~~Table~~UNITED ofSTATES SECURITIES ~~Contents~~AND EXCHANGE COMMISSION

~~UNITED~~Washington, ~~STATES~~D.C. 20549-0001

~~SECURITIES~~FORM ~~AND EXCHANGE COMMISSION~~ 10-Q

~~Washington,~~(MARK ~~D.C. 20549-0001~~ ONE)

~~FORM~~þ ~~10-Q~~QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

~~(MARK~~For ~~ONE)~~the three months ended June 30, 2005

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

~~For~~o ~~the~~TRANSITION ~~three~~REPORT ~~months~~PURSUANT ~~ended~~TO ~~June~~SECTION ~~30,~~13 ~~2004~~OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

ORCommission File Number 000-23699

¨VISUAL ~~TRANSITION~~NETWORKS, ~~REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934~~INC.

~~Commission~~(Exact ~~File~~name ~~Number~~of ~~000-23699~~registrant as specified in its charter)

VISUAL NETWORKS, INC.


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

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

~~(Exact~~Registrant’s ~~name~~telephone ofnumber, ~~registrant~~including asarea ~~specified~~code: ~~in its charter~~(301) 296-2300

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

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 þ No o

~~Registrant’s telephone~~ Indicate ~~number,~~by ~~including~~check ~~area~~mark ~~code:~~whether the registrant is an accelerated filer (~~301)~~as ~~296~~defined in Rule 12b-~~2300~~2 of the Exchange Act). Yes þ No o

~~Indicate~~ The bynumber ~~check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d)~~ of ~~the Securities~~outstanding ~~Exchange~~shares ~~Act~~ of ~~1934 during~~ the ~~preceding~~Registrant’s 12Common ~~months~~Stock, ~~(or~~par ~~for~~value ~~such~~$.01 ~~shorter~~per ~~period~~share, as ~~that~~of ~~the~~August 5, ~~registrant~~2005 was ~~required to file such reports)~~34,673,926 ~~and (2) has been subject to the filing requirements for the past 90 days~~shares. ~~Yes x No ¨~~

~~Indicate~~VISUAL byNETWORKS, ~~check~~INC. QUARTERLY ~~mark~~REPORT ~~whether~~ON ~~the~~FORM ~~registrant is an accelerated filer (as defined in Rule 12b~~10-2Q FOR ofTHE ~~the~~THREE ~~Exchange~~MONTHS ~~Act).~~ENDED June ~~Yes ¨ No x~~30, 2005

~~The~~TABLE ~~number~~OF ~~of outstanding shares of the Registrant’s Common Stock, par value $.01 per share, as of August 9, 2004 was 33,272,007 shares.~~ CONTENTS


PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets — December 31, 2004 and June 30, 2005			3
Consolidated Statements of Operations — Three and six months ended June 30, 2004 and 2005			4
Consolidated Statements of Cash Flows — Six months ended June 30, 2004 and 2005			5
Notes to Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			16
Item 3. Qualitative and Quantitative Disclosures about Market Risk			33
Item 4. Controls and Procedures			33
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			34
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			34
Item 3. Defaults Upon Senior Securities			34
Item 4. Submission of Matters to a Vote of Security Holders			35
Item 5. Other Information			35
Item 6. Exhibits			35
Signatures			36

~~Table of Contents~~2

~~VISUAL~~PART ~~NETWORKS,~~I: ~~INC.~~FINANCIAL INFORMATION

~~QUARTERLY~~Item 1. ~~REPORT~~Financial ~~ON FORM 10-Q~~ Statements

~~FOR~~VISUAL ~~THE~~NETWORKS, ~~THREE AND SIX MONTHS ENDED~~ INC.

~~JUNE~~CONSOLIDATED 30BALANCE SHEETS (In thousands, ~~2004~~except share data)

TABLE OF CONTENTS


	December 31,			June 30,
	2004			2005
				(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	11,317		$	4,294
Accounts receivable, net of allowance of $399 and $409, respectively		9,335			9,098
Inventory, net		3,822			3,331
Other current assets		940			1,017

Total current assets		25,414			17,740
Property and equipment, net		2,001			1,583

Total assets	$	27,415		$	19,323


Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable and accrued expenses	$	9,341		$	7,022
Deferred revenue		3,388			2,340
Short-term debt		—			4,000
Convertible debentures, net of unamortized debt discount of $837 and $112, respectively		8,163			1,888

Total current liabilities		20,892			15,250

Commitments and contingencies (Note 4)
Stockholders’ equity:
Common stock, $.01 par value; 200,000,000 shares authorized, 33,981,840 and 34,655,691 shares issued and outstanding, respectively		340			346
Additional paid-in capital		477,343			478,685
Warrants		2,087			2,087
Deferred compensation		(143	)		(77	)
Accumulated deficit		(473,104	)		(476,968	)

Total stockholders’ equity		6,523			4,073

Total liabilities and stockholders’ equity	$	27,415		$	19,323

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets — December 31, 2003 and June 30, 2004		3
Consolidated Statements of Operations — Three and six months ended June 30, 2003 and 2004		4
Consolidated Statements of Cash Flows — Six months ended June 30, 2003 and 2004		5
Notes to Consolidated Financial Statements		6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		16
Item 3. Qualitative and Quantitative Disclosure about Market Risk		33
Item 4. Controls and Procedures		33
PART II. OTHER INFORMATION
Items 1 - 6		34-35
Signatures		39

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

2 3

~~Table~~VISUAL ofNETWORKS, ~~Contents~~INC.

~~PART~~CONSOLIDATED I:STATEMENTS ~~FINANCIAL~~OF ~~INFORMATION~~OPERATIONS (Unaudited) (In thousands, except per share data)

Item 1. Financial Statements


	For the						For the
	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2004			2005			2004			2005
Revenue:
Hardware	$	9,091		$	3,990		$	18,621		$	8,498
Software		1,514			5,413			1,666			8,542
Support and services		2,218			2,035			4,377			3,962

Total revenue		12,823			11,438			24,664			21,002

Cost of revenue:
Product		3,745			2,880			6,783			6,065
Support and services		257			195			542			409

Total cost of revenue		4,002			3,075			7,325			6,474

Gross profit		8,821			8,363			17,339			14,528

Operating expenses:
Research and development		2,391			2,198			5,061			4,745
Sales and marketing		3,968			4,298			7,772			7,965
General and administrative		2,278			1,528			4,452			3,900
Restructuring		—			716			—			716

Total operating expenses		8,637			8,740			17,285			17,326

Income (loss) from operations		184			(377	)		54			(2,798	)
Other expense		(262	)		(547	)		(262	)		(547	)
Interest income		35			46			62			101
Interest expense		(371	)		(291	)		(758	)		(620	)

Net loss	$	(414	)	$	(1,169	)	$	(904	)	$	(3,864	)


Basic and diluted loss per share	$	(0.01	)	$	(0.03	)	$	(0.03	)	$	(0.11	)

Basic and diluted weighted-average shares outstanding		33,185			34,607			33,098			34,425

~~VISUAL~~The ~~NETWORKS,~~accompanying ~~INC.~~notes are an integral part of these consolidated financial statements.

4 ~~CONSOLIDATED BALANCE SHEETS~~

~~(In~~VISUAL ~~thousands~~NETWORKS, ~~except share data)~~ INC.

	December 31,2003			June 30,2004
				(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	15,671		$	13,555
Restricted short-term investments		1,530			528
Accounts receivable, net of allowance of $377 and $257, respectively		2,326			4,636
Inventory		3,346			2,005
Deferred debt issuance costs		532			355
Other current assets		256			884
Total current assets		23,661			21,963
Property and equipment, net		2,378			2,056
Total assets	$	26,039		$	24,019
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable and accrued expenses	$	8,115		$	8,279
Deferred revenue		6,333			5,302
Convertible debentures, net of unamortized debt discount of $1,756 and $1,171, respectively		8,744			7,829
Total current liabilities		23,192			21,410
Commitments and contingencies
Stockholders’ equity:
Common stock, $.01 par value; 200,000,000 shares authorized, 32,866,010 and 33,231,836 shares issued and outstanding, respectively		328			332
Additional paid-in capital		475,222			476,093
Warrants		2,087			2,087
Deferred compensation		—			(209	)
Accumulated deficit		(474,790	)		(475,694	)
Total stockholders’ equity		2,847			2,609
Total liabilities and stockholders’ equity	$	26,039		$	24,019

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

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


	For the
	Six Months Ended
	June 30,
	2004			2005
Cash Flows From Operating Activities:
Net loss	$	(904	)	$	(3,864	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		744			671
Non-cash interest expense		500			397
Early extinguishment of debt		262			547
Bad debt expense (recovery)		(6	)		10
Non-cash compensation expense		121			66
Provision for excess and obsolete inventory		24			—
Changes in assets and liabilities:
Accounts receivable		(2,304	)		227
Inventory		1,317			491
Other assets		(628	)		(297	)
Accounts payable and accrued expenses		164			(2,317	)
Deferred revenue		(1,031	)		(1,048	)

Net cash used in operating activities		(1,741	)		(5,117	)

Cash Flows From Investing Activities:
Sales of short-term investments		1,002			—
Expenditures for property and equipment		(422	)		(253	)

Net cash provided by (used in) investing activities		580			(253	)

Cash Flows From Financing Activities:
Repayment of debentures		(1,500	)		(7,000	)
Proceeds from issuance of short-term debt		—			4,000
Exercise of stock options and issuance of common stock under the employee stock purchase plan		545			1,347

Net cash provided by (used in) financing activities		(955	)		(1,653	)

Net decrease in cash and cash equivalents		(2,116	)		(7,023	)
Cash and cash equivalents, beginning of period		15,671			11,317

Cash and cash equivalents, end of period	$	13,555		$	4,294


Supplemental Cash Flow Information:
Cash paid for interest	$	258		$	223

3The accompanying notes are an integral part of these consolidated financial statements.

~~Table of Contents~~5

VISUAL NETWORKS, INC.

~~CONSOLIDATED~~NOTES ~~STATEMENTS~~TO OFCONSOLIDATED ~~OPERATIONS~~FINANCIAL STATEMENTS June 30, 2005 (Unaudited)

~~(Unaudited)~~1. Nature of Operations and Significant Accounting Policies:

~~(In~~ Visual ~~thousands~~Networks, ~~except~~Inc. ~~per~~(the ~~share data~~“Company”) is a leading provider of network and application performance management solutions.

