SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549-0001




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FORM 10-Q

(MARK ONE)



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

For the three months ended March 31, 2001

OR



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

Commission File Number 000-23699



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VISUAL NETWORKS, INC.

(Exact name of registrant as specified in its
charter)


|                                                                         |  |                                                
|------------------------------------------------------------------------ |  | -----------------------------------------------
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|Delaware(State or other jurisdiction of
	incorporation or organization)  |  | 52-1837515(I.R.S. Employer
	Identification No.)
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|                                                                        
|2092 Gaither Road, Rockville, MD(Address of principal executive offices) |  | 20850-4013(Zip Code)                           

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



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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   No

The number of outstanding shares of the Registrants Common
Stock, par value $.01 per share, as of May 11, 2001 was
33,444,006 shares, including 2,000,000 shares held in
escrow.









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VISUAL NETWORKS, INC.

QUARTERLY REPORT ON FORM 10-Q


FOR THE THREE MONTHS ENDED


MARCH 31, 2001


TABLE OF CONTENTS

|                              |                                                                                                |                                                                                     |  |    |   | 
|----------------------------- | ---------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------- |  | -- | - | 
|                              |                                                                                                | Page                                                                               
|                              |                                                                                                |                                                                                    
|PART I. FINANCIAL INFORMATION |                                                                                                |                                                                                     |  |   
|                             
|                             
|                             
|                             
|                              | Item 1. Financial Statements:                                                                  |                                                                                     |  |    |  
|                             
|                             
|                             
|                             
|                              |                                                                                                | Consolidated Balance Sheets  March 31, 2001 and
	December 31, 2000                 |  |    | 3 | 
|                             
|                             
|                             
|                             
|                              |                                                                                                | Consolidated Statements of Operations  Three months ended
	March 31, 2001 and 2000 |  |    | 4 | 
|                             
|                             
|                             
|                             
|                              |                                                                                                | Consolidated Statements of Cash Flows  Three months ended
	March 31, 2001 and 2000 |  |    | 5 | 
|                             
|                             
|                             
|                             
|                              |                                                                                                | Notes to Consolidated Financial Statements                                          |  |    | 6 | 
|                             
|                             
|                             
|                             
|                              | Item 2. Managements Discussion and Analysis of
	Financial Condition and Results of Operations |                                                                                     |  | 13 |  
|                             
|                             
|                             
|                             
|                              | Item 3. Qualitative and Quantitative Disclosure about
	Market Risk                             |                                                                                     |  | 17 |  
|PART II. OTHER INFORMATION    |                                                                                                |                                                                                     |  |   
|                             
|                             
|                             
|                             
|                              | Items 1  6                                                                                    |                                                                                     |  | 18 |  
|                             
|                             
|                             
|                             
|                              | Signatures                                                                                     |                                                                                     |  | 21 |  

2



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PART I:  FINANCIAL INFORMATION

Item  1:  Financial Statements

VISUAL NETWORKS, INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited)


(In thousands, except share data)


|                                       |                                                                                                                                                                                |                                            |       |              |        |  |        |          |        | 
|-------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------ | ----- | ------------ | ------ |  | ------ | -------- | ------ | 
|                                       |                                                                                                                                                                                | March 31,                                  |       | December 31,
|                                       |                                                                                                                                                                                | 2001                                       |       | 2000        
|                                       |                                                                                                                                                                                |                                            |       |             
|ASSETS                                 |                                                                                                                                                                                |                                            |       |              |        |  |        |         
|                                      
|                                      
|                                      
|                                      
|Current assets:                        |                                                                                                                                                                                |                                            |       |              |        |  |        |         
|                                      
|                                      
|                                      
|                                      
|                                       | Cash and cash equivalents                                                                                                                                                      |                                            | $     | 7,011        |        |  | $      | 17,369   |       
|                                      
|                                      
|                                      
|                                      
|                                       | Short-term investments                                                                                                                                                         |                                            |       | 8,863        |        |  |        | 3,700    |       
|                                      
|                                      
|                                      
|                                      
|                                       | Accounts receivable, net of allowance of $1,087 and $1,103,
	respectively                                                                                                      |                                            |       | 4,409        |        |  |        | 4,222    |       
|                                      
|                                      
|                                      
|                                      
|                                       | Inventory                                                                                                                                                                      |                                            |       | 13,990       |        |  |        | 13,474   |       
|                                      
|                                      
|                                      
|                                      
|                                       | Other current assets                                                                                                                                                           |                                            |       | 3,802        |        |  |        | 3,089    |       
|                                       |                                                                                                                                                                                |                                            |       |              |        |  |        |         
|                                       |                                                                                                                                                                                | Total current assets                       |       |              | 38,075 |  |        |          | 41,854 | 
|                                      
|                                      
|                                      
|                                      
|Property and equipment, net            |                                                                                                                                                                                |                                            | 9,458 |              |        |  | 10,738 |         
|                                      
|                                      
|                                      
|                                      
|Intangible assets, net                 |                                                                                                                                                                                |                                            | 8,037 |              |        |  | 8,510  |         
|                                      
|                                      
|                                      
|                                      
|Other assets                           |                                                                                                                                                                                |                                            | 4,369 |              |        |  | 9,562  |         
|                                       |                                                                                                                                                                                |                                            |       |              |        |  |        |         
|                                       |                                                                                                                                                                                | Total assets                               |       | $            | 59,939 |  |        | $        | 70,664 | 
|                                       |                                                                                                                                                                                |                                            |       |              |        |  |        |         
|LIABILITIES AND STOCKHOLDERS EQUITY   |                                                                                                                                                                                |                                            |       |              |        |  |        |         
|                                      
|                                      
|                                      
|                                      
|Current liabilities:                   |                                                                                                                                                                                |                                            |       |              |        |  |        |         
|                                      
|                                      
|                                      
|                                      
|                                       | Accounts payable and accrued expenses                                                                                                                                          |                                            | $     | 22,540       |        |  | $      | 27,912   |       
|                                      
|                                      
|                                      
|                                      
|                                       | Customer deposit                                                                                                                                                               |                                            |       | 2,501        |        |  |        |         |       
|                                      
|                                      
|                                      
|                                      
|                                       | Deferred revenue                                                                                                                                                               |                                            |       | 15,243       |        |  |        | 15,818   |       
|                                      
|                                      
|                                      
|                                      
|                                       | Current portion of long-term debt                                                                                                                                              |                                            |       | 697          |        |  |        | 606      |       
|                                       |                                                                                                                                                                                |                                            |       |              |        |  |        |         
|                                       |                                                                                                                                                                                | Total current liabilities                  |       |              | 40,981 |  |        |          | 44,336 | 
|                                      
|                                      
|                                      
|                                      
|Long-term debt, net of current portion |                                                                                                                                                                                |                                            | 461   |              |        |  | 243    |         
|                                       |                                                                                                                                                                                |                                            |       |              |        |  |        |         
|                                       |                                                                                                                                                                                | Total liabilities                          |       |              | 41,442 |  |        |          | 44,579 | 
|                                       |                                                                                                                                                                                |                                            |       |              |        |  |        |         
|Stockholders equity:                  |                                                                                                                                                                                |                                            |       |              |        |  |        |         
|                                      
|                                      
|                                      
|                                      
|                                       | Common stock, $.01 par value, 50,000,000 shares authorized,
	31,397,403 and 31,296,383 shares issued and outstanding as of
	March 31, 2001 and December 31, 2000, respectively |                                            |       | 314          |        |  |        | 313      |       
|                                      
|                                      
|                                      
|                                      
|                                       | Additional paid-in capital                                                                                                                                                     |                                            |       | 472,923      |        |  |        | 473,108  |       
|                                      
|                                      
|                                      
|                                      
|                                       | Deferred compensation                                                                                                                                                          |                                            |       | (135         | )      |  |        | (402     | )     
|                                      
|                                      
|                                      
|                                      
|                                       | Accumulated other comprehensive income                                                                                                                                         |                                            |       | 7            |        |  |        | 11       |       
|                                      
|                                      
|                                      
|                                      
|                                       | Accumulated deficit                                                                                                                                                            |                                            |       | (454,612     | )      |  |        | (446,945 | )     
|                                       |                                                                                                                                                                                |                                            |       |              |        |  |        |         
|                                       |                                                                                                                                                                                | Total stockholders equity                 |       |              | 18,497 |  |        |          | 26,085 | 
|                                       |                                                                                                                                                                                |                                            |       |              |        |  |        |         
|                                       |                                                                                                                                                                                | Total liabilities and stockholders equity |       | $            | 59,939 |  |        | $        | 70,664 | 
|                                       |                                                                                                                                                                                |                                            |       |              |        |  |        |         

