================================================================================

                       SECURITIES AND EXCHANGE COMMISSION
                           Washington, D.C. 20549-0001

                                 ---------------

                                    FORM 10-Q

(MARK ONE)

|X|   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934

                    For the three months ended June 30, 2002

                                       OR

|_|   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934

                        Commission File Number 000-23699

                                 ---------------

                              VISUAL NETWORKS, INC.
             (Exact name of registrant as specified in its charter)

                     Delaware                              52-1837515
         (State or other jurisdiction of                (I.R.S. Employer
          incorporation or organization)               Identification No.)

         2092 Gaither Road, Rockville, MD                  20850-4013
    (Address of principal executive offices)                (Zip code)

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

                                 ---------------

      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 the
filing requirements for the past 90 days. Yes |X|  No |_|

      The number of outstanding shares of the Registrant's Common Stock, par
value $.01 per share, as of August 15, 2002 was 32,173,420 shares.

================================================================================


                                       1
<PAGE>

                              VISUAL NETWORKS, INC.
                          QUARTERLY REPORT ON FORM 10-Q
                            FOR THE SIX MONTHS ENDED
                                  JUNE 30, 2002

                                TABLE OF CONTENTS

                                                                            Page
                                                                            ----
PART I. FINANCIAL INFORMATION
  Item 1. Financial Statements:
     Consolidated Balance Sheets--  December 31, 2001
       and June 30, 2002 ..................................................    3
     Consolidated Statements of Operations -- Three and six months
      ended June 30, 2001 and 2002 ........................................    4
     Consolidated Statements of Cash Flows-- Six months
      ended June 30, 2001 and 2002 ........................................    5
     Notes to Consolidated Financial Statements ...........................    6
  Item 2. Management's Discussion and Analysis of Financial
     Condition and Results of Operations ..................................   14
  Item 3. Qualitative and Quantitative Disclosure about
     Market Risk ..........................................................   27
PART II. OTHER INFORMATION
  Items 1-- 6 .............................................................   28
  Signatures ..............................................................   33


                                       2
<PAGE>

                          PART I: FINANCIAL INFORMATION

Item 1: Financial Statements

                              VISUAL NETWORKS, INC.

                           CONSOLIDATED BALANCE SHEETS
                                   (Unaudited)
                        (In thousands, except share data)

<TABLE>
<CAPTION>
                                                                                   December 31,             June 30,
                                                                                       2001                   2002
                                                                                   ------------            ---------
<S>                                                                                 <C>                    <C>
ASSETS
Current assets:
  Cash and cash equivalents .................................................       $   5,921              $   6,634
  Restricted short-term investment ..........................................           2,503                  2,503
  Accounts receivable, net of allowance of $554 and $1,057,
     respectively ...........................................................           7,488                 11,899
  Inventory, net ............................................................           5,768                  5,310
  Other current assets ......................................................           1,161                  1,036
                                                                                    ---------              ---------
          Total current assets ..............................................          22,841                 27,382
Property and equipment, net .................................................           6,061                  4,856
Deferred debt issuance costs, net of current portion ........................              --                    637
                                                                                    ---------              ---------
          Total assets ......................................................       $  28,902              $  32,875
                                                                                    =========              =========

LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
  Accounts payable and accrued expenses .....................................       $  11,723              $  11,354
  Deferred revenue ..........................................................          11,782                  9,413
  Customer deposits .........................................................           3,588                     --
  Line of credit ............................................................           1,663                     --
  Current portion of long-term debt .........................................             661                     --
                                                                                    ---------              ---------
          Total current liabilities .........................................          29,417                 20,767
Convertible debentures, net of unamortized debt discount of $2,928 ..........              --                  7,572
                                                                                    ---------              ---------
          Total liabilities .................................................          29,417                 28,339
                                                                                    ---------              ---------

Stockholders' equity (deficit):
  Common stock, $.01 par value, 200,000,000 shares
     authorized, 31,915,752 and 32,175,386 shares issued
     and outstanding as of December 31, 2001 and
     June 30, 2002, respectively ............................................             319                    322
  Warrants ..................................................................              --                  2,087
  Additional paid-in capital ................................................         473,132                474,614
  Deferred compensation .....................................................             (80)                   (76)
  Accumulated other comprehensive income ....................................              21                     --
  Accumulated deficit .......................................................        (473,907)              (472,411)
                                                                                    ---------              ---------
          Total stockholders' equity (deficit) ..............................            (515)                 4,536
                                                                                    ---------              ---------
          Total liabilities and stockholders' equity (deficit) ..............       $  28,902              $  32,875
                                                                                    =========              =========
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       3
<PAGE>

                              VISUAL NETWORKS, INC.

                      CONSOLIDATED STATEMENTS OF OPERATIONS
                                   (Unaudited)
                      (In thousands, except per share data)

<TABLE>
<CAPTION>
                                                                      For the Three Months         For the Six Months
                                                                         Ended June 30,               Ended June 30,
                                                                     ---------------------      -----------------------
                                                                        2001        2002          2001           2002
                                                                     --------     --------      --------       --------
<S>                                                                  <C>          <C>           <C>            <C>
Revenue:
  Hardware revenue .........................................         $ 14,621     $  8,759      $ 26,714       $ 19,820
  Software revenue .........................................            1,002        3,703         1,310          5,094
  Support and services revenue .............................            4,706        2,747         9,691          7,088
                                                                     --------     --------      --------       --------
      Total revenue ........................................           20,329       15,209        37,715         32,002
                                                                     --------     --------      --------       --------
Cost of revenue:
  Product cost of revenue ..................................            7,207        3,071        11,796          7,303
  Support and services cost of revenue .....................            2,094          580         4,467          1,324
                                                                     --------     --------      --------       --------
      Total cost of revenue ................................            9,301        3,651        16,263          8,627
                                                                     --------     --------      --------       --------
  Gross profit .............................................           11,028       11,558        21,452         23,375
                                                                     --------     --------      --------       --------
Operating expenses:
  Research and development .................................            5,377        3,137        11,160          6,462
  Sales and marketing ......................................            9,137        5,266        18,587         11,201
  General and administrative ...............................            2,346        1,971         5,018          3,738
  Restructuring and impairment charges .....................            6,276           --         6,276             --
  Amortization of acquired intangibles .....................              319           --           792             --
                                                                     --------     --------      --------       --------
          Total operating expenses .........................           23,455       10,374        41,833         21,401
                                                                     --------     --------      --------       --------
Income (loss) from operations ..............................          (12,427)       1,184       (20,381)         1,974
Interest income (expense), net .............................               97         (369)          384           (478)
                                                                     --------     --------      --------       --------
Income (loss) before income taxes ..........................          (12,330)         815       (19,997)         1,496
Income taxes ...............................................               --           --            --             --
                                                                     --------     --------      --------       --------
Net income (loss) ..........................................         $(12,330)    $    815      $(19,997)      $  1,496
                                                                     ========     ========      ========       ========
Basic earnings (loss) per share ............................         $  (0.39)    $   0.03      $  (0.64)      $   0.05
                                                                     ========     ========      ========       ========
Diluted earnings (loss) per share ..........................         $  (0.39)    $   0.03      $  (0.64)      $   0.05
                                                                     ========     ========      ========       ========
Basic weighted-average shares outstanding ..................           31,514       32,106        31,455         32,033
                                                                     ========     ========      ========       ========
Diluted weighted-average shares outstanding ................           31,514       32,142        31,455         32,487
                                                                     ========     ========      ========       ========
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       4
<PAGE>

                              VISUAL NETWORKS, INC.

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (Unaudited)
                                 (In thousands)

<TABLE>
<CAPTION>
                                                                                           For the Six Months
                                                                                              Ended June 30,
                                                                                        ------------------------
                                                                                          2001            2002
                                                                                        --------         -------
<S>                                                                                     <C>              <C>
Cash flows from operating activities:
  Net income (loss) ........................................................            $(19,997)        $ 1,496
  Adjustments to reconcile net income (loss) to net cash
     used in operating activities:
     Depreciation and amortization .........................................               3,459           1,898
     Non-cash restructuring and impairment charges .........................               4,292              --
     Non-cash interest expense .............................................                  --             253
     Translation gain from foreign subsidiary ..............................                  --             (21)
  Changes in assets and liabilities:
     Accounts receivable ...................................................               1,703          (4,411)
     Inventory .............................................................               3,577             458
     Other assets ..........................................................                 741             357
     Accounts payable and accrued expenses .................................              (7,910)           (369)
     Deferred revenue ......................................................              (1,925)         (2,369)
     Customer deposits .....................................................               1,664          (3,588)
                                                                                        --------         -------
       Net cash used in operating activities ...............................             (14,396)         (6,296)
Cash flows from investing activities:
                                                                                        --------         -------
  Net sales of short-term investments ......................................               3,122              --
  Expenditures for property and equipment ..................................                (328)           (589)
                                                                                        --------         -------
       Net cash provided by (used in) investing activities .................               2,794            (589)
                                                                                        --------         -------
Cash flows from financing activities:
  Exercise of stock options and employee stock purchase
     plan ..................................................................                 602             349
  Proceeds from issuance of convertible debentures and
     warrants, net of issuance costs .......................................                  --           9,573
  Net borrowings (repayments) under credit agreements ......................                 451          (2,039)
  Principal payments on capital lease obligations ..........................                (306)           (285)
                                                                                        --------         -------
       Net cash provided by financing activities ...........................                 747           7,598
                                                                                        --------         -------
Effect of exchange rate changes ............................................                   4              --
                                                                                        --------         -------
Net increase (decrease) in cash and cash equivalents .......................             (10,851)            713
Cash and cash equivalents, beginning of period .............................              17,369           5,921
                                                                                        --------         -------
Cash and cash equivalents, end of period ...................................            $  6,518         $ 6,634
                                                                                        ========         =======
Supplemental cash flow information:
  Cash paid for interest ...................................................            $     46         $   166
                                                                                        ========         =======
Supplemental disclosure of non-cash investing and financing activities:
  Issuance of common stock, options and warrants in acquisition ............            $   (990)        $    --
                                                                                        ========         =======
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       5
<PAGE>

                              VISUAL NETWORKS, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  JUNE 30, 2002
                                   (Unaudited)

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

      Visual Networks, Inc. ("Visual" or the "Company") designs, manufactures,
sells and supports systems that manage the level of service provided over
telecommunications networks, including networks that support the Internet.

Risks and Other Important Factors

      The Company incurred significant losses from the second quarter of 2000
through the fourth quarter of 2001. The deterioration of the Company's operating
results in 2000, excluding the effects of impairment and restructuring charges
and the write-off of in-process research and development ("IPR&D"), was due
primarily to decreased revenue and increased operating expenses compared to
1999. The Company made significant reductions in operating expenses in 2000,
2001 and 2002, including those resulting from the closure of three facilities
and the reduction of its workforce by approximately 270 employees from October
2000 through June 2002, approximately 40 of whom were terminated during the six
months ended June 30, 2002.

      Based on its current cost structure, the Company's ability to generate
operating income is, in large part, dependent on its success in achieving
quarterly revenue of at least $14.0 million to $15.0 million, achieving
quarterly gross margins of 70% to 75% and maintaining or further reducing
operating expenses. Due to market conditions, competitive pressures and other
factors beyond the Company's control, there can be no assurances that the
Company will be able to achieve these quarterly goals. In the event that the
Company does not realize anticipated cost reductions or achieve its revenue
goals, it may be required to further reduce its cost structure. While the
Company returned to profitability for the three and six months ended June 30,
2002, there can be no assurance that the Company will remain profitable.

      The success of the Company is also dependent on its ability to generate
adequate cash for operating and capital needs. To meet its cash requirements,
the Company is relying on its existing cash and cash equivalents and the net
proceeds from the issuance of the convertible debentures (see Note 3), together
with future product sales and the collection of the related accounts receivable.
If cash provided by these sources is not sufficient to fund future operations,
the Company will be required to further reduce its operating expenditures or to
seek additional capital through other means including the sale of assets, the
sale of equity securities or additional borrowings. There can be no assurances
that additional capital will be available, or available on terms that are
reasonable or acceptable to the Company, particularly in light of the Company's
accumulated deficit position.

      The Company's operations and financial position are subject to certain
risks and uncertainties including, among other things, its accumulated deficit,
uncertainty of future profitability and possible fluctuations in financial
results, substantial fixed operating costs, possible substantial dilution to
common stockholders as a result of the terms of its convertible debentures,
dependence on sales to key customers, including WorldCom, dependence on a
sole-source subcontract manufacturer, potential delisting and reduced liquidity
of its shares resulting from failure to meet the Nasdaq listing requirements,
the potential triggering of early repayment of the debentures, the downturn in
the telecommunications industry, long sales cycles, improvements to the
infrastructure of the Internet, rapid technological change, growing competition
from several market segments, product errors, dependence upon sole and limited
source suppliers and fluctuations in component pricing, claims of patent
infringement by third parties, failure to protect its intellectual property
rights, dependence upon key employees, ability to retain employees and the
defense of a purported class action lawsuit. Failure to meet any of these and
other challenges could adversely affect the Company's future operating results
and financial condition.

Financial Statement Presentation

      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, the
disclosure of contingent assets and liabilities at the date of statements and
the reported amounts of revenue and expenses during the reporting periods.
Actual results could differ from those estimates.