	For theThree Months Ended June 30,						For theSix Months Ended June 30,
	2003			2004			2003			2004
Revenue:
Hardware	$	6,572		$	9,091		$	13,146		$	18,621
Software		732			1,514			1,028			1,666
Support and services		2,469			2,218			4,803			4,377
Total revenue		9,773			12,823			18,977			24,664
Cost of revenue:
Product		2,306			3,745			4,284			6,783
Support and services		259			257			535			542
Total cost of revenue		2,565			4,002			4,819			7,325
Gross profit		7,208			8,821			14,158			17,339
Operating expenses:
Research and development		2,572			2,391			5,319			5,061
Sales and marketing		3,437			3,968			6,880			7,772
General and administrative		1,512			2,278			2,460			4,452
Total operating expenses		7,521			8,637			14,659			17,285
Income (loss) from operations		(313	)		184			(501	)		54
Other income (expense)		—			(262	)		452			(262	)
Interest income		28			35			65			62
Interest expense		(392	)		(371	)		(785	)		(758	)
Net loss	$	(677	)	$	(414	)	$	(769	)	$	(904	)
Basic and diluted loss per share	$	(0.02	)	$	(0.01	)	$	(0.02	)	$	(0.03	)
Basic and diluted weighted-average shares outstanding		32,569			33,185			32,500			33,098

Risk Factors

The ~~accompanying~~Company ~~notes~~is subject to certain risks and uncertainties which could affect its ability to continue as a going concern and materially and adversely affect its financial condition and results of operations. These risks and uncertainties include, but are not limited to: our dependence on sales to telecommunications service providers, the sufficiency of currently available cash, expenses and an ~~integral~~uncertain ~~part~~outcome associated with the Paradyne litigation (see Note 4), reliance on one subcontract manufacturer, availability of hardware ~~these~~components, ~~consolidated~~customer ~~financial~~migration ~~statements.~~to Visual UpTime® Select™, dilution to our common stockholders, the Company’s history of losses and the size of its accumulated deficit, uncertainty about future profitability, the effect of stock compensation expense on earnings, 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.

The future success of the Company will depend upon its ability to generate adequate cash for operating and capital needs. The Company is relying on its existing balance of cash and cash equivalents ($4.3 million at June 30, 2005), a recently signed investment in senior secured convertible notes (see Note 5), future sales and the collection of related accounts receivable to meet its future operating cash requirements. If cash provided by these sources is inadequate, 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.

~~Table~~Financial ofStatement ~~Contents~~Presentation

~~VISUAL~~ The ~~NETWORKS~~preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, ~~INC~~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 ~~CONSOLIDATED~~rules ~~STATEMENTS~~and OFregulations ~~CASH~~of ~~FLOWS~~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, 2004. In the opinion of management, the comparative financial statements for the periods presented herein include all adjustments that are normal and recurring which are necessary for a fair presentation of results for the interim periods. The results of operations for the six months ended June 30, 2005 are not necessarily indicative of the results that will be achieved for the year ended December 31, 2005.

~~(Unaudited)~~ 6

~~(In~~Principles ~~thousands)~~of Consolidation

	For the Six Months EndedJune 30,
	2003			2004
Cash Flows From Operating Activities:
Net loss	$	(769	)	$	(904	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation		1,019			744
Non-cash interest expense		508			500
Early extinguishment of debt		—			262
Bad debt expense		—			(6	)
Non-cash compensation expense		2			121
Changes in assets and liabilities:
Accounts receivable		302			(2,304	)
Inventory		(104	)		1,341
Other assets		(792	)		(628	)
Accounts payable and accrued expenses		(2,693	)		164
Deferred revenue		(414	)		(1,031	)
Net cash used in operating activities		(2,941	)		(1,741	)
Cash Flows From Investing Activities:
Sales of short-term investments		503			1,002
Expenditures for property and equipment		(428	)		(422	)
Net cash provided by investing activities		75			580
Cash Flows From Financing Activities:
Exercise of stock options and employee stock purchase plan		222			545
Repayment of debentures		—			(1,500	)
Net cash provided by (used in) financing activities		222			(955	)
Net decrease in Cash and Cash Equivalents		(2,644	)		(2,116	)
Cash and Cash Equivalents, Beginning of Period		12,708			15,671
Cash and Cash Equivalents, End of Period	$	10,064		$	13,555
Supplemental Cash Flow Information:
Cash paid for interest	$	277		$	258

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.

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

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


	December 31,			June 30,
	2004			2005
				(Unaudited)
Raw materials	$	1,138		$	1,085
Work-in-progress		—			—
Finished goods		4,902			4,075

Inventory, gross	$	6,040			5,160
Reserve for excess and obsolete inventory		(2,218	)		(1,829	)

Inventory, net	$	3,822		$	3,331

~~VISUAL~~ The ~~NETWORKS,~~Company ~~INC~~writes down its inventory to the lower of cost or market value based on assumptions about future demand and market conditions. The following table summarizes the activity in the Company’s reserve for excess and obsolete inventory during the three months ended June 30, 2004 and 2005 (in thousands):

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


	2004			2005
Balance, beginning of period	$	3,593		$	2,021
Provision for excess and obsolete inventory		24			—
Sale of previously reserved inventory		—			(157	)
Actual inventory scrapped		(806	)		(35	)

Balance, end of period	$	2,811		$	1,829

~~JUNE~~ The following table summarizes the activity in the Company’s reserve for excess and obsolete inventory during the six months ended June 30, 2004 and 2005 (in thousands):

(Unaudited)


	2004			2005
Balance, beginning of period	$	3,638		$	2,218
Provision for excess and obsolete inventory		414			117
Sale of previously reserved inventory		(66	)		(343	)
Actual inventory scrapped		(1,175	)		(163	)

Balance, end of period	$	2,811		$	1,829

1.Accounts ~~Nature~~Payable ~~of Operations~~ and ~~Summary~~Accrued ~~of Significant Accounting Policies:~~Expenses

~~Visual~~ Accounts ~~Networks,~~payable ~~Inc. (the “Company”) designs, manufactures, sells~~ and ~~supports~~accrued ~~performance~~expenses ~~management~~consist ~~platforms~~of ~~for~~the ~~communications~~following ~~networks.~~(in thousands):

Risk Factors


	December 31,		June 30,
	2004		2005
			(Unaudited)
Accounts payable	$	1,940	$	896
Accrued compensation		2,108		1,283
Accrued warranty		384		384
Deferred rent		434		423
Other accrued expenses		4,475		4,036

Total	$	9,341	$	7,022

~~The Company is subject to certain risks and uncertainties which could affect~~7 its ability to continue as a going concern. These risks and uncertainties include the timing and nature of payment on the outstanding debentures (see Note 3), expenses and an uncertain outcome associated with the Paradyne litigation (see Note 4), customer migration to UpTime Select, availability of hardware components, reliance on two subcontract manufacturers, limited access to the new line of credit (see Note 2), 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.

~~The~~Revenue ~~future success of the Company will depend~~Recognition upon its ability to generate adequate cash for operating and capital needs. The Company is relying on its existing balance of cash and cash equivalents ($13.6 million at June 30, 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 and the new line of credit 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.

~~Financial~~ The Company’s products and services include software, hardware, professional services and technical support. The Company sells its products directly to service providers, through resellers (indirect channels) and, occasionally, to end-user customers. The Company recognizes revenue from software licensing in accordance with the American Institute of Certified Public Accountants Statement ~~Presentation~~of Position (“SOP”) No. 97-2, “Software Revenue Recognition.” The Company recognizes revenue from the sale of hardware in accordance with SEC Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition,” which summarizes existing accounting literature and requires that four criteria be met prior to the recognition of revenue. The Company’s accounting policies regarding revenue recognition comply with the following criteria: 1) persuasive evidence of an arrangement exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectibility is probable. Professional services and technical support revenues are included in support and services revenue in the accompanying consolidated statements of operations.

~~The~~ To ~~preparation~~determine ofif ~~financial~~a ~~statements~~fee inis ~~conformity~~fixed ~~with~~or ~~generally~~determinable, ~~accepted accounting principles in~~ the ~~United~~Company ~~States~~evaluates ~~requires~~rights ~~management~~of ~~to make~~return, ~~estimates~~customer ~~and~~acceptance ~~assumptions~~rights ~~that~~(if ~~affect~~applicable), ~~the~~extended ~~reported~~payment ~~amounts~~terms of(if ~~assets~~any), and ~~liabilities,~~multiple-element arrangements ~~the disclosure~~ of ~~contingent~~products ~~assets~~ and ~~liabilities~~services atto ~~the~~determine ~~date of~~ the ~~financial~~impact ~~statements~~on ~~and the reported amounts of~~ revenue ~~and expenses during the reporting periods~~recognition. ~~Actual results could differ from those estimates.~~

~~These~~ Certain ~~financial~~reseller ~~statements~~agreements ~~are~~include ~~unaudited~~stock ~~and~~rotation ~~have~~rights. If an agreement provides for a right of return, the Company recognizes revenue when the right has expired or a specific end-user customer has been ~~prepared~~identified by the reseller as evidenced with a letter of acceptance or documentation provided by the reseller. If the Company ~~pursuant~~has sufficient historical information to allow ~~the~~it ~~rules~~to ~~and~~make ~~regulations~~an estimate of returns in accordance with the ~~Securities~~Financial ~~and~~Accounting ~~Exchange~~Standards ~~Commission~~Board (“FASB”) ~~regarding~~Statement ~~interim~~of ~~financial~~Financial ~~reporting~~Accounting Standards (“SFAS”) No. 48, ~~Accordingly~~“Revenue Recognition When Right of Return Exists,” ~~they~~the doCompany ~~not~~defers ~~include~~revenue ~~all~~based on an estimate for such returns. If an agreement calls for a right of return and sufficient historical return information does not exist, the ~~information~~Company ~~and~~defers ~~footnotes~~revenue ~~required~~for bythe ~~generally~~entire ~~accepted~~agreement until the right of return expires.

6 If an agreement provides for evaluation or customer acceptance, the Company recognizes revenue upon the completion of the evaluation process, acceptance of the product by the customer and completion of all other criteria.