See accompanying notes to consolidated financial statements.

3



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VISUAL NETWORKS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)


(In thousands, except per share data)


|                                            |                                      |                          |        |        |        |   |        |        |        | 
|------------------------------------------- | ------------------------------------ | ------------------------ | ------ | ------ | ------ | - | ------ | ------ | ------ | 
|                                            |                                      |                         
|                                            |                                      | For the three months    
|                                            |                                      | ended March 31,         
|                                            |                                      |                         
|                                            |                                      | 2001                     |        | 2000  
|                                            |                                      |                          |        |       
|Revenue                                     |                                      | $                        | 17,386 |        |        | $ | 30,494 |       
|                                           
|                                           
|                                           
|                                           
|Cost of revenue                             |                                      |                          | 6,962  |        |        |   | 9,295  |       
|                                            |                                      |                          |        |        |        |   |        |       
|                                            | Gross profit                         |                          |        | 10,424 |        |   |        | 21,199 |       
|                                            |                                      |                          |        |        |        |   |        |       
|Operating expenses:                         |                                      |                          |        |        |        |   |        |       
|                                           
|                                           
|                                           
|                                           
|                                            | Research and development             |                          |        | 5,783  |        |   |        | 5,057  |       
|                                           
|                                           
|                                           
|                                           
|                                            | Sales and marketing                  |                          |        | 9,450  |        |   |        | 6,977  |       
|                                           
|                                           
|                                           
|                                           
|                                            | General and administrative           |                          |        | 2,672  |        |   |        | 2,251  |       
|                                           
|                                           
|                                           
|                                           
|                                            | Amortization of acquired intangibles |                          |        | 473    |        |   |        |       |       
|                                            |                                      |                          |        |        |        |   |        |       
|                                            |                                      | Total operating expenses |        |        | 18,378 |   |        |        | 14,285 | 
|                                            |                                      |                          |        |        |        |   |        |       
|Income (loss) from operations               |                                      |                          | (7,954 | )      |        |   | 6,914  |       
|                                           
|                                           
|                                           
|                                           
|Interest income, net                        |                                      |                          | 287    |        |        |   | 677    |       
|                                            |                                      |                          |        |        |        |   |        |       
|Income (loss) before income taxes           |                                      |                          | (7,667 | )      |        |   | 7,591  |       
|                                           
|                                           
|                                           
|                                           
|Income taxes                                |                                      |                          |       |        |        |   | (2,050 | )     
|                                            |                                      |                          |        |        |        |   |        |       
|Net income (loss)                           |                                      | $                        | (7,667 | )      |        | $ | 5,541  |       
|                                            |                                      |                          |        |        |        |   |        |       
|Basic income (loss) per share               |                                      | $                        | (0.24  | )      |        | $ | 0.22   |       
|                                            |                                      |                          |        |        |        |   |        |       
|Diluted income (loss) per share             |                                      | $                        | (0.24  | )      |        | $ | 0.20   |       
|                                            |                                      |                          |        |        |        |   |        |       
|Basic weighted average shares outstanding   |                                      |                          | 31,381 |        |        |   | 24,940 |       
|                                            |                                      |                          |        |        |        |   |        |       
|Diluted weighted average shares outstanding |                                      |                          | 31,381 |        |        |   | 27,544 |       
|                                            |                                      |                          |        |        |        |   |        |       

See accompanying notes to consolidated financial statements.

4



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VISUAL NETWORKS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)


(In thousands)