                                       6
<PAGE>

      These financial statements are unaudited and have been prepared by the
Company pursuant to the rules and regulations of the Securities and Exchange
Commission regarding interim financial reporting. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements, and it is suggested
that these financial statements be read in conjunction with the financial
statements, and notes thereto, included in the Company's Annual Report on Form
10-K/A (Amendment No. 2) for the year ended December 31, 2001. In the opinion of
management, the comparative financial statements for the periods presented
herein include all adjustments that are normal and recurring which are necessary
for a fair presentation of results for the interim periods. The results of
operations for the six months ended June 30, 2002 are not necessarily indicative
of the results that will be achieved for the entire year ending December 31,
2002.

Principles of Consolidation

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

Investments

      As of December 31, 2001, the Company held a certificate of deposit in the
amount of $2.5 million that matures on October 31, 2002. The certificate of
deposit has been included as a restricted short-term investment (see Note 2) in
the accompanying consolidated balance sheets as of December 31, 2001 and June
30, 2002. The certificate of deposit is held by a bank to collateralize a $2.5
million letter of credit issued in favor of the Company's contract manufacturer.

Inventory

      Cost of revenue consists of subcontracting costs, component parts,
warehouse costs, direct compensation costs, communication costs, warranty and
other contractual obligations, royalties, license fees and other overhead
expenses related to the manufacturing operations. Product cost of revenue
includes both hardware and software cost of revenue in the accompanying
consolidated statements of operations. Cost of revenue related to software sales
has not been significant. Support and services cost of revenue includes
benchmark services, professional services and technical support costs in the
accompanying consolidated statements of operations. Inventory is stated at the
lower of average cost or market, and consists of the following (unaudited, in
thousands):

                                           December 31,     June 30,
                                               2001           2002
                                           ------------     --------
            Raw materials ............       $  1,137       $  1,705
            Work-in-progress .........            238             74
            Finished goods ...........          4,393          3,531
                                             --------       --------
                                             $  5,768       $  5,310
                                             ========       ========

Accounts Payable and Accrued Expenses

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

                                           December 31,     June 30,
                                               2001           2002
                                           ------------     --------
            Accounts payable ...........     $   2,644      $  4,219
            Accrued compensation .......         1,794         1,600
            Accrued restructuring ......         1,421           898
            Other accrued expenses .....         5,864         4,637
                                             ---------      --------
                                             $  11,723      $ 11,354
                                             =========      ========

Revenue Recognition

      The Company's service management products and services include hardware,
software, benchmark services, professional services and technical support.
Benchmark services, professional services and technical support revenues are
reported as service revenue in the accompanying consolidated statements of
operations. The Company recognizes revenue from the sale or license of its
products in accordance with the American Institute of Certified Public
Accountants Statement of Position No. 97-2, "Software Revenue Recognition" and
SEC Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial
Statements," which summarizes existing accounting literature and require that
four criteria are met prior to the recognition of revenue. The Company's
accounting policies regarding revenue recognition are written to comply with the
following criteria: 1) persuasive evidence of an arrangement exists; 2) delivery
has occurred or services have been rendered; 3) the fees are fixed and
determinable; and 4) collectibility is probable.


                                       7
<PAGE>

Where agreements provide for customer acceptance, the Company recognizes revenue
upon acceptance of the product by the customer. Generally, the Company's
agreements have not included any specific customer acceptance provisions.
However, the Company does allow some of its customers to evaluate its products
before making a decision to purchase. The Company recognizes revenue under these
arrangements once the evaluation process is complete and all other criteria are
met. Revenue from multiple-element software arrangements is recognized using the
residual method whereby the fair value of any undelivered elements, such as
customer support and services, is deferred and any residual value is allocated
to the software and recognized as revenue upon delivery and passage of title.
The fair values of professional services, technical support and training have
been determined based on the Company's specific objective evidence of fair
value. The Company's specific objective evidence of fair value is based on the
price the Company charges customers when the service is sold separately.

      Maintenance contracts require the Company to provide technical support and
unspecified software updates to customers on a when and if available basis. The
Company recognizes technical support revenue, including support revenue that is
bundled with product sales, ratably over the term of the contract period, which
generally ranges from one to five years. Revenue from professional services is
recognized when the services are performed. Subscription fees for the Company's
benchmark reports are recognized upon delivery of the reports.

      The Company sells its products directly to service providers and end-user
customers, as well as through indirect channels. Certain reseller customers have
stock rotation rights, under which the customer can exchange previously
purchased products for other products of equal or greater cost, subject to
certain limitations, based on their end-user customers' requirements. The
Company recognizes revenue under these arrangements once the stock rotation
right expires or the product has been resold by the Company's master
distributor.

      The Company examines the specific facts and circumstances of all sales
arrangements with payment terms extending beyond its normal payment terms to
make a determination of whether the sales price is fixed and determinable and
whether collectibility is probable. Payment terms are not tied to milestone
deliverables or customer acceptance. The evaluation of the impact on revenue
recognition, if any, includes the Company's history with its customers and the
specific facts of each arrangement. The Company generally does not offer payment
terms that differ from its normal payment terms. However, in the year ended
December 31, 2001, the Company recognized software license revenue of
approximately $2.6 million on new arrangements with previously existing
customers that contain payment terms beyond the normal payment terms. Payments
become due under these arrangements through July 2002. As of August 19, 2002,
all scheduled payments had been made in full in accordance with the terms of the
relevant arrangements.

      The Company has agreements with certain service providers that provide
price protection in the event that more favorable prices and terms are granted
to any other similarly situated customer. When required, 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 service provider inventory levels and makes
adjustments to these reserves when management believes that actual price
protection credits may differ from established estimates.

      In May 2001, the Company announced the discontinuation of the Visual
Trinity product. This product was the primary product acquired with Avesta, and
the Company does not plan to continue development efforts on the Visual Trinity
product. As a result, future revenue related to this product will consist
primarily of technical support revenue, all of which is currently included in
deferred revenue. The Company plans to provide technical support for the Visual
Trinity product through September 2002.

      In June 2001, the Company announced the sale of the Visual Internet
Benchmark service. The Company will continue to recognize revenue from the
Visual Internet Benchmark service for existing contracts, under which the
Company is still required to perform services through May 2003, most of which is
currently in deferred revenue. The Company receives royalty payments from the
purchaser on new contracts, which are included in support and services revenue
in the accompanying statement of operations for the three and six months ended
June 30, 2002.

Credit Risk

      Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash and cash equivalents,
investments and accounts receivable. The Company generally sells its products to
large telecommunications and Internet service provider companies primarily in
the United States. The Company grants credit terms without collateral to its
customers and, prior to June 30, 2002, has not experienced any significant
credit related losses. Accounts receivable include allowances to record
receivables at their estimated net realizable value. As of June 30, 2002, three
customers individually represented


                                       8
<PAGE>

38%, 35% and 10% of accounts receivable. Subsequent to June 30, 2002, the
Company wrote-off approximately $650,000 in receivable balances against the
allowance for bad debts, which was $1.1 million as of June 30, 2002.

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.

Comprehensive Income

      The Company reports comprehensive income in accordance with SFAS No. 130,
"Reporting Comprehensive Income," which establishes rules for the reporting and
display of comprehensive income and its components. SFAS No. 130 requires
foreign currency translation adjustments and the unrealized gains and losses on
marketable securities to be included in other comprehensive income. Because the
Company has not had any significant components of other comprehensive income,
the reported net income (loss) does not differ materially from comprehensive
income (loss) for the three and six months ended June 30, 2001. During 2002, the
Company converted operations for its Canadian subsidiary to U.S. Dollars and
recorded the translation gain in the accompanying consolidated statement of
operations, and as of June 30, 2002, the Company had no operations denominated
in foreign currency.

Segment Reporting and Significant Customers

      SFAS No. 131, "Disclosure about Segments of an Enterprise and Related
Information," establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that these enterprises report selected information about operating
segments in interim financial reports. Management has concluded that the
Company's operations occur in one segment only based upon the information used
by management in evaluating the performance of the business. SFAS No. 131 also
establishes standards for related disclosures about products and services,
geographic areas and major customers. The revenue and assets of the Company's
foreign subsidiaries have not been significant. During the six months ended June
30, 2002, the Company closed its branch in France and began efforts to close its
subsidiary in Singapore. For the six months ended June 30, 2001, three customers
individually represented 31%, 14% and 11% of revenue. For the six months ended
June 30, 2002, three customers individually represented 34%, 15% and 11% of
revenue. The agreements with the Company's significant customers do not obligate
these customers to make any minimum purchases from the Company.

      The following table presents the Company's revenue by product (unaudited,
in thousands):

<TABLE>
<CAPTION>
                                                                    Three Months Ended              Six Months Ended
                                                                        June 30,                         June 30,
                                                                 -----------------------         -----------------------
                                                                   2001            2002            2001            2002
                                                                 -------         -------         -------         -------
<S>                                                              <C>             <C>             <C>             <C>
            Visual UpTime ..............................         $15,450         $10,446         $28,109         $24,063
            Visual Cell Tracer .........................             854               1           1,329             768
            Visual IP InSight ..........................           1,600           4,261           2,696           5,813
            Royalties ..................................              --             194              --             282
                                                                 -------         -------         -------         -------
                  Continuing products ..................          17,904          14,902          32,134          30,926
            Visual Internet Benchmark ..................           1,269             235           2,658             630
            Visual Trinity and eWatcher ................           1,156              72           2,923             446
                                                                 -------         -------         -------         -------
                  Discontinued products ................           2,425             307           5,581           1,076
                                                                 -------         -------         -------         -------
                  Total  revenue .......................         $20,329         $15,209         $37,715         $32,002
                                                                 =======         =======         =======         =======
</TABLE>

      During 2001, the Company discontinued development and sales efforts of
Visual Trinity and sold the Visual Internet Benchmark service. During 2001, the
Company began evaluating the Visual eWatcher product, which, to date, has not
generated significant revenue. The Company believes this product's web
performance management functionality may be valuable and is exploring
alternatives for this product.

Basic and Diluted Earnings (Loss) Per Share

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


                                       9
<PAGE>

number of common shares outstanding for the period.

      Diluted earnings (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 and warrants to purchase
8,395,481 shares of common stock that were outstanding as of June 30, 2001 were
not included in the computation of diluted loss per share for the three and six
months ended June 30, 2001 as their effect would be anti-dilutive. The treasury
stock effect of options and warrants to purchase 8,636,436 shares of common
stock that were outstanding at June 30, 2002 are included in the computation of
diluted earnings per share for the three and six months ended June 30, 2002. The
effect of the convertible debentures issued in March 2002 (see Note 3) that are
convertible into 2,986,093 shares of common stock has not been included in the
computation of diluted earnings per share for the three or six months ended June
30, 2002 as their effect would be anti-dilutive.

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

<TABLE>
<CAPTION>
                                                                        Three Months Ended              Six Months Ended
                                                                               June 30,                      June 30,
                                                                      -----------------------       -----------------------
                                                                         2001          2002           2001            2002
                                                                      --------        -------       --------        -------
<S>                                                                   <C>             <C>           <C>             <C>
         Net income (loss) ....................................       $(12,330)       $   815       $(19,997)       $ 1,496
                                                                      ========        =======       ========        =======
         Diluted weighted-average shares outstanding
         Weighted-average share calculation:
         Basic weighted-average shares outstanding:
           Average number of shares of common stock
              outstanding .....................................         31,514         32,106         31,455         32,033
         Diluted weighted-average shares
         outstanding:
           Treasury stock effect of options and
              warrants ........................................             --             36             --            454
                                                                      --------        -------       --------        -------
         Diluted weighted-average shares outstanding ..........         31,514         32,142         31,455         32,487
                                                                      ========        =======       ========        =======
         Earnings (loss) per common share:
           Basic earnings (loss) per share ....................       $  (0.39)       $  0.03       $  (0.64)       $  0.05
                                                                      ========        =======       ========        =======
           Diluted earnings (loss) per share ..................       $  (0.39)       $  0.03       $  (0.64)       $  0.05
                                                                      ========        =======       ========        =======
</TABLE>

New Accounting Pronouncements

      In June 2001, the Financial Accounting Standards Board (the "FASB") issued
SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 141 prospectively prohibits the pooling of interest
method of accounting for business combinations initiated after June 30, 2001.
SFAS No. 142 requires companies to cease amortizing goodwill on December 31,
2001 that existed at June 30, 2001. Any goodwill resulting from acquisitions
completed after June 30, 2001 will also not be amortized. SFAS No. 142 also
establishes a new method of testing goodwill for impairment on an annual basis
or on an interim basis if an event occurs or circumstances change that would
reduce the fair value of a reporting unit below its carrying value. The Company
did not have any outstanding goodwill or other intangibles as of December 31,
2001 and June 30, 2002. The Company also did not have any goodwill during 2001.
The adoption of SFAS No. 142 did not have a material effect on the Company's
financial position or results of operations.

      In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." It requires an entity to recognize the fair value of a
liability for an asset retirement obligation in the period in which it is
incurred if a reasonable estimate of fair value can be made. If a reasonable
estimate of fair value cannot be made in the period the asset retirement
obligation is incurred, the liability shall be recognized when a reasonable
estimate of fair value can be made. This new standard is effective in the first
quarter of 2003. The Company does not believe that SFAS No. 143 will have a
material effect on the Company's financial position or results of operations.

      In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which supersedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of." Though it retains the basic requirements of SFAS No. 121
regarding when and how to measure impairment loss, SFAS No. 144 provides
additional implementation guidance. SFAS No. 144 is effective in the first
quarter of 2002. The Company adopted SFAS No. 144 during the six months ended
June 30, 2002 and the adoption did not have a material effect on the Company's
financial position or results of operations.