~~Table~~ The Company’s normal payment terms are between 30 and 45 days. Any payment terms beyond those normal terms are considered to be extended payment terms. The Company examines the specific facts and circumstances of ~~Contents~~all sales arrangements with extended payment terms to make a determination of whether the sales price is fixed or determinable and whether collectibility is probable. Payment terms are not tied to milestone deliverables or customer acceptance. The evaluation of the impact on revenue recognition, if any, includes the Company’s history with the particular customer and the specific facts of each arrangement. Historically, the Company has not provided any concessions or written off any accounts receivable related to extended payment term arrangements.

~~accounting~~ Many ~~principles~~of ~~for~~the ~~complete~~Company’s ~~financial~~sales ~~statements~~are multiple element arrangements and include software, hardware, professional services, and ittechnical issupport. ~~suggested~~The ~~that~~Company’s software sales may include professional services for installation, but these ~~financial~~services ~~statements~~are benot ~~read~~a insignificant ~~conjunction~~source ~~with~~of revenue. The Company does not perform professional services to customize the ~~financial~~product. Training is also offered but is ~~statements,~~not ~~and~~a ~~notes~~significant ~~thereto,~~source ~~included~~of inrevenue. Revenue from multiple element arrangements is recognized using the ~~Company’s~~residual ~~Annual~~method, ~~Report~~as onprescribed ~~Form~~in 10SOP No. 98-K9, ~~for~~“Modification ~~the~~of ~~year~~SOP ~~ended~~97-2, ~~December~~Software 31Revenue Recognition, ~~2003.~~With InRespect to Certain Transactions,” whereby the ~~opinion~~fair value of ~~management~~any undelivered elements, ~~the~~such ~~comparative~~as ~~financial~~customer ~~statements~~support ~~for~~and services, is deferred and any residual value is allocated to the ~~periods~~software ~~presented~~and ~~herein~~recognized ~~include~~as revenue upon delivery provided all other basic revenue recognition ~~adjustments~~criteria ~~that~~have ~~are~~been ~~normal~~met. The fair value of any undelivered elements, typically professional services, technical support and ~~recurring~~training, ~~which~~have ~~are~~been ~~necessary~~determined ~~for~~based aon ~~fair~~the ~~presentation~~Company’s specific objective evidence of ~~results~~fair ~~for~~value, which is based on the ~~interim~~price ~~periods.~~that ~~The~~the ~~results~~Company ofcharges ~~operations~~customers when ~~for~~the element is sold separately. Should the ~~three~~Company introduce ~~and~~new ~~six~~multiple ~~months~~element ~~ended~~arrangements ~~June~~into 30its sales channels, ~~2004~~a ~~are~~determination ~~not~~of ~~necessarily~~the objective ~~indicative~~evidence of the ~~results~~fair ~~that~~ value of the undelivered elements will be ~~achieved~~necessary ~~for~~and an inability to provide objective evidence could impact the ~~year~~Company’s ~~ending~~ability ~~December~~to ~~31,~~recognize ~~2004~~revenue.

~~Principles of~~8 ~~Consolidation~~

The ~~consolidated~~Company ~~financial~~recognizes ~~statements include~~revenue ~~the~~from ~~accounts~~services, ofsuch ~~Visual~~as ~~Networks~~installation and training, ~~Inc~~when the services are performed. ~~and~~The ~~its~~Company’s ~~wholly~~technical ~~owned~~support ~~subsidiaries.~~contracts ~~All~~require ~~intercompany~~it ~~account~~to ~~balances~~provide technical support and ~~transactions~~unspecified ~~have~~software ~~been~~updates ~~eliminated~~to incustomers ~~consolidation~~on a when and if available basis. The Company recognizes customer support revenue, including support revenue that is bundled with product sales, ratably over the term of the contract period, which typically ranges from one to three years.

~~Investments~~ The Company has agreements with certain service providers that provide price protection in the event that more favorable prices and terms are granted to any other similarly situated customer. When required, reserves for estimated price protection credits are established by the Company concurrently with the recognition of revenue. The Company monitors the factors that influence the pricing of its products and service provider inventory levels and makes adjustments to these reserves when management believes that actual price protection credits may differ from established estimates.

AtAccrued ~~June~~Warranty ~~30, 2004, the Company holds a certificate of deposit (“CD”) in the amount of $0.5 million that matures on July 31, 2004. This CD~~Costs collateralizes a $0.5 million letter of credit expiring on September 30, 2004 and issued in favor of a subcontract manufacturer. The balance of this collateralizing CD was $1.5 million at December 31, 2003. Subsequent to June 30, 2004, the subcontract manufacturer eliminated its letter of credit requirement and the $0.5 million CD became unrestricted.

At The ~~June~~Company 30warrants Visual UpTime Select hardware for one year. The Company warrants Visual UpTime hardware, ~~2004~~its prior hardware platform, ~~the~~for a period of up to five years. The Company estimates ~~holds~~its ~~another~~warranty CDobligation inat the ~~amount~~end of ~~$28,000,~~each ~~which~~period ~~matures~~and onrecords ~~August~~changes ~~25,~~in ~~2004,~~the liability to cost ~~collateralize~~of arevenue ~~$28,000~~in ~~letter~~the ofrespective ~~credit expiring~~period. Such estimates are based in part on ~~July~~historical ~~30,~~warranty cost ~~2004~~experience and ~~issued~~expectations inof ~~favor~~future ofclaims aunder ~~customer~~warranty.

The ~~CDs~~following ~~have~~is ~~been~~a ~~reflected~~summary asof ~~restricted~~the ~~short-term~~change ~~investments~~ in the ~~accompanying~~Company’s ~~consolidated~~accrued ~~balance~~warranty ~~sheets~~costs atduring ~~December~~the three ~~31,~~months ~~2003~~ended ~~and~~ June 30, 2004. and 2005 (in thousands):

Inventory


	2004			2005
Balance, beginning of period	$	428		$	384
Provisions for warranty		30			14
Settlements made		(30	)		(14	)

Balance, end of period	$	428		$	384

~~Inventory,~~ The ~~stated~~following atis ~~the~~a ~~lower~~summary of ~~standard~~the ~~cost~~change orin ~~market,~~the ~~with~~Company’s ~~costs~~accrued ~~determined~~warranty oncosts during the ~~first-in,~~six ~~first-out~~months ~~basis~~ended June 30, ~~consists~~2004 ofand ~~the~~2005 ~~following~~ (~~unaudited,~~ in thousands):

	December 31,2003			June 30,2004
	2004			2005
Raw materials	$	2,114		$	2,124
Balance, beginning of period	$	425		$	384
Work-in-progress		74			118
Provisions for warranty		52			21
Finished goods		4,796			2,574
Settlements made		(49	)		(21	)
Gross inventory	$	6,984			4,816
Balance, end of period	$	428		$	384
Reserve for excess and obsolete inventory		(3,638	)		(2,811	)
	$	3,346		$	2,005

7Segment Reporting and Significant Customers

~~Table~~ SFAS No. 131, “Disclosure about Segments of ~~Contents~~an Enterprise and Related Information,” establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that these enterprises report selected information about operating segments in interim financial reports. Management has concluded that the Company’s operations occur in one segment only based upon the information used by management in evaluating the performance of the business. SFAS No. 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. The revenue and assets of the Company’s foreign subsidiaries and subsidiaries operating in foreign countries were less

~~The Company records a provision for excess and obsolete inventory whenever such an impairment has been~~9 ~~identified. The following is a summary of the change in the Company’s reserve for excess and obsolete inventory during the three months ended June 30, 2003 and 2004 (unaudited, in thousands):~~

	2003			2004
Balance, beginning of period	$	4,673		$	3,593
Reserve for excess and obsolete inventory		—			24
Actual inventory scrapped		(13	)		(806	)
Balance, end of period	$	4,660		$	2,811

than 10% of consolidated revenue and assets. As of June 30, 2004 four customers individually represented 25%, 19%, 18% and 13% of accounts receivable. As of June 30, 2005 three customers individually represented 31%, 24% and 21% of accounts receivable. Three customers individually represented 24%, 24% and 23% of revenue for the three months ended June 30, 2004. Three customers individually represented 36%, 23%, and 23% of revenue for the three months ended June 30, 2005. Four customers individually represented 21%, 20%, 19% and 17% of revenue for the six months ended June 30, 2004. Three customers individually represented 28%, 26% and 20% of revenue for the six months ended June 30, 2005. The Company’s major service provider customers include, among others: AT&T, BellSouth, Equant, MCI, SBC, Sprint and Verizon. The revenue generated from sales to service providers was 85% and 91% of the Company’s consolidated revenue for the three months ended June 30, 2004 and 2005, respectively. The revenue generated from sales to service providers was 87% and 86% of the Company’s consolidated revenue for the six months ended June 30, 2004 and 2005, respectively. The agreements with the Company’s significant customers do not obligate these customers to make any minimum purchases from the Company.

~~The~~Accounting ~~following is a summary of the change in the Company’s reserve~~ for ~~excess~~Stock ~~and obsolete inventory during the six months ended June 30, 2003 and 2004 (unaudited, in thousands):~~ Options

	2003			2004
Balance, beginning of period	$	4,930		$	3,638
Reserve for excess and obsolete inventory		—			414
Sale of previously reserved inventory		—			(66	)
Actual inventory scrapped		(270	)		(1,175	)
Balance, end of period	$	4,660		$	2,811

During 2004, the Company granted non-qualified stock options to purchase 465,213 shares of common stock to employees under the 1997 Non-Qualified Stock Option Plan at an issuance price that was less than the fair market value of the Company’s common stock and recorded deferred compensation of $330,000. The deferred compensation is being amortized over the vesting period of the stock options, which is 20% as of the grant date and the remaining portion over 24 equal monthly installments after the grant date. As a result, the Company recorded deferred compensation expense of approximately $33,000 during each of the three months ended June 30, 2004 and 2005 and $121,000 and $66,000 during each of the six months ended June 30, 2004 and 2005, respectively.

~~Accounts~~ The ~~Payable~~Company accounts for its stock-based compensation under the recognition and ~~Accrued~~measurement ~~Expenses~~principles of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. APB Opinion No. 25 provides that compensation expense relative to a company’s employee stock options is measured based on the intrinsic value of the stock options at the measurement date.

