305 and 1,988,875 shares of common
stock that were outstanding at December 31, 1996 and 1997, were not included in
the computation of diluted loss per share as their effect would be
anti-dilutive. The treasury stock effect of options to purchase 2,191,763
shares of common stock that were outstanding as of December 31, 1998 was
included in the computation of diluted income per share for the year ended
December 31, 1998. The effect of preferred stock convertible into 10,605,735
shares of common stock as of December 31, 1996 and 1997, respectively, has also
not been included in the computation of diluted loss per share as such effect
would have been 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 was included in the computation of diluted income per share for the
year ended December 31, 1998. The effect of the conversion of the preferred
stock into 10,605,735 shares of common stock is included in the computation of
both basic and diluted loss per share from the date of conversion on February
11, 1998. Pro forma basic and diluted weighted-average common shares
outstanding assumes the conversion of all of the Company's outstanding
convertible preferred stock into common stock for each period presented.


                                      F-10
<PAGE>   50


The following details the computation of the income (loss) per share.

<TABLE>
<CAPTION>
                                                                                    YEAR ENDED DECEMBER 31,
                                                                     -------------------------------------------------------
                                                                           1996               1997                1998
                                                                     ----------------   ----------------   -----------------
ADJUSTMENTS TO NET INCOME (LOSS):
<S>                                                                     <C>                <C>                <C>         
      Net income (loss)...........................................      $  (12,193)        $    (7,030)       $       508
      Dividends and accretion on preferred stock..................          (1,012)             (1,457)              (171)
                                                                     -------------      --------------     --------------
            Net income (loss) attributable to common shareholders.      $  (13,205)        $    (8,487)       $       337
                                                                     -------------      --------------     --------------
WEIGHTED-AVERAGE SHARE CALCULATION:
      Basic weighted-average shares outstanding:
            Average number of shares of common stock outstanding .       4,439,522           4,926,802         18,228,982
                                                                     -------------      --------------     --------------
      Diluted weighted-average shares outstanding:
            Treasury stock effect of options......................             -                   -            1,695,849      
            Conversion of preferred stock.........................             -                   -            1,220,385      
                                                                     -------------      --------------     --------------
      Diluted weighted-average shares outstanding.................       4,439,522           4,926,802         21,145,216
      Pro forma basic and diluted weighted-average shares 
        outstanding:
            Conversion of preferred stock.........................                          10,605,735                -
                                                                                        --------------     --------------
            Pro forma basic and diluted weighted-average shares 
              outstanding.........................................                          15,532,537         21,145,216
                                                                                        ==============     ==============
INCOME (LOSS) PER COMMON SHARE:
      Basic income (loss) per share...............................      $    (2.97)        $     (1.72)       $      0.02
      Diluted income (loss) per share.............................      $    (2.97)        $     (1.72)       $      0.02
      Pro forma basic and diluted income (loss) per share.........                         $     (0.45)       $      0.02
</TABLE>

New Accounting Pronouncements

In June 1997, the Financial Accounting Standards Board issued SFAS No. 130,
"Reporting Comprehensive Income" and No. 131, "Disclosures about Segments of an
Enterprise and Related Information." The Company adopted SFAS No. 130 and SFAS
No. 131 during 1998. The adoption of these new pronouncements did not have a
material impact on the Company's results of operations, financial position or
cash flows.

2. CREDIT AGREEMENTS AND NOTES PAYABLE:

The Company's revolving line of credit, as amended (the "Revolving Line"),
provides for borrowings up to the lesser of $7,000,000 or 80% of eligible
accounts receivable. The Revolving Line matures on April 5, 1999 and borrowings
under the Revolving Line bear interest at the prime rate. Borrowings are
collateralized by the Company's accounts receivable and inventory. The Revolving
Line also contains restrictive covenants, including, but not limited to,
restrictions related to liquidity and net worth, as well as restrictions related
to acquisitions, dispositions of assets, distributions and investments. As of
December 31, 1997 and 1998, the Company had no borrowings against the Revolving
Line.

Net2Net had a $1,000,000 accounts receivable based line-of-credit facility with
a bank. Borrowings under this line were collateralized by substantially all of
Net2Net's assets. Net2Net had outstanding borrowings of approximately $126,000,
under this line as of December 31, 1997. Interest on outstanding borrowings
under this line was based on the bank's prime rate (8.5% at December 31, 1997)
plus 2%. In April 1998, all outstanding borrowings under this line of credit
were repaid and the facility was terminated.