      In August 2002, the FASB issued SFAS No. 146 "Accounting for Costs
Associated with Exit or Disposal Activities". It addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including


                                       10
<PAGE>

Certain Costs Incurred in a Restructuring)." SFAS No. 146 requires that a
liability for a cost associated with an exit or disposal activity be recognized
when the liability is incurred and establishes that fair value is the objective
for initial measurement of the liability. Under EITF Issue No. 94-3, a liability
for an exit cost is recognized at the date of an entity's commitment to an exit
plan. The new standard is effective for exit or disposal activities that are
initiated after December 31, 2002, with early adoption encouraged. The Company
does not believe that SFAS No. 146 will have a material effect on the Company's
financial position or results of operations.

2. Credit Agreements and Long-Term Debt:

      During 2001 through March 2002, the Company maintained a credit facility,
as amended, that included an accounts receivable-based arrangement providing for
borrowings up to the lesser of $10.0 million or 80% of eligible accounts
receivable (as defined in the credit facility and determined by the bank). The
bank credit facility included an equipment financing facility. During the six
months ended June 30, 2001, the Company borrowed approximately $451,000 to be
repaid over 36 months under the equipment financing facility, of which $376,000
was outstanding as of December 31, 2001. As of December 31, 2001, the Company
also had approximately $1.7 million of borrowings outstanding at an interest
rate of 6.75% under the accounts receivable-based arrangement.. In connection
with the issuance of the convertible debentures (see Note 3), the Company repaid
the outstanding balance of the credit facility, and the related loan agreements
were terminated. As a result, the borrowings under the accounts receivable-based
and equipment financing arrangements were classified as current in the
accompanying consolidated balance sheet as of December 31, 2001.

      In December 2000, the bank issued a standby letter of credit, as amended,
in favor of the Company's contract manufacturer, that expires on September 30,
2002 in the amount of $2.5 million. The Company secured the letter of credit
with a pledge of a certificate of deposit in the amount of $2.5 million, as
amended, which is recorded as a restricted short-term investment in the
accompanying consolidated balance sheets as of December 31, 2001 and June 30,
2002.

3. Convertible Debentures:

      In March 2002, the Company issued senior secured convertible debentures
(the "Debentures") in the aggregate amount of $10.5 million in a private
placement. The Debentures are due March 25, 2006, are payable in common stock or
cash at the Company's option provided certain conditions are satisfied, and bear
interest at an annual rate of 5% payable quarterly in common stock or cash at
the Company's option provided certain conditions are satisfied. The Debentures
are secured by a first priority lien on substantially all of the Company's
assets. The Debentures may be converted initially into 2,986,093 shares of the
Company's common stock at the option of the holders at a price of $3.5163 per
share, subject to certain adjustments. The conversion price of the Debentures
will adjust if the Company issues additional shares of common stock or
instruments convertible into common stock at a price that is less than the
then-effective conversion price of the Debentures. The Company has the right to
require the holders to convert their Debentures into common stock if the closing
price of the Company's common stock exceeds 175% of the conversion price for 20
consecutive days after September 26, 2003.

      The Debentures include certain financial covenants related to earnings
before interest, taxes, depreciation and amortization, less capital
expenditures, for 2002 and 2003. If the financial covenants are not met, the
holders may cause the Company to redeem the Debentures at a price equal to the
principal amount of the Debentures plus accrued interest. The redemption may be
made in common stock or cash at the Company's option provided certain conditions
are satisfied. Cash redemption of the Debentures also may be required upon a
specified change of control or upon the occurrence of any one of the other
triggering events, including but not limited to, default on other indebtedness
and failure to maintain the common stock listing on an eligible market. In the
event that the financial covenant for 2002 is achieved, the first priority lien
in favor of the debenture holders shall be released.

      In connection with the issuance of the Debentures, the Company issued to
the holders warrants to purchase 828,861 shares of its common stock at an
initial exercise price of $4.2755 per share. The exercise price will be adjusted
if the Company issues additional shares of common stock or instruments
convertible into common stock at a lower price than the then-effective exercise
price. The warrants expire on March 25, 2007.

      The holders of the Debentures also received the right to purchase shares
of to-be-created Series A preferred stock (the "Preferred Stock Rights") at
certain dates in the future. The first Preferred Stock Right for 575 shares for
$5.8 million expired on May 6, 2002. The holders did not exercise the right to
purchase these shares of Series A preferred stock. The second Preferred Stock
Right for 307 shares for $3.1 million may be exercised at any time after the
six-month anniversary but before the fifteen-month anniversary of the issuance
of the Debentures. The third Preferred Stock Purchase Right for 170 shares for
$1.7 million also expired on May 6, 2002.


                                       11
<PAGE>

The holders also did not exercise the right to purchase these shares of Series A
preferred stock. The Debenture holders were also granted certain equity
participation and registration rights.

      Under the terms of the Debentures, a number of events could trigger the
Debenture holders' right to force early repayment of 115% of the outstanding
principal plus accrued and unpaid interest owed under the debentures. Events
constituting a triggering event include:

      o     default by the Company on other indebtedness or obligations under
            any other debenture, any mortgage, credit agreement or other
            facility, indenture agreement, factoring agreement or other
            instrument under which there may be issued, or by which there may be
            secured or evidenced, any indebtedness for borrowed money or money
            due under any long term leasing or factoring arrangement in an
            amount exceeding $500,000;

      o     failure by the Company to have its common stock listed on an
            eligible market;

      o     bankruptcy of the Company;

      o     engagement by the Company in certain change in control, sale of
            assets or redemption transactions;

      o     failure by the Company to timely file its 2002 or 2003 annual
            reports on Form 10-K; and

      o     certain other failures by the Company to perform obligations under
            the Debenture agreement and/or the related agreements.

      In addition, if the Company's earnings before interest, taxes,
depreciation and amortization, less capital expenditures, for the fiscal year
ended December 31, 2002 is less than $2,750,000, the Debenture holders may
require the Company to prepay all or a portion of up to 50% of the outstanding
principal amount of their Debentures. If the Company's earnings before interest,
taxes, depreciation and amortization, less capital expenditures, for the fiscal
year ended December 31, 2003 is less than $6,500,000, the Debenture holders may
require the Company to prepay all or a portion of up to 100% of the outstanding
principal amount of the Debentures.

      If the Company does not have sufficient cash to repay these amounts if
required, the Company may be required to seek additional capital through a sale
of assets, sale of additional securities or through additional borrowings, none
of which may be available on terms reasonably acceptable to the Company.

      The total Debentures of $10.5 million are included in the accompanying
balance sheet as of June 30, 2002, net of unamortized debt discount of
approximately $2.9 million, which represents the fair market value after
allocating the proceeds to the various additional components of the debt.
Approximately $2.1 million in proceeds from the Debentures were allocated to the
value of the warrants. The fair value of the warrants was determined using the
Black-Scholes valuation model with the following assumptions: no dividend yield,
expected volatility of 129%, risk-free interest rate of 4.85% and a term of five
years. Approximately $260,000 in proceeds from the Debentures was allocated to
the value of the Preferred Stock Rights as determined by an independent
appraisal. On the date of issuance of the Debentures, the conversion price of
the Debentures, after taking into consideration the allocation of proceeds to
the warrants and Preferred Stock Rights, was less than the quoted market price
of the Company's common stock. Accordingly, approximately $1.0 million in
proceeds from the Debentures was allocated to additional paid-in capital to
recognize this beneficial conversion feature. The discount on the Debentures
resulting from the allocation of proceeds to the value of the warrants,
Preferred Stock Rights and beneficial conversion will be amortized as a charge
to interest expense over the four-year period until the Debentures become due in
March 2006.

4. Commitments and Contingencies:

Litigation

      In July, August and September 2000, several purported class action
complaints were filed against the Company and certain of the Company's former
executives (collectively, the "defendants"). These complaints have since been
combined into a single consolidated amended complaint (the "complaint"). The
complaint alleges that between February 7, 2000 and August 23, 2000, the
defendants made false and misleading statements, which had the effect of
inflating the market price of the Company's stock, in violation of Sections
10(b) and 20(a) of the Securities Exchange Act of 1934. The complaint does not
specify the amount of damages sought. The Company believes that the plaintiffs'
claims are without merit and intends to defend against these allegations
vigorously. The Company has filed a motion to dismiss the complaint, which is
now pending before the court. The Company expects that a substantial portion of
the legal costs that it has incurred and may continue to incur related to this
matter will be paid by its directors' and officers' insurance policy. The
Company cannot presently determine the ultimate outcome of this action. A
negative outcome could have a material adverse effect on the Company's financial
position or results of operations. Failure to prevail in the litigation could
result in, among other things, the payment of substantial monetary damages, in
excess of any amounts paid by the Company's directors' and


                                       12
<PAGE>

officers' insurance. The Company has not recorded any liability related to this
matter in the accompanying balance sheets as of December 31, 2001 and June 30,
2002.

      The Company is periodically a party to disputes arising from normal
business activities including various employee-related matters. In the opinion
of management, resolution of these matters will not have a material adverse
effect upon the Company's financial position or future operating results.

5. Subsequent Events:

      A significant customer of the Company, WorldCom, filed for bankruptcy on
July 21, 2002. WorldCom represented approximately $12.3 million and $7.6 million
in revenue for the years ended December 31, 2000 and 2001, respectively, and
approximately $1.3 million and $2.3 million in revenue for the three months
ended March 31, 2002 and June 30, 2002, respectively. As of June 30, 2002,
WorldCom owed the Company approximately $1.3 million that is included in
accounts receivable in the accompanying balance sheet. The Company received a
subsequent payment from WorldCom prior to bankruptcy for approximately $700,000.
The remaining accounts receivable balance of approximately $650,000 will be
written off against the allowance for bad debts during the three months ended
September 30, 2002, which was $1.1 million as of June 30, 2002. Any future
recoveries of these to-be-written-off receivables will be recorded when and if
they are received.

      Due to the relationship that the Company has with WorldCom and its
customers, the Company is continuing to sell products to WorldCom in bankruptcy.
The Company has taken steps to limit its financial exposure. In July 2002, the
Company signed an amendment to its agreement with WorldCom that established new
terms and conditions under which the Company will conduct business with WorldCom
during the bankruptcy. WorldCom agreed to payment terms of 15 calendar days
after the receipt of products and is currently subject to an overall credit
limit of $1.0 million.


                                       13
<PAGE>

Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations

Overview

      From our incorporation in August 1993 through December 1996, our principal
objective was to secure sufficient equity financing to enable us to accelerate
product development efforts of Visual UpTime for frame relay deployment and
create the infrastructure necessary to support these efforts. We first shipped
Visual UpTime in mid-1995 and began generating significant revenue during 1996.
Since our inception, we have focused on establishing relationships with service
providers with the goal of having these service providers include our products
into their infrastructure or in their service offerings to their subscribers.
Consistent with this goal, we have established agreements with AT&T, Equant,
Sprint and WorldCom. During 1998, 1999 and 2000, we continued to focus on
selling Visual UpTime, and added to the following products: the Net2Net product,
Cell Tracer, in 1998; the Inverse products, Visual IP InSight and Visual
Internet Benchmark, in 1999; and the Avesta products, Visual Trinity and Visual
eWatcher, in 2000. During 2001, we discontinued development and sales efforts of
Visual Trinity and sold the Visual Internet Benchmark service. During 2001, we
began evaluating our Visual eWatcher product, which, to date, has not generated
significant revenue. We believe the web performance management functionality of
this product may be valuable, and we are exploring alternatives. During the six
months ended June 30, 2002, we amended our agreement with Network Associates,
Inc. (NAI) for the Cell Tracer product so that NAI received the source code for
the Visual Cell Tracer product to allow it to support and modify the product. As
a result of decreased demand from NAI, we anticipate that NAI will place final
orders with us by early 2003, and we do not anticipate any significant revenue
from the sale of this product to other customers. We continue to focus on sales
of Visual UpTime and Visual IP InSight. In response to these events, we have
revised our business plan to reflect lower projected revenues and reduced our
operating expenses to a level that we believe is sufficient to allow us to
remain profitable if we are able to achieve revenues of $14.0 million to $15.0
million each quarter and meet our target operating margins.

      We acquired Avesta Technologies on May 24, 2000. We believed that the
acquisition of Avesta would provide critical pieces to our articulated strategy
to become one of the largest service management vendors with one of the
industry's broadest portfolios of products and functionality. We also
anticipated that the merger would bring us closer to providing a single-vendor
solution to the internet infrastructure management needs of customers,
especially the integration of networks, systems and applications into a unified
service view for service providers and their enterprise subscribers. We expected
to generate revenue from the Avesta products of approximately $30 million in
2000. Instead, these products generated revenues of only $7.3 million in 2000,
and significantly increased our operating expenses. Subsequent to the
acquisition, we concluded that, without significant modifications, the primary
Avesta product, Trinity, was not a viable solution for our strategic service
provider customers. The product was more specifically targeted to direct
enterprise customers, which did not fit with our service provider focused
business plan. As a result of an analysis performed by a company-wide task
force, we determined that the time and expense required to make the Visual
Trinity product competitive in its market space and more suitable to our service
provider customers would be prohibitive. These factors, in conjunction with
revenue declines in our other products, resulted in a $328.8 million impairment
charge and $7.0 million in restructuring charges in 2000. In 2001, we
discontinued the Visual Trinity product, resulting in $3.3 million in additional
impairment charges related to the remaining intangible assets from the Avesta
acquisition, $3.7 million in a write down related to an investment that was
acquired with Avesta that was determined to be impaired as of December 31, 2001
and $2.3 million (net of reversals) in restructuring charges. We did not have
any significant remaining assets related to Avesta included in our balance sheet
as of December 31, 2001.