~~Accounts~~ If ~~payable~~compensation ~~and~~expense ~~accrued~~had ~~expenses~~been ~~consist~~determined based on the fair value of the options at the grant dates consistent with the ~~following~~method ~~(unaudited~~of accounting under SFAS No. 123, “Accounting for Certain Transactions Involving Stock Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure,” the Company’s net earnings (loss) per share would have changed to the pro forma amounts as indicated below (in thousands, except per share amounts):

	December 31,2003			June 30,2004
	Three Months Ended							Six Months Ended
Accounts payable	$	2,452		$	1,914
	June 30,							June 30,
Accrued compensation		1,387			1,556
	2004				2005			2004			2005
Other accrued expenses		4,276			4,809
Net loss, as reported	$	(414	)		$	(1,169	)	$	(904	)	$	(3,864	)
	$	8,115		$	8,279
Add: Stock-based employee compensation expense included in reported net loss		33				33			121			66
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards		(1,101	)			(420	)		(2,432	)		(836	)
Pro forma net loss	$	(1,482	)		$	(1,556	)	$	(3,215	)	$	(4,634	)
Loss per share:
Basic and diluted: as reported	$	(0.01	)		$	(0.03	)	$	(0.03	)	$	(0.11	)
Basic and diluted: pro forma	$	(0.04	)		$	(0.04	)	$	(0.10	)	$	(0.13	)

~~Revenue Recognition~~ 10

The ~~Company’s~~fair ~~products~~value and services include hardware, software, professional services and technical support. Professional services and technical support revenues are included in support and services revenue in the accompanying consolidated statements of ~~operations.~~each ~~The~~option ~~Company~~is ~~recognizes~~estimated ~~revenue~~on ~~from~~ the ~~sale~~date ~~or license~~ of ~~its~~grant ~~products~~using ~~in accordance with~~ the ~~American Institute of Certified Public Accountants Statement of Position (“SOP”) No. 97~~Black-~~2, “Software Revenue Recognition” and SEC Staff Accounting Bulletin (“SAB”) No. 104,~~Scholes ~~“Revenue~~option-pricing ~~Recognition,”~~model which summarizes existing accounting literature and requires that four criteria be met prior to the recognition of revenue. The Company’s accounting policies regarding revenue recognition are written to comply with the following ~~criteria:~~assumptions 1)used ~~persuasive~~for ~~evidence~~grants ofas anindicated ~~arrangement exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectibility is probable.~~ below:

The Company sells its products directly to service providers, through resellers (indirect channels) and, occasionally, to end-user customers. Certain reseller customers have stock rotation rights, under which the customer can exchange products for other products of equal or greater cost, subject to certain limitations, based on their end-user customers’ requirements. The Company recognizes revenue under these arrangements once


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2004			2005			2004			2005
Dividend yield	None			None			None			None
Expected volatility		67	%		98	%		67	%		98	%
Risk-free interest rate.		3.72	%		4.00	%		3.36	%		3.88	%
Expected term (in years)		5			5			5			5

8 The weighted-average grant-date fair value per share of options granted was $1.98 and $1.08 during the three months ended June 30, 2004 and 2005, respectively, and $1.65 and $1.40 during the six months ended June 30, 2004 and 2005, respectively.

~~Table~~Basic ofand ~~Contents~~Diluted Earnings (Loss) Per Share

~~the~~ SFAS ~~stock~~No. 128, ~~rotation~~“Earnings ~~right~~Per ~~expires~~Share,” arequires ~~specific~~dual ~~end-user~~presentation ~~customer~~of ~~has~~basic ~~been~~and ~~identified,~~diluted orincome (loss) per ~~the~~share. ~~product~~Basic ~~has~~income ~~been~~(loss) per ~~resold~~share includes no dilution and is computed by dividing net income (loss) available to common stockholders by the ~~distributor.~~weighted-average number of common shares outstanding for the period.

To Diluted ~~determine~~income if a fee is fixed or determinable, the Company evaluates rights of return, customer acceptance rights, if applicable, and multiple-element arrangements of products and services to determine the impact on revenue recognition. The Company’s agreements generally have not included rights of return except in certain reseller relationships that include stock rotation rights. If an agreement provides for a right of return, the Company typically recognizes revenue when the right has expired, a specific end-user customer has been identified, or the product has been resold by the distribution channel. If the Company has sufficient historical information to allow it to make an estimate of returns in accordance with the Financial Accounting Standards Board (~~“FASB”~~loss) per ~~Statement~~share ofincludes ~~Financial Accounting Standards (“SFAS”) No. 48, “Revenue Recognition When Right of Return Exists,”~~ the ~~Company~~potential ~~defers~~dilution anthat ~~estimate~~could ~~for~~occur ~~such~~if ~~returns and recognizes the remainder at the date of shipment. If an agreement provides for~~securities ~~evaluation~~ or ~~customer acceptance, the Company recognizes revenue upon the completion of the evaluation process, acceptance of the product by the customer and completion of all~~ other ~~criteria.~~contracts Most of the Company’s sales are multiple element arrangements and include hardware, software, and technical support. The Company’s software sales sometimes include professional services for implementation but these services are not a significant source of revenue. Training is also offered but is not a significant source of revenue. Revenue from multiple element arrangements is recognized using the residual method whereby the fair value of any undelivered elements, such as customer support and services, is deferred and any residual value is allocated to ~~the~~issue ~~software~~common ~~and~~stock ~~recognized~~were asexercised ~~revenue~~or ~~upon~~converted delivery. The fair values of any undelivered elements, typically professional services, technical support and training, have been determined based on the Company’s specific objective evidence of fair value, which is based on the price that the Company charges customers when the element is sold separately. Should the Company introduce new multiple element arrangements into ~~its~~common sales channels, a determination of the objective evidence of the fair value of the undelivered elements will be necessary and an inability to provide objective evidence could impact the Company’s ability to recognize revenuestock.

~~The~~ Options ~~Company~~and ~~generally~~warrants ~~recognizes~~to ~~revenue~~purchase ~~from~~10,295,407 ~~services~~and ~~when~~9,567,123 ~~the~~shares ~~services~~of ~~are~~common ~~performed.~~stock ~~The~~outstanding at ~~Company’s~~June 30, ~~technical~~2004 ~~support contracts~~and ~~require~~2005, itrespectively, towere ~~provide~~not ~~technical~~included ~~support~~in ~~and~~the ~~unspecified~~computation ~~software~~of ~~updates~~diluted toloss ~~customers~~per share onas atheir ~~when~~effect ~~and~~would ifbe ~~available basis~~anti-dilutive. The ~~Company~~effect ~~recognizes~~of ~~customer~~the ~~support~~convertible ~~revenue,~~debentures ~~including~~issued ~~support~~in March 2002 ~~revenue~~(see Note 3) that iswere ~~bundled~~convertible ~~with~~into ~~product~~2,559,509 ~~sales~~and 568,780 ~~ratably~~shares of common stock at ~~over~~June 30, 2004 and 2005, respectively, has not been included in the ~~term~~computation of diluted earnings per share for the ~~contract~~three ~~period~~or six months ended June 30, ~~which~~2004 ~~generally~~and ~~ranges~~2005 ~~from~~as ~~one~~their toeffect ~~three~~would ~~years~~be anti-dilutive.

~~The~~Restructuring Company examines the specific facts and circumstances of all sales arrangements with payment terms extending beyond its normal payment terms to make a determination of whether the sales price is fixed orCharges determinable and whether collectibility is probable. Payment terms are not tied to milestone deliverables or customer acceptance. The evaluation of the impact on revenue recognition, if any, includes the Company’s history with the particular customer and the specific facts of each arrangement. It is generally not the Company’s practice to offer payment terms that differ from its normal payment terms, and the Company has not written off any accounts receivable related to extended payment term arrangements.

~~The~~ SFAS ~~Company~~No. 146, ~~has~~“Accounting ~~agreements~~for Costs Associated with Exit or Disposal Activities,” ~~certain~~addresses ~~service~~financial ~~providers~~accounting ~~that~~and ~~provide~~reporting ~~price~~for ~~protection~~costs inassociated ~~the~~with ~~event~~exit or disposal activities and requires that ~~more~~a ~~favorable~~liability ~~prices~~for ~~and~~a ~~terms~~cost ~~are~~associated ~~granted~~with toan ~~any~~exit ~~other~~or ~~similarly~~disposal ~~situated~~activity ~~customer.~~be ~~When~~recognized when ~~required,~~the ~~reserves~~liability is incurred and establishes that fair value is the objective for initial measurement of the liability.

9 On April 6, 2005, the Company announced a plan to realign its cost structure with an adjusted business model which reflects procurement changes within the Company’s distribution channels and the related effect on the Company’s anticipated future revenue stream. The reorganization included a workforce reduction of approximately 25 employees throughout the Company. In connection with this plan, the Company recorded a restructuring charge of $716,000 during the three months ended June 30, 2005. The charge consisted primarily of employee termination costs, including severance and other benefits. During the three months ended June 30, 2005, the Company paid $671,000 of restructuring costs and $45,000 remains unpaid as of June 30, 2005.

~~Table~~New ofAccounting ~~Contents~~Pronouncements

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 ~~estimated~~(revised), ~~price~~“Share-Based ~~protection~~Payment” ~~credits~~(“SFAS ~~are~~No. 123R”). ~~established~~SFAS byNo. 123R eliminates the ~~Company~~intrinsic ~~concurrently~~value method ~~with~~under ~~the~~APB ~~recognition~~25 as an alternative method of ~~revenue~~accounting for stock-based awards. ~~The~~SFAS ~~Company~~No. 123R also ~~monitors~~revises the ~~factors~~fair ~~that~~value-based method of accounting for share-based payment liabilities, ~~influence~~forfeitures ~~the~~and ~~pricing~~modifications of ~~its~~stock-based ~~products~~awards and ~~service~~clarifies ~~provider~~the ~~inventory~~guidance ~~levels~~of ~~and~~SFAS ~~makes~~No. 123, “Accounting ~~adjustments~~for toStock-based ~~these~~Compensation,” ~~reserves~~in ~~when~~several ~~management~~areas, ~~believes~~including ~~that~~measuring ~~actual~~fair ~~price~~value, classifying ~~protection~~an ~~credits~~award ~~may~~as ~~differ~~equity ~~from~~or ~~established~~as ~~estimates~~a liability and attributing compensation cost to reporting periods. In addition, SFAS No.