On January 9, 1998, Net2Net executed a Loan and Security Agreement with a bank
to provide $500,000 of bridge financing. Under this credit facility, borrowings
were secured by substantially all of Net2Net's assets and accrued interest at
the prime rate plus 2%. All borrowings under this facility were repaid in April 
1998.


                                      F-11
<PAGE>   51

In connection with the Loan and Security Agreement, the Company issued the bank
a warrant to purchase 4,004 shares of common stock at a price of $12.49 per
share. The warrant was valued at approximately $12,000 on the date of issuance
and proceeds from the debt of this amount have been allocated to the warrant in
the accompanying financial statements. The resulting discount on the debt was
amortized using the effective interest method. In October 1998, the bank, in
lieu of exercising the warrant, elected to convert the warrant into 2,225
shares of common stock in accordance with the terms of the warrant.

Effective as of December 31, 1997, Net2Net issued a $500,000 subordinated note
payable to a stockholder, bearing interest at a per annum rate of 15%. In July
1998, this note was satisfied by issuing 16,848 shares of common stock to the
holder of the note. The fair value of the shares issued approximated the
carrying value of the note plus accrued but unpaid interest. Accordingly, no
gain or loss was recognized on this transaction.

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 ("IPO") in February 1998. The following details the number of shares
issued and the liquidation preference (in thousands) for each series of the
convertible preferred stock as of December 31, 1997.

<TABLE>
<CAPTION>
                                                                            LIQUIDATION
                           SHARES OUTSTANDING            AMOUNT             PREFERENCE
                          --------------------         ----------         --------------
<S>                           <C>                      <C>                   <C>    
Series A..............           347,070                 $     3               $   149
Series B..............         2,588,438                   1,611                 1,560
Series C..............         1,600,000                   2,551                 2,483
Series D..............         2,285,714                   4,904                 4,773
Series E..............           754,321                   5,789                 5,668
                             -----------                 -------               -------
                               7,575,543                 $14,858               $14,633
                             ===========                 =======               =======
</TABLE>

Series A Preferred Stock

In connection with the Series B Preferred Stock ("Series B") offering, notes
payable of $119,500 together with accrued interest of $1,176 were converted into
shares of Series A Preferred Stock ("Series A"). The Series A had liquidation
preferences over the common stock. The Series A shares were convertible at any
time at the option of the holder, or automatically upon the consummation of a
qualified (as defined) underwritten public offering into an aggregate of 485,890
shares of common stock. The Series A had cumulative dividends equal to 8% per
annum. The Company had not declared dividends through December 1997 on Series A
shares based on legal limitations on the declarations of dividends. At December
31, 1997, dividends in arrears on Series A were approximately $29,000.

Upon conversion, all accrued and unpaid dividends could also be converted into
common stock at the then current market price of the common stock (as defined).
The Company could, however, elect to pay any accrued but unpaid dividends in
cash in lieu of converting such dividends into shares of common stock. In
connection with the conversion of the Series A 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.

Series B Preferred Stock

In December 1994, the Company issued 2,588,438 shares of Series B and received
approximately $1,170,000 in proceeds, net of issuance costs of approximately
$30,000. The Series B had liquidation preferences over the Series A and the
common stock. The holders of Series B were entitled to receive dividends payable
equal to 10% of the 


                                      F-12
<PAGE>   52

Series B stated value annually. Such dividends were cumulative from the date of
issuance. Upon the conversion of Series B shares into shares of common stock,
any accrued but unpaid or undeclared dividends on Series B would be waived. The
Series B was convertible at any time at the option of the holder, or
automatically upon the consummation of a qualified (as defined) underwritten
public offering into an aggregate of 3,623,811 shares of common stock.

At any time after five years following the Series E Preferred Stock ("Series E")
issuance, the Company was required to redeem at the option of the holder, the
outstanding Series B shares at a redemption price equal to 110% of the Series B
stated value plus all accrued and unpaid dividends. The Company recorded
periodic accretion under the interest method for the excess of the redemption
value over the stated value.