      Following the acquisition of Avesta, we allowed our business strategy to
become less focused, which increased the complexity of our business and
adversely affected our results of operations. We incurred significant losses
from the second quarter of 2000 through the fourth quarter of 2001. The
deterioration of our operating results that began in 2000, excluding the effects
of the impairment and restructuring charges and the write-off of in-process
research and development, was due primarily to decreased revenue and increased
operating expenses following the Avesta acquisition. In response, we made
significant reductions in operating expenses in the remainder of 2000, 2001 and
2002 resulting from the closure of three facilities and the reduction of our
workforce by approximately 270 employees from October 2000 to June 2002,
including approximately 40 of whom were terminated during the six months ended
June 30, 2002.

      We returned to profitability for the three and six months ended June 30,
2002. However, we have continued to experience declining revenue from $37.7
million for the six months ended June 30, 2001 to $32.0 million for the six
months ended June 30, 2002. The revenue decrease included a reduction in the
sale of each of our major products. The decrease included $561,000 in revenue
from the Cell Tracer product, which consisted almost entirely of reduced demand
from NAI. Visual UpTime revenue decreased by $4.0 million decrease in Visual
UpTime revenue reflecting: 1) the overall downturn in the telecommunications
industry, which was reflected in a slowdown in demand for telecommunications
products and services, including those based on our products and 2) our


                                       14
<PAGE>

service provider customers, specifically AT&T, and their tighter inventory
control. Revenue from the Visual IP InSight product increased $3.1 million due
to a $3.5 million sale to Verizon, offset by decreases in revenue from other
customers. Exclusive of the sale to Verizon, we have seen a decline in Visual IP
InSight revenue resulting from both the bankruptcies of many of the new Internet
Service Providers that were our primary targets for Visual IP InSight, and the
events of September 11, 2001, which caused a slowdown in acquisition and
deployment of telecommunications products and services, including those based on
Visual IP InSight. The $4.5 million decrease in revenue from Visual eWatcher,
Visual Internet Benchmark and Visual Trinity reflects, respectively, the reduced
sales and marketing focus on Visual eWatcher as we evaluated prospects for that
technology, the sale of Visual Internet Benchmark and the discontinuation of
sales of Visual Trinity.

      In response to our revenue decreases, we have focused on implementing a
comprehensive plan to strengthen our business by:

      o     Strengthening our product portfolio - During the six months ended
            June 30, 2002, we released Visual UpTime 7.0, and we introduced the
            Visual IP InSight Dedicated Suite (Internet Service Element or ISE)
            which gives service providers and their enterprise customers
            improved capabilities to monitor network performance, decrease
            problem resolution time, increase the availability of networked
            services and reduce operational costs. During 2001, we released
            Visual 6.0 and IP Insight 5.5 and eliminated Visual Trinity and
            Visual Internet Benchmark;

      o     Strengthening our senior management team - During 2001, Elton King
            was hired as President and Chief Executive Officer and in January
            2002, John Saunders became our Chief Financial Officer;

      o     Concentrating our sales, marketing, research and product development
            initiatives around service providers and their end user customers -
            We established a new service provider relationship with Equant for
            IP-VPN services worldwide and increased our total revenue from our
            service provider channels, as a percentage of total revenue, from
            81% for the six months ended June 30, 2001 to 87% for the six months
            ended June 30, 2002;

      o     Focusing on our Make It Visual Partnership Program - In February
            2002, we announced a plan to deliver an integrated service
            management solution for Cisco ATM products; and in 2001, we began to
            deliver a comprehensive ATM managed service solution to Kentrox
            customers; and

      o     Reducing our operating expenses - We have reduced our workforce by
            approximately 270 people since October 2000, closed our facilities
            in Ottawa, Canada; Sunnyvale, California; and New York, New York;
            and subleased a portion of our facilities in Rockville, Maryland
            resulting in a 39% reduction in operating expenses (excluding
            charges related to acquisitions and restructuring and impairment),
            from $34.8 million for the six months ended June 30, 2001 to $21.4
            million for the six months ended June 30, 2002.

      Based on our current cost structure, our ability to generate operating
income in the future is, in large part, dependent on our success in achieving
quarterly revenue of at least $14.0 million to $15.0 million, achieving
quarterly gross margins of 70% to 75% and maintaining or further reducing
operating expenses. Due to market conditions, competitive pressures, and other
factors beyond our control, there can be no assurances that we will be able to
meet these goals. In the event that the anticipated revenue goals are not met,
we may be required to further reduce our cost structure.

      We have addressed those factors that have caused revenue to decline and
that are within our control. We have refocused our sales, marketing and other
efforts on our core Visual UpTime and Visual IP InSight products and our core
service provider customers. We have directed our Visual IP InSight development
efforts at making the product more suitable for our core service provider
customers and enabling the use of our product in higher-margin broadband
networks over, for example, cable lines and Digital Subscriber Lines (DSL). We
have also aggressively reduced our operating expenses to be more in line with
our reduced revenue projections. While we do not know when the downturn in
telecommunications industry will end, or how robust the recovery will be once it
does begin, we have revised our business plan to reflect lower projected
revenues and reduced our operating expenses as we seek to remain profitable even
with this reduced demand. There can be no assurance that we will remain
profitable.

      Our business may be adversely affected by WorldCom's bankruptcy. WorldCom,
one of our significant customers, filed for bankruptcy on July 21, 2002.
WorldCom represented $12.3 million and $7.6 million of our revenue for the years
ended December 31, 2000 and 2001, respectively, and $1.3 million and $2.3
million of our revenue for the three months ended March 31, 2002 and June 30,
2002, respectively. As of June 30, 2002, WorldCom owed us approximately $1.3
million that is included in accounts receivable in the accompanying balance
sheet. We received a subsequent payment from WorldCom prior to bankruptcy for
approximately $700,000. The remaining accounts receivable balance of
approximately $650,000 will be written off against the allowance for bad


                                       15
<PAGE>

debts during the three months ended September 30, 2002, which was $1.1 million
as of June 30, 2002. Any future recoveries of these to-be-written-off
receivables will be recorded when and if they are received.

      Due to our relationship with WorldCom and its customers, we are continuing
to sell products to WorldCom in bankruptcy. However, we have taken steps to
limit our financial exposure. In July 2002, we signed an amendment to our
agreement with WorldCom that established new terms and conditions under which we
will conduct business with WorldCom during the bankruptcy. WorldCom agreed to
payment terms of 15 calendar days after the receipt of products and is currently
subject to an overall credit limit of $1.0 million. Although we intend to
continue doing business with WorldCom under the new arrangement, we are
uncertain how the recent events reported by WorldCom will impact our revenue
going forward.

      We face risks of delayed orders from another significant customer, Equant,
due to its slower than expected deployment of our products. This may result in a
delay of orders from Equant. Equant represented $2.4 million, or 7.6%, of
revenue for the six months ended June 30, 2002. Due to the slower deployment,
revenue from this customer may be reduced for the remainder of 2002.

      Our business may also be impacted if we fail to comply with Nasdaq listing
standards. We recently moved the trading of our common stock to the Nasdaq Small
Cap Market. To maintain the listing on this market, we are required to meet
certain listing requirements, including a minimum bid price of $1.00 per share.
If our stock is traded below the minimum bid price of $1.00 for 30 consecutive
trading days, we would receive a deficiency notice and, assuming we continue to
satisfy the other Nasdaq listing requirements, would have a grace period of 180
calendar days to cure the deficiency by meeting the minimum bid price per share
trading price for 10 consecutive trading days. As of August 15, 2002, we have
been trading below $1.00 for 21 consecutive trading days. There can be no
assurance that we will return to compliance with the minimum bid price. If we
fail to meet the minimum bid price for 10 consecutive days during the grace
period our common stock may be delisted from the Nasdaq Small Cap Market. Even
if we are able to comply with the minimum bid requirement, there is no assurance
that in the future we will continue to satisfy Nasdaq listing requirements, with
the result that our common stock may be delisted. Should our common stock be
delisted from the Nasdaq Small Cap Market, it would likely be traded on the
so-called "pink sheets" or the "Electronic Bulletin Board" maintained by the
National Association of Securities Dealers, Inc. Consequently, it would likely
be more difficult to trade in or obtain accurate quotations as to the market
price of our common stock. Furthermore, if we are no longer listed on the Nasdaq
Small Cap Market, our $10.5 million of outstanding debentures may be accelerated
and become immediately due and payable upon demand by the debenture holders.

Results of Operations

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

<TABLE>
<CAPTION>
                                                                           Three Months Ended           Six Months Ended
                                                                                June 30,                      June 30,
                                                                          -------------------         -------------------
                                                                           2001          2002          2001          2002
                                                                          -----         -----         -----         -----
<S>                                                                       <C>           <C>           <C>           <C>
         Revenue:
           Hardware revenue .......................................        71.9%         57.6%         70.8%         61.9%
           Software revenue .......................................         4.9          24.3           3.5          15.9
           Support and services revenue ...........................        23.2          18.1          25.7          22.2
                                                                          -----         -----         -----         -----
                   Total revenue ..................................       100.0         100.0         100.0         100.0
                                                                          -----         -----         -----         -----
         Cost of revenue:
           Product cost of revenue ................................        35.5          20.2          31.3          22.8
           Support and services cost of revenue ...................        10.3           3.8          11.8           4.2
                                                                          -----         -----         -----         -----
                   Total cost of revenue ..........................        45.8          24.0          43.1          27.0
                                                                          -----         -----         -----         -----
           Gross profit ...........................................        54.2          76.0          56.9          73.0
                                                                          -----         -----         -----         -----
         Operating expenses:
           Research and development ...............................        26.4          20.6          29.6          20.2
           Sales and marketing ....................................        44.9          34.6          49.3          35.0
           General and administrative .............................        11.6          13.0          13.3          11.6
           Restructuring and impairment charges ...................        30.9            --          16.6            --
           Amortization of goodwill and other intangibles .........         1.6            --           2.1            --
                                                                          -----         -----         -----         -----
                   Total operating expenses .......................       115.4          68.2         110.9          66.8
                                                                          -----         -----         -----         -----
         Income (loss) from operations ............................       (61.2)          7.8         (54.0)          6.2
         Interest income (expense), net ...........................         0.5          (2.4)          1.0          (1.5)
                                                                          -----         -----         -----         -----
         Net income (loss) ........................................       (60.7)%         5.4%        (53.0)%         4.7%
                                                                          =====         =====         =====         =====
</TABLE>

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


                                       16
<PAGE>

<TABLE>
<CAPTION>
                                                                              Three Months Ended         Six Months Ended
                                                                                   June 30,                  June 30,
                                                                             --------------------      --------------------
                                                                               2001         2002         2001         2002
                                                                             -------      -------      -------      -------
<S>                                                                          <C>          <C>          <C>          <C>
         Visual UpTime ................................................      $15,450      $10,446      $28,109      $24,063
         Visual Cell Tracer ...........................................          854            1        1,329          768
         Visual IP InSight ............................................        1,600        4,261        2,696        5,813
         Royalties ....................................................           --          194           --          282
                                                                             -------      -------      -------      -------
               Continuing products ....................................       17,904       14,902       32,134       30,926
         Visual Internet Benchmark ....................................        1,269          235        2,658          630
         Visual Trinity and eWatcher ..................................        1,156           72        2,923          446
                                                                             -------      -------      -------      -------
               Discontinued products ..................................        2,425          307        5,581        1,076
                                                                             -------      -------      -------      -------
               Total  revenue .........................................      $20,329      $15,209      $37,715      $32,002
                                                                             =======      =======      =======      =======
</TABLE>

      The following table presents the hardware, software, and support and
services revenue attributable to customers that individually represented more
than 10% of our total revenue for each period presented (unaudited, in
thousands):

<TABLE>
<CAPTION>
                                                                              Three Months Ended         Six Months Ended
                                                                                   June 30,                  June 30,
                                                                             --------------------      --------------------
                                                                               2001         2002         2001         2002
                                                                             -------      -------      -------      -------
<S>                                                                          <C>          <C>          <C>          <C>
         AT&T .........................................................      $ 7,179      $ 5,376      $11,813      $11,017
         Interlink Communications Systems Inc. ........................            *            *        3,627            *
         Sprint .......................................................        2,161            *        5,171            *
         Verizon ......................................................            *        4,054            *        4,655
         WorldCom .....................................................        2,189        2,282        4,125        3,585
         All other customers (each individually less than 10%) ........        8,800        3,497       12,979       12,745
                                                                             -------      -------      -------      -------
          Total revenue ...............................................      $20,329      $15,209      $37,715      $32,002
                                                                             =======      =======      =======      =======
</TABLE>

        *Less than 10%

      Revenues from three of our major customers, AT&T, Sprint and WorldCom,
declined $0.8 million, $3.1 million and $0.5 million, respectively, for the six
months ended June 30, 2002 compared to the six months ended June 30, 2001. This
revenue decrease was partially offset by increased revenue of $2.9 million from
Verizon for the six months ended June 30, 2002 compared to the six months ended
June 30, 2001. The reduction in AT&T revenue was the result of tighter inventory
control. We believe that the reduction in Sprint revenue was the result of a
loss of market share of Sprint to its competitors. We believe that the reduction
in WorldCom revenue was the result of reduced demand resulting from the overall
downturn in the telecommunications industry. The agreements with the Company's
significant customers do not obligate these customers to make any minimum
purchases from the Company.

