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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS

PURSUANT TO SECTIONS 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

(MARK ONE)

FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003

OR

FOR THE TRANSITION PERIOD FROM                      TO                     

Commission File Number: 000-23699

VISUAL NETWORKS, INC.

(Exact Name of Registrant as Specified in Its Charter)

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

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

NONE

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

Common Stock, par value $0.01 per share

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K. x

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ¨ No x

The aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 30, 2003 and March 26, 2004 was approximately $43,089,228 and $101,365,115, respectively. The number of outstanding shares of the Registrant’s common stock as of March 26, 2004 was 33,107,169 shares.

Documents Incorporated by Reference

Part III of the Form 10-K incorporates by reference certain portions of the Registrant’s proxy statement for its 2004 annual meeting of stockholders to be filed with the Commission not later than 120 days after the end of the fiscal year covered by this report.

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VISUAL NETWORKS, INC. FORM 10-K

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FORWARD LOOKING STATEMENTS

IN ADDITION TO HISTORICAL INFORMATION, THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY. FACTORS THAT MIGHT CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN THE SECTION ENTITLED “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.” READERS SHOULD CAREFULLY REVIEW THE RISKS DESCRIBED IN OTHER DOCUMENTS THE COMPANY FILES FROM TIME TO TIME WITH THE SECURITIES AND EXCHANGE COMMISSION, INCLUDING THE QUARTERLY REPORTS ON FORM 10-Q TO BE FILED BY THE COMPANY IN 2004. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF THE DATE OF THIS ANNUAL REPORT ON FORM 10-K. THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY RELEASE ANY REVISIONS TO THE FORWARD-LOOKING STATEMENTS OR REFLECT EVENTS OR CIRCUMSTANCES AFTER THE DATE OF THIS DOCUMENT.

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PART I

In addition to historical information, our annual report on Form 10-K contains forward-looking statements that involve risks and uncertainties that could cause our actual results to differ materially from our expectations. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Readers should carefully review the risks described in other documents we file from time to time with the Securities and Exchange Commission, including our quarterly reports on Form 10-Q. We caution you not to place undue reliance on these forward-looking statements, which speak only as of the date of this annual report on Form 10-K. We undertake no obligation to revise the forward-looking statements to reflect events or circumstances after the date of this document.

OVERVIEW

We design, manufacture, sell, and support performance management platforms for communications networks. Our products, Visual UpTime^® Select^™ and Visual IP InSight^®, allow businesses and organizations (which we call enterprises), and their providers of network services (which we call service providers and systems integrators) to measure the performance of their networks, to determine whether a network is performing consistent with the requirements of the software applications running on that network, and to determine whether the level of service being provided is meeting those standards agreed upon by the service provider and its enterprise customer. These platforms also help enterprises to understand how their software applications and users are using the network, the performance those applications and users are experiencing, and required network capacity. Our platforms constantly monitor the data traffic traveling between service providers’ and enterprises’ networks. Network operators using our platforms can quickly identify and isolate network problems without dispatching personnel to remote sites. By learning how much traffic is traveling on the service provider network and understanding the characteristics of that traffic, network operators can efficiently address bandwidth capacity and response time issues. Although our products do not perform any active control of networks or applications, they are categorized as “performance management” tools and we may refer to our products as those that “manage” networks.

We market our products to enterprises, service providers, and systems integrators. Network performance is critical to enterprises because networks enable applications that are vital to an enterprise’s operations. Enterprises require tools to ensure the availability of their networks and the applications they support, to predict and validate network performance, and to optimize the price/performance ratio of their networks. As of December 31, 2003, we had shipped platforms to manage over 170,000 data transport circuits, or connections between service providers’ networks and enterprises’ networks, and 17.5 million remote Internet access devices.

Service providers and systems integrators use our products to create services that are differentiated from their competitors and to reduce their operating and other costs associated with initiating and providing services for their customers. Our major service provider customers include, among others: AT&T, BellSouth, Earthlink, Equant, MCI, SBC, Sprint and Verizon. The revenue we generated by selling our products to service providers was 77%, 82% and 83% of our consolidated revenue in 2001, 2002 and 2003, respectively.

Despite having returned to profitability in 2002, decreased sales led to a net loss of $4.3 million for 2003. Decreased capital spending by enterprise customers associated with the continuing economic downturn slowed the deployment of services based on our products. We have been able to limit our operating losses by primarily controlling discretionary spending. In order to increase sales and take advantage of an anticipated economic recovery, we have introduced a new product suite, Visual UpTime Select, which is the successor to our original flagship product, Visual UpTime. This new architecture is

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intended to offer greater flexibility to fit the evolving needs of our enterprise customers, service providers and systems integrators. Our new modular approach allows companies to buy what they need—when they need it—in order to effectively optimize and manage applications delivered over their network infrastructure. We believe that the increased flexibility of Visual UpTime Select is critical to meet the changing needs and budgets of today’s enterprise customer.

We were incorporated in Maryland in August 1993 under the name Avail Networks, Inc. and reincorporated in Delaware in December 1994 as Visual Networks, Inc. Our common stock began trading on the Nasdaq National Market on February 6, 1998. Our principal executive offices are located at 2092 Gaither Road, Rockville, Maryland, 20850. Our telephone number is (301) 296-2300. You may obtain copies of this Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports free of charge on our corporate Web site at www.visualnetworks.com.