Series C Preferred Stock

In August 1995, the Company issued 1,600,000 shares of Series C Preferred Stock
("Series C") and received approximately $1,965,000 in proceeds, net of issuance
costs of approximately $35,000. The Series C had liquidation preferences over
the Series B and Series A and the common stock and had parity with the Series D
Preferred Stock ("Series D") with respect to liquidation. The holders of Series
C were entitled to receive dividends payable equal to 10% of the Series C stated
value annually. Such dividends were cumulative from the date of issuance. Upon
the conversion of Series C shares into shares of common stock, any accrued but
unpaid or undeclared dividends on Series C would be waived. The Series C was
convertible at any time at the option of the holder, or automatically upon the
consummation of a qualified (as defined) underwritten public offering into an
aggregate of 2,239,998 shares of common stock.

At any time after five years following the issuance of the Series E, the holders
of at least 66 2/3% of the shares of Series C, Series D and Series E, together
as one class, could request that the Company redeem all or a part of the
outstanding Series C, Series D, and Series E. Any redemption was to be made pro
rata among all of the holders of the Series C, Series D, and Series E, in
proportion to their respective stated values. The redemption price for each
series of preferred stock was equal to 110% of the stated value for such series
of preferred stock plus all accrued and unpaid dividends. The Company recorded
periodic accretion under the interest method of the excess of the redemption
values of each series over the stated value.

Series D Preferred Stock

In January 1996, the Company issued 2,285,714 shares of Series D and received
approximately $3,983,000 in proceeds, net of issuance costs of approximately
$17,000. The Series D had liquidation preferences over the Series B and Series A
preferred stock and the common stock and had parity with the Series C with
respect to liquidation. The holders of Series D were entitled to receive
dividends payable equal to 10% of the Series D stated value annually. Such
dividends were cumulative from the date of issuance. Upon the conversion of
Series D shares into shares of common stock, any accrued but unpaid or
undeclared dividends on Series D would be waived. The Series D was convertible
at any time at the option of the holder, or automatically upon the consummation
of a qualified (as defined) underwritten public offering into an aggregate of
3,199,996 shares of common stock.

At any time after five years following the issuance of the Series E, the holders
of at least 66 2/3% of the shares of Series C, Series D and Series E, together
as one class, could request that the Company redeem all or a part of the
outstanding Series C, Series D and Series E. The redemption price for each
series of preferred stock was equal to 110% of the stated value for such series
of preferred stock plus all accrued and unpaid dividends. The Company recorded
periodic accretion under the interest method of the excess of the redemption
values of each series over the stated value.


                                      F-13
<PAGE>   53

Series E Preferred Stock

In September 1996, the Company issued 754,321 shares of Series E and received
approximately $5,018,000 in proceeds, net of issuance costs of approximately
$6,000. The Series E had liquidation preferences over the Series D, Series C,
Series B and Series A preferred stock and the common stock. The holders of
Series E were entitled to receive dividends payable equal to 10% of the Series E
stated value annually. Such dividends were cumulative from the date of issuance.
Upon the conversion of Series E shares into shares of common stock, any accrued
but unpaid or undeclared dividends on Series E would be waived. The Series E was
convertible at any time at the option of the holder, or automatically upon the
consummation of a qualified (as defined) underwritten public offering into an
aggregate of 1,056,040 shares of common stock.

At any time after five years following the issuance of the Series E, the holders
of at least 66 2/3% of the shares of Series C, Series D and Series E, together
as one class, could request that the Company redeem all or a part of the
outstanding Series C, Series D, and Series E. The redemption price for each
series of preferred stock was equal to 110% of the stated value for such series
of preferred stock plus all accrued and unpaid dividends. The Company recorded
periodic accretion under the interest method of the excess of the redemption
values of each series over the stated value.

4. STOCKHOLDERS' EQUITY (DEFICIT):

Initial Public Offering

In February 1998, the Company completed an IPO of 4,025,000 shares of the
Company's common stock resulting in net proceeds of approximately $45,353,000.
Concurrent with the offering, the Series A convertible preferred stock and its
Series B, C, D, and E redeemable convertible preferred stock were converted into
485,890 and 10,119,845 shares of common stock, respectively.

Other Sales of Common Stock

In June 1997, the Company sold 25,000 shares of common stock to an officer of
the Company for $1.75 per share. In September 1997, the Company sold 10,504
shares of common stock to a director of the Company for $4.76 per share.