      The recent events at WorldCom did not have a significant impact on revenue
from WorldCom for the six months ended June 30, 2002 because the events occurred
subsequent to product shipments and revenue recognition. However, there is a
risk that these events could affect our future revenue.

      Our primary sales and marketing strategy depends predominantly on sales to
telecommunications service providers. Aspects of our service provider deployment
strategy depend on the sale of Visual UpTime and Visual IP InSight to service
providers for use as operations tools in their own network infrastructures. In
addition, our service provider deployment strategy depends on the sale of Visual
UpTime and Visual IP InSight to service providers for resale and as the basis
for value-added services to their customers. Pressure on capital expenditures
and the decline in the telecommunications markets may delay the roll-out of new
services based on our products. Furthermore, any potential reduction in demand
for value added services or products from the service providers' customers would
directly impact the volume of our products purchased.

      We expect that a significant portion of our revenue during the remainder
of 2002 will be attributable to sales of Visual UpTime and Visual IP InSight to
service providers. The loss of any one of AT&T, Equant, Sprint or WorldCom,
which together have historically provided a majority of our revenue, would
result in a substantial loss of revenue that could have a material adverse
effect on our business. Existing service provider customers are not easily
replaced because of the relatively few participants in that market. High
barriers to entry due to extraordinary capital requirements and the increased
potential that existing service providers may merge or fail because of the
current downturn in the telecommunications industry may further reduce their
number, and would make replacing a significant service provider customer very
difficult. Furthermore, our small number of service provider customers means
that the reduction, delay or cancellation of orders or a delay in shipment of
our products to any one service provider customer could have a material adverse
effect on our revenue for a quarter. Our anticipated dependence on sizable
orders from a limited number of


                                       17
<PAGE>

service providers will make the relationship between us and each service
provider critically important to our business. Both AT&T and WorldCom posted
losses in their most recent quarterly reports. These losses, coupled with
WorldCom's bankruptcy, have created uncertainty about potential changes in the
buying habits of these key customers. We currently have contracts with all of
our material customers and such contracts generally have automatic renewal
provisions. Further, because none of our agreements contain minimum purchase
requirements, there can be no assurance that the issuance of a purchase order
will result in significant recurring business. There can be no assurance that
our customers will not elect to terminate and renegotiate these contracts
seeking more favorable terms.

      Our operations and financial position are subject to certain other risks
and uncertainties, including among others, our accumulated deficit, uncertainty
of future profitability and possible fluctuations in financial results,
substantial fixed operating costs, possible dilution to our common stockholders
due to the conversion features of our convertible debentures, dependence on
sales to key customers, dependence on WorldCom as a significant customer,
dependence on a sole-source subcontract manufacturer, potential delisting and
reduced liquidity of our shares resulting from failure to meet the Nasdaq
listing requirements, the potential triggering of early repayment of our
debentures, the downturn in the telecommunications industry, long sales cycles,
improvements to the infrastructure of the Internet, rapid technological change,
growing competition from several market segments, errors in our products,
dependence upon sole and limited source suppliers and fluctuations in component
pricing, claims of patent infringement by third parties, failure to protect our
intellectual property rights, dependence upon key employees, ability to retain
employees and the defense of a purported class action lawsuit. Failure to meet
any of these and other challenges could adversely affect our future operating
results.

Results of Operations for the Three Months Ended June 30, 2002 Compared with the
Three Months Ended June 30, 2001

      Revenue

      Our revenue can be divided into three types: hardware revenue, software
revenue and support and services revenue. Each of our products has components of
each revenue type. Sales of Visual UpTime are primarily classified as hardware
revenue. We also sell licenses related to Visual UpTime that are classified as
software revenue. Sales of Cell Tracer are classified as hardware revenue. Sales
of Visual IP InSight are primarily classified as software revenue. However,
sales of our newest hardware product, the ISE, which embeds certain Visual IP
InSight functionality in a hardware device, are classified as hardware revenue.
Sales of our Visual IP InSight subscription service, which we no longer offer to
our customers, were classified as support and services revenue. Sales of Visual
eWatcher are classified as software revenue. Sales of Visual Trinity, prior to
discontinuation in May 2001, were classified as software revenue. Sales of the
Visual Internet Benchmark service, prior to sale of that product in June 2001,
were classified as support and services revenue. Royalties from the Visual
Internet Benchmark service are classified as support and services revenue. Sales
of technical support, professional services and training for all of our products
are classified as support and services revenue.

      Total revenue was $20.3 million for the three months ended June 30, 2001
compared to $15.2 million for the three months ended June 30, 2002, a decrease
of $5.1 million. Sales to all service providers increased from approximately 79%
of revenue for the three months ended June 30, 2001 to 93% for the three months
ended June 30, 2002. We anticipate that the percentage of revenue attributable
to our service providers for the remainder of 2002 may decrease from the levels
achieved during the three months ended June 30, 2002 to levels more consistent
with the levels achieved for the three months ended June 30, 2001. This
anticipated decrease is based on a significant Visual IP InSight sale to a
service provider during the three months ended June 30, 2002 that is not
expected to be a recurring event.

      Hardware revenue. Hardware revenue was $14.6 million for the three months
ended June 30, 2001 compared to $8.8 million for the three months ended June 30,
2002, a decrease of $5.8 million. The overall decrease was due to decreased
demand for Visual UpTime and Cell Tracer. We did not have any significant
revenue from the ISE for the three months ended June 30, 2002. The decrease in
Cell Tracer revenue of $0.9 million, from one customer, NAI was attributable to
reduced demand from NAI. We anticipate that NAI will place final orders with us
by early 2003, and we do not anticipate any significant revenue from the sale of
this product to other customers. The decrease in sales of Visual UpTime,
primarily from service providers and value-added resellers, of $5.4 million was
primarily attributable to a decrease in purchases from AT&T, Sprint and
WorldCom. The reduction in AT&T revenue was the result of tighter inventory
control. We believe the reduction in Sprint revenue was the result of a loss of
market share of Sprint to its competitors. We believe the reduction in WorldCom
revenue was the result of reduced demand resulting from the overall downturn in
the telecommunications industry. The recent events at WorldCom did not have a
significant impact on revenue from WorldCom for the three months ended June 30,
2002 because the events occurred subsequent to product shipments and revenue
recognition. However, there is a risk that WorldCom's bankruptcy could have an
impact on our future revenue.

      Software revenue. Software revenue was $1.0 million for the three months
ended June 30, 2001 compared to $3.7 million for the


                                       18
<PAGE>

three months ended June 30, 2002, an increase of $2.7 million. A significant
sale of Visual IP Insight to Verizon resulted in $3.5 million of the $3.7
million total software revenue during the three months ended June 30, 2002. This
increase is partially offset by a decrease in revenue from the Visual Trinity
product, the primary product acquired from Avesta, resulting from the
discontinuation of that product. As a result of the discontinuation of the
Visual Trinity product, we anticipate that future revenue for the product will
consist primarily of technical support revenue, all of which is currently
included in deferred revenue. We plan to provide technical support for the
Visual Trinity product through September 2002.

      Support and services revenue. Support and services revenue was $4.7
million for the three months ended June 30, 2001 and $2.7 million for the three
months ended June 30, 2002, a decrease of $2.0 million. The decrease in support
and services revenue was primarily attributable to decreased revenue from
support of the Visual Trinity product of $1.1 million and Visual Internet
Benchmark of $1.0 million due to expired contracts that have not renewed as a
result of the discontinuation of these products during the three months ended
June 30, 2001. Subscription fees for Visual IP InSight decreased by $0.6 million
as customers have migrated to a perpetual license for that product. Since June
30, 2001, we sell Visual IP InSight as a software license only. Prior to June
30, 2001, we offered both a subscription service and a software license for that
product. These decreases are partially offset by increased technical support
revenue for Visual IP InSight and the larger installed base of our Visual UpTime
product for which we are selling technical support. We will continue to
recognize revenue from the Visual Internet Benchmark service that was sold
during 2001, for existing contracts under which we are still required to perform
services through May 2003, most of which is currently in deferred revenue. We
also receive royalty payments from the purchaser on new contracts.

      Cost of revenue and gross profit

      Cost of revenue consists of subcontracting costs, component parts,
warehouse costs, direct compensation costs, communication costs, warranty and
other contractual obligations, royalties, license fees and other overhead
expenses related to manufacturing operations and support of our software
products and benchmark services.

      Total cost of revenue was $9.3 million for the three months ended June 30,
2001 compared to $3.7 million for the three months ended June 30, 2002, a
decrease of $5.6 million. Gross profit was $11.0 million for the three months
ended June 30, 2001 compared to $11.6 million for the three months ended June
30, 2002, an increase of $0.6 million. Gross profit margin was 54.2% of revenue
for the three months ended June 30, 2001 as compared to 76.0% of revenue for the
three months ended June 30, 2002. The increase in gross profit margin was
primarily attributable to a significant Visual IP InSight sale, overall high
margin of our new Visual UpTime 7.0 release, decreased low margin Cell Tracer
revenue, decreased fixed costs such as fees paid to third parties to provide the
Visual IP InSight subscription service and Visual Internet Benchmark service to
customers for which we had existing contracts and overall decreased fixed costs
in our manufacturing and support operations due to our cost reduction
initiatives being implemented since the fourth quarter of 2000. Our gross
margins have been improving quarter over quarter since June 2001 as a result of
the changes and initiatives discussed above. These margins were 54.2%, 63.0%,
65.0%, 70.1% and 76.0% for the three months ended June 30, 2001, September 30,
2001, December 31, 2001, March 31, 2002 and June 30, 2002, respectively. Our
future gross margins may be affected by a number of factors, including product
mix, the proportion of sales to service providers, competitive pricing,
manufacturing volumes and an increase in the cost of component parts. Based on
our current product offerings and the level of fixed cost reductions that has
been achieved to date, we expect our future margins to be in the range of 70% to
75%.

      Product cost of revenue. Product cost of revenue, which includes both
hardware and software cost of revenue, was $7.2 million for the three months
ended June 30, 2001 compared to $3.1 million for the three months ended June 30,
2002, a decrease of $4.1 million. Our software costs of revenue are
insignificant. The gross profit margin attributable to products was 53.9% for
the three months ended June 30, 2001 and 75.4% for the three months ended June
30, 2002. The increase in gross profit margin was primarily attributable to a
significant Visual IP InSight sale, overall high margin of our new Visual UpTime
7.0 release, decreased low margin Cell Tracer revenue and overall decreased
fixed costs in our manufacturing and support operations due to our cost cutting
initiatives being implemented since the fourth quarter of 2000.

      Support and services cost of revenue. Support and services cost of
revenue, which includes Visual Internet Benchmark services, Visual IP InSight
subscription services, professional services and technical support costs, was
$2.1 million for three months ended June 30, 2001 compared to $0.6 million for
the three months ended June 30, 2002, a decrease of $1.5 million. The gross
profit margin attributable to support and services was 55.5% for the three
months ended June 30, 2001 and 78.9% for the three months ended June 30, 2002.
The increase in gross profit margin was primarily due to decreased fixed costs
such as fees paid to third parties to provide the Visual IP InSight subscription
service and Visual Internet Benchmark service to customers for which we had
existing contracts.

      Research and development expense. Research and development expense
consists of compensation for research and development


                                       19
<PAGE>

staff, depreciation of test and development equipment, certain software
development costs and costs of prototype materials. Research and development
expense was $5.4 million for the three months ended June 30, 2001 compared to
$3.1 million for the three months ended June 30, 2002, a decrease of $2.3
million. The decrease in research and development expense was due primarily to
the full period effect of workforce reductions and facility closures during 2001
and additional workforce reductions during 2002. Research and development
expense was 26.4% and 20.6% of revenue for the three months ended June 30, 2001
and 2002, respectively. For the remainder of 2002, we intend to incur research
and development expense at or below the level of such expense in the second
quarter of 2002 as a result of our continued focus on the control of operating
expenses.

      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 $9.1 million for the three months ended June 30,
2001 compared to $5.3 million for the three months ended June 30, 2002, a
decrease of $3.8 million. The decrease in sales and marketing expense was due
primarily to the full period effect of workforce reductions and facility
closures during 2001 and 2002. Sales and marketing expense was 44.9% and 34.6%
of revenue for the three months ended June 30, 2001 and 2002, respectively. For
the remainder of 2002, we intend to incur sales and marketing expense at or
below the level of such expense in the second quarter of 2002 as a result of our
continued focus on the control of operating expenses.

      General and administrative expense. General and administrative expense
consists of the costs of executive management, finance, administration and other
activities. General and administrative expense was $2.3 million for the three
months ended June 30, 2001 compared with $2.0 million for the three months ended
June 30, 2002, a decrease of $0.3 million. The decrease in general and
administrative expense was due primarily to the bad debt expense of $0.5 million
recorded to cover our anticipated financial exposure from WorldCom and the full
period effect of workforce reductions and facility closures during 2001 and
additional workforce reductions during 2002. General and administrative expense
was 11.6% and 13.0% of revenue for the three months ended June 30, 2001 and
2002, respectively. For the remainder of 2002, we intend to incur general and
administrative expense at or below the level of such expense in the second
quarter of 2002 or decrease them in absolute dollars during 2002 as a result of
our continued focus on the control of operating expenses.