INDUSTRY BACKGROUND

General

Software applications that are used to operate enterprises, such as enterprise resource planning, supply chain management, customer relationship management, transaction processing, file transfers, software distribution and e-commerce have grown in number and complexity over the past decade. All of these applications require communications systems to operate, resulting in growing activity, or “data traffic,” on telecommunications networks. Increasingly, the applications are becoming more complex, often depending on the interaction of computers in geographically distant locations to accomplish their tasks. At the same time, traditional business communications like voice telephony and video teleconferencing are being shifted from leased lines and the public switched telephone network to the same networks used by the software applications. The merging of these technologies onto the same communication network can dramatically reduce costs. It also allows businesses to operate in a more decentralized fashion with a geographically disbursed workforce. Enterprises can more closely and easily communicate with important business partners.

The network infrastructure that enables software applications, including telephone and video, to function is more critical than ever. Businesses deploy the application delivery infrastructure through a combination of internal capital investment and staffing, and external leasing and outsourcing using various service providers and systems integrators. They demand both high reliability and performance from their internal and external telecommunications networks and verification of their return on investment.

The application delivery infrastructure includes networks of various types of communications links and equipment. Local Area Networks (LANs) interconnect computers within individual buildings and occasionally between buildings that are nearby, generally using some form of Ethernet technology. Metropolitan Area Networks (MANs) interconnect LANs in a smaller geographical region such as a city. Wide Area Networks (WANs) connect LANs and MANs over longer distances. LANs are often deployed and operated by the individual businesses. Service providers generally operate MANs and WANs for business customers as services. The communication provided by LANs is typically private while MAN and WAN services can either be of a private or a shared public nature.

Private MAN and WAN services connect an enterprise’s internal sites over a service provider’s network facilities, or backbone. In order for this connection to meet the customer’s requirements, the main network facility needs to have a certain capacity level and to be able to provide additional capacity to accommodate the customer’s increase in traffic during peak usage times. Most private networks use one, or a combination of four technologies: (1) frame relay, (2) asynchronous transfer mode (ATM), (3) IP virtual private network (IP/VPN), or (4) various forms of Ethernet.

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A public network is a network that uses the Internet, or multiple service providers’ networks, to interconnect sites. Businesses use public networks to connect remote and mobile users to their corporate network, to connect to remote sites in situations where private network connections are not available or cost effective, to connect to the networks of business partners, and to connect to public Web sites. Businesses often choose to use private networks when they are concerned with network performance issues, network availability, security, and privacy.

Regardless of the type of infrastructure employed, applications require certain levels of performance to enable the business productivity they are designed to provide. Enterprises need applications infrastructure to deliver:

High availability. When applications are not available, businesses can incur increased costs and experience reduced revenue. Businesses require tools that will warn them of pending problems in their applications delivery infrastructure, quickly identify those problems, and cost-effectively resolve them.

Predictable performance. The telecommunications infrastructure must support the performance requirements of the business applications running on it. Businesses require tools that show them how the infrastructure is being utilized and by whom or what, what impact applications are having on it, whether it has adequate capacity to support the applications, and what the end user’s experience is with the overall performance of the telecommunications infrastructure.

Appropriate price/performance. Business managers must also control infrastructure costs and validate that their investments are performing as promised. They require tools to measure the performance of the network that may be the subject of a guarantee contained in their agreement with their service provider. They also need to identify areas of the network where excess capacity exists.

To satisfy customers’ requirements by offering network services that meet these requirements and remain competitive and profitable, service providers and systems integrators need solutions that provide:

Efficient installation and maintenance. Service providers and systems integrators need to install services quickly and efficiently. They need tools that enable them to verify that a newly installed network service is operational, independent of the readiness of the customer’s networking equipment. The goal is to decrease the costs associated with installing network services and the delay between service installation and when the service provider can begin billing the customer.

Collaborative troubleshooting. The service provider or systems integrator is typically the first place a business customer will call with an applications delivery infrastructure problem, regardless of the true source of that problem. Service providers and systems integrators need tools that enable them to rapidly identify the root cause of customers’ problems without dispatching personnel to the customers’ locations. These tools must be able to determine whether the problem resides within the service provider network, the local telephone company, or the customer. By having the right tools, service providers and systems integrators reduce costs and improve their customer relationships by being a responsive, informed, and reliable business partner.

Verifiable service performance. Because public and private networks share network resources among all customers, a service provider must be able to offer its customers the ability to verify the quality of the service that is being provided to those customers. The service provider needs tools to accurately measure the level of service it provides and to report those performance levels to the customer. Many service providers and systems integrators actually enter into service level agreements, or SLAs, with their customers that guarantee certain levels of performance. Without the ability to measure the service levels being provided, however, an SLA is meaningless.

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Effective network planning. The service provider and the customer must work together to deliver a network that satisfies the customer’s requirements. The service provider needs tools to determine application bandwidth requirements and identify places on the customer network with either insufficient or excess capacity. This allows the service provider to make recommendations to the customer for enhancing the efficiency of their network.

The Visual Networks Solution

We provide platforms for managing the performance of application data traffic across networks. Our platforms measure and analyze in real time the telecommunications networks that are critical for the proper operation of software applications and the optimal productivity of their users. We provide software and hardware components that are placed at various locations in networks to perform tests, take measurements and analyze traffic. Key locations are the points that divide the network portion provided by the service provider from the portion provided by the customer. We call this point the service boundary. Service providers, systems integrators and their business customers manage network performance from service boundary to service boundary because this defines the service offering to customers.