|                                                     |                                                                                            |                                       |                                                     |        |        |         |        |        |        |        |  
|---------------------------------------------------- | ------------------------------------------------------------------------------------------ | ------------------------------------- | --------------------------------------------------- | ------ | ------ | ------- | ------ | ------ | ------ | ------ | -
|                                                     |                                                                                            |                                      
|                                                     |                                                                                            | For the three months                 
|                                                     |                                                                                            | ended March 31,                      
|                                                     |                                                                                            |                                      
|                                                     |                                                                                            | 2001                                  |                                                     | 2000  
|                                                     |                                                                                            |                                       |                                                     |       
|Cash flows from operating activities:                |                                                                                            |                                       |                                                     |        |        |         |        |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Net income (loss)                                                                          |                                       | $                                                   | (7,667 | )      |         | $      | 5,541  |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Adjustments to reconcile net loss to net cash provided by (used
	in) operating activities: |                                       |                                                     |        |        |         |        |        |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                                            | Depreciation and amortization         |                                                     |        | 1,838  |         |        |        | 1,144  |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Changes in assets and liabilities:                                                         |                                       |                                                     |        |        |         |        |        |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                                            | Accounts receivable                   |                                                     |        | (187   | )       |        |        | (1,472 | )     
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                                            | Inventory                             |                                                     |        | (516   | )       |        |        | 278    |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                                            | Other assets                          |                                                     |        | (520   | )       |        |        | 58     |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                                            | Accounts payable and accrued expenses |                                                     |        | (5,372 | )       |        |        | 317    |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                                            | Customer deposits                     |                                                     |        | 2,501  |         |        |        |       |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     |                                                                                            | Deferred revenue                      |                                                     |        | (575   | )       |        |        | (378   | )     
|                                                     |                                                                                            |                                       |                                                     |        |        |         |        |       
|                                                     |                                                                                            |                                       | Net cash provided by (used in) operating activities |        |        | (10,498 | )      |        |        | 5,488  |  
|                                                     |                                                                                            |                                       |                                                     |        |        |         |        |       
|Cash flows from investing activities:                |                                                                                            |                                       |                                                     |        |        |         |        |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Net purchases of short-term investments                                                    |                                       |                                                     | (163   | )      |         |        |       |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Expenditures for property and equipment                                                    |                                       |                                                     | (69    | )      |         |        | (2,598 | )     
|                                                     |                                                                                            |                                       |                                                     |        |        |         |        |       
|                                                     |                                                                                            |                                       | Net cash used in investing activities               |        |        | (232    | )      |        |        | (2,598 | )
|                                                     |                                                                                            |                                       |                                                     |        |        |         |        |       
|Cash flows from financing activities:                |                                                                                            |                                       |                                                     |        |        |         |        |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Exercise of stock options                                                                  |                                       |                                                     | 59     |        |         |        | 2,046  |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Net borrowings (repayments) under credit agreements                                        |                                       |                                                     | 451    |        |         |        | (22    | )     
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Principal payments on capital lease obligations                                            |                                       |                                                     | (142   | )      |         |        | (104   | )     
|                                                     |                                                                                            |                                       |                                                     |        |        |         |        |       
|                                                     |                                                                                            |                                       | Net cash provided by financing activities           |        |        | 368     |        |        |        | 1,920  |  
|                                                     |                                                                                            |                                       |                                                     |        |        |         |        |       
|Effect of exchange rate changes                      |                                                                                            |                                       | 4                                                   |        |        |         |       |       
|                                                     |                                                                                            |                                       |                                                     |        |        |         |        |       
|Net increase (decrease) in cash and cash equivalents |                                                                                            |                                       | (10,358                                             | )      |        |         | 4,810  |       
|                                                    
|                                                    
|                                                    
|                                                    
|Cash and cash equivalents, beginning of period       |                                                                                            |                                       | 17,369                                              |        |        |         | 54,629 |       
|                                                     |                                                                                            |                                       |                                                     |        |        |         |        |       
|Cash and cash equivalents, end of period             |                                                                                            | $                                     | 7,011                                               |        |        | $       | 59,439 |       
|                                                     |                                                                                            |                                       |                                                     |        |        |         |        |       
|Supplemental cash flow information:                  |                                                                                            |                                       |                                                     |        |        |         |        |       
|                                                    
|                                                    
|                                                    
|                                                    
|                                                     | Cash paid for interest                                                                     |                                       | $                                                   | 20     |        |         | $      | 23     |       
|                                                     |                                                                                            |                                       |                                                     |        |        |         |        |       

See accompanying notes to consolidated financial statements.

5



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VISUAL NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2001


(Unaudited)


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

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

Risks and Other Important Factors

The Company incurred a net loss of $7.7 million for the
three months ended March 31, 2001 following a net loss of
$415.5 million for the year ended December 31, 2000.
The deterioration of the operating results in 2000 was due, in
part, to decreased revenue and increased operating expenses. In
the fourth quarter of 2000, the Company announced a plan to
realign its product portfolio, streamline its operations and
devote resources to the markets and products that the Company
believes have the greatest opportunity for growth. The
Companys ability to generate operating income in the
future is, in large part, dependent on its success in increasing
revenue and reducing operating expenses. Due to market
conditions, competitive pressures and other factors beyond its
control, there can be no assurances that the Company will be
able to adequately increase revenue in the future. The Company
also believes that its plans will result in a reduction in
operating expenses that, when combined with the anticipated
revenue growth, will result in a return to profitability. In the
event that the anticipated cost reductions are not realized or
revenue does not increase, the Company may be required to
further reduce its cost structure. There can be no assurance
that the Company will become profitable.

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

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

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 revenues and expenses during the reporting periods.
Actual results could differ from those estimates.

These financial statements are unaudited and have been prepared
by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission (SEC) 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

6



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VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

on Form 10-K for the year ended December 31, 2000. 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 three months ended March 31, 2001 are not
necessarily indicative of the results for the entire year ending
December 31, 2001.

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

Principles of Consolidation

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

Investments

Investments in marketable securities are classified as
available-for-sale and are reported at fair value in accordance
with Statement of Financial Accounting Standards
(SFAS) No. 115, Accounting for Certain
Investments in Debt and Equity Securities. The fair values
are based on quoted market prices. Unrealized gains and losses
on marketable securities are reported as a separate component of
comprehensive income, if significant. As of March 31, 2001,
the Company held short-term investments in U.S. Treasury
obligations that mature within one year. The Company also held a
$5.0 million certificate of deposit that matures on
March 31, 2002. As of March 31, 2001, unrealized gains
and losses were not material.

The Company has an investment in an entity in which the Company
has less than a majority ownership interest but over which the
Company can exercise significant influence. The Company uses the
equity method to account for this investment and its carrying
value of $657,000 as of March 31, 2001 is included in other
assets in the accompanying balance sheets. Under the equity
method, investments originally recorded at cost are adjusted to
recognize the Companys share of net earnings or losses of
the affiliates as they occur, rather than as dividends or other
distributions are received, limited to the extent of the
Companys investment in, advances to and guarantees for the
investment entity. The Company also has an investment in an
entity in which the Company exercises no control or significant
influence. Such investment is accounted for under the cost
method and its carrying value of approximately $3.7 million
is included in other assets in the accompanying balance sheets.
The Company periodically reviews its investments for permanent
impairments.

Inventory

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

|                 |       |           |       |              |  |   |       |        | 
|---------------- | ----- | --------- | ----- | ------------ |  | - | ----- | ------ | 
|                 |       | March 31, |       | December 31,
|                 |       | 2001      |       | 2000        
|                 |       |           |       |             
|Raw materials    |       | $         | 4,173 |              |  | $ | 4,301 |       
|                
|                
|                
|                
|Work-in-progress |       |           | 274   |              |  |   | 151   |       
|                
|                
|                
|                
|Finished goods   |       |           | 9,543 |              |  |   | 9,022 |       
|                 |       |           |       |              |  |   |       |       
|                 | Total |           | $     | 13,990       |  |   | $     | 13,474 | 
|                 |       |           |       |              |  |   |       |       

7



---



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Intangible Assets

Intangible assets consist of identifiable intangibles related to
the acquisition of Avesta (see Note 3). Such intangibles are
amortized using the straight-line method over the following
estimated useful lives. Intangible assets consist of the
following (in thousands):

|                      |       |           |       |              |  |             |       |       |  |  |         |  | 
|--------------------- | ----- | --------- | ----- | ------------ |  | ----------- | ----- | ----- |  |  | ------- |  | 
|                      |       | March 31, |       | December 31, |  |            
|                      |       | 2001      |       | 2000         |  | Useful Life
|                      |       |           |       |              |  |            
|Assembled workforce   |       | $         | 201   |              |  | $           | 224   |       |  |  | 3 years | 
|                     
|                     
|                     
|                     
|Trademarks/tradenames |       |           | 1,022 |              |  |             | 1,064 |       |  |  | 7 years | 
|                     
|                     
|                     
|                     
|Completed technology  |       |           | 6,814 |              |  |             | 7,222 |       |  |  | 5 years | 
|                      |       |           |       |              |  |             |       |       |  |  |         | 
|                      | Total |           | $     | 8,037        |  |             | $     | 8,510 |  |  |         |  | 
|                      |       |           |       |              |  |             |       |       |  |  |         | 