      Restructuring and impairment charges. We reversed approximately $0.7
million of prior period restructuring charges in the three months ended June 30,
2001. The reversal resulted primarily from the lower than estimated costs
related to facility closings. We recorded a restructuring charge in the three
months ended June 30, 2001 in the amount of $3.9 million related primarily to a
workforce reduction of approximately 50 employees and the closure of our New
York facility as a result of the discontinuation of the Visual Trinity product.
We recorded an impairment charge of $3.1 million in the three months ended June
30, 2001 for the write-off of intangible assets related to the Avesta
acquisition. There have been no restructuring or impairment charges in 2002.
Costs associated with the workforce reductions in 2002 have been charged to
operating expenses as incurred.

      Amortization of acquired intangibles. We recorded $319,000 in amortization
of goodwill and other intangibles during the three months ended June 30, 2001
related to the Avesta acquisition. All amounts of goodwill and other intangible
assets were amortized or written-off as of December 31, 2001. Therefore, no
amortization was recorded during the three months ended June 30, 2002.

      Interest income (expense), net. Interest income, net, was $97,000 for the
three months ended June 30, 2001 compared to expense of $0.4 million for the
three months ended June 30, 2002. The decrease of $0.5 million was primarily due
to both cash and non-cash interest expense related to the convertible debentures
we issued in March 2002 (see Note 3).

      Net income (loss). Net loss for the three months ended June 30, 2001 was
$12.3 million as compared to net income of $0.8 million for the three months
ended June 30, 2002, an increase in income of $13.1 million. The increase was
due primarily to decreases in operating expenses, restructuring and impairment
charges and amortization of intangible assets offset by decreased revenue.

Results of Operations for the Six Months Ended June 30, 2002 Compared with the
Six Months Ended June 30, 2001

      Revenue

      Total revenue was $37.7 million for the six months ended June 30, 2001
compared to $32.0 million for the six months ended June 30, 2002, a decrease of
$5.7 million. Sales to all service providers increased from approximately 81% of
revenue for the six months ended June 30, 2001 to 87% for the six months ended
June 30, 2002. We anticipate that the percentage of revenue attributable to our
service providers for the remainder of 2002 may decrease from the levels
achieved during the six months ended June 30, 2002. This anticipated decrease is
based on a significant IP InSight sale to a service provider during the six
months ended June 30, 2002 that is not expected to be a recurring event.


                                       20
<PAGE>

      Hardware revenue. Hardware revenue was $26.7 million for the six months
ended June 30, 2001 compared to $19.8 million for the six months ended June 30,
2002, a decrease of $6.9 million. As a result, the overall decrease was due to
decreased demand for Visual UpTime and Cell Tracer. We did not have any
significant revenue from the ISE for the six months ended June 30, 2002. The
decrease in Cell Tracer revenue of $0.6 million, from NAI, was attributable to
reduced demand from NAI. The decrease in sales of Visual UpTime, primarily from
service providers and value-added resellers, of $4.0 million was primarily
attributable to a decrease in purchases from AT&T, Sprint and WorldCom. The
reduction in AT&T revenue was the result of tighter inventory control. We
believe the reduction in Sprint revenue was the result of a loss of market share
of Sprint to its competitors. We believe the reduction in WorldCom revenue was
the result of reduced demand resulting from the overall downturn in the
telecommunications industry. The recent events at WorldCom did not have a
significant impact on revenue from WorldCom for the six months ended June 30,
2002 because the events occurred subsequent to product shipments and revenue
recognition. However, there is a risk that WorldCom's bankruptcy could have an
impact on our future revenue.

      Software revenue. Software revenue was $1.3 million for the six months
ended June 30, 2001 compared to $5.1 million for the six months ended June 30,
2002, an increase of $3.8 million. A significant sale of Visual IP Insight to
Verizon resulted in $3.5 million of the $5.1 million total software revenue
during the six months ended June 30, 2002. This sale is the primary source of
the increase. This increase is partially offset by a decrease in revenue from
the Visual Trinity product, the primary product acquired from Avesta, resulting
from the discontinuation of that product.

      Support and services revenue. Support and services revenue was $9.7
million for the six months ended June 30, 2001 and $7.1 million for the six
months ended June 30, 2002, a decrease of $2.6 million. The decrease in support
and services revenue was primarily attributable to decreased revenue from the
Visual Trinity product of $2.5 million and Visual Internet Benchmark of $2.0
million due to expired contracts that have not renewed as a result of the
discontinuation of these products during the three months ended June 30, 2001.
Subscription fees for Visual IP InSight decreased by approximately $1.2 million
as customers have migrated to a perpetual license for that product. Since June
30, 2001, we sell Visual IP InSight as a software license only. Prior to June
30, 2001, we offered both a subscription service and a software license for that
product. These combined decreases are offset by the larger installed base of our
Visual UpTime product for which we are selling technical support.

      Cost of revenue and gross profit

      Total cost of revenue was $16.3 million for the six months ended June 30,
2001 compared to $8.6 million for the six months ended June 30, 2002, a decrease
of $7.7 million. Gross profit was $21.5 million for the six months ended June
30, 2001 compared to $23.4 million for the six months ended June 30, 2002, an
increase of $1.9 million. Gross profit margin was 56.9% of revenue for the six
months ended June 30, 2001 as compared to 73.0% of revenue for the six months
ended June 30, 2002.

      Product cost of revenue. Product cost of revenue was $11.8 million for the
six months ended June 30, 2001 compared to $7.3 million for the six months ended
June 30, 2002, a decrease of $4.5 million. Our software costs of revenue are
insignificant. The gross profit margin attributable to products was 57.9% for
the six months ended June 30, 2001 and 70.7% for the six months ended June 30,
2002. The increase in gross profit margin was primarily attributable to a
significant high margin Visual IP InSight sale, overall high margin of our new
Visual UpTime 7.0 release, decreased low margin Cell Tracer revenue and overall
decreased fixed costs in our manufacturing and support operations due to our
cost cutting initiatives resulting from our continued focus on the control of
our expenses.

      Support and services cost of revenue. Support and services cost of revenue
was $4.5 million for six months ended June 30, 2001 compared to $1.3 million for
the six months ended June 30, 2002, a decrease of $3.2 million. The gross profit
margin attributable to support and services was 53.9% for the six months ended
June 30, 2001 and 81.3% for the six months ended June 30, 2002. The increase in
gross profit margin was primarily due to decreased fixed costs to support the
Visual IP InSight subscription service and Visual Internet Benchmark service for
existing contracts such as fees paid to third parties to provide the Visual IP
InSight subscription service and Visual Internet Benchmark service to customers
for which we had existing contracts.

      Research and development expense. Research and development expense was
$11.2 million for the six months ended June 30, 2001 compared to $6.5 million
for the six months ended June 30, 2002, a decrease of $4.7 million. The decrease
in research and development expense was due primarily to the full period effect
of workforce reductions and facility closures during 2001 and additional
workforce reductions during 2002. Research and development expense was 29.6% and
20.2% of revenue for the six months ended June 30, 2001 and 2002, respectively.


                                       21
<PAGE>

      Sales and marketing expense. Sales and marketing expense was $18.6 million
for the six months ended June 30, 2001 compared to $11.2 million for the six
months ended June 30, 2002, a decrease of $7.4 million. The decrease in sales
and marketing expense was due primarily to the full period effect of workforce
reductions and facility closures during 2001 and 2002. Sales and marketing
expense was 49.3% and 35.0% of revenue for the six months ended June 30, 2001
and 2002, respectively.

      General and administrative expense. General and administrative expense was
$5.0 million for the six months ended June 30, 2001 compared with $3.7 million
for the six months ended June 30, 2002, a decrease of $1.3 million. The decrease
in general and administrative expense was due primarily to the bad debt expense
of $0.5 million recorded to cover our anticipated financial exposure from
WorldCom and the full period effect of workforce reductions and facility
closures during 2001 and additional workforce reductions during 2002. General
and administrative expense was 13.3% and 11.6% of revenue for the six months
ended June 30, 2001 and 2002, respectively.

      Restructuring and impairment charges. We reversed approximately $0.7
million of prior period restructuring charges in the six months ended June 30,
2001. The reversal resulted primarily from the lower than estimated costs
related to facility closings. We recorded a restructuring charge in the six
months ended June 30, 2001 in the amount of $3.9 million related primarily to a
workforce reduction of approximately 50 employees and the closure of our New
York facility as a result of the discontinuation of the Visual Trinity product.
We recorded an impairment charge of $3.1 million in the six months ended June
30, 2001 for the write-off of intangible assets related to the Avesta
acquisition. There have been no restructuring or impairment charges in 2002.
Costs associated with the workforce reductions in 2002 have been charged to
operating expenses as incurred.

      Amortization of acquired intangibles. We recorded $0.8 million in
amortization of goodwill and other intangibles during the six months ended June
30, 2001 related to the Avesta acquisition. All amounts of goodwill and other
intangible assets were amortized or written-off as of December 31, 2001.
Therefore, no amortization was recorded during the six months ended June 30,
2002.

      Interest income (expense), net. Interest income, net, was $0.4 million for
the six months ended June 30, 2001 compared to expense of $0.5 million for the
six months ended June 30, 2002. The decrease of $0.9 million was primarily due
to both cash and non-cash interest expense related to the convertible debentures
we issued in March 2002 (see Note 3) plus interest expense incurred on
borrowings under our line of credit facility prior to the issuance of the
convertible debentures.

      Net income (loss). Net loss for the six months ended June 30, 2001 was
$20.0 million as compared to net income of $1.5 million for the six months ended
June 30, 2002, an increase in income of $21.5 million. The increase was due
primarily to decreases in operating expenses, restructuring and impairment
charges and amortization of intangible assets offset by decreased revenue.

Liquidity and Capital Resources

      At December 31, 2001, our unrestricted cash balance was $5.9 million
compared to $6.6 million as of June 30, 2002, an increase of $0.7 million. This
increase is primarily attributable to $9.6 million in cash received from the
issuance of convertible debentures, net of issuance costs, in March 2002, offset
by cash used in operations as well as the payment of the outstanding balances
under our credit facility and capital leases. Net cash used in operating
activities during the six months ended June 30, 2002 was $6.3 million. We also
used cash of $0.6 million to purchase equipment and other fixed assets, made
principal payments on capital lease obligations of $0.3 million and made
principal payments on our credit facility obligations of $2.0 million. Cash
provided by the sale of common stock pursuant to the exercise of employee stock
options and our employee stock purchase plan was $0.3 million.

      We require substantial working capital to fund our business, particularly
to finance inventories, accounts receivable, research and development activities
and capital expenditures. To date, we have financed our operations and capital
expenditures primarily with the proceeds from our initial public offering
completed in February 1998, our operating income and the proceeds from the
issuance of convertible debentures in March 2002. In 2001, we became dependent
on cash that was provided by our bank under a credit facility. In addition, from
time to time, we have obtained advance payments in connection with certain
customer purchase orders. In the fourth quarter of 2001, we received an advance
payment of approximately $3.6 million that was classified as a customer deposit
in the accompanying consolidated balance sheet as of December 31, 2001; the
related customer orders were fulfilled in February 2002. We do not anticipate
receiving customer advance payments in the future. Our future capital
requirements will depend on many factors, including the rate of revenue growth,
if any, as well as our gross margin and our levels of operating expenses,
including product research and development, sales and marketing and general and
administrative expenses.

      Our revenue for the six months ended June 30, 2002 was $32.0 million,
which was a decrease of $5.7 million compared to the six months ended June 30,
2001. In response to the trends of decreasing revenue and increasing operating
expenses that began in the


                                       22
<PAGE>

second quarter of 2000 following our acquisition of Avesta, we initiated a
restructuring plan in the fourth quarter of 2000 to realign our product
portfolio, streamline our operations and devote resources to the markets and
products that we believe have the greatest opportunity for growth. In the second
quarter of 2001, we announced a plan to discontinue development and sales
efforts on the Visual Trinity product, the primary product acquired from Avesta,
and eliminate the related costs. In the fourth quarter of 2001 and first and
second quarters of 2002, we made additional reductions in staff and other
operating costs. As a result of these actions, operating expenses, excluding
charges related to acquisitions and restructuring and impairment charges, have
been reduced from a level of $34.8 million for the six months ended June 30,
2001 to $21.4 million for the six months ended June 30, 2002. As a result of our
cost reductions to date, we returned to profitability for the three and six
months ended June 30, 2002.

      Our ability to generate operating income in the future is dependent upon
not only our continued success in reducing operating expenses, but also our
ability to sustain revenue. General market conditions, competitive pressures and
other factors beyond our control may adversely affect our ability to generate
sufficient revenue to enable us to remain profitable. Our ability to sustain
revenue may be negatively affected by our dependence on sales to our service
providers. Pressure on capital expenditures and the decline in the
telecommunications industry may delay the roll-out of new services offered by
our service providers based on our products. Furthermore, any potential
reduction in demand for value added services or products from the service
providers' customers directly impacts the volume of our products purchased and
may impact our ability to sustain revenue. AT&T posted losses in its most recent
quarterly reports. We are uncertain as to whether these losses will affect the
buying habits of this key customer. However, we believe that our revenue goals
are achievable based on the role that our products have in directly enhancing
our service providers' product offerings and related profit margins and
mitigating such losses.

      The recent events at WorldCom did not have a significant impact on revenue
from WorldCom for the six months ended June 30, 2002 because the events occurred
subsequent to product shipments and revenue recognition. However, we anticipate
that WorldCom's bankruptcy could have a material adverse impact on our future
revenue. As of June 30, 2002, WorldCom owed us $1.3 million that is included in
accounts receivable in the accompanying balance sheet. We received a subsequent
payment from WorldCom prior to bankruptcy for approximately $0.7 million. The
remaining accounts receivable balance of approximately $0.7 million will be
written-off against the allowance for bad debts during the three months ended
September 30, 2002, which was $1.1 million as of June 30, 2002. Any future
recoveries of these to-be-written off receivables will be recorded when and if
they are received.