Information gathered from the analysis points is then periodically stored in databases located in network operations centers, at the customer’s and/or the service provider’s location. We also provide tool sets that use the information stored in these databases to assist network operations center personnel in such daily activities as customer care, usage analysis, troubleshooting, service level monitoring and management, and network planning. The operator is also able to use the performance history stored in the database to observe times when software applications and/or the network may have been experiencing performance problems. The operator can use this information to help solve intermittent problems that tend to be difficult to identify and remedy. The operator also has the ability to monitor performance in real time.

Enterprises may either buy our products and operate them on their own, or they may purchase from a service provider a service offering that includes our performance management platforms. Our platforms provide the following capabilities:

Application usage. Our platforms identify the in-use applications and the top users of bandwidth on each network connection. Where network traffic is differentiated into classes in order to prioritize the handling of delay-sensitive traffic, our platforms analyze the assignment of applications to these classes and the breakdown of traffic load between them. Businesses use this information to drive infrastructure resource allocation, prioritization, and tuning, as well as to detect abuse and intrusion by miscreants and computer viruses.

Network utilization. Our platforms monitor and report the network utilization by type of service (e-mail, instant messaging, FTP, web browsing, etc.). Businesses use this capability for network planning to determine the impact that various applications have on network capacity and performance. In addition, a business can determine whether the applications and networking equipment are properly configured. One of the modules we offer is Burst Advisor, which provides a view of network usage in one-second increments. A business can use this information to determine if network capacity is sized appropriately for its needs, if more bandwidth should be procured, or if too much bandwidth has been provided.

Troubleshooting. Infrastructure operators can program our platforms to provide an early warning of potential problems if certain metrics are exceeded. When specified thresholds are exceeded, the platforms generate alarms to alert the operator to the problem in real-time. These alarms can be automatically forwarded to an external fault management system. Our platforms then provide a number of troubleshooting tools that use information gathered from the infrastructure in real-time to

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enable the operator to isolate the cause of the problem. Our platforms can also capture application traffic at the service boundaries for diagnosing difficult application problems.

In addition to receiving real-time views, the operator can also look back in time to understand the condition of the infrastructure at the point when problems actually occurred. Using our platforms, an infrastructure operator can resolve performance problems without the need to dispatch technicians to remote sites with expensive analysis equipment, and can quickly identify and diagnose hard-to-find, intermittent problems. Our tools identify whether the problems exist in the data center, on a router, in the network equipment or service of the network service provider, with the end-user client, or in the application itself. The use of our platforms results in higher applications infrastructure availability, performance and lower operating costs.

Performance monitoring. For infrastructure provided by a network service provider, our platforms monitor and report information on a number of service factors that are often contractually promised to the customer by the service provider. For private IP networks, our platforms measure and report on these same metrics for a particular level or class of service. We offer Service Advisor, a module that gives a real time view of the service quality metrics. For public IP networks, our platforms execute and report on tests that measure the availability and performance of IP services and protocols. In addition, for remote dial Internet access, our platforms monitor and report on the connection performance from the user’s point of view. These performance-monitoring tools enable a business to have an early indication of potential network problems.

Planning and reporting. Our platforms generate a number of summary and detailed reports on infrastructure usage, performance, and capacity that can be used for both short and long-term network planning. Information Technology (IT) executives use the reports to assess the quality of the services being provided and to verify that their providers’ contractual performance obligations are being met.

Service providers and systems integrators purchase our platforms in an effort to reduce their operating costs and differentiate their services through better network performance. We provide the following capabilities to our service provider and system integrator customers:

Service creation. We assist providers in defining and creating service offerings that incorporate our solutions. We help define the elements to be provided in the service, develop the methods and procedures for implementing and deploying the service, calculate the service provider’s return on investment, develop marketing and sales materials, train the service provider sales force and generate demand for the new service.

Service validation. Service providers and systems integrators incorporate network performance metrics into their customer contracts and use the information provided by our solutions to confirm that they are, or are not, meeting their contractual commitments. These commitments normally include delay of network traffic flow, availability of access ports, percentage of traffic dropped, validation of type of service provided and availability and performance of IP services and protocols. Our platforms’ ability to measure service performance metrics also provides a justification for the service provider’s premium pricing on certain service level agreements.

Collaborative management. The service provider is typically the first to receive a trouble call if a business’ networked application is performing poorly. In many cases, the source of the problem is not the service provider, but rather the access line provided by the local telephone company, the configuration of the customer’s equipment, or the application itself. Our platforms enable the customer and the service provider to collaborate when solving a problem and to quickly identify its source.

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Scalability. Our platforms can be increased in capacity to manage multiple customers’ networks, larger numbers of sites and vast amounts of traffic.

OUR STRATEGY

Our primary objective for success is to maximize the number of enterprise locations that are managed by our platforms. Key elements of the strategy include:

Performance management of applications delivery infrastructure. We are shifting the focus of our product platforms beyond just performance management of WANs to broadly address performance management of the delivery of applications across network infrastructure. We seek to reflect this shift throughout our product portfolio with architectural changes, new option modules, and feature set enhancements. The first major installment of this strategy is the introduction of Visual UpTime Select.

Flexibility and choice. Current economic conditions have made it that much harder for businesses to justify investments in large infrastructure changes, including the systems they use to manage IT. We are making our solutions easier to cost-justify by providing flexible deployment and purchase options that allow customers to buy what they need when they need it. This is being implemented through Visual Uptime Select which features the unbundling of product functionality, dynamic software licensing, and related professional services.