Long-Lived Assets

The Company reviews it long-lived assets, including property and
equipment, identifiable intangibles, and goodwill whenever
events or changes in circumstances indicate that the carrying
amount of the assets may not be fully recoverable. To determine
recoverability of its long-lived assets, the Company evaluates
the probability that future estimated undiscounted net cash
flows will be less than the carrying amount of the assets. If
future estimated undiscounted net cash flows are more likely
than not to be less than the carrying amount of the long-lived
asses, then such assets are written down to their fair value.
The Company recorded an impairment charge of $328.8 million
in the fourth quarter of 2000 against long-lived assets (see
Note 3). The Companys estimates of anticipated revenues
and profits and the remaining estimated lives of tangible and
intangible assets, or both, could be reduced significantly in
the future. As a result, the carrying amount of long-lived
assets, including intangibles, could be reduced materially in
the future.

Revenue Recognition

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

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

The Company has agreements with certain resellers that provide
price protection in the event that more favorable prices and
terms are granted to any other customer. Reserves for estimated
price protection credits

8



---



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

are established by the Company concurrently with the recognition
of revenue. The Company monitors the factors that influence the
pricing of its products and reseller inventory levels and makes
adjustments to these reserves when management believes that
actual price protection credits may differ from established
estimates.

Credit Risk and Significant Customers

Financial instruments that potentially subject the Company to
significant concentrations of credit risk consist principally of
cash and cash equivalents, investments and accounts receivable.
The Company primarily sells its products to large
telecommunications companies,and Internet service providers
primarily in the United States. The Company grants credit terms
without collateral to its customers and has not experienced any
significant credit related losses. Accounts receivable include
allowances to record receivables at their estimated net
realizable value. For the three months ended March 31,
2001, three customers individually represented 27%, 17% and 11%
of revenue, respectively. For the three months ended
March 31, 2000, two customers individually represented 33%
and 19% of revenue, respectively. As of March 31, 2001, two
customers individually represented 18% and 12% of accounts
receivable, respectively.

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.

Foreign Currency and International Operations

The functional currencies of certain of the Companys
subsidiaries are the respective local currencies. The financial
statements of these subsidiaries are translated to U.S. dollars
using period-end rates for assets and liabilities and average
rates during the relevant period for revenues and expenses.
Translation gains and losses are accumulated as a component of
other comprehensive loss in stockholders equity. Such
gains and loses have not been material.

Comprehensive Income (Loss)

The Company reports comprehensive income (loss) in
accordance with SFAS No. 130, Reporting Comprehensive
Income. SFAS No. 130 establishes rules for the
reporting and presentation of comprehensive income and its
components. SFAS No. 130 requires foreign currency translation
adjustments and the unrealized gains and losses on marketable
securities, net of tax, to be included in other comprehensive
income (loss). Because the Company has not had any significant
components of other comprehensive income (loss), the reported
net income (loss) does not differ materially from comprehensive
income (loss) for the three months ended March 31,
2001 and 2000.

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 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 2,806,796 shares of common stock that were
outstanding at March 31, 2001, were not included in the
computations of diluted loss per share for the three ended
March 31, 2001 as their effect would be anti-dilutive.

9



---



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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

|                                    |                                              |                                                                         |        |        |   |   |       |        |       | 
|----------------------------------- | -------------------------------------------- | ----------------------------------------------------------------------- | ------ | ------ | - | - | ----- | ------ | ----- | 
|                                    |                                              |                                                                        
|                                    |                                              | For the three                                                          
|                                    |                                              | months ended                                                           
|                                    |                                              | March 31,                                                              
|                                    |                                              |                                                                        
|                                    |                                              | 2001                                                                    |        | 2000  
|                                    |                                              |                                                                         |        |       
|Net income (loss)                   |                                              | $                                                                       | (7,667 | )      |   | $ | 5,541 |       
|                                    |                                              |                                                                         |        |        |   |   |       |       
|Weighted average share calculation: |                                              |                                                                         |        |        |   |   |       |       
|                                   
|                                   
|                                   
|                                   
|                                    | Basic weighted average shares outstanding:   |                                                                         |        | 31,381 |   |   |       | 24,940 |      
|                                    |                                              | Average number of shares of common stock outstanding during the
	period |        |        |   |   |       |        |       | 
|                                   
|                                   
|                                   
|                                   
|                                    | Diluted weighted average shares outstanding: |                                                                         |        |        |   |   |       |        |      
|                                   
|                                   
|                                   
|                                   
|                                    |                                              | Treasury stock effect of options and warrants                           |        |        |  |   |       |        | 2,604 | 
|                                    |                                              |                                                                         |        |        |   |   |       |       
|                                    | Diluted weighted average shares outstanding  |                                                                         |        | 31,381 |   |   |       | 27,544 |      
|                                    |                                              |                                                                         |        |        |   |   |       |       
|Income per common share:            |                                              |                                                                         |        |        |   |   |       |       
|                                   
|                                   
|                                   
|                                   
|                                    | Basic income (loss) per share                |                                                                         | $      | (0.24  | ) |   | $     | 0.22   |      
|                                    |                                              |                                                                         |        |        |   |   |       |       
|                                    | Diluted income (loss) per share              |                                                                         | $      | (0.24  | ) |   | $     | 0.20   |      
|                                    |                                              |                                                                         |        |        |   |   |       |       

New Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board (the
FASB) issued SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, which
establishes accounting and reporting standards requiring every
derivative instrument to be reported on the balance sheet as
either an asset or liability measured at its fair value. It
requires that changes in the derivatives fair value be
recognized currently in earnings unless specific hedge
accounting criteria are met. The Company adopted SFAS
No. 133 for the fiscal year beginning January 1, 2001
and there was no material effect on the Companys financial
position or results of operations.

2.  Credit Agreements:

The Company has a credit facility, as amended, that includes an
asset-based arrangement providing for borrowings up to the
lesser of $10.0 million or 80% of eligible accounts receivable
(as defined in the credit facility) with a maximum of
$5.0 million available for issuing standby letters of
credit, provided that the Company either maintains a minimum of
$10.0 million cash on deposit with the bank, secures with cash
any outstanding letters of credit, or treats any unsecured
letters of credit as borrowings. In December 2000, the
Companys bank issued a standby letter of credit that
expires on March 31, 2002 in the amount of
$5.0 million with the Company satisfying the minimum
deposit requirement. This credit facility also includes an
equipment financing facility. The credit facility matures on
February 28, 2002, and borrowings under the credit facility
bear interest at prime plus 2%. Borrowings under the equipment
financing facility cannot be made after March 31, 2001, and
are repayable over 36 months and bear interest at prime
plus 2%. The credit facility contains restrictive financial
covenants, including, but not limited to, requirements related
to liquidity and operating results as well as restrictions
related to other borrowings, acquisitions, dispositions of
assets, distributions and investments. The credit facility also
provides for certain administrative and facility fees. As of
March 31, 2001, the Company borrowed approximately $451,000
under the equipment financing facility which is repayable over
36 months.