~~Credit Risk~~ 11

~~Financial~~123R ~~instruments~~amends ~~that~~SFAS ~~potentially~~No. 95, ~~subject~~“Statement ~~the~~of ~~Company~~Cash Flows,” to ~~significant~~require ~~concentrations~~that ofexcess ~~credit~~tax ~~risk~~benefits ~~consist~~be ~~principally~~reported ofas ~~accounts~~a ~~receivable.~~financing ~~The~~cash ~~Company~~inflow ~~generally~~rather ~~sells~~than ~~its~~as ~~products~~a toreduction ~~large~~of ~~telecommunications~~taxes ~~and~~paid, ~~Internet~~which ~~service~~is ~~provider~~included ~~companies~~within operating ~~primarily~~cash inflows. In March 2005, the ~~United~~SEC ~~States.~~issued ~~The~~Staff ~~Company~~Accounting ~~grants~~Bulletin ~~credit~~No. 107, ~~terms~~which provides ~~without~~guidance ~~collateral~~for tothe ~~its~~implementation ~~customers~~of ~~and~~SFAS No. 123R, ~~other~~including ~~than a~~guidance ~~loss~~ related to share-based ~~the~~payment ~~MCI~~transactions ~~bankruptcy~~with ~~(described~~nonemployees, ~~below)~~valuation methods, ~~has~~the ~~not~~accounting ~~experienced~~for ~~any~~certain redeemable ~~significant~~financial ~~credit~~instruments ~~related~~issued ~~losses.~~under ~~Accounts~~share-based ~~receivable~~payment ~~include~~arrangements, ~~allowances~~the toclassification of ~~record~~compensation ~~receivables~~expense, atand ~~their~~the ~~estimated~~accounting ~~net~~for ~~realizable~~income ~~value.~~tax effects of share-based payment arrangements under SFAS No. 123R.

A In ~~significant~~April 2005, ~~customer~~the ofSEC delayed the ~~Company,~~implementation ~~MCI,~~date ~~filed~~ for ~~bankruptcy~~SFAS onNo. 123R ~~July~~until ~~21,~~an issuer’s ~~2002.~~first ~~During~~annual ~~the~~period ~~three~~that ~~months~~begins ~~ended~~after ~~March 31~~June 15, ~~2003~~2005. Therefore, the Company ~~sold~~is ~~approximately~~required ~~$0.7 million of previously written off MCI receivables~~ to anadopt SFAS ~~unrelated~~No. 123R ~~third~~effective ~~party~~January 1, ~~for approximately $0.3 million~~2006, ~~which~~using ~~was~~one ~~recorded~~of asthree aimplementation ~~reduction~~alternatives ~~to bad debt~~specified ~~expense~~under ~~included~~SFAS inNo. 123R. ~~general~~The ~~and~~Company ~~administrative~~anticipates ~~expense~~that in the ~~consolidated~~adoption ~~statement~~ of ~~operations~~SFAS ~~for that period~~No. 123R ~~Subsequent~~will tohave ~~its~~a significant ~~bankruptcy~~impact ~~filing,~~on ~~MCI~~the ~~has~~Company’s ~~complied~~financial ~~with~~statements. ~~all~~The ~~agreements~~Company ~~which~~is ~~revised~~currently ~~payment~~in ~~terms with~~ the ~~Company.~~process of ~~MCI~~determining ~~emerged from~~which ~~bankruptcy~~implementation inalternative ~~April~~to ~~2004~~use and ~~continues~~what tothe beexpected afinancial ~~significant~~impact ~~customer~~of SFAS No. 123R may be.

~~Warranty~~2. ~~and~~Line ~~Indemnifications~~of Credit:

~~The~~ In ~~Company accounts~~July 2004, ~~for~~the Company and ~~discloses~~Silicon ~~its~~Valley ~~obligations~~Bank ~~for~~(“SVB”) ~~warranties~~entered ininto ~~accordance~~a ~~with~~$6.0 million ~~FASB~~line ~~Interpretation~~of credit ~~No.~~agreement 45 (the “~~FIN~~July 2004 45Facility”),. ~~“Guarantor’s~~Funds ~~Accounting~~under the ~~and~~July ~~Disclosure~~2004 ~~Requirements~~Facility ~~for~~were ~~Guarantees,~~available ~~Including~~once ~~Indirect~~the ~~Guarantees~~senior ofsecured convertible ~~Indebtedness~~debentures (the “Debentures”) (see Note 3) were offully ~~Others~~repaid.” ~~FIN~~The 45Company ~~requires~~entered into the ~~accounting~~July ~~for~~2004 ~~and~~Facility primarily ~~disclosure~~to ofprovide ~~guarantees~~additional ~~and~~capital ~~clarifies~~in the ~~requirements~~event that the Debenture holders exercised their right to require the Company to repay the Debentures in full prior to their due date, and the Company made all or a substantial portion of ~~FASB~~the Norepayment in cash. 5The original expiration of the July 2004 Facility with SVB was July 22, ~~“Accounting~~2005, ~~for~~at ~~Contingencies.”~~which time any outstanding advances under the July 2004 Facility were to be immediately payable.

On June 21, 2005, the Company entered into a $4.0 million line of credit agreement with SVB (the “June 2005 Facility”), which replaced the July 2004 Facility. The Company ~~warrants~~entered ~~Visual~~into the ~~UpTime~~June ~~hardware~~2005 Facility primarily to provide additional capital for the ~~periods~~repayment of upthe Debentures during the three months ended June 30, 2005 (see Note 3). While the Company continues to ~~five~~have ~~years~~outstanding obligations to the holders of the Debentures, SVB has committed to make loans to the Company at the Company’s request of up to $4.0 million, ~~The~~which the Company ~~warrants~~requested ~~Visual~~in ~~UpTime~~full and SVB ~~Select~~paid ~~hardware~~on ~~for~~June 21, ~~one~~2005. ~~year~~These loans will bear interest at a rate equal to SVB’s prime rate plus 6.0% per ~~The~~annum and the June 2005 Facility will expire on October 31, 2005. If the Company ~~estimates~~satisfies all of its obligations ~~warranty~~under ~~obligation~~the Debentures prior to October 31, 2005, SVB will make loans to the Company at the ~~end~~Company’s request of ~~each~~up ~~period~~to ~~and~~the ~~charges~~lesser ~~changes~~of in(i) ~~the~~$4.0 million ~~liability~~or (ii) a borrowing base equal to ~~cost~~80% of ~~revenue~~eligible inaccounts receivable as defined by the ~~respective~~terms of ~~period~~the June 2005 Facility. ~~Such~~These ~~estimates~~loans ~~are~~will ~~based~~bear interest onat ~~actual~~a ~~warranty~~rate ~~cost experience~~equal to SVB’s prime rate plus 2.0% per annum and the agreement will expire on December 31, 2005.

~~The Company typically includes standard intellectual property indemnification clauses in software license agreements~~3. ~~Pursuant~~Convertible to these clauses, the Company agrees to pay any final judgments or final settlements against the customer, in connection with certain intellectual property infringement claims by third parties relating to the Company’s products. The indemnification clauses apply at any time after the execution of the software license agreement. In addition, the Company generally warrants that software products will perform in accordance with material specifications in effect at the time of delivery of the licensed products to the customer for 90 days following delivery. The Company has not experienced any material intellectual property indemnification claims historically and has no amounts accrued as of June 30, 2004 relating to such obligations. Debentures:

In March 2002, the Company issued Debentures in the aggregate amount of $10.5 million in a private placement transaction. The Debentures, now due on demand but no later than March 25, 2006, are payable in cash or common stock at the Company’s option provided certain conditions are satisfied, which are currently satisfied. The Debentures bear interest at an annual rate of 5% payable quarterly in cash or common stock, at the Company’s option, provided certain conditions are satisfied, which are currently satisfied. To date, all quarterly interest payments under the Debentures have been made in cash. The conversion price of the Debentures will adjust if the Company issues additional equity or instruments convertible into equity at a price that is less than the then-effective conversion price of the Debentures. The Company has the right to require the holders to convert their Debenture holdings into common stock if the weighted average price of the Company’s common stock exceeds 175% of the conversion price for 20 consecutive trading days. The remaining Debentures totaling $2.0 million are convertible into 568,780 shares of common stock at June 30, 2005 at a price of $3.5163 per share.

~~Table of Contents~~12

~~The~~ In connection ~~following~~with isthe aissuance ~~summary~~ of the ~~change~~Debentures, in the Company’s ~~accrued~~issued ~~warranty~~to the ~~during~~Debenture holders warrants (the ~~three~~“2002 ~~months ended~~Warrants”) ~~June~~to 30purchase an aggregate of 828,861 ~~2003~~shares ~~and~~of ~~2004~~its common stock at an exercise price of $4.2755 per share (~~unaudited,~~see inNote ~~thousands~~5):. The Debenture holders were also granted registration rights.

	2003			2004
Balance, beginning of period	$	421		$	428
Provisions for warranty		36			30
Settlements made		(23	)		(30	)
Balance, end of period	$	434		$	428

Because the Company did not meet the 2003 earnings target set forth in the Debentures, the Debenture holders may require that the Company repay, in whole or in part, at any time and from time to time, the outstanding principal amount of their Debenture holdings, plus accrued interest. Accordingly, the Debentures, net of unamortized debt discount, are classified as current liabilities in the accompanying consolidated balance sheets. Under the terms of the Debentures: (i) a Debenture holder electing payment for some portion of the Debentures must notify the Company of this election; (ii) the Company, in turn, must notify the Debenture holder of the manner in which it intends to repay that Debenture holder (either all cash or all common stock); and (iii) the notifying Debenture holder then notifies the Company of the amount to be paid in that form at that time. The redemption of each Debenture may be made in cash or common stock, at the Company’s option, provided certain conditions are satisfied, which the Company currently satisfies.