Emphasis on channels. We intend to capitalize on our relationships with major service providers and systems integrators to assist them in defining and selling service offerings based on our platforms. Service providers and systems integrators are the predominant means for the deployment of service performance management capability for private networks, and are an increasingly important provider of service performance management for public IP networks. We also intend to expand our market coverage in the Value-Added Reseller (VAR) channel by our own marketing programs, supporting the marketing programs of our wholesale distributors, Interlink Communications Systems and Sprint North Supply, and through our Cisco relationship.

Make it Visual Partner Program. Through our Make it Visual Partner Program (MIVPP), we are seeking to have our platforms deployed on the greatest number of network access sites possible. We seek to partner with leading providers of network access equipment to have components of our agent technology embedded into their equipment. To date, we have entered into strategic relationships with Cisco Systems and Kentrox, both of which are leading providers of network access equipment. We intend to expend development, marketing and sales resources to support and expand these relationships and to extend the program to other providers of private and public data networking access equipment.

Managed routers. We intend to have our platforms used by service providers and systems integrators in outsourced network services, including those service providers that use the router as the service boundary, rather than the data service unit, or DSU, which serves as the service boundary in most service providers’ offerings. Many service providers, systems integrators and managed network service vendors offer complete packages of network services to large businesses, often including routers as the service boundaries. Through our MIVPP initiatives our platforms can be used in these networks through the customer’s router equipment. In other offerings, our stand-alone analysis service elements, or ASEs, are used as a clearly defined service boundary, even though the service provider also provides further services and equipment on the customers’ premises. We intend to focus certain marketing and sales resources to create and market Visual Networks-based performance management services for these offerings.

Global expansion. We intend to use our customer relationships with large, multinational corporations to expand our coverage outside the United States. We intend to focus on service providers that have the largest share of private network services, and direct and remote Internet access markets, and

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by leveraging our relationships with equipment providers. We are also establishing reseller relationships globally with local and regional VARs and increasing our international sales resources.

OUR PRODUCTS

We have two product lines: Visual UpTime^® Select^™ and Visual IP InSight^®.

Visual UpTime Select

In the fourth quarter of 2003, we announced a new product platform that is the successor to our original flagship product, Visual UpTime. Based on the original Visual UpTime software code base, Visual UpTime Select introduces a new product architecture and signals a major shift in the Visual UpTime product family’s capabilities, packaging and future direction. Visual UpTime Select is a platform for managing the performance of application delivery on private data networks. This contrasts with the original Visual UpTime product that focused on performance management of the private data networks themselves. Other key improvements provided by Visual UpTime Select include:

Visual UpTime Select consists of the following tightly integrated capabilities:

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Each of these capabilities provides information in real-time, showing what is actually occurring in the infrastructure at that moment, or, alternatively, an historical view of performance over the previous two weeks.

The Service Summary and Traffic Capture tool sets are individual software modules in the Visual Uptime Select architecture. The remaining tool sets are available in several individual software modules that present their information in domains tailored to fit specific customer’s needs: Select Real-Time^™ provides analysis and reporting of what is happening in the infrastructure right now; Select Back-In-Time^™ allows the operator to analyze and report on historic performance and problems for up to one year; Select Class-of-Service^™ analyzes usage and traffic according to the service priorities assigned.

Service providers currently use Visual UpTime to improve the performance of their own networks, reduce network operating costs, differentiate their services from other providers, validate compliance of contractual performance obligations and create value-added services that are then sold to businesses. Several service providers have based value added services on Visual UpTime, including the following services: AT&T Frame Relay Plus, AT&T IP-enabled Frame Relay Plus (IPeFR Plus), Sprint Web-based Network Manager, Sprint Managed DSU, MCI Frame Relay Platinum, MCI Private IP Platinum, and Verizon Frame Watch. Service providers also resell the Visual UpTime platform to businesses that host the system and manage their own networks. We believe that our service provider customers will migrate over time to Visual UpTime Select.

We license private-label versions of Visual UpTime to Cisco Systems. Visual UpTime is the basis for Cisco’s WAN Access Performance Management System (WAPMS). WAPMS currently manages Frame Relay and ATM networks, and Cisco plans to expand into Multi-Protocol Label Switching (MPLS) network management in 2004.

The Visual UpTime Select platform includes the following components: Agents and Analysis Service Elements (ASEs), the Server, Web Clients, and Software Modules.

Agent and ASE. The Agent is proprietary software that performs detailed analyses of network and application performance. The Agent resides either in our proprietary hardware, called an ASE, or third-party hardware such as a router. Most versions of the ASE also provide the functionality of wide area network access equipment known as a channel service unit/data service unit, or CSU/DSU. Although it does not perform modulation or demodulation, a CSU/DSU can be thought of as a “digital modem” that connects a business customer’s network to their service provider’s network. The ASE incorporates Agent software in conjunction with networking-specific microprocessors and integrated circuits to perform detailed analyses of every bit of data traversing

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the service boundary. Agents operating on third-party hardware platforms may have more limited capabilities depending on the hardware resources available on that specific hardware platform.