Common Stock Split

In December 1996, the Board of Directors declared a 1.4 for one stock split of
the common stock of the Company effected in the form of a stock dividend. All
share and per-share amounts have been restated in these notes and the
accompanying financial statements to reflect this stock split.

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.


                                      F-14
<PAGE>   54

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.

Net2Net 1994 Stock Plan

The Net2Net 1994 Stock Plan (the "Net2Net Plan") authorizes the issuance of an
aggregate of up to 189,733 shares of Common Stock with respect to certain "Stock
Rights" granted under the Net2Net Plan. In connection with the Company's
acquisition of Net2Net, the Company assumed the obligations of Net2Net under the
Net2Net Plan. Subsequent to the merger, Visual's Board of Directors adopted a
resolution not to make any future option grants under the Net2Net Plan. Stock
Rights under the Net2Net Plan took the form of grants of incentive stock
options, non-statutory stock options, awards of stock of the Company,
opportunities to make direct purchases of stock in the Company or any
combination thereof. The Net2Net Plan provided for grants of options to
employees, officers, directors and consultants of Net2Net or any affiliate of
Net2Net.

1997 Omnibus Stock Plan

The Company's 1997 Omnibus Stock Plan (the "Omnibus Plan") authorizes the
issuance of an aggregate of up to 1,000,000 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-15
<PAGE>   55

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.

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

<TABLE>
<CAPTION>
                                                                OPTION PRICE PER   WEIGHTED-AVERAGE
                                                  OPTIONS            SHARE          EXERCISE PRICE
                                               -------------    ----------------   ----------------
<S>                                             <C>              <C>                 <C>   
Options outstanding at December 31, 1995....       590,716         $0.02- 1.58         $ 0.26
Granted.....................................       842,054          0.19- 4.73           0.86
Canceled....................................       (98,680)         0.19- 1.58           0.34
Exercised...................................       (38,785)         0.02- 1.58           0.28
                                               -----------      --------------     ----------
Options outstanding at December 31, 1996....     1,295,305          0.02- 4.73           0.64
Granted.....................................       942,192          1.43- 7.00           3.64
Canceled....................................      (118,608)         0.07- 7.00           2.03
Exercised...................................      (130,141)         0.02- 7.00           0.19
                                               -----------      --------------     ----------
Options outstanding at December 31, 1997....     1,988,748          0.07- 7.00           2.01
Granted.....................................       794,185         5.36- 34.50          20.49
Canceled....................................      (150,989)        0.29- 29.00          18.35
Exercised...................................      (440,181)        0.07- 17.50           1.47
                                               -----------      --------------     ----------
Options outstanding at December 31, 1998....     2,191,763        $0.07- 34.50         $ 7.69
                                               ===========      ==============     ==========
</TABLE>

As of December 31, 1998, options to purchase 477,011 shares of common stock were
exercisable with a weighted-average exercise price of $3.16. The
weighted-average remaining contractual life of options outstanding at December
31, 1998 was 7.80 years.

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, no
compensation expense has been recognized in the accompanying financial
statements related to stock option grants in 1996 and 1998. The Company has
recorded deferred compensation of approximately $292,000 related to stock option
grants in 1997, of which approximately $45,000 and $50,000 has been amortized in
the years ended December 31, 1997 and 1998, respectively.


                                      F-16
<PAGE>   56

Had compensation expense 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):

<TABLE>
<CAPTION>
                                                            YEAR ENDED DECEMBER 31,
                                                    ---------------------------------------
                                                        1996          1997          1998
                                                    ------------  ------------   ----------
<S>                                                  <C>            <C>           <C>   
Net income (loss) attributable to common 
  stockholders:
      As reported................................    $(13,205)      $(8,487)       $ 337
      Pro forma..................................     (13,231)       (8,625)      (1,683)

Basic and diluted income (loss) per share:
      As reported................................    $  (2.97)      $(1.72)       $ 0.02
      Pro forma..................................    $  (2.98)      $(1.75)        (0.09)
</TABLE>

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, 1996, 1997 and 1998: no dividend
yield, expected volatility from zero to 88.0%, risk-free interest rates from
4.4% to 7.6% and an expected terms ranging from 5 to 10 years.