10



---



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

3.  Avesta Acquisition:

The acquisition of Avesta was completed on May 24, 2000 and
has been accounted for as a purchase business combination. At
closing, all of the outstanding preferred and common stock of
Avesta was exchanged for shares of Visual common stock. In
addition, the outstanding stock options and warrants of Avesta
were converted into options and warrants to purchase and shares
of Visual common stock.

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

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

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

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

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

In connection with the Avesta acquisition, the Company recorded
approximately $900,000 in liabilities as the cost of closing a
redundant facility and terminating certain employees. The
accrual consisted primarily of severance and other employee
termination costs. These activities resulted in the termination
of approximately 20 employees in connection with a facility
closure, the elimination of duplicate positions and the
consolidation of certain operations. During the three months
ended March 31, 2001, the Company charged approximately
$29,000 against the accrual for the amounts paid. The remaining
accrual as of March 31, 2001 of approximately $65,000
primarily relates to severance costs, substantially all of which
are expected to be paid in 2001.

The pro forma information presented below (unaudited, in
thousands, except per share data) reflects the Avesta
acquisition as if it occurred on January 1, 2000. These
results are not necessarily indicative of future operating
results or what would have occurred had the acquisition been
consummated on that date.

|                                           |  |                    |         |  
|------------------------------------------ |  | ------------------ | ------- | -
|                                           |  | Three Months Ended
|                                           |  | March 31, 2000    
|                                           |  |                   
|Pro forma net revenues                     |  | $                  | 33,189  |  
|                                          
|                                          
|                                          
|                                          
|Pro forma net loss                         |  | $                  | (16,765 | )
|                                          
|                                          
|                                          
|                                          
|Pro forma basic and diluted loss per share |  | $                  | (0.55   | )

During the fourth quarter of 2000, management performed an
evaluation of the recoverability of its long-lived assets,
including those related to the Avesta acquisition, in accordance
with SFAS No. 121. Based upon this evaluation, the Company
concluded that the remaining values of the goodwill and other
intangible assets

11



---



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

related to the Avesta acquisition were impaired. As a result,
the Company recorded an impairment charge of $328.8 million
in the fourth quarter of 2000. This charge included
$203.2 million related to goodwill, which represented the
entire remaining unamortized balance, and $125.6 million
related to the other acquired intangibles including the
completed technology, assembled workforce and trademarks. The
fair values of the remaining Avesta long-lived assets were
determined based upon the estimated discounted cash flows to be
derived from Avesta operations.

4.  Revenue by Product:

|                              |       |           |        |           |  |   |        |        | 
|----------------------------- | ----- | --------- | ------ | --------- |  | - | ------ | ------ | 
|                              |       | March 31, |        | March 31,
|                              |       | 2001      |        | 2000     
|                              |       |           |        |          
|Visual UpTime and Cell Tracer |       | $         | 13,134 |           |  | $ | 25,180 |       
|                             
|                             
|                             
|                             
|Visual IP Insight             |       |           | 1,096  |           |  |   | 4,113  |       
|                             
|                             
|                             
|                             
|Visual Internet Benchmark     |       |           | 1,389  |           |  |   | 1,201  |       
|                             
|                             
|                             
|                             
|Visual Trinity and eWatcher   |       |           | 1,767  |           |  |   |       |       
|                              |       |           |        |           |  |   |        |       
|                              | Total |           | $      | 17,386    |  |   | $      | 30,494 | 
|                              |       |           |        |           |  |   |        |       

5.  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 executives. The complaints 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 complaints do not
specify the amount of damages sought. The Company believes that
the plaintiffs claims are without merit and intends to
defend against these allegations vigorously. The Company expects
that a substantial portion of the legal costs that it might
incur related to this matter will be paid by its directors
and officers insurance policy. The Company cannot
presently determine the ultimate outcome of this action. A
negative outcome could have a material adverse effect on the
Companys financial position or results of operations.
Failure to prevail in the litigation could result in, among
other things, the payment of substantial monetary or punitive
damages.

In October 1997, a lawsuit was filed against Avesta and one
of its employees alleging infringement of two patents, unfair
competition, breach of contract and interference with
contractual relations resulting in unjust enrichment. Avesta
answered the complaint, denying all allegations, and also
asserted counterclaims against the plaintiff for patent misuse,
unfair competition and interference with business and patent
invalidity. The plaintiff has since dropped one of the patents
from the lawsuit and certain of Avestas counterclaims have
been dismissed. Avestas counterclaims currently seek a
declaratory judgement (i) that its products do not infringe
the plaintiffs patents; (ii) that the remaining
patent is invalid; and (iii) that the remaining patent is
unenforceable. The Company intends to vigorously defend itself
in this matter and management believes that the plaintiffs
claims are without merit. The Company cannot presently determine
the ultimate outcome of this action. Both parties have filed
motions for partial summary judgement that have been denied. A
negative outcome could have a material adverse effect on the
financial position or results of operations of the Company.
Failure to prevail in the litigation could result in one or more
of the following: (i) the payment of substantial monetary
and punitive damages; (ii) the reimbursement of the
plaintiffs legal costs; (iii) the requirement to stop
selling one of our major products in its current form;
(iv) the redesign of that product; (v) the requirement
to license certain technology from the plaintiff, which could
include significant royalty payments; and (vi) the
indemnification of certain customers against the losses they may
incur due to the alleged infringement. In addition, the Company
has incurred and may continue to incur significant legal costs
related to this legislation.

12



---



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



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

On May 15, 1998, we acquired Net2Net Corporation
(Net2Net) in a merger accounted for as a pooling of
interests. On September 30, 1999, we acquired Inverse
Network Technology (Inverse) in a merger accounted
for as a pooling of interests. On May 24, 2000, we acquired
Avesta in a merger accounted for using the purchase method of
accounting. We realize revenue from sales of hardware, software,
benchmark services, professional services and technical support.
We generally recognize revenue from the sale or license of our
products upon delivery of the product and passage of title to
the customer. Where the agreements provide for evaluation or
customer acceptance, we recognize revenue upon the completion of
the evaluation process and acceptance of the product by the
customer. Maintenance contracts call for us to provide technical
support and software updates to customers. We recognize
maintenance revenue, including maintenance revenue that is
bundled with product sales, ratably over the lengths of the
maintenance contracts, which currently range from one to five
years. Revenue recognized from multiple-element software
arrangements is allocated to each element of the arrangement
based on the relative fair values of the elements. The fair
values of professional services, technical support and training
have been determined based on the Companys specific
objective evidence of fair value. Revenue from services is
recognized when the services are performed. Subscription fees
for our benchmark reports are deferred and recognized upon
delivery of the reports. We currently contract with third party
subcontract manufacturers for most of the assembly, testing and
shipping of our products. We anticipate maintaining a portion of
our internal manufacturing function for the foreseeable future
at our Rockville, Maryland facility.