The Agent generally stores the analyses locally in memory and waits for the Server, described below, to request the results. When the Agent detects an anomalous condition on the network, it alerts the network operator, who can then take prompt action to remedy the situation. Our core Agent technology can be deployed in a number of configurations and data speeds depending on customer requirements. Under Visual UpTime Select, the Agent can also be deployed without end user access to the management data. The end user can remove the restrictions by purchasing and deploying license keys that “unlock” the restricted area. Service providers and systems integrators can use this arrangement when they make the ASE the default WAN access equipment deployed every time they install a circuit, but do not initially provide the management capabilities to their customer, and subsequently purchase the management capability when value-added services are sold to their customer.

Server. The Server is our platform database, and it manages requests between the Web Client, described below, and either the database or an Agent. Traditional management data collection architectures depend on the continuous gathering of data, a bandwidth consuming process. In contrast, Visual UpTime Select distributes most of the processing burden to the Agent, allowing the Server-Agent data sharing to take place less frequently, typically once a day. This feature is critical in WAN environments where costly bandwidth makes continuous management data collection impractical. The Server is a partitioned database with secure access control, meaning that only certain users can access certain parts of the database. This enables a service provider to serve multiple customers from a single Server. The Server is also responsible for maintaining the software license keys that control access to the various modules, described below.

Web Client. The Web Client is server-based software accessed by a standard web browser, which is used for packaging and presenting the data stored in the Server and the Agent. It enables access to the Visual UpTime Select tool sets, features, and data according to user permissions and software licenses registered on the Server.

Software modules. The software modules are optional capabilities that are resident on the Server, but are not accessible until the customer has purchased the corresponding licenses and activated them with a software license key. Software module licenses are available either on a perpetual or limited duration basis. Service Summary and Traffic Capture are packaged as individual software modules. Other tool sets’ capabilities are available in several individual software modules, depending on the ways that customers need to use the analysis information. Select Real-Time software module provides analysis and reporting of what is happening in the infrastructure right now while the Select Back-In-Time software module allows the operator to analyze and report on historical performance and problems for up to one year. The Select Class-of-Service software module analyzes usage and traffic according to the service priorities assigned.

At a price competitive with an ordinary unmanaged network access device, we offer a Visual UpTime Select ASE bundled with the Visual UpTime Select Server software licensed for an unlimited number of Web Clients. This bundle allows the customer to access the Service Summary component only. Thus, it is essentially a price neutral decision for the customer to begin deploying Visual UpTime Select capabilities one Agent at a time and immediately begin reaping the benefits. Customers may then purchase Software Modules according to their needs and can temporarily license additional Software Modules to address short-term needs. We are continuously enhancing Visual UpTime Select with new features and capabilities to expand our value, address new network service requirements, and support new applications. We expect to package many of these enhancements as optional modules that are individually licensed.

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Visual IP InSight

Visual IP InSight is a service performance management platform for public IP networks. It enables service providers and enterprises to manage IP connectivity and accessibility to IP network services from the end-user’s perspective. It helps manage IP connectivity across all IP access technologies, including dial, dedicated, broadband (DSL, wireless, cable and ISDN), and VPN connections.

We license Visual IP InSight to public IP service providers to enable them to improve network performance, reduce network operating costs, differentiate services, validate contractual performance obligations and create value-added services. We have several public IP service providers using Visual IP InSight for performance management including BellSouth.Net dial service, Earthlink Fastlane, Verizon On-Line and SBC dial and broadband services. Value-added services that are based on Visual IP InSight include MCI Dial Analysis and MCI Dedicated Analysis.

Platform components for Visual IP InSight include agents, data collectors and a data repository. These components communicate with each other over an IP network providing real-time information. These components are packaged into application suites that address various public IP networking environments including: Dial Suite, Broadband Suite and Dedicated Suite. Visual IP InSight’s architecture is distributed, fault-tolerant, and scalable to carrier-class networks.

Agents. Agents are the software clients that actually perform the tests and collect the data used by the Visual IP InSight platform. The platform’s agents are the origin of quality of service and test data. There are two types of agents: dedicated and client. Dedicated agents are embedded in hardware devices called IP Service Elements (ISE). An ISE is connected to the network at a suitable monitoring point and performs active tests on command as configured by the network manager. Client agents are installed on the PC of service subscribers. The software runs transparently until end-user assistance is required. Context-sensitive online “help” suggests solutions to more than 150 dial-access problems and keeps a descriptive error log that customer care personnel can use to solve problems that end users cannot resolve on their own. At the same time, the client agent can passively monitor user activity on the network or perform active tests when requested by the network manager. The client agent can be deployed in any remote access environment — dial modem, cable modem, DSL, ISDN, or wireless services. All varieties of dedicated and client agents can be used together in the same network with the same Visual IP InSight platform.

Visual IP InSight Collectors. The collectors gather data from the various agents and transfer it to the Visual IP InSight Aggregator, described below. A collector can be deployed either on the LAN side of a firewall or at key points in the public IP network. A single collector can handle hundreds of thousands of active agents.

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

Visual IP InSight Service Operations. This application provides information regarding problems in real-time and monitors connection performance and the performance of IP applications, such as e-mail and domain name servers.

Visual IP InSight Service Level Manager. This application allows an Internet Service Provider (“ISP”) to define specific contractual arrangements with customers that are automatically monitored on a customer by customer basis. It generates detailed service reports showing the end-users’ actual experiences compared to the performance metrics agreed upon by the customer and the ISP. Within the enterprise, an internal IT department uses it to manage the performance of multiple ISPs on a partitioned

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basis and to manage service level objectives across business services. Visual IP InSight Service Level Manager helps service managers by automating the service monitoring process; measuring actual performance against thresholds; and generating hourly, daily, weekly, and monthly reports.