6. RESTRUCTURING:

In the second quarter of 1998, the Company recorded a restructuring charge of
approximately $2,749,000 primarily 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 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, the Company reversed approximately $1,998,000 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 have been paid and all of the employee terminations have been 
completed and the related benefits have been paid. 

7. EMPLOYEE 401(k) SAVINGS PLAN:

Effective January 1, 1996, Visual adopted a defined contribution plan (the
"Savings Plan"), available to all full-time employees upon employment. The
Savings Plan qualifies for preferential tax treatment under Section 401(a) of
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 the plan year, not to exceed the annual Internal Revenue Service
contribution limitations. All participants are fully vested in their
contributions. There were no employer contributions under the Savings Plan.


                                      F-17
<PAGE>   57

In March 1996, Net2Net adopted a qualified 401(k) retirement plan (the "Net2Net
401(k) Plan"). The Net2Net 401(k) Plan covers substantially all employees who
have satisfied a three-month service requirement and have attained the age of
21. The Net2Net 401(k) Plan provides for an optional Net2Net contribution for
any plan year at Net2Net's discretion. Vesting in Net2Net contributions will be
based on a five-year schedule (20% per year). There were no Net2Net
contributions to the plan for the years ended December 31, 1997 and 1998.

8. INCOME TAXES:

For the years ended December 31, 1996 and 1997, the tax provision was comprised
primarily of a deferred tax benefit which was offset by a valuation allowance
of the same amount. The tax provision for 1996 and 1997 differed from  the
expected tax benefit, computed by applying the U.S. Federal statutory rate,
principally due  to the effect of increases in the valuation allowance. For the
year ended December 31, 1998, the tax provision consisted of a current
provision and increases to the valuation allowance offset by a deferred tax
benefit. The tax provision for 1998 differed from the expected amount, computed
by applying the U.S. Federal statutory rate, principally due to the effects of
net operating loss carryforwards, tax credits and increases in the valuation
allowance.

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

<TABLE>
<CAPTION>
                                                             DECEMBER 31
                                                        ---------------------
                                                           1997       1998
                                                        ---------   ---------
<S>                                                      <C>         <C>   
Deferred tax asset:
      Net operating loss carryforwards................   $5,140      $4,631
      Depreciation....................................      161         351
      Allowance for doubtful accounts.................      152         181
      Inventory valuation.............................      657         680
      Warranty reserve................................      106         327
      Accrued liabilities.............................      748         921
      Deferred revenue................................    1,627       1,169
      Tax credit carryforwards........................       20       1,002
      Valuation allowance.............................   (8,611)     (9,262)
                                                        -------     -------
                        Total net deferred tax asset     $  -        $  -
                                                        =======     =======
</TABLE>

The Company had net operating loss carryforwards to offset future taxable income
of approximately $12,600,000 as of December 31, 1998. These net operating loss
carryforwards expire through 2013. 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 change in the
ownership of Net2Net, the use of the Net2Net net operating losses will be
limited to approximately $3,500,000 per year and may not be available to offset
future taxable income.

9. COMMITMENTS AND CONTINGENCIES:

Leases

The Company leases office space and office equipment under noncancelable
operating leases expiring through October 2001. The Company recorded rent
expense of approximately $286,000, $718,000 and $842,000 during 1996, 1997 and
1998, respectively.


                                      F-18
<PAGE>   58

The Company also leases certain equipment under noncancelable capital lease
agreements which expire in 1999. Future minimum lease payments as of December
31, 1998 under noncancelable operating and capital leases are as follows (in
thousands):

<TABLE>
<CAPTION>
                                                            CAPITAL   OPERATING
                                                            LEASES      LEASES
                                                            -------   ---------
<S>                                                          <C>       <C>   
1999....................................................     $409      $  938
2000....................................................       -          892
2001....................................................       -          839
                                                            -----     -------
                        Total minimum lease payments....      409      $2,669
                                                                      =======
Interest element of lease payment.......................       26
                                                            -----
Present value of future minimum lease payments..........      383
Current portion.........................................      383
                                                            -----
Long-term portion.......................................     $ -
                                                            =====
</TABLE>

During 1997, Visual entered into additional sale-leaseback transactions in which
equipment with a net book value of approximately $544,000 was sold and leased
back under noncancelable capital leases. Proceeds from the transactions totaled
approximately $544,000, resulting in no gain or loss on the transactions.