~~The~~ In ~~following~~addition, isunder ~~a summary~~the terms of the ~~change~~Debentures, ina number of events could trigger the ~~Company~~Debenture holders’s ~~accrued~~right ~~warranty~~to ~~during~~force ~~the~~early ~~six~~repayment ~~months~~of ~~ended~~115% ~~June~~of ~~30,~~the ~~2003~~outstanding principal plus accrued and unpaid ~~2004~~interest ~~(unaudited,~~owed inunder ~~thousands):~~the Debentures. Events constituting a triggering event include:

	2003			2004
Balance, beginning of period	$	402		$	425
Provisions for warranty		71			52
Settlements made		(39	)		(49	)
Balance, end of period	$	434		$	428

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

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

	•		failure to have an effective registration statement covering the shares of common stock issuable upon conversion of the Debentures or exercise of the warrants;

	•		bankruptcy of the Company;

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

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

~~Segment~~ Pursuant ~~Reporting~~to requests from Debenture holders, the Company elected to repay $1.5 million, $3.0 million and ~~Significant~~$4.0 million of the outstanding Debentures in cash in June 2004, May 2005 and June ~~Customers~~2005, respectively. The remaining aggregate amount of the Debentures is reflected in the accompanying balance sheets as a current liability of $9.0 million and $2.0 million as of December 31, 2004 and June 30, 2005, respectively, net of unamortized debt discount of $0.8 million and $0.1 million, as of December 31, 2004 and June 30, 2005, respectively. The net amount reflects the fair market value on the date of issuance after allocating the proceeds to the various additional components of the debt. $2.1 million in proceeds from the Debentures was allocated to the value of the warrants. Approximately $0.3 million in proceeds from the Debentures was allocated to additional paid-in capital to recognize the value of the rights of the holders to purchase shares of preferred stock, which expired in 2002, as determined by an appraisal. On the date of issuance of the Debentures, the effective conversion price of the Debentures was less than the quoted market price of the Company’s common stock. Accordingly, $0.7 million in proceeds from the Debentures was allocated to additional paid-in capital to recognize this beneficial conversion feature. The discount on the Debentures resulting from the allocation of proceeds to the value of the warrants, preferred stock rights and beneficial conversion feature is being amortized as a charge to interest expense over the four-year period until the Debentures become due in March 2006. Debt issuance costs of $0.9 million were deferred and are being amortized over the term of the Debentures.

~~SFAS No. 131, “Disclosure about Segments~~13 of an Enterprise and Related Information,” establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that these enterprises report selected information about operating segments in interim financial reports. Management has concluded that the Company’s operations occur in one segment only based upon the information used by management in evaluating the performance of the business. SFAS No. 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. The revenue and assets of the Company’s foreign subsidiaries have not been significant.

~~For~~ 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 Debentures. During the three months ended June 30, ~~2003~~2004, ~~three~~the ~~customers~~Company ~~individually represented~~paid ~~34%,~~such ~~20%~~amounts and ~~10%~~any interest due thereon in cash pursuant to the terms of ~~revenue~~the Debentures. ~~For~~Because of the early repayment of $1.5 million of the outstanding Debentures during the three months ended June 30, 2004, ~~three~~a ~~customers~~proportionate amount ~~individually~~of ~~represented~~the ~~24%,~~unamortized ~~24%~~discount and ~~23%~~debt issuance costs associated with these repayments were expensed and the related charge of ~~revenue~~$0.3 million ~~For~~was included in other expense in the ~~six~~statement of operations for the three months ended June 30, ~~2003~~2004. On April 29, ~~three~~2005, ~~customers~~the ~~individually~~Company ~~represented~~received ~~35%~~a definitive, ~~21%~~binding ~~and~~notice from a Debenture holder requesting the repayment in full of an aggregate ~~10%~~of $3.0 million of ~~revenue~~the Company’s Debentures. ~~For~~On June 7, 2005, the ~~six~~Company received a definitive, binding notice from a Debenture holder requesting the repayment in full of an aggregate of $4.0 million of the Company’s Debentures. During the three months ended June 30, ~~2004~~2005, ~~four~~the ~~customers~~Company ~~individually~~paid such ~~represented~~amounts ~~21%~~and any interest due thereon in cash pursuant to the terms of the Debentures. Because of the early repayment of $7.0 million of the outstanding Debentures during the three months ended June 30, ~~20%~~2005, ~~19%~~a proportionate amount of the unamortized discount and ~~17%~~debt issuance costs associated with these repayments were expensed and the related charge of ~~revenue~~$0.5 million was included in other expense in the statement of operations for the three months ended June 30, 2005.

~~The Company’s major service provider customers include, among others: AT&T, MCI, SBC, Sprint and Verizon~~4. ~~The~~Commitments ~~revenue from sales to service providers was 83%~~ and 85% for the three months ended June 30, 2003 and 2004, respectively. The revenue from sales to service providers was 84% and 87% for the six months ended June 30, 2003 and 2004, respectively. The supply agreements with the Company’s significant customers do not contain minimum purchase requirements. Contingencies:

As In ofJanuary 2004, ~~June~~the 30Company received notice that a lawsuit had been filed by Paradyne Networks, ~~2004~~Inc. (“Paradyne Networks”) of Largo, ~~four~~Florida, ~~customers~~in ~~individually~~the ~~represented~~United ~~25%~~States District Court for the Middle District of Florida, ~~19%~~Tampa Division (the “Florida Court”) against the Company, ~~18%~~seeking damages and ~~13%~~injunctive relief, for the Company’s alleged infringement of ~~accounts~~patents ~~receivable.~~owned by Paradyne Corporation (“Paradyne”), a subsidiary of Paradyne Networks.

~~Accounting~~ On May 14, 2004, the Florida Court granted the Company’s motion to dismiss the case for ~~Stock~~lack of ~~Options~~subject matter jurisdiction and denied Paradyne Networks’ motion for leave to amend its complaint and its motion for preliminary injunction. Paradyne Networks did not appeal the decision.

~~The~~ In a related matter, one of the Company’s ~~has~~subsidiaries, ~~accounted~~Visual ~~for~~Networks ~~its~~Operations, ~~stock-based~~Inc. (“VNO”), ~~compensation~~filed a lawsuit in ~~accordance~~United ~~with~~States District Court for the ~~provisions~~District of ~~Accounting~~Maryland, ~~Principles~~Southern Division ~~Board~~ (the “~~APB~~Maryland Court”), ~~Opinion~~against NoParadyne. This lawsuit requests declaratory judgment that ~~25,~~Visual ~~“Accounting~~UpTime and Visual IP InSight do not infringe upon certain patents owned by Paradyne and that those patents are invalid and unenforceable and alleges that Paradyne’s assertion of its patents against the Company is baseless and has been for ~~Stock~~the ~~Issued~~sole topurpose ~~Employees~~of obtaining an unfair competitive advantage,” asand ~~interpreted~~that Paradyne has infringed upon certain patents owned by ~~FASB~~the ~~Interpretation~~Company. Paradyne Nofiled counterclaims alleging that VNO infringes upon its patents, mirroring the Florida claims. 44On October 15, ~~“Accounting~~2004, ~~for~~Paradyne ~~Certain~~filed ~~Transactions~~amended ~~Involving~~counterclaims, ~~Stock~~adding allegations of willful patent infringement and unenforceability of two of the Company’s patents in the lawsuit. The Maryland lawsuit presently is in the expert discovery phase of the litigation. The Maryland Court conducted a hearing concerning patent claim construction on February 7, 2005 and issued an order on June 15, 2005. A trial date has not yet been scheduled.

Pursuant to the terms of a confidential settlement agreement entered into on March 11, 2005 between Paradyne and VNO, Paradyne has agreed to dismiss its patent claims against Visual IP Insight. VNO has agreed to dismiss its unfair competition claim against Paradyne with respect to Visual IP Insight and pay royalties to Paradyne through the remaining life of Paradyne’s patents in the amount of 1% of revenue recognized by the Company from the licensing and distribution of Visual IP Insight. On March 15, 2005, the Maryland Court approved a Stipulation of Partial Dismissal submitted by the parties concerning the patent claims against Visual IP InSight and the unfair competition claim against Paradyne.

~~Table of Contents~~14

Despite the Company’s belief that its products do not infringe upon Paradyne’s patents and ~~Compensation,~~that anParadyne’s ~~Interpretation~~claims ofare ~~APB~~frivolous ~~Opinion~~and ~~No.~~without 25merit,” the defense of these claims is expensive and ~~present~~may divert the ~~pro~~Company’s ~~forma~~resources ~~disclosures~~from ~~required~~other byactivities, ~~SFAS~~which ~~No.~~could ~~123,~~have ~~“Accounting~~a ~~for~~material ~~Stock-Based~~adverse ~~Compensation,”~~effect ason ~~amended~~the byCompany’s ~~SFAS~~business Noand results of operations. ~~148~~At this point in the litigation, ~~“Accounting~~the likelihood ~~for~~of ~~Stock-Based~~any ~~Compensation-Transition~~outcome cannot be determined and ~~Disclosure.”~~the adverse effect, if any, cannot be estimated.

~~During~~ The ~~the three months ended March 31, 2004, the~~ Company ~~granted~~is ~~non-qualified~~periodically ~~stock~~a ~~options~~party to ~~purchase~~disputes ~~465,213~~arising ~~shares~~from ofnormal ~~common~~business ~~stock to employees,~~activities ~~under~~including ~~the~~various ~~1997 Non~~employee-~~Qualified~~related ~~Stock Option Plan, at an issuance price that was less than the fair market value of the Company’s common stock and recorded deferred compensation of $330,000~~matters. ~~The~~In ~~deferred compensation is being amortized over~~ the ~~vesting~~ ~~period~~opinion of ~~the stock options~~management, ~~which~~resolution ~~is 20% as~~ of ~~the~~these various ~~grant~~employee-related ~~date~~matters ~~and~~will ~~the~~not ~~remaining~~have ~~portion~~a ~~over~~material 24adverse ~~equal~~effect ~~monthly~~upon ~~installments after~~ the ~~grant date. As a result, the~~ Company ~~recorded deferred compensation expense of approximately $33,000 and~~’s ~~$121,000~~financial ~~during~~position ~~the~~or ~~three~~future ~~and~~operating ~~six months ended June 30, 2004, respectively~~results. ~~The Company also recorded deferred compensation expense of $2,000 during the six months ended June 30, 2003.~~

If Litigation ~~compensation~~costs ~~expense~~are ~~had~~expensed ~~been determined based on the fair value of the options at the grant dates consistent with the method of accounting under SFAS No. 123,~~ as ~~amended by SFAS No~~incurred. ~~148, the Company’s net loss per share would have increased to the pro forma amounts indicated below (unaudited, in thousands, except per share amounts):~~

	Three Months Ended June 30,						Six Months EndedJune 30,
	2003			2004			2003			2004
Net loss, as reported	$	(677	)	$	(414	)	$	(769	)	$	(904	)
Add: Stock-based employee compensation expense included in reported net loss		—			33			2			121
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards		(1,469	)		(1,101	)		(2,942	)		(2,432	)
Pro forma net loss	$	(2,146	)	$	(1,482	)	$	(3,709	)	$	(3,215	)
Loss per share:
Basic and diluted: as reported	$	(0.02	)	$	(0.01	)	$	(0.02	)	$	(0.03	)
Basic and diluted: pro forma	$	(0.07	)	$	(0.04	)	$	(0.11	)	$	(0.10	)

