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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549-0001

FORM 10-Q

(MARK ONE)

For the three months ended March 31, 2004

OR

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

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

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

The number of outstanding shares of the Registrant’s Common Stock, par value $.01 per share, as of May 13, 2004 was 33,212,040 shares.

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VISUAL NETWORKS, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE MONTHS ENDED

MARCH 31, 2004

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PART I: FINANCIAL INFORMATION

VISUAL NETWORKS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

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

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VISUAL NETWORKS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share data)

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

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VISUAL NETWORKS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

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

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VISUAL NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2004

(Unaudited)

Visual Networks, Inc. (the “Company”) designs, manufactures, sells and supports performance management platforms for communications networks.

Risk Factors

Despite having returned to profitability in 2002, the Company continued to experience declining revenue which began in 2000. In response to this decreased revenue, the Company made significant reductions in operating expenses to be in alignment with revised business plans. This program to reduce operating expenses resulted in the closure of three facilities and workforce reductions of approximately 290 employees by the end of 2002. While there have been no workforce reductions since 2002, the Company has continued to monitor and control discretionary spending. Despite this focus on operating expenses and sequential improvements in revenue in the three months ended December 31, 2003 and the three months ended March 31, 2004, the Company has experienced net losses in fiscal year 2003 through the three months ended March 31, 2004.

The future success of the Company will be dependent upon, among other factors, its ability to generate adequate cash for operating and capital needs. The Company is relying on its existing balance of cash and cash equivalents, of $16.7 million at March 31, 2004, together with future sales and the collection of the related accounts receivable to meet its future operating cash requirements. If cash provided by these sources is not sufficient to fund future operations, the Company will be required to further reduce its expenditures for operations or to seek additional capital through other means that may include additional borrowings, the sale of equity securities or the sale of assets. Under those circumstances, there can be no assurances that additional capital would be available under reasonable or acceptable terms, particularly in light of the Company’s history of losses and accumulated deficit position.

In March 2002, the Company issued senior secured convertible debentures (the “Debentures”) in the aggregate amount of $10.5 million in a private placement (see Note 3). Because the Company’s earnings before interest, taxes, depreciation and amortization, less capital expenditures (“adjusted EBITDA”), as defined in the Debentures, for 2003 was less than $6.5 million, the Debenture holders may require that the Company pay, in whole or in part, at any time and from time to time, the outstanding principal amount of their Debentures plus accrued interest. The Company can choose whether to pay all common stock or all cash provided certain criteria specified in the Debentures are met, which are currently met. If the Company chooses to pay any such demand with common stock, and the issuance price of such shares is below the then-current conversion price of the Debentures, the conversion price of the Debentures is immediately reset to such lower price and the exercise price of the warrants and the number of shares issuable upon

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exercise would be adjusted on a weighted-average basis. If the Company chooses to pay any such demand with cash, and there is insufficient cash to both pay those amounts and to fund ongoing operations, the Company may be required to seek additional capital through a sale of assets, sale of additional securities or through additional borrowings, none of which may be available on acceptable terms.

On May 11, 2004, the Company received a definitive, binding notice from two Debenture holders requesting the repayment in full of an aggregate of $1.5 million of the Company’s $10.5 million outstanding Debentures. The Company plans to pay in cash such amounts and any interest due thereon no later than June 14, 2004, pursuant to the terms of the Debentures.

The Company and Silicon Valley Bank have a non-binding letter of intent to enter into a line of credit, which the parties are currently negotiating (see Note 2). There can be no assurances that such negotiations will be successful. Borrowings under the line of credit would only be available for working capital purposes once the agreement is finalized and the Debentures have been repaid.

The ongoing patent litigation between the Company and one of its subsidiaries and Paradyne Networks, Inc. (“Paradyne”) and one of its subsidiaries could have a significant detrimental effect on the Company’s business (see Note 4). Despite the Company’s belief that its products do not infringe the Paradyne subsidiary’s patents and that Paradyne’s claims are frivolous and without merit, the conduct of the litigation in Florida and Maryland may be expensive and may divert limited resources from other more productive activities, resulting in adverse effects on the Company’s business and results of operations. At this point in the litigation, the likelihood of any outcome cannot be determined and the adverse effect of any finding cannot be estimated.