During 1996 and 1997, Net2Net entered into sale/leaseback transactions involving
computer and lab equipment. Such equipment was sold at its net book value and
leased back under capital leases. Such leases are part of a $400,000 equipment
lease line of credit that expired in February 1998.

Litigation

The Company is periodically a party to disputes arising from normal business
activities. In the opinion of management, resolution of these matters will not
have a material adverse effect upon the financial position or future operating
results of the Company, and adequate provision for any potential losses has been
made in the accompanying financial statements.

10. 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:

<TABLE>
<CAPTION>
                                                        (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
                                        --------------------------------------------------------------------------------------------
                                                MARCH 31,            JUNE 30,             SEPTEMBER 30,           DECEMBER 31,
                                        ---------------------- -------------------- ----------------------- ------------------------
                                           1997       1998       1997       1998        1997       1998         1997        1998
                                        --------------------------------------------------------------------------------------------
<S>                                      <C>       <C>         <C>       <C>         <C>         <C>         <C>         <C>    
Revenue...............................    $3,988    $10,327     $6,229    $11,979     $ 7,934     $13,460     $ 9,194     $15,097
Gross profit..........................     2,283      5,786      3,807      7,619       4,947       8,630       5,554       9,818
Income (loss) from operations.........    (2,830)    (1,529)    (1,672)    (6,731)     (1,169)      1,596      (1,452)      4,897
Net income (loss).....................    (2,793)    (1,635)    (1,643)    (5,570)     (1,167)      2,211      (1,427)      5,502
Net income (loss) attributable to
  common shareholders                     (3,157)    (1,806)    (2,008)    (5,570)     (1,532)      2,211      (1,790)      5,502
Basic income (loss) per share.........     (0.65)     (0.14)     (0.41)     (0.28)      (0.31)       0.11       (0.36)       0.27
Diluted income (loss) per share.......     (0.65)     (0.14)     (0.41)     (0.28)      (0.31)       0.10       (0.36)       0.25
Pro forma diluted income (loss) per
  share...............................     (0.18)     (0.09)     (0.13)     (0.28)      (0.07)       0.10       (0.08)       0.25
</TABLE>


                                      F-19
<PAGE>   59

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.
The net loss for the three months ended June 30, 1998, includes merger-related
costs of approximately $7,347,000 related to the Net2Net merger. Net income for
the three months ended December 31, 1998, includes the reversal of approximately
$2,278,000 of the aforementioned merger-related costs (see Notes 1 and 6). The
reversal resulted from the payment of lower than estimated costs in connection
with the Net2Net transaction and subsequent restructuring and included
approximately $280,000 in transaction costs and approximately $1,998,000 in
restructuring costs.


                                      F-20
<PAGE>   60

                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Stockholders of
Visual Networks, Inc.:

We have audited, in accordance with generally accepted auditing standards, the
consolidated financial statements of Visual Networks, Inc. (a Delaware
corporation) and subsidiaries and have issued our report thereon dated January
15, 1999. Our audits were made for the purpose of forming an opinion on the
basic financial statements taken as a whole. The schedule listed in item 16(b)
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



Washington, D.C.
January 15, 1999


                                      S-1
<PAGE>   61

                                                                     SCHEDULE II


                              VISUAL NETWORKS, INC.

                        VALUATION AND QUALIFYING ACCOUNTS
                                 (IN THOUSANDS)

<TABLE>
<CAPTION>
                                                 BALANCE AT BEGINNING   ADDITIONS CHARGED TO                  BALANCE AT END OF
                  DESCRIPTION                         OF PERIOD         COSTS AND EXPENSES     DEDUCTIONS          PERIOD
----------------------------------------------   --------------------   --------------------   ----------     -----------------
<S>                                                    <C>                  <C>                 <C>                 <C> 
For the year ended December 31, 1996,
  Deducted from assets accounts:
      Allowance for doubtful accounts.........         $  -                 $   260             $  -                $260
For the year ended December 31, 1997,
  Deducted from assets accounts:
      Allowance for doubtful accounts.........           260                    152                -                 412
For the year ended December 31, 1998,
  Deducted from assets accounts:
      Allowance for doubtful accounts.........           412                    106                 25               493
      Reserves related to restructuring.......            -                   2,749              2,749 (a)            -
</TABLE>

(a) 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 6 of the Notes to Consolidated Financial
Statements.


                                      S-2