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

In connection with this plan, we recorded a restructuring charge
of $7.0 million in the fourth quarter of 2000. The failure to
successfully implement our plan would have a material adverse
effect on our business, financial condition and results of
operations. We anticipate that our plan will be fully executed
by the end of 2001.

13



---



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Results of Operations for the Three Months Ended
March 31, 2001 Compared with the Three Months Ended
March 31, 2000

Revenue.We recognized $17.4 million in
revenue for the three months ended March 31, 2001, a 43.0%
decrease over revenue of $30.5 million for the three months
ended March 31, 2000. Revenue for the three months ended
March 31, 2001 and 2000 was comprised of the following (in
thousands):

|                              |       |           |        |           |  |   |        |        | 
|----------------------------- | ----- | --------- | ------ | --------- |  | - | ------ | ------ | 
|                              |       | March 31, |        | March 31,
|                              |       | 2001      |        | 2000     
|                              |       |           |        |          
|Visual UpTime and Cell Tracer |       | $         | 13,134 |           |  | $ | 25,180 |       
|                             
|                             
|                             
|                             
|Visual IP Insight             |       |           | 1,096  |           |  |   | 4,113  |       
|                             
|                             
|                             
|                             
|Visual Internet Benchmark     |       |           | 1,389  |           |  |   | 1,201  |       
|                             
|                             
|                             
|                             
|Visual Trinity and eWatcher   |       |           | 1,767  |           |  |   |       |       
|                              |       |           |        |           |  |   |        |       
|                              | Total |           | $      | 17,386    |  |   | $      | 30,494 | 
|                              |       |           |        |           |  |   |        |       

The overall decrease in revenue was primarily due to a decrease
in Visual Uptime revenue of $12.0 million, primarily from
service providers and the decrease in Visual IP Insight revenue
of $3.0 million offset by the effect of the acquisition of
the Visual Trinity and Visual eWatcher products. The decrease in
sales of Visual Uptime was primarily attributable to a change in
purchasing behavior of two major customers. Sales to service
providers accounted for approximately 83% and 71% of revenue for
the three months ended March 31, 2001 and 2000,
respectively.

Gross Profit.Cost of revenue consists of
subcontracting costs, component parts, direct compensation
costs, communication costs, warranty and other contractual
obligations, royalties, license fees and other overhead expenses
related to our manufacturing operations and to supporting our
software products and benchmark services. Gross profit was
$10.4 million for the three months ended March 31,
2001, as compared to $21.2 million for the three months
ended March 31, 2000, a decrease of $10.8 million.
Gross margin was 60.0% of revenue for the three months ended
March 31, 2001, as compared to 69.5% of revenue for the
three months ended March 31, 2000. The decrease in gross
margin percentage was due primarily to higher fixed product
support and manufacturing costs supporting a lower revenue base
and the decrease in the higher margin software sales of Visual
IP Insight, offset in part, by the addition of higher margin
software sales of the Visual Trinity and Visual eWatcher
products. Our future gross margins may be adversely affected by
a number of factors, including product mix, the proportion of
sales to providers, competitive pricing, manufacturing volumes
and an increase in component part costs.

Research and Development Expense.Research and
development expense consists of compensation for research and
development staff, depreciation of test and development
equipment, certain software development costs and costs of
prototype materials. Research and development expense was
$5.8 million for the three months ended March 31,
2001, as compared to $5.1 million for the three months
ended March 31, 2000, an increase of $0.7 million. The
increase in research and development expense was due primarily
to the addition of Avesta research and development staff and
costs, increased staffing levels and related support costs, and
purchases of materials and services used in the development of
new or enhanced products. Research and development expense was
33.3% and 16.6% of revenue for the three months ended
March 31, 2001 and 2000, respectively. We expect that
research and development expenditures may increase in absolute
dollars and may decrease as a percentage of revenue, during the
remainder of 2001. The increase in absolute dollars will support
continued development of new or enhanced products and the
exploration of new or complementary technologies.

Sales and Marketing Expense.Sales and marketing
expense consists of compensation for the sales and marketing
staff, commissions, pre-sales support, travel and entertainment,
trade shows and other marketing programs. Sales and marketing
expense was $9.5 million for the three months ended
March 31, 2001, as

14



---



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

compared to $7.0 million for the three months ended
March 31, 2000, an increase of $2.5 million. The
increase in sales and marketing expense was due primarily to the
addition of the costs of Avesta sales and marketing staff and
programs and continued growth in staffing, commissions, and
marketing programs. Sales and marketing expense was 54.4% and
22.9% of revenue for the three months ended March 31, 2001
and 2000, respectively. We expect that sales and marketing
expenditures may increase in absolute dollars, and may decrease
as a percentage of revenue, during the remainder of 2001. This
increase in absolute dollars is expected to be incurred to add
personnel to our existing sales force and for promotional
expenditures to allow us to increase our market penetration and
to pursue market opportunities.

General and Administrative Expense.General and
administrative expense consists of finance, administration and
general management activities. General and administrative
expense was $2.7 million for the three months ended
March 31, 2001, as compared to $2.3 million for the
three months ended March 31, 2000, an increase of
$0.4 million. The increase in general and administrative
expense was due to the addition of Avesta staff and increased
staffing, professional services and corporate facilities and
network infrastructure costs. General and administrative expense
was 15.4% and 7.4% of revenue for the three months ended
March 31, 2001 and 2000, respectively. We expect that
general and administrative expenditures may increase in absolute
dollars and may decrease as a percentage of revenue, during the
remainder of 2001. The increase in absolute dollars is expected
to be required for the expansion of our administrative staff and
internal systems to support expanding operations.

Amortization of Acquired Intangibles.The Company
recorded $473,000 in amortization of intangibles related to the
acquisition of Avesta during the three months ended
March 31, 2001.

Interest Income, Net.Interest income, net, for
the three months ended March 31, 2001, was approximately
$0.3 million as compared to $0.7 million for the three
months ended March 31, 2000, a decrease of
$0.4 million. The decrease was primarily due to decreased
cash and investment balances.

Income Taxes.There was no income tax benefit for
the three months ended March 31, 2001 due to increases in
the valuation allowance. The provision for income taxes for the
three months ended March 31, 2000, was $2.1 million,
which represents an effective tax rate of approximately 27%.

Net Loss.Net loss for the three months ended
March 31, 2001, was $7.7 million as compared to net income
of $5.5 million for the three months ended March 31,
2000, an increase of $13.2 million. This increase was due
primarily to a decrease in revenue and gross profit, increased
operating expenses and the amortization of intangible assets.