Visual IP InSight Customer Care. This application monitors the end user’s experiences by gathering the connection history, system configuration, and current network status from the end user’s personal computer. This gives customer care representatives the ability to more accurately identify problems, effectively diagnose their causes and rapidly resolve the issues.

Visual IP InSight Performance Management Suites. The capabilities of Visual IP InSight are organized into application suites that address various public IP networking environments:

We license Visual IP InSight as a complete platform which requires at least one back-end data base system, a Collector, an Aggregator and the Service Operation application per deployment along with one ISE or agent license for each performance management point. Platform pricing is dependent on the number of ISE and client agent management licenses authorized and the applications used.

SALES AND MARKETING

We have implemented an indirect channel strategy to enterprises and a direct channel strategy to service providers and systems integrators. Our marketing programs are designed to generate demand for our products at the enterprise level—those organizations and businesses with application delivery infrastructure management needs. Our sales force is responsible for this effort. Enterprises purchase our platforms either through a service provider, systems integrator, or one of our authorized value-added resellers, or VARs. We have several support programs to educate the sales forces of service providers, systems integrators, and VARs that are designed to shorten sales cycles.

Enterprises that want to host their own systems may procure them through a service provider resale program or through a VAR. Pursuant to agreements with us, our service provider customers purchase our products for internal use, for resale to their customers or to serve as the basis for a value-added service offering. Our major service provider customers include AT&T, BellSouth, Earthlink, Equant, MCI, SBC, Sprint, and Verizon. Revenue related to our shipment of products to service providers represented 77%, 82% and 83% of our total revenue in 2001, 2002 and 2003, respectively. In 2003, AT&T, SBC, and Sprint represented 27%, 18% and 17% of our consolidated revenue, respectively. The loss of any one of these major service provider customers would have a material adverse effect on our financial position and results of operations.

VARs place orders for Visual Networks products through wholesale distributors. Visual Networks has wholesale distribution relationships with Interlink Communication Systems (ICS) and Sprint North Supply. Visual Networks’ regional sales people work closely with VARs, calling on enterprise accounts and assisting in closing business. At the end of 2003, there were 71 VARs actively selling Visual Networks products in North America. Revenue generated from our shipments to ICS for distribution to authorized and affiliate

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VARs was 11% of consolidated revenue for 2003. It was less than 10% of consolidated revenue for each of 2001 and 2002.

Although our business is predominantly within the United States, we market our products to customers outside the United States pursuant to agreements with international VARs. Our most significant international reseller partners are located in Canada and the United Kingdom. Although revenue from international customers was less than 10% of our consolidated revenue for each of 2001, 2002 and 2003, we have reorganized our sales organization in order to allow us to aggressively pursue international opportunities.

Our sales organization consists of five groups: two territory sales groups whose members focus on North America and international opportunities; a sales group that focuses on channels; a systems engineering organization that provides pre-sales technical support for the sales groups; and a sales operations group that facilitates sales organization efficiency.

The two territory sales groups consist of sales people who generate and cultivate leads. A regional sales person qualifies opportunities, presents the value proposition to the prospective enterprise customer, ascertains the preferred procurement alternative (the purchase of a product or a service), determines the preferred channel partner or service provider, and works with the selected channel to close the transaction. The field sales organization is supported by an inside sales group. We rarely take a product order directly from an enterprise customer.

The channel sales group consists of dedicated account teams that support individual service providers, including AT&T, SBC, Sprint, Verizon, MCI, other Local Exchange Carriers (LECs), systems integrators, and VARs. The account teams work with the service providers, LECs and systems integrators to create services based on our products. They also ensure that the channel’s own sales teams are proficient in presenting the value proposition to enterprise customers and that sales opportunities are closed in a timely fashion.

The individual members of the systems engineering organization are assigned to specific sales teams to provide pre-sales technical support. The systems engineers are responsible for making technical sales presentations, answering technical questions from channel partners, supporting the product certification and other evaluation efforts of existing and prospective customers, and supporting the channel partners as required by their customers.

The sales operations group is responsible for generating leads for our solutions and developing and delivering support programs to service providers, systems integrators, and channel partners. We use road shows, advertising, trade shows, Webinars, public relations programs, our web page and inside sales programs to generate leads. We have developed a number of service creation templates and programs for both public and private networks, to assist the providers in developing, implementing and selling services based on our solutions.

As of December 31, 2003, we employed 62 people in sales and marketing. In addition, our senior management team and our product management organization devote significant time furthering the business relationships with service providers, systems integrators and VARs. Our expenditures for sales and marketing activities were approximately $33.5 million, $20.5 million and $15.4 million in 2001, 2002 and 2003, respectively.

KEY CUSTOMERS AND STRATEGIC RELATIONSHIPS

AT&T. In December 1997, we entered into a non-exclusive procurement agreement with AT&T. The agreement had an initial term of three years, but continues indefinitely with the right by either party to terminate the agreement upon thirty days notice. The discounted prices for most of the software

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licensed and equipment purchased by AT&T are established in the contract. The contract also contains other terms and conditions of purchase by AT&T of the products for incorporation into a service offering or for resale, including payment terms, software licenses, product warranties and product support responsibilities. If we offer more favorable prices and terms under a supply agreement to any other customer for the same quantities of similar products during the term of the agreement, we are obligated to provide AT&T with the same or comparable overall terms.