      The current level of our operating expenses, which include a substantial
fixed component in the form of compensation, other employee-related costs,
occupancy costs and other costs incurred under contractual arrangements, is
based, in part, on our expectation of future revenue. In the event that the
anticipated cost reductions are not realized or we do not meet our revenue
goals, we may be required to further reduce our cost structure. While we are
able to further reduce these expenses, should reductions become appropriate, it
would take at least thirty to sixty days for the full effects of any such
further expense reductions to be felt. If revenue levels are below expectations,
operating results are likely to be materially and adversely affected because we
may not be able to reduce operating expenses in sufficient time to compensate
for the reduction in revenue. There can be no assurances that we will be able to
sustain revenue or remain profitable. Failure to sustain revenue and remain
profitable coupled with our limited capital resources and significant
accumulated deficit could also result in our inability to continue as a going
concern.

      The significant operating losses incurred by us since the third quarter of
2000 have resulted in a significant reduction in our cash. In order to
strengthen our financial position and provide cash for working capital purposes,
in March 2002, we issued senior secured convertible debentures in the aggregate
amount of $10.5 million in a private placement. The debentures are due March 25,
2006, are payable in common stock or cash at our option provided certain
conditions are satisfied and bear interest at an annual rate of 5% payable
quarterly in common stock or cash at our option provided certain conditions are
satisfied. The debentures are secured by a first priority lien on substantially
all of our assets. The debentures may be converted initially into 2,986,093
shares of our common stock at the option of the holders at a price of $3.5163
per share, subject to certain adjustments. The conversion price will adjust if
we issue certain additional shares of our common stock or instruments
convertible into common stock at a price that is less than the conversion price
of the debentures. We have the right to require the holders to convert their
debentures into common stock if the closing price of our common stock exceeds
175% of the conversion price for 20 consecutive days after September 26, 2003.

      The debentures include certain financial covenants related to earnings
before interest, taxes, depreciation and amortization for 2002 and 2003. If the
financial covenants are not met, the holders may cause us to redeem the
debentures at a price equal to the principal amount of the debentures plus
accrued interest. The redemption may be made in common stock or cash at our
option provided certain conditions are satisfied. Cash redemption of the
debentures also may be required upon a specified change of control or upon the
occurrence of any one of the other triggering events, including but not limited
to, our default on other indebtedness and our failure to maintain our common
stock listing on an eligible market. In the event that the financial covenant
for 2002 is achieved,


                                       23
<PAGE>

the first priority lien in favor of the debenture holders shall be released.

      We also issued warrants to purchase 828,861 shares of our common stock at
an initial exercise price of $4.2755 per share. The exercise price may be
adjusted if we issue certain additional shares of our common stock or
instruments convertible into common stock at a lower price than the initial
exercise price. The warrants expire on March 25, 2007. The holders of the
debentures also received the right to purchase shares of to-be-created Series A
preferred stock (the "Preferred Stock Rights") at certain dates in the future.
The first Preferred Stock Right for 575 shares for $5.8 million expired on May
6, 2002. The holders did not exercise the right to purchase these shares of
Series A preferred stock. The second Preferred Stock Right for 307 shares for
$3.1 million may be exercised at any time after the six-month anniversary but
before the fifteen-month anniversary of the issuance of the debentures. The
third Preferred Stock Purchase Right for 170 shares for $1.7 million expired on
May 6, 2002. The holders did not exercise the right to purchase these shares of
Series A preferred stock. The debenture holders were also granted certain equity
participation and registration rights.

    Under the terms of the debentures, a number of events could trigger the
debenture holders' right to force early repayment of 115% of the outstanding
principal plus accrued and unpaid interest owed under the debentures. Events
constituting a triggering event include:

      o     our default on other indebtedness or obligations under any other
            debenture, any mortgage, credit agreement or other facility,
            indenture agreement, factoring agreement or other instrument under
            which there may be issued, or by which there may be secured or
            evidenced, any indebtedness for borrowed money or money due under
            any long term leasing or factoring arrangement in an amount
            exceeding $500,000;

      o     failure to have our common stock listed on an eligible market;

      o     our bankruptcy;

      o     engaging in certain change in control, sale of assets or redemption
            transactions;

      o     failure to timely file our 2002 or 2003 annual reports; and

      o     certain other failures to perform our obligations under the
            debenture agreement and/or the related agreements.

      In addition to the above, if our earnings before interest, taxes,
depreciation and amortization, less capital expenditures, for the fiscal year
ended December 31, 2002 is less than $2,750,000, our debenture holders may
require that we prepay all or a portion of up to 50% of the outstanding
principal amount of their debentures. If our earnings before interest, taxes,
depreciation and amortization, less capital expenditures, for the fiscal year
ended December 31, 2003 is less than $6,500,000, our debenture holders may
require that we prepay all or a portion of up to 100% of the outstanding
principal amount of their debentures.

      If we do not have sufficient cash to repay these amounts early, we may be
required to seek additional capital through a sale of assets, sale of additional
securities or through additional borrowings, none of which may be available on
terms reasonably acceptable to us.

      In connection with the issuance of the debentures, the outstanding amounts
borrowed from the bank under our accounts receivable-based and our equipment
financing arrangements were repaid, and the related loan agreements were
terminated. The standby letter of credit, as amended, issued by the bank in
December 2000 in the amount of $2.5 million with an expiration date of September
30, 2002 remains outstanding and secured with our pledge of a certificate of
deposit in the amount of $2.5 million that matures on October 31, 2002.


                                       24
<PAGE>

      The following table represents our future minimum payments (including
interest) related to our outstanding Debentures and obligations we have under
operating leases (unaudited, in thousands):

<TABLE>
<CAPTION>
                                                                              Operating
                                                        Debentures              Leases
                                                       -----------           ------------
<S>                     <C>                            <C>                   <C>
           Remainder of 2002................           $       403           $        979
           2003.............................                   528                  1,712
           2004.............................                   528                  1,699
           2005.............................                   528                  1,625
           2006.............................                10,622                  1,597
           Thereafter.......................                    --                     --
                                                       -----------           ------------
                Total minimum payments......           $    12,609           $      7,612
                                                       ===========           ============
</TABLE>

      Subsequent to the receipt of the $10.5 million investment, our cash
position has improved. Our balance of cash and cash equivalents was $6.6 million
as of June 30, 2002, up $0.7 million from December 31, 2001. Accounts payable
and accrued liabilities totaled $11.4 million at June 30, 2002, down $0.3
million from December 31, 2001, and current assets exceeded current liabilities
by approximately $6.6 million.

      The future success of our company will be dependent upon, among other
factors, our ability to generate adequate cash for operating and capital needs.
We are relying on our existing balance of cash and cash equivalents and the net
proceeds from the issuance of the convertible debentures discussed above
together with future sales and the collection of the related accounts
receivable, at least at the levels set forth in our business plan, to meet our
future cash requirements for at least the next twelve months. If cash provided
by these sources is not sufficient, we will be required to further reduce our
expenditures for operations or to seek additional capital through other means
that may include the sale of assets, the sale of equity securities or additional
borrowings. There can be no assurance that additional capital will be available,
or available on terms that are reasonable or acceptable to us. If we are unable
to generate additional cash, our business and financial condition may be
materially and adversely affected such that we may need to consider other
alternatives for our future.

Critical Accounting Policies and Estimates

      Our significant accounting policies are described in Note 1 of Notes to
Consolidated Financial Statements. We consider the accounting policies related
to revenue recognition and inventory valuation to be critical to the
understanding of our results of operations. Our critical accounting policies
also include the areas where we have made the most difficult, subjective or
complex judgments in making estimates, and where these estimates can
significantly impact our financial results under different assumptions and
conditions. We prepare our financial statements in conformity with generally
accepted accounting principles in the United States. As such, we are required to
make certain estimates, judgments and assumptions that we believe are reasonable
based upon the information available. These estimates and assumptions affect the
reported amounts of assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the periods
presented. Actual results could differ from those estimates.

Revenue Recognition

      Our revenue recognition policies follow the American Institute of
Certified Public Accountants Statement of Position No. 97-2, "Software Revenue
Recognition" and SEC Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements," which summarizes existing accounting literature and
requires that four criteria be met prior to the recognition of revenue. Our
accounting policies regarding revenue recognition are written to comply with the
following criteria (see Note 1 of Notes to Consolidated Financial Statements):
1) persuasive evidence of an arrangement exists; 2) delivery has occurred; 3)
the fee is fixed and determinable; and 4) collectibility is probable. The third
and fourth criteria may require us to make significant judgments or estimates.

      To determine if a fee is fixed and determinable, we evaluate rights of
return, customer acceptance rights, if applicable, and multiple-element
arrangements of products and services to determine the impact on revenue
recognition. Our agreements generally have not included rights of return except
in certain reseller relationships that include stock rotation rights. If an
agreement provides for a right of return, we recognize revenue when the right
has expired or the product has been resold master distributor. If an agreement
provides for evaluation or customer acceptance, we recognize revenue upon the
completion of the evaluation process, acceptance of the product by the customer
and completion of all other criteria. Revenue from multiple-element software
arrangements is recognized using the residual method whereby the fair value of
any undelivered elements, such as customer support and services, is deferred and
any residual value is allocated to the software and recognized as revenue upon
delivery. The fair values of professional


                                       25
<PAGE>

services, technical support and training have been determined based on our
specific objective evidence of fair value. Our vendor specific objective
evidence of fair value is based on the price that we charge customers when the
element is sold separately.

      Our maintenance contracts require us to provide technical support and
unspecified software updates to customers on a when and if available basis. We
recognize customer support revenue, including support revenue that is bundled
with product sales, ratably over the term of the contract period, which
generally ranges from one to five years. We recognize revenue from services when
the services are performed. Subscription fees for our benchmark reports are
recognized upon delivery of the reports.

      We sell our products directly to service providers, end-user customers and
through indirect channels. Certain reseller customers have stock rotation
rights, under which the customer can exchange previously purchased products for
other products of equal or greater cost, subject to certain limitations, based
on their end-user customers' requirements. We recognize revenue under these
arrangements once the stock rotation right expires or the product has been
resold by our master distributor.

      We also examine the specific facts and circumstances of all sales
arrangements with payment terms extending beyond our normal payment terms to
make a determination of whether the sales price is fixed and determinable and
whether collectibility is probable. Payment terms are not tied to milestone
deliverables or customer acceptance. Our evaluation of the impact on revenue
recognition, if any, includes our history with our customers and the specific
facts of each arrangement. It is generally not our practice to offer payment
terms that differ from our normal payment terms, and we have not written off any
accounts receivable related to extended payment term arrangements.

Inventory

      Because of the order lead times required to obtain manufactured product,
we must maintain sufficient quantities of inventory of all of our products to
meet expected demand. If actual demand is much lower than forecasted, we may not
be able to dispose of our inventory at or above its cost. We write down our
inventory for estimated excess and obsolete amounts to the lower of cost or
market value. If future demand is lower than currently estimated, additional
write-downs of our inventory may be required.

Allowance for Bad Debt

      We grant credit terms without collateral to our customers and, prior to
June 30, 2002, have not experienced any significant credit related losses.
Subsequent to June 30, 2002, the Company will write-off approximately $0.7
million in receivable balances due from WorldCom following WorldCom's bankruptcy
filing against the allowance for bad debts, which was $1.1 million as of June
30, 2002. Any future recoveries of these to-be-written-off receivables will be
recorded when and if they are received. Accounts receivable include allowances
to record receivables at their estimated net realizable value, which is
determined based on estimates for bad debt. If future events occur that impact
our customers, additional write-downs of our accounts receivable may be
required.

Factors That May Affect Future Results

      Our operations and financial condition are subject to certain other risks
and uncertainties, including among others, our accumulated deficit and
uncertainty of future profitability and possible fluctuations in financial
results, dependence on network service providers, substantial fixed operating
costs, possible dilution to our common stockholders, dependence on sales to key
customers, including WorldCom, dependence on a sole-source subcontract
manufacturer, potential delisting and reduced liquidity of our shares resulting
from failure to meet the Nasdaq listing requirements, the potential triggering
of early repayment of our debentures, the downturn in the telecommunications
industry, long sales cycles, improvements to the infrastructure of the Internet,
rapid technological change, growing competition from several market segments,
errors in our products, dependence upon sole and limited source suppliers and
fluctuations in component pricing, claims of patent infringement by third
parties, failure to protect our intellectual property rights, dependence upon
key employees, ability to retain employees and the defense of a purported class
action lawsuit. In addition, the September 11 terrorist attacks and the military
actions being taken by the United States and its allies have created substantial
economic and political uncertainties that could have an adverse effect on Visual
Networks' business. The market for our products is growing and our business
environment is characterized by rapid technological changes, changes in customer
requirements and new emerging market segments. Consequently, to compete
effectively, we must make frequent new product introductions and enhancements
and deploy sales and marketing resources to take advantage of new business
opportunities. Failure to meet any of these and other challenges could adversely
affect our future operating results.

      In light of the uncertainty regarding the use of past audits by Arthur
Andersen LLP, our former auditors, we may be required to take action, including
asking our current auditors, PricewaterhouseCoopers LLP, to undertake an audit,
with respect to our financial


                                       26
<PAGE>

statements for the periods ended December 31, 2001. We may undertake this action
if we conclude that to do so would increase our flexibility with respect to
future transactions and corporate structuring or ensure that we can meet our
compliance requirements. No such transactions are currently planned.