Liquidity and Capital Resources

At March 31, 2001, our combined balance of cash and cash
equivalents and investments was $15.9 million as compared
to $26.1 million as of December 31, 2000, a decrease
of $10.2 million. This decrease is primarily attributable
to cash used in operations, including the payment of certain
restructuring charges. We require substantial working capital to
fund our core business, particularly to finance inventories,
accounts receivable, research and development activities and
capital expenditures. To date, we have financed our operations
and capital expenditures with the proceeds from our initial
public offering completed in February 1998 and from our
income from operations generated through the first quarter of
2000. We currently anticipate that capital expenditures for 2001
will not exceed $2.0 million. Our future capital
requirements will depend on many factors, including the rate of
revenue growth, if any, the timing and extent of spending to
support product development efforts and sales and marketing, the
timing of introductions of new products and enhancements to
existing products and market acceptance of our products.

In addition to our cash, cash equivalents and investments,
another potential source of liquidity is our bank credit
facility. The credit facility, as amended, includes an
asset-based arrangement providing for borrowings up to the
lesser of $10.0 million or 80% of eligible accounts
receivable (as defined in the credit facility) with a

15



---



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

maximum of $5.0 million available for issuing standby
letters of credit, provided that we either maintain a minimum of
$10.0 million cash on deposit with the bank, secure with cash
any outstanding letters of credit, or treat any unsecured
letters of credit as borrowings. In December 2000, our bank
issued a standby letter of credit that expires on March 31,
2002 in the amount of $5.0 million with us satisfying the
minimum deposit requirement. This credit facility also includes
an equipment financing arrangement. The credit facility matures
on February 28, 2002 and borrowings under the credit
facility bear interest at prime plus 2%. Borrowings under the
equipment financing agreement cannot be made after
March 31, 2001, are repayable over 36 months and bear
interest at prime plus 2%. The bank credit facility contains
restrictive financial covenants, including, but not limited to,
requirements related to liquidity and operating results as well
as restrictions related to other borrowings, acquisitions,
dispositions of assets, distributions and investments. The
credit facility also provides for certain administrative and
facility fees. We borrowed approximately $451,000 under the
equipment financing arrangement in March 2001.

The deterioration of our operating results in 2000, excluding
the effects of the non-cash Avesta-related charges and the
restructuring charge, was due primarily to decreased revenue and
increased operating expenses. In response to the deterioration,
we initiated a restructuring plan in the fourth quarter of 2000.
Revenue increased to $17.4 million in the first quarter of
2001 from $15.3 million in the fourth quarter of 2000 and
the operating expenses, excluding the non-cash Avesta-related
charges, decreased from $24.0 million in the fourth quarter
of 2000 to $17.9 million in the first quarter of 2001. Our
ability to generate operating income in the future is, in large
part, dependent upon our success in continuing to increase
revenue and reduce operating expenses. While we believe that our
restructuring plan will result in a growth in revenue, there can
be no assurances that we will be able to adequately increase
revenue in the future due to market conditions, competitive
pressures and other factors beyond our control. We also believe
that our restructuring will result in a reduction in operating
expenses that, when combined with the anticipated revenue
growth, will result in a return to profitability. In the event
that the anticipated cost reductions are not realized or revenue
does not increase, we may be required to further reduce our cost
structure. There can be no assurance that we will become
profitable.

Our success is also dependent on our ability to generate
adequate cash for operating and capital needs. We are relying on
our existing cash and cash equivalents, investments and credit
facility together with future sales and the collection of the
related accounts receivable to meet our future cash
requirements. If cash provided by these sources is not
sufficient to fund future operations, we will be required to
further reduce our expenditures for operations or to seek
additional capital through other means that may include the sale
of assets, the sale of equity securities or additional
borrowings. Although we believe that we have the ability to
generate additional cash through such actions, the results of
such actions may be dilutive. There can be no assurance that
additional capital will be available, or available on terms that
are reasonable or acceptable to us. If we are unable to generate
additional cash, our business and financial condition would be
materially and adversely affected such that we may need to
consider other alternatives for the future of the Company.

Factors That May Affect Future Results

The market for our products is growing rapidly 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. Our operations are also subject to certain other
risks and uncertainties including, among other things,
successful implementation of new strategic business initiatives,
failure of broadband access services to achieve market
penetration, lack of profitability, inability to sustain
historical revenue trends, successful incorporation of products
into service provider company infrastructure, long sales cycles,
dependence on significant customers, rapidly changing
technology, current and potential competitors with greater
financial, technological, production, and marketing resources,
dependence on sole and limited source suppliers, dependence on
key management personnel, inability to

16



---



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

recruit and retain employees, limited protection of intellectual
property and proprietary rights, integration of acquisitions,
uncertainty of future profitability and possible fluctuations in
financial results. Failure to meet any of these challenges could
adversely affect future operating results.

Although a significant majority of our sales to date have been
made to customers in the United States and Canada, we intend to
increase our sales efforts in other international markets. We
plan to sell our products to international customers at prices
denominated in U.S. dollars. However, if we experience material
levels of sales at prices not denominated in U.S. dollars, we
intend to adopt a strategy to hedge against currency
fluctuations.

The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting
periods. Actual results could differ from those estimates.

The foregoing discussion 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 various
important factors including, but not limited to, successful
implementation of new business strategic initiatives, failure of
broadband access services to achieve market penetration, lack of
profitability, inability to sustain historical revenue trends,
successful incorporation of products into service provider
company infrastructure, long sales cycles, dependence on
significant customers, rapidly changing technology, current and
potential competitors with greater financial, technological,
production, and marketing resources, dependence on sole and
limited source suppliers, dependence on key management
personnel, ability to recruit and retain employees, limited
protection of intellectual property and proprietary rights,
integration of acquisitions, uncertainty of future profitability
and possible fluctuations in financial results, and other risk
factors set forth in our Annual Report on Form 10-K for the
year ended December 31, 2000.

Item 3.  Qualitative and Quantitative
Disclosure About Market Risk

There have been no material changes in the market risks faced by
the Company or in how those risks are managed since
December 31, 2000. Refer to the Companys Annual
Report on Form 10-K for the year ended December 31,
2000 for a discussion about such market risk.

17



---



VISUAL NETWORKS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



PART II  OTHER INFORMATION

Item  1.  Legal Proceedings

In July, August and September 2000, several purported class
action complaints were filed against the Company and certain of
the Companys executives. The complaints 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 complaints do not specify
the amount of damages sought. The Company believes that the
plaintiffs claims are without merit and intends to defend
against these allegations vigorously. The Company expects that a
substantial portion of the legal costs that it might incur
related to this matter will be paid by its directors and
officers insurance policy. The Company cannot presently
determine the ultimate outcome of this action. A negative
outcome could have a material adverse effect on the
Companys financial position or results of operations.
Failure to prevail in the litigation could result in, among
other things, the payment of substantial monetary or punitive
damages.