Subsequent Events:

~~The~~ On ~~fair~~August 5, ~~value~~2005, ofthe ~~each option~~Company isentered ~~estimated~~into ona definitive agreement under which the ~~date~~Company will ofissue ~~grant~~$10 million ~~using~~in senior secured convertible notes (the ~~Black-Scholes~~“2005 ~~option~~Notes”). ~~pricing~~The ~~model~~2005 ~~with~~Notes will be secured by a blanket lien against all of the ~~following~~Company’s ~~assumptions~~assets ~~used~~and ~~for~~will ~~grants~~be ~~during~~convertible at any time by the ~~six~~investors ~~months~~into common ~~ended~~stock ~~June~~of ~~30,~~the ~~2003~~Company ~~and~~at ~~2004:~~a noconversion ~~dividend~~price ~~yield,~~of ~~expected~~$1.45 ~~volatility~~per ~~from~~share, ~~100%~~which, toif ~~587%~~fully converted, ~~risk-free~~represents ~~interest~~6,896,552 ~~rates~~shares ~~from~~of ~~3.4%~~the toCompany’s 4common stock.4% ~~and~~The conversion anprice ~~expected~~adjusts ~~term~~upon ofthe 5occurrence ~~years.~~of ~~Assumptions~~certain ~~used~~events including, inamong ~~determining~~other things, the ~~fair~~Company’s ~~value~~issuance of ~~options~~equity securities ~~are~~or ~~used~~securities ~~solely~~convertible ~~for~~into ~~this~~equity ~~purpose~~of ~~and~~the ~~there~~Company isat noa price ~~prediction~~less orthan ~~guarantee~~the ~~that~~conversion ~~the~~price ~~expense~~then ~~reflected~~in ~~under~~effect. ~~these~~The Company will have registration ~~assumptions~~obligations with respect to the common stock issuable upon conversion. Shareholder approval will also be ~~realized.~~required for certain aspects of the transaction which the Company will seek following the closing of the sale.

~~Basic~~ Under the terms of the 2005 Notes, a number of events could trigger the note holders’ right to force early repayment of the outstanding principal plus accrued and ~~Diluted~~unpaid ~~Earnings~~interest ~~(Loss)~~owed under ~~Per~~the ~~Share~~2005 Notes. Events constituting an event of default include:

~~SFAS~~• ~~No.~~default ~~128,~~by ~~“Earnings~~the ~~Per~~Company ~~Share,”~~on ~~requires dual~~other ~~presentation~~indebtedness ofin ~~basic~~an ~~and~~amount ~~diluted~~exceeding ~~earnings~~$100,000; ~~(loss)~~• ~~per~~a ~~share.~~final, ~~Basic~~non-appealable ~~earnings~~judgment or ~~loss~~judgments ~~per~~rendered ~~share~~against ~~includes~~the noCompany ~~dilution~~exceeding ~~effect~~$250,000 ~~and~~in isaggregate; ~~computed~~• failure to meet certain covenants as defined by ~~dividing~~the ~~net~~terms ~~income~~of orthe ~~net~~2005 ~~loss~~Notes; ~~available~~• tobankruptcy ~~common~~of ~~stockholders~~the Company; and • certain other failures by the ~~weighted-average~~Company ~~number~~to ~~of common~~perform ~~shares~~obligations ~~outstanding~~under ~~for~~the 2005 Notes and/or the ~~period.~~related agreements.

~~Diluted~~ The ~~earnings~~proceeds orfrom the issuance of the 2005 Notes will be used to pay off in full (a) the ~~loss~~outstanding ~~per~~$2.0 million ~~share~~of ~~includes~~Debentures (see Note 3) and (b) the ~~potential~~outstanding ~~dilution~~amounts ~~that~~under ~~could~~the ~~occur~~June if2005 ~~securities~~Facility orand terminate ~~other~~the ~~contracts~~June to2005 ~~issue~~Facility ~~common~~(see ~~stock~~Note ~~were~~2). The remaining proceeds will be used for working capital and general corporate purposes. The 2005 Notes will mature on December 31, 2007. The Company will not have a prepayment right with respect to the 2005 Notes.

12 In connection with the issuance of the 2005 Notes, which will be convertible into equity at a lower price than the then-effective exercise price of the 2002 Warrants (see Note 3), the exercise price of the 2002 Warrants will be adjusted from $4.2755 per share to $3.8962 per share in accordance with the terms of the 2002 Warrants. The holders of the 2002 Warrants will also be entitled to an additional 80,691 warrants so that the total number of outstanding 2002 Warrants will be increased to 909,552. The 2002 Warrants expire on March 25, 2006.

~~Table of Contents~~15

~~exercised or converted into common stock~~Item 2. ~~Options~~Management’s ~~and~~Discussion ~~warrants to purchase 9,590,533~~ and ~~10,295,407~~Analysis ~~shares~~ of ~~common~~Financial ~~stock~~Condition ~~outstanding at June 30, 2003~~ and ~~2004,~~ ~~respectively,~~Results ~~were not included in the computation~~ of ~~diluted loss per share as their effect would be anti-dilutive. The effect of the Debentures issued in March 2002 (see Note 3) that are potentially convertible into 2,986,093 and 2,559,509~~Operations ~~shares of common stock at June 30, 2003 and 2004, respectively, has not been included in the computation of diluted loss per share as such effect would be anti-dilutive.~~

~~The~~ This ~~computation~~Management’s Discussion and Analysis of Financial Condition and Results of Operations may contain forward-looking statements that involve risks and uncertainties. Under the ~~loss~~section ~~per~~“Risk Factors”, ~~share~~we ishave asdescribed ~~follows~~what ~~(unaudited~~we believe to be some of the major risks related to these forward-looking statements, as well as the general outlook for our business. Investors should review these risk factors and the rest of this Quarterly Report on Form 10-Q in ~~thousands,~~combination ~~except~~with the ~~per~~more ~~share~~detailed ~~data):~~description of our business in our 2004 Annual Report on Form 10-K for a more complete understanding of the risks associated with an investment in our common stock.

	Three Months EndedJune 30,						Six Months EndedJune 30,
	2003			2004			2003			2004
Net loss	$	(677	)	$	(414	)	$	(769	)	$	(904	)
Basic and diluted weighted-average number of shares of common stock outstanding		32,569			33,185			32,500			33,098
Loss per common share:
Basic and diluted	$	(0.02	)	$	(0.01	)	$	(0.02	)	$	(0.03	)

Overview

~~Reclassifications~~ We design and sell products that allow enterprises and network service providers to measure the performance of their networks and identify and monitor software applications that operate on the network. Our solutions correlate traditional network performance information with application data collected from various network locations to provide the network manager with the ability to understand the health and performance of the network and the applications traversing that network - the primary objective is to reduce or avoid expensive network and application downtime. Currently, we offer two product lines to our customers, Visual UpTime® and Visual IP InSight®. Most of our revenue is derived from the sales and licenses of Visual UpTime products, which sales represented 94% and 97% of our total revenue for the three months ended June 30, 2004 and 2005, respectively, and 94% and 97% of our total revenue for the six months ended June 30, 2004 and 2005, respectively.

~~Certain~~ We ~~prior~~market ~~period~~our ~~amounts~~products to enterprises, service providers and Value Added Resellers (“VAR’s”). We sell our products through indirect sales channels. An enterprise which desires our technology generally acquires the solution from either a service provider or a VAR. Many of our service provider channel partners have ~~been~~incorporated ~~reclassified~~our products into their value added service offerings to ~~conform~~enterprises. Consequently, an enterprise can choose either to ~~current~~utilize our solutions as part of ~~period~~a ~~presentation~~monthly service offered by the service providers or to purchase our solution. Enterprises that want to host their own systems may procure our solutions 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, among others: AT&T, BellSouth, Equant, MCI, SBC, Sprint and Verizon. The revenue generated from sales to service providers was 85% and 91% of the Company’s consolidated revenue for the three months ended June 30, 2004 and 2005, respectively, and 87% and 86% of the Company’s consolidated revenue for the six months ended June 30, 2004 and 2005, respectively. We intend to increase our efforts in the VAR channel in order to grow this distribution channel. We also intend to expand our international focus, and, during the fourth quarter of 2004, announced the opening of our European headquarters outside of London, England.

2 With the appointment of Lawrence Barker as our President and Chief Executive Officer in April 2003, we began to restructure our senior management team and launch new corporate initiatives. ~~Bank~~The most ~~Borrowings:~~important initiative involved fundamental changes to our flagship product, Visual UpTime. In 2004, we launched Visual UpTime Select™ built upon the strength of the original Visual UpTime product as the successor to Visual UpTime. Where Visual UpTime was focused solely on performance monitoring of private data networks and was sold only one way – fully loaded as a highly intelligent and capable hardware appliance, Visual UpTime Select represents a modular software approach with expanded capabilities beyond traditional performance monitoring. Visual UpTime Select is an unbundled series of discrete software modules and associated hardware appliances and agents. Now customers can purchase only those aspects of our solutions they require while preserving the capability of adding incremental features at a later date. This modular approach has made our solutions more economical for new customers when compared to the original Visual UpTime and enables us to sell additional capabilities to our installed base of end-user customers, a capability not possible under the original Visual UpTime. We announced Visual UpTime Select in October 2003, began shipping in April 2004 and by year end 2004 had essentially completed the transition from Visual UpTime to Visual UpTime Select.

~~In December 2000, Silicon Valley Bank (“SVB”) had issued a $1.5 million standby letter of credit, as amended, in favor of one of the~~16 Company’s subcontract manufacturers that expires on September 30, 2004. The letter of credit, secured by the pledge of a CD in the amount of $1.5 million that matures on July 30, 2004, was $1.5 million as of December 31, 2003. In the three months ended March 31, 2004, the letter of credit and corresponding CD were reduced from $1.5 million to $0.5 million. The $1.0 million reduction in the CD was a source of cash in the three months ended March 31, 2004. Subsequent to June 30, 2004, the subcontract manufacturer eliminated its line of credit requirements and the $0.5 million CD became unrestricted.