      This Quarterly Report on Form 10-Q contains forward-looking information
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934, and is subject to the safe harbor
created by those sections. Our future results may be impacted by the various
important factors summarized in this Quarterly Report and more fully discussed
in our Annual Report on Form 10-K/A (Amendment No. 2) for the year ended
December 31, 2001.

Item 3. Qualitative and Quantitative Disclosure About Market Risk

      During the three months ended March 31, 2002, we issued long-term debt in
the form of the convertible debentures discussed in Note 3 of Notes to
Consolidated Financial Statements. The convertible debentures bear interest at a
fixed annual rate of 5%. There have been no other material changes in the market
risks faced by us or in how those risks are managed since December 31, 2001.
Refer to our Annual Report on Form 10-K/A (Amendment No. 2) for year ended
December 31, 2001 for a discussion about such market risk.

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


                                       27
<PAGE>

                          PART II -- OTHER INFORMATION

Item 1. Legal Proceedings

      In July, August and September 2000, several purported class action
complaints were filed against us and certain of our former executives
(collectively the "defendants"). These complaints have since been combined into
a single consolidated amended complaint (the "complaint"). The complaint alleges
that between February 7, 2000 and August 23, 2000, the defendants made false and
misleading statements that had the effect of inflating the market price of our
stock, in violation of Sections 10(b) and 20(a) of the Securities Exchange Act
of 1934. The complaint does not specify the amount of damages sought. We believe
that the plaintiffs' claims are without merit and intend to defend against these
allegations vigorously. We filed a motion to dismiss the complaint, which is now
pending before the court. We expect that a substantial portion of the legal
costs that we have incurred and may continue to incur related to this matter
will be paid by our directors' and officers' insurance policy. We cannot
presently determine the ultimate outcome of this action. A negative outcome
could have a material adverse effect on our financial position or results of
operations. Failure to prevail in the litigation could result in, among other
things, the payment of substantial monetary damages, in excess of any amounts
paid by our directors' and officers' insurance. We have not recorded any
liability related to this matter in the accompanying balance sheets as of
December 31, 2001 and June 30, 2002.

      We are periodically a party to disputes arising from normal business
activities including various employee-related matters. In the opinion of
management, resolution of these matters will not have a material adverse effect
upon our financial position or future operating results.

Item 2. Changes in Securities and Use of Proceeds

      None.

Item 3. Defaults Upon Senior Securities

      None.

Item 4. Submission of Matters to Vote of Security Holders

      (a)   The Company held its Annual Meeting of Stockholders on May 29, 2002
            (the "Annual Meeting").

      (b)   n/a

      (c)   The following matters were voted upon at the Annual Meeting:

            (i) Two directors were elected to serve until the 2005 annual
            meeting of stockholders, and until their successors are elected and
            duly qualified, with 82% of the eligible voting shares voting for
            Messrs. Benson and Minihane, as follows:

                   Nominee                  For               Against or Abstain
                   -------                  ---               ------------------

                   Marc F. Benson           24,714,250        1,553,406

                   Peter J. Minihane        24,737,815        1,529,841

            (ii) An amendment to the 1999 Employee Stock Purchase Plan to make
            available for purchase under the Plan an additional 1,000,000 shares
            of Common Stock was approved by 82% of the eligible voting shares.
            (Votes for: 24,117,816; votes against or withheld: 2,137,305;
            abstain: 12,535).

            (iii) The issuance of shares of our common stock upon (a) the
            conversion of the 5% Senior Secured Convertible Debentures due March
            25, 2006, (b) payment of interest thereon, (c) the conversion of
            to-be-created series of convertible preferred stock, (d) payment of
            dividends thereon, (e) the exercise of related warrants by the
            holders thereof, and (f) redemption of the debentures or the
            to-be-created preferred stock, which upon such conversion, payment,
            exercise and


                                       28
<PAGE>

            redemption, would result in an investor in the Company holding more
            than 19.99% of the Company's outstanding common stock was approved
            by 64% of the eligible voting shares (Votes for: 9,497,370; votes
            against or withheld: 2,649,786; abstain: 18,960).

Item 5. Other Information

      None.


                                       29
<PAGE>

Item 6. (a) Exhibits

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

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

            3.1$              Amended and Restated Certificate of Incorporation
                              of the Company.

            3.1.1@            Certificate of Amendment to Amended and Restated
                              Certificate of Incorporation.

            3.2*              Restated By-Laws of the Company.

            4.1@@             Registration Rights Agreement, dated as of March
                              25, 2002, between Visual Networks Inc. and the
                              Purchasers named therein (filed as Exhibit 99.3 to
                              the Form 8-K).

            4.2@@             Form of 5% Senior Secured Convertible Debenture of
                              Visual Networks, Inc. due March 25, 2006 (filed as
                              Exhibit 99.2 to the Form 8-K).

            4.1@@             Form of Warrant of Visual Networks, Inc., dated
                              March 25, 2002 (filed as Exhibit 99.4 to the Form
                              8-K).

            10.1*             1994 Stock Option Plan.

            10.2*             1997 Omnibus Stock Plan, as amended.

            10.3*             Amended and Restated 1997 Directors' Stock Option
                              Plan.

            10.4!!            2000 Stock Incentive Plan, as amended.

            10.5*+            Reseller/Integration Agreement, dated August 29,
                              1997, by and between the Company and MCI
                              Telecommunications Corporation.

            10.5.1$$$++       Second Amendment, dated November 4, 1998, to the
                              Reseller/Integration Agreement between the Company
                              and MCI Telecommunications Corporation (relating
                              to Exhibit 10.5).

            10.5.2            MCI Amendment dated July 25, 2002.

            10.6****++        Master Purchase of Equipment and Services
                              Agreement, dated as of May 22, 2000, between
                              Sprint/United Management Company and the Company.

            10.7*+            General Agreement for the Procurement of
                              Equipment, Services and Supplies, dated November
                              26, 1997, between the Company and AT&T Corp.

            10.8*             Lease Agreement, dated December 12, 1996, by and
                              between the Company and The Equitable Life
                              Assurance Society of the United States.

            10.8.1*           Lease Amendment, dated September 2, 1997, by and
                              between the Company and The Equitable Life
                              Assurance Society of The United States (related to
                              Exhibit 10.8).

            10.8.2$$$         Second Lease Amendment, dated February 8, 1999, by
                              and between the Company and TA/Western, LLC,
                              successor to The Equitable Life Assurance Society
                              of The United States (relating to Exhibit 10.8).

            10.8.3***         Third Lease Amendment, dated January 10, 2000, by
                              and between the Company and TA/ Western, LLC
                              (relating to Exhibit 10.8).

            10.8.4!!          Fourth Lease Amendment, dated May 17, 2000, by and
                              between the Company and TA/ Western, LLC (relating
                              to Exhibit 10.8).

            10.10*            Employment Agreement, dated December 15, 1994, by
                              and between the Company and Scott E. Stouffer, as
                              amended.

            10.11!!           Lease Agreement, dated April 7, 2000, by and
                              between Visual Networks, Inc. and TA/ Western,
                              LLC.

            10.17**           Net2Net 1994 Stock Option Plan.

            10.20$$           1999 Employee Stock Purchase Plan, as amended
                              April 11, 2001.

            10.22%            Inverse Network Technology 1996 Stock Option Plan.

            10.23!!           Avesta Technologies 1996 Stock Option Plan.

            10.24****         Loan and Security Agreement, dated February 28,
                              2001, by and between Silicon Valley Bank and the
                              Company.

            10.24.1!!!        First Loan Modification to the Loan and Security
                              Agreement, dated May 24, 2001 (related to Exhibit
                              10.24).

            10.24.2!!!!       Second Loan Modification to the Loan and Security
                              Agreement, dated December 20, 2001 (related to
                              Exhibit 10.24).

            10.25****         Accounts Receivable Financing Agreement dated
                              February 28, 2001, by and between Silicon Valley
                              Bank and the Company.

            10.25.1!!!        First Loan Modification to the Accounts Receivable
                              Financing Agreement, dated May 24, 2001 (related
                              to Exhibit 10.25).

            10.25.2!!!!       Second Loan Modification to the Accounts
                              Receivable Financing Agreement, dated December 20,
                              2001 (related to Exhibit 10.25).


                                       30
<PAGE>

            10.25.3!!!!       Third Loan Modification to the Accounts Receivable
                              Financing Agreement, dated February 28, 2002
                              (related to Exhibit 10.25).

            10.26****         Intellectual Property Security Agreement dated
                              February 28, 2001, by and between Silicon Valley
                              Bank and the Company.

            10.28!!!          Employment Agreement, dated May 3, 2001, by and
                              between the Company and Elton King.

            10.29!!!          Nonstatutory Stock Option Grant Agreement, dated
                              May 3, 2001, by and between the Company and Elton
                              King.

            10.30!!!          Terms of Employment, dated July 27, 2000, by and
                              between the Company and Steve Hindman.

            10.31!!!!         Terms of Employment, dated October 23, 2001, by
                              and between the Company and John Saunders.

            10.32!!!!         Consulting Agreement, dated February 16, 2002, by
                              and between the Company and Peter J. Minihane.

            10.33@@           Securities Purchase Agreement, dated as of March
                              25, 2002, between Visual Networks, Inc. and the
                              Purchasers named therein (filed as Exhibit 99.1 to
                              the Form 8-K).

            10.34@@           Security Agreement, dated as of March 25, 2002,
                              between Visual Networks, Inc. and the Secured
                              Parties named therein (filed as Exhibit 99.5 to
                              the Form 8-K).

            10.35@@           IP Security Agreement, dated as of March 25, 2002,
                              between Visual Networks, Inc., its subsidiaries
                              and the Secured Parties named therein (filed as
                              Exhibit 99.6 to the Form 8-K).

            10.36++&          Agreement for Electronic Manufacturing Services,
                              dated March 1, 2000, by and between Visual
                              Networks Operations, Inc. and Celestica
                              Corporation.

            21.1****          List of subsidiaries of the Company.

            *                 Incorporated herein by reference to the Company's
                              Registration Statement on Form S-1, No. 333-41517.

            **                Incorporated herein by reference to Exhibit 10.1
                              to the Company's Registration Statement on Form
                              S-8, No. 333-53153.

            ***               Incorporated herein by reference to the Company's
                              Annual Report on Form 10-K for the year ended
                              December 31, 1999.

            ****              Incorporated herein by reference to the Company's
                              Annual Report on Form 10-K for the year ended
                              December 31, 2000.

            %                 Incorporated herein by reference to Exhibit 10.1
                              to the Company's Registration Statement on Form
                              S-8, No. 333-88719.

            @                 Incorporated herein by reference to the Company's
                              Registration Statement on Form S-4, No. 333-33946.

            @@                Incorporated herein by reference to the Company's
                              Current Report on Form 8-K filed March 27, 2002.

            $                 Incorporated herein by reference to Exhibit 3.1 to
                              the Company's Quarterly Report on Form 10-Q for
                              the three months ended June 30, 1999.

            $$                Incorporated herein by reference to the Company's
                              Definitive Proxy Statement on Schedule 14A filed
                              April 30, 2001.

            $$$               Incorporated herein by reference to the Company's
                              Annual Report on Form 10-K for the year ended
                              December 31, 1998.

            +                 Portions of this Exhibit were omitted and have
                              been filed separately with the Secretary of the
                              Commission pursuant to the Company's Application
                              Requesting Confidential Treatment under Rule 406
                              of the Securities 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
                              Commission pursuant to the Company's Application
                              Requesting Confidential Treatment under Rule 24b-2
                              of the Securities Exchange Act.

            !!                Incorporated herein by reference to the Company's
                              Quarterly Report on Form 10-Q for the three months
                              ended June 30, 2000.

            !!!               Incorporated herein by reference to the Company's
                              Quarterly Report on Form 10-Q for the three months
                              ended June 30, 2001.

            !!!!              Incorporated herein by reference to the Company's
                              Annual Report on Form 10-K/A for the year ended
                              December 31, 2001.

            &                 Incorporated herein by reference to the Company's
                              Quarterly Report on Form 10-Q for the three months
                              ended March 31, 2002.

(b) Reports on Form 8-K

      (1) The Company filed a Current Report on Form 8-K on May 28, 2002,
reporting under Item 5 that the Company's common stock trading was transferred
from the Nasdaq National Market to the Nasdaq SmallCap Market, effective May 28,
2002.


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<PAGE>

      (2) The Company filed a Current Report on Form 8-K on June 18, 2002,
reporting under Item 4 the termination of the engagement of Arthur Andersen LLP
as its independent auditors and the appointment of PricewaterhouseCoopers LLP as
its new independent accountants. The Company also reported under Item 5 that the
registration statement on Form S-3 (333-85628) (the "Registration Statement")
was declared effective by the SEC on June 14, 2002. The Registration Statement
related to the resale of shares of common stock issuable upon exercise of the
senior secured convertible debentures in the aggregate principal amount of $10.5
million and warrants to purchase shares of common stock, which were sold to four
institutional investors on March 25, 2002.


                                       32
<PAGE>

                                   SIGNATURES

      Pursuant to the requirements of the Securities Exchange Act of 1934, the
Company has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.

                                      VISUAL NETWORKS, INC.


                                   By:     /s/ ELTON R. KING
                                      ------------------------------------------
                                           Elton R. King
                                           President and Chief Executive Officer

August 19, 2002


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