In October 1997, a lawsuit was filed against Avesta and one
of its employees alleging infringement of two patents, unfair
competition, breach of contract and interference with
contractual relations resulting in unjust enrichment. Avesta
answered the complaint, denying all allegations, and also
asserted counterclaims against the plaintiff for patent misuse,
unfair competition and interference with business and patent
invalidity. The plaintiff has since dropped one of the patents
from the lawsuit and certain of Avestas counterclaims have
been dismissed. Avestas counterclaims currently seek a
declaratory judgement (i) that its products do not infringe
the plaintiffs patents; (ii) that the remaining
patent is invalid; and (iii) that the remaining patent is
unenforceable. The Company intends to vigorously defend itself
in this matter and management believes that the plaintiffs
claims are without merit. The Company cannot presently determine
the ultimate outcome of this action. Both parties have filed
motions for partial summary judgement that have been denied. A
negative outcome could have a material adverse effect on the
financial position or results of operations of the Company.
Failure to prevail in the litigation could result in one or more
of the following: (i) the payment of substantial monetary
and punitive damages; (ii) the reimbursement of the
plaintiffs legal costs; (iii) the requirement to stop
selling one of our major products in its current form;
(iv) the redesign of that product; (v) the requirement
to license certain technology from the plaintiff, which could
include significant royalty payments; and (vi) the
indemnification of certain customers against the losses they may
incur due to the alleged infringement. In addition, the Company
has incurred and may continue to incur significant legal costs
related to this legislation.

Item  2.  Changes in Securities

None.

Item  3.  Defaults Upon Senior
Securities

None.

Item  4.  Submission of Matters to Vote of
Security Holders

None.

Item  5.  Other Information

None.

18



---



Item  6.  (a) Exhibits

|        |  |                     |  |                                                                                                                                                                                                       
|------- |  | ------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|        |  |                    
|Exhibit |  |                    
|Number  |  | Exhibit 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.                                                                                                                                                                      
|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  |  | $$$               |  | Second Amendment, dated November 4, 1998, to the
	Reseller/Integration Agreement between the Company and MCI
	Telecommunications Corporation (relating to Exhibit 10.5).                              
|10.6    |  | !                   |  | Master Purchase Agreement, dated as of May 22, 2000,
	between Sprint/United Management Company and the Company.                                                                                       
|10.7    |  | *                  |  | General Agreement for the Procurement of Equipment, Services and
	Supplies, dated November 26, 1997, between the Company and
	AT&T Corp.                                                              
|10.8    |  | *                   |  | Lease Agreement, dated December 12, 1996, by and between
	the Company and The Equitable Life Assurance Society of the
	United States.                                                                 
|10.8.1  |  | *                   |  | Lease Amendment, dated September 2, 1997, by and between
	the Company and The Equitable Life Assurance Society of The
	United States (related to Exhibit 10.8).                                       
|10.8.2  |  | $$$                 |  | 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).                                                                               
|10.9    |  | ***                 |  | Sublease, dated October 1, 1999, between the Company and
	Micron Technology, Inc.                                                                                                                     
|10.10   |  | *                   |  | Employment Agreement, dated December 15, 1994, by and
	between the Company and Scott E. Stouffer, as amended.                                                                                         
|10.11   |  | !!                  |  | Lease Agreement, dated April 7, 2000, by and between Visual
	Networks, Inc. and TA/Western, LLC.                                                                                                      
|10.12   |  | *                   |  | Terms of Employment, dated June 11, 1997, by and between
	the Company and Peter J. Minihane, as amended.                                                                                              
|10.15   |  | %                   |  | Loan and Security Agreement, dated April 5, 1999, by and
	between Silicon Valley Bank and the Company.                                                                                                
|10.15.1 |  | !                   |  | Second Amendment to Loan and Security Agreement, effective
	October 5, 2000, by and between Silicon Valley Bank and the
	Company (relating to Exhibit 10.15).                                         
|10.15.2 |  | !                   |  | Amended and Restated Revolving Promissory Note issued by the
	Company on October 5, 2000, to Silicon Valley Bank
	(relating to Exhibit 10.15).                                                        
|10.17   |  | **                  |  | Net2Net 1994 Stock Option Plan.                                                                                                                                                                       
|10.20   |  | $$                  |  | 1999 Employee Stock Purchase Plan.                                                                                                                                                                    
|10.21   |  | %%                  |  | Agreement and Plan of Merger, dated September 15, 1999, by
	and among the Company, Visual Acquisitions Two, Inc. and Inverse
	Network Technology.                                                     
|10.22   |  | %%%                 |  | Inverse Network Technology 1996 Stock Option Plan.                                                                                                                                                    
|10.23   |  | @                   |  | Merger Agreement, dated February 7, 2000, by and among
	Visual Networks, Inc., Visual Acquisitions Three, Inc. and
	Avesta Technologies, Inc.                                                         
|10.23.1 |  | !!                  |  | Avesta Technologies 1996 Stock Option Plan.                                                                                                                                                           

19



---



|        |  |                     |  |                                                  
|------- |  | ------------------- |  | -------------------------------------------------
|        |  |                    
|Exhibit |  |                    
|Number  |  | Exhibit Description
|        |  |                    
|16.2    |  | @                   |  | Letter regarding change in certified accountants.
|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
	Registration Statement on Form S-3, No. 333-90105.                                                                                                                                                                                           
|%%  |  | Incorporated herein by reference to Exhibit 2.1 to the
	Companys Current Report on Form 8-K dated
	October 8, 1999.                                                                                                                                                                            
|%%% |  | Incorporated herein by reference to Exhibit 10.1 to the
	Companys Registration Statement on Form S-8,
	No.  333-88719.                                                                                                                                                                         
|@   |  | Incorporated herein by reference to the Companys
	Registration Statement on Form S-4, No. 333-33946.                                                                                                                                                                                           
|$   |  | Incorporated herein by reference to Exhibit 3.1 to the
	Companys Quarterly Report on Form 10-Q for the three
	months ended June 30, 1999.                                                                                                                                                      
|$$  |  | Incorporated herein by reference to the Companys
	Definitive Proxy Statement on Schedule 14A filed
	April 30, 1999.                                                                                                                                                                            
|$$$ |  | Incorporated herein by reference to the Companys Annual
	Report on Form 10-K for the year ended December 31,
	1998.                                                                                                                                                                            
|   |  | Portions of 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.
|  |  | Portions 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.                                                          
|!   |  | To be filed by amendment.                                                                                                                                                                                                                                                                       
|!!  |  | Incorporated herein by reference to the Companys Quarterly
	Report on Form 10-Q for the three months ended
	June 30, 2000.                                                                                                                                                                     

(b)  Reports on Form 8-K

None.

20



---



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/ PETER J. MINIHANE                        
| |                                                   
| | Peter J. Minihane                                 
| | Executive Vice President, Chief Financial Officer,
| | Treasurer and Director (principal financial and   
| | accounting officer)                               

May 15, 2001

21