SBC. In September 2000, we entered into a non-exclusive resale agreement with SBC. The agreement had an initial term of three years, but continues indefinitely with the right by either party to terminate the agreement upon ninety days notice. The discounted prices for most of the software licensed and equipment purchased by SBC are established in the contract. The contract also contains the other terms and conditions of purchase by SBC of the products for incorporation into a service offering or for resale, including payment terms, software licenses, product warranties and product support responsibilities. We warrant that we will not offer more favorable prices and terms under a supply agreement to any other similarly situated customer.

Sprint. In May 2000, we entered into a master agreement with Sprint for the purchase of equipment and services. This agreement has an initial term of three years and provides Sprint with the indefinite right to terminate the agreement upon thirty days prior notice. The discounted prices for most of the Visual UpTime software licensed and equipment purchased by Sprint are established in the contract. The contract, as amended, also contains the other terms and conditions of purchase by Sprint of the product for incorporation into a service offering or for resale, including payment terms, software licenses, product warranties and product support responsibilities. Under the contract, Sprint is entitled to a price rebate in the event that it was determined that we provided more favorable prices or other terms and conditions to another customer acquiring like quantities of our products. Sprint uses the Visual IP InSight product pursuant to separate software agreement.

Verizon. In July 1997, we entered into a non-exclusive integrator agreement with Verizon, and a related support agreement, that was amended in June 1999 to extend the term for five years. Unless terminated at the end of the term, or any renewal term, the contract will renew automatically for successive one-year terms. The discounted prices for most of the Visual UpTime software licensed and equipment purchased by Verizon are established in the contract. The contract, as amended, also contains the other terms and conditions of purchase by Verizon of the products for incorporation into a service offering or for resale, including payment terms, software licenses, product warranties and product support responsibilities. Verizon uses the Visual IP InSight product pursuant to a separate software license agreement.

MCI. In August 1997, we entered into a non-exclusive reseller/integration agreement with WORLDCOM Telecommunications, now WorldCom, but doing business under the brand name “MCI.” The agreement had an initial term of three years, but renews automatically for successive one-year terms with the right by either party to terminate the agreement for convenience at any time. The discounted prices for most of the Visual UpTime software licensed and equipment purchased by MCI are established in the contract. The contract, as amended, also contains the other terms and conditions of purchase by MCI of the product for incorporation into a service offering or for resale, including payment terms, software licenses, product warranties, and product support responsibilities. The contract contains our agreement to reduce prices if we offer lower prices to another customer for the same quantities of products supplied over a similar period of time under like conditions. Subsequent to MCI’s Chapter 11 bankruptcy filing, in July 2002, we executed an agreement, as amended, that documents the payment terms related to the fulfillment of subsequent orders received from MCI. MCI uses the Visual IP InSight product pursuant to a separate software license agreement.

Make it Visual Partner Program (MIVPP). In October 2000 and December 2000, we entered into agreements with ADC, since sold and renamed Kentrox, and Cisco, respectively, under which these

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hardware manufacturers are authorized to embed certain Visual UpTime functionality into their hardware products. Both agreements required either a license key from us or authorization under a subsequent agreement for the embedded Visual UpTime functionality to be activated and/or managed. We have been selling licenses to manage Kentrox devices since the fourth quarter of 2001. In December 2002, we entered into an OEM relationship with Cisco under which we provide a Cisco branded version of the Visual UpTime server product to Cisco which, when appropriate license keys have been entered, is able to manage Visual UpTime-enabled Cisco and other devices. In addition to these two existing relationships, we are pursuing various other opportunities for further Visual UpTime and Visual IP InSight MIVPP relationships, both domestically and internationally.

CUSTOMER SERVICE

Our customer service organization provides 24 hour per day technical support for products under active warranty or maintenance contracts. Our Visual Technical Assistance Center (VTAC) provides level 1 and 2 support. Problems that cannot be resolved by VTAC are escalated to our engineering organization for level 3 problem resolution. We sell software maintenance and equipment replacement services to customers, typically under one-year contracts. Software maintenance contracts entitle a customer to VTAC access, bug fixes, and product upgrades. Equipment replacement contracts entitle customers to the replacement of problem units within 4 or 24 hours, on average, depending on the level of the prearranged service. The customer service organization also provides fee based product training for the network managers and operators of our service providers, system integrators, VARs and their customers. We outsource our hardware installation and our emergency equipment replacement service. Our customers continue to rank the quality of our customer service very highly in our customer satisfaction surveys. We will continue to invest in customer service to maintain or improve the quality of our service and to assure that we have satisfied customers with minimal service outages. As of December 31, 2003, we employed five people in customer service.

RESEARCH AND DEVELOPMENT

The demands for performance management capabilities are constantly growing and changing as new access technologies are deployed, new applications and services create the demand for higher transmission speeds, and new networking technologies result in lower cost alternatives for transporting mission critical information. We utilize a number of sources as input to our product development process, including input from customers, our analysis of market and technical trends, and data from industry analysts and market research. Research and product development are critical to our continued success.

In recent years, we have made significant investments in platform architecture and product enhancements. We have updated our products to incorporate new client technologies such as Java and new server technologies such as symmetrical multiprocessor arrays. We have enhanced our architecture to facilitate relationships with companies that seek to embed our technology into their product offerings. We have added support for new network access technologies such as DSL and higher transmission speeds. We have expanded the product line to manage the performance of private IP networks and public IP VPNs. We have also continued to improve the ability to expand our platforms.