The Company may experience difficulties in convincing its customers to adopt the new Visual UpTime Select product line. This product line is based on a new licensing model and includes significant new technological innovations. As with any major change in the way a company does business, the Company has sales and technical obstacles to overcome related to upgrading current Visual UpTime customers to the new Visual UpTime Select product line. These obstacles may delay new orders, slow deployment of our products by our customers or result in other unforeseen challenges with otherwise negative impacts.

The Company has outsourced the manufacture of the analysis service element (“ASE”) hardware component of the Visual UpTime platform to two subcontract manufacturing firms. The Company derives a substantial portion of its revenue from the sale and shipment of ASEs. A subcontract manufacturer could decide to reduce or eliminate the amount of credit extended to the Company or to stop the shipment of products due to concerns about the Company’s financial condition or the amount of their credit and inventory risk.

If the Company is required to establish alternative subcontract manufacturers, there can be no assurances that it would be able to do so, or to do so on acceptable terms. Furthermore, if the Company were required to replace its current subcontract manufacturers, it could face substantial production delays and could be required to pay substantially higher prices in order to complete delivery of customers’ orders. Such a delay or price increase could substantially damage the Company’s ability to generate sufficient revenue to achieve profitability.

The Company’s subcontract manufacturers purchase a number of critical components from vendors for which alternative sources are not currently available. Delays or interruptions in the supply of these components could

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result in delays or reductions in product shipments and revenue. The purchase of these components from outside suppliers on a sole source basis subjects the Company to risks, including the continued availability of supplies, price increases and potential quality assurance problems. While alternative suppliers may be available, these suppliers must be identified and qualified. The Company cannot be certain that any such suppliers will meet its required qualifications or that alternative suppliers can be identified in a timely fashion, if at all. The Company’s subcontract manufacturers may not be able to obtain sufficient quantities of these components on the same or substantially the same terms. Consolidations involving suppliers could further reduce the number of component alternatives and affect the cost of such supplies. An increase in the cost of such supplies could make the Company’s products less competitive with products which do not incorporate such components. Production delays, lower margins or less competitive product pricing could have a material adverse impact on the Company’s financial position and results of operations.

The Company is subject to certain other risks and uncertainties which could further affect its ability to continue as a going concern. These include, among others, substantial dilution if the Company is required to raise capital through the sale of equity, the Company’s history of losses and the size of its accumulated deficit, uncertainty about future profitability, dependence on a limited number of major service provider customers for the majority of its revenue, long sales cycles, rapidly changing technology, competition from several market segments, potential errors in the Company’s products or services, and anti-takeover protections that may delay or prevent a change in control that could benefit stockholders.

Financial Statement Presentation

The preparation of financial statements in conformity with generally accepted accounting principles in the United States 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 the financial statements and the reported amounts of revenue 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 regarding interim financial reporting. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements, and it is suggested that these financial statements be read in conjunction with the financial statements, and notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. 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, 2004 are not necessarily indicative of the results that will be achieved for the year ended December 31, 2004.

Principles of Consolidation

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

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Investments

As of March 31, 2004, the Company holds a certificate of deposit (“CD”) in the amount of $500,000 that matures on July 31 2004. This CD collateralizes a $500,000 letter of credit expiring on September 30, 2004 and issued in favor of a contract manufacturer. The balance of this collateralizing CD was $1.5 million as of December 31, 2003. As of March 31, 2004, the Company holds another CD in the amount of $28,000, which matures on May 27, 2004, to collateralize a $28,000 letter of credit expiring on July 30, 2004 and issued in favor of a customer. The CDs have been reflected in restricted short-term investments in the accompanying consolidated balance sheets as of December 31, 2003 and March 31, 2004.

Inventory

Inventory, stated at the lower of standard cost or market, with costs determined on the first-in, first-out basis, consists of the following (unaudited, in thousands):

The Company records a provision for excess and obsolete inventory whenever such an impairment has been identified. The following is a summary of the change in the Company’s reserve for excess and obsolete inventory during the three months ended March 31, 2004 (unaudited, in thousands):

The following is a summary of the change in the Company’s reserve for excess and obsolete inventory during the three months ended March 31, 2003 (unaudited, in thousands):