We plan to continue to devote significant research and development resources to enhance our existing products and introduce new service management capabilities. We plan to make additional architectural enhancements in order to integrate our private and public network solutions, to facilitate our MIVPP and to integrate with operations support systems. We plan to continue to enhance our private and public IP VPN management, including performance management details by class of service, and voice over IP, or VOIP, performance management. We will continue to invest to support higher speed access to ATM and private IP networks. We will continue to focus on the scalability that is required for wide scale deployment by service providers and systems integrators. Additionally, we expect to invest in platform modifications that will increase the marketability of our products outside North America.

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As of December 31, 2003, we had 55 employees in our research and development group. Our research and development expenditures were approximately $19.3 million, $12.3 million and $10.5 million in 2001, 2002 and 2003, respectively.

MANUFACTURING

We outsource the manufacture and repair of our proprietary hardware products to contract manufacturers. To mitigate the risks associated with our prior dependency on a sole source manufacturer, Celestica, we have established a manufacturing supply contract with a second contract manufacturer, MC Assembly. We procure the hardware platform for our ISE product from a third party. We generally use standard parts and components in the manufacture of our products and procure them from suppliers in the United States. However, we currently procure several key components from sole or limited sources. Our engineering and manufacturing personnel coordinate activities in order to replace unavailable parts on a timely basis and acquire sufficient quantities of critical parts which may have been discontinued. To date, we have not experienced any significant delays or material unanticipated costs related to our use of contract manufacturers or an inability to obtain required parts when needed. To support our manufacturing partners, we provide material resource planning, quality assurance, manufacturing and test engineering, and product and component planning and purchasing. As of December 31, 2003, there were six employees in our manufacturing operations.

Because we are embedded in network service offerings of many service providers, high quality is essential to our continued success. Our Rockville, Maryland facility is ISO 9001-2000 certified for the design and manufacture of network and application performance management systems.

COMPETITION

The market for solutions related to applications delivery infrastructure management is intensely competitive. Our products integrate key functionality found in six distinct market segments: WAN access equipment; bandwidth management equipment; network test and analysis equipment; performance management reporting software; application management systems; and client-based network management and Internet infrastructure test beds. We believe our products are the only platforms that integrate functional attributes from all these market segments to provide fully capable and cost-effective applications delivery infrastructure management. We expect to encounter increased competition from current and potential participants in each of these segments. Increased competition may result in price reductions, reduced profit margins, reduced profitability, and the loss of market share, any of which would have a material adverse effect on our business, financial condition, and results of operations.

WAN access equipment. Our introduction of the ASE products redefined the WAN access equipment market by adding superior analysis capability for frame relay and ATM networks. This caused existing vendors in this space to lose market share and counter our products with improvements to their own products. The leading vendors in the segment include Kentrox, Paradyne and Adtran. These companies may partner with companies offering network test and analysis products, or performance reporting products in order to better compete with us. Additionally, router vendors may integrate WAN access equipment and agent technology in their routers, which may adversely affect Visual UpTime’s cost justification. We are working to mitigate these risks through our MIVPP partnerships with Cisco and Kentrox.

Bandwidth management equipment. The primary purpose of this equipment is to alter and adjust the flows of customer traffic on their network to improve the performance of the network services through techniques like priority based queuing and compression. To understand and manage the traffic flows, this equipment must provide a certain degree of analysis functionality that is also found in performance management systems. The major supplier in this market is Packeteer.

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Network test and analysis. An essential element of WAN service performance management is technology and expertise associated with network test and analysis. Products in the market include portable and distributed protocol analyzers, transmission test instruments, active testing agents, and passive monitoring probes. The major suppliers in this market segment include Network Associates, Agilent Technologies, Acterna, Fluke, Spirent and NetScout.

Performance management reporting software. These software platforms provide broad reporting of network and equipment status and performance, based on polling standard management information bases resident in network and customer premises equipment. The major suppliers in this market segment include Concord, InfoVista, Agilent and Quallaby.

Client-based network management and Internet infrastructure test-beds. An emerging trend in network management is increased emphasis on visibility of actual user experience. Installing clients on end user desktops is an effective way to gather this type of data. This technology can be deployed either as a service offering using simulated desktops or sold as stand-alone software. Major suppliers of stand-alone software include Lucent, NetIQ, Concord and NetScout. The major supplier of service-based solutions is Keynote Software.

Application management platforms. These software platforms allow application, database and server operators, as well as application developers to analyze, tune and troubleshoot the performance of the applications themselves. Our products complement such offerings by allowing infrastructure operators to analyze, tune and troubleshoot the performance of the application delivery infrastructure that enables the applications.

We intend to compete by offering superior features, performance and reliability, packaged with buying flexibility at competitive prices. We also intend to compete on the strength of our relationships with service providers. These relationships and the services that have been built around our products constitute high barriers to entry. As competition in the applications delivery infrastructure management market intensifies, we may encounter price competition. In response to competitive trends, we will continue our efforts to reduce the manufacturing costs to minimize deterioration of gross profits.

PATENTS AND OTHER PROPRIETARY RIGHTS.

Our success depends significantly upon our proprietary technology. We rely on a combination of patent, copyright, trademark and trade secret laws, non-disclosure agreements and other contractual provisions to establish, maintain and protect our proprietary rights. However, use of contractual, statutory and common law protections of our proprietary technologies offers only limited protection.