~~The~~ We ~~Company~~expect ~~and~~to ~~SVB~~release ~~have~~one ~~entered~~to ~~into~~two anew ~~$6.0~~Visual ~~million~~UpTime ~~line~~Select ofsoftware ~~credit.~~modules ~~Borrowings~~each ~~under~~year for the next ~~line~~few ofyears. ~~credit~~Our ~~are~~first ~~available~~new ~~only~~Visual ~~for~~UpTime ~~working~~Select ~~capital~~modules ~~purposes once~~were ~~the~~released ~~debentures~~during ~~(see~~the ~~Note~~third 3)quarter of ~~have~~2004 ~~been~~– ~~fully~~Select ~~paid.~~AppFlows ~~The~~and ~~Company~~Select ~~entered~~AppSummary. ~~into~~These ~~this~~two ~~line~~modules ofare ~~credit~~focused ~~agreement~~on toapplication discovery, ~~provide~~monitoring ~~additional~~and ~~capital~~reporting. inOur ~~the~~newest ~~event~~module, ~~the~~Select ~~debentures~~VOIP ~~are~~MRI, ~~paid~~significantly inenhanced ~~cash.~~our existing Novoice ~~amounts~~over ~~are~~internet ~~outstanding~~protocol ~~under~~(“VoIP”) ~~this~~capabilities ~~line~~and ofwas ~~credit~~released atduring ~~June~~the second ~~30,~~quarter ~~2004.~~of 2005.

~~The~~ We ~~Loan~~incurred ~~and~~net ~~Security~~losses ~~Agreement~~in ~~with~~2003 ~~SVB~~and ~~expires~~in ~~on July~~the ~~22,~~first ~~2005,~~two atquarters ~~which~~of ~~time~~2004. ~~any~~However, ~~outstanding~~we ~~advances~~returned ~~under~~to profitability in the ~~agreement~~third ~~are~~and ~~immediately~~fourth ~~payable~~quarters of 2004. ~~Under~~We ~~the~~reported ~~agreement,~~net ~~the~~income ~~Company~~of ~~can~~$15,000 ~~make~~in ~~advances~~2004, compared ~~not~~with ~~exceeding~~a ~~the~~net ~~lesser~~loss of ~~(a)~~ $64.0 3 million orin ~~(b)~~2003. aThese ~~borrowing~~improvements ~~base~~can ~~which~~be isattributed ~~80%~~to ~~of eligible~~both ~~accounts~~initial ~~receivable~~success ~~as defined~~ in ~~the~~launching ~~agreement.~~Visual ~~Interest~~UpTime isSelect ~~payable~~and ~~monthly~~improvement atin the ~~greater~~economy. ofHowever, ~~(i)~~during the ~~SVB’s~~first ~~prime~~six ~~rate~~months ~~plus~~of ~~1.25%~~2005, ~~per~~we ~~annum~~reported ora ~~(ii)~~net ~~5.25%~~loss ~~per~~of ~~annum~~$3.9 million. ~~Collateral~~This ~~under~~loss was the ~~agreement~~result ~~consists~~ of lower ~~the~~revenues ~~Company’s~~primarily ~~right,~~due ~~title~~to ~~and interest~~tighter ininventory control and toreduced ~~substantially~~capital ~~all~~expenditures resulting offrom ~~its~~pending ~~assets~~consolidation ~~other~~in ~~than~~the ~~its~~telecommunications ~~intellectual property~~industry. ~~The~~Sales ~~agreement~~cycles ~~subjects~~have increased to accommodate for the ~~Company~~increased response time to ~~certain~~customer ~~financial~~requests from our service provider channels and ~~other~~the ~~covenants,~~extended ~~which~~approval ~~are~~process ~~presently~~within ~~met~~the service provider channel. There can be no assurance that we will return to profitability.

13 On April 6, 2005, we announced a plan to realign our cost structure with an adjusted business model which reflects the changes within our distribution channels and the anticipated future revenue stream. The reorganization included a workforce reduction of approximately 25 employees throughout the Company. In connection with this plan, we recorded a restructuring charge of $716,000 during the three months ended June 30, 2005. The charge consisted primarily of employee termination costs, including severance and other benefits.

~~Table~~ Based on our current cost structure, our ability to generate net income in the future is, in large part, dependent on our success in achieving quarterly revenue of ~~Contents~~at least $11.5 million to $12.0 million, achieving quarterly gross margins of 70% to 75% and maintaining or further reducing operating expenses. Due to market conditions, competitive pressures, and other factors beyond our control, there can be no assurances that we will be able to meet these goals. In the event that the anticipated revenue goals are not met, we may not be profitable and we may be required to further reduce our cost structure.

3 The market for solutions related to applications delivery infrastructure management is intensely competitive. ~~Convertible~~Increased ~~Debentures:~~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. Current competitors continue to include, among others, Paradyne, Packeteer, Concord Communications (now operating as a subsidiary of Computer Associates) and NetScout. If we are successful in the applications management marketplace, we may compete more frequently with significantly larger software companies like IBM, BMC and Computer Associates. Also, consolidations in our traditional service provider channels continue in 2005 and the impact of these consolidations on our business is uncertain.

In We ~~March~~are ~~2002,~~continuously ~~the~~enhancing ~~Company~~Visual ~~issued~~UpTime ~~senior~~Select ~~secured~~with ~~convertible~~new ~~debentures~~features ~~(the~~and ~~“Debentures”)~~capabilities ~~in the aggregate amount of $10.5 million in a private~~to ~~placement.~~expand ~~The~~our ~~Debentures are due March 25~~value, ~~2006,~~address ~~are~~new ~~payable~~network inservice ~~cash or common stock at the Company’s option provided certain conditions are satisfied~~requirements, ~~which~~and ~~are~~support ~~currently~~new ~~satisfied~~applications. ~~The~~We ~~Debentures~~expect to ~~bear~~package ~~interest~~many ~~at an annual rate~~ of 5%these ~~payable quarterly~~enhancements inas ~~cash or common stock~~additional, atoptional ~~the~~software ~~Company’s~~modules ~~option,~~that ~~provided~~will ~~certain~~be separately ~~conditions are satisfied, which are currently satisfied~~licensed. To ~~date~~compete successfully, ~~all~~we ~~quarterly~~must ~~interest~~be ~~payments~~able ~~under~~to ~~the~~deliver ~~Debentures~~our ~~have~~new ~~been~~product ~~made in cash. The Debentures are~~offerings ~~convertible~~through ~~into~~our ~~2,986,093~~distribution ~~shares~~channels ~~of common stock at the option of the Debenture holders at a price of $3.5163 per share, subject~~ to ~~certain~~enterprise ~~adjustments~~end-users. ~~The~~To ~~conversion~~assure ~~price~~demand offor ~~the~~our ~~Debentures~~products, ~~will adjust if the Company issues additional equity or~~we ~~instruments~~intend ~~convertible into equity at a price that is less than the then-effective conversion price of the Debentures. The Company has the right~~ to ~~require~~continue ~~the holders~~ to ~~convert~~strengthen ~~their~~our ~~Debenture~~direct ~~holdings~~relationships ~~into~~with ~~common~~enterprise ~~stock~~end-user ifcustomers ~~the value weighted~~and ~~average~~cultivate ~~price~~mature ofalternative ~~the~~distribution ~~Company’s~~channels ~~common stock exceeds 175% of the conversion price~~ for 20bringing ~~consecutive~~our ~~trading~~products ~~days.~~to ~~Debentures totaling $1~~market.~~5 million were paid in cash in June 2004. The remaining Debentures are convertible into 2,559,509 shares of~~ ~~common stock at June 30, 2004.~~

~~In connection with the issuance~~17 of the Debentures, the Company issued to the holders warrants to purchase 828,861 shares of its common stock at an exercise price of $4.2755 per share. If the Company issues additional equity or instruments convertible into equity at a lower price than the then-effective exercise price, the exercise price would be adjusted downward on a weighted average basis. The warrants expire on March 25, 2007.

~~Because~~Results the Company did not meet the financial targets for 2003 set forth in the Debentures, 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 Debenture holdings, plus accrued interest. Under the terms of the Debentures: (i) a Debenture holder electing payment for some portion of the Debentures~~Operations must notify the Company of this election; (ii) the Company, in turn, must notify the Debenture holder of the manner in which it intends to pay that Debenture holder (either all cash or all common stock); and (iii) the notifying Debenture holder then notifies the Company of the amount to be paid in that form at that time. The redemption of each Debenture may be made in cash or common stock, at the Company’s option, provided certain conditions are satisfied, which the Company currently satisfies. If the Company chooses to issue common stock to pay the debt, its stockholders could be subject to significant dilution.

On The ~~May~~primary ~~11,~~statements ~~2004, the Company received a definitive, binding notice from two Debenture holders requesting the payment in full~~ of anoperations ~~aggregate~~components ~~of $1.5~~are: ~~million of the Company’s $10.5 million outstanding Debentures. On June 11, 2004, the Company paid $1.5 million in cash to these two Debenture holders.~~

~~The~~ Revenue. ~~Company~~Our ~~expects~~revenue ~~that~~consists ~~its~~of ~~existing~~three ~~capital~~types: ~~resources~~software, ~~will~~hardware, ~~enable~~and itsupport toand ~~pay~~services. The ~~the~~fees ~~remaining~~we ~~Debentures~~receive inassociated ~~cash,~~with ifthe ~~such~~licensing ~~payment~~of isour ~~required.~~software ~~However,~~products ifare classified as ~~the~~software ~~Company’s~~revenue. ~~remaining~~The ~~cash~~sale ~~balance~~of ~~and~~the ~~available~~hardware ~~line~~component of ~~credit~~the ~~are~~Visual ~~not~~UpTime ~~sufficient~~and toVisual ~~fund~~UpTime ~~operations~~Select platforms, the ~~Company~~analysis ~~would~~service ~~need~~element to(“ASE”), ~~seek~~is ~~additional~~classified ~~capital~~as ~~through~~hardware ~~additional~~revenue. ~~borrowings,~~Visual aUpTime sales ~~sale~~are ofprimarily ~~additional~~hardware ~~securities~~revenue. orIn acontrast, ~~sale~~Visual ofUpTime ~~assets.~~Select ~~The results~~sales ofhave ~~raising~~unbundled software ~~such~~and ~~capital~~hardware ~~may~~components beand ~~dilutive.~~such ~~There~~sales ~~can~~are beclassified nounder ~~assurance~~software ~~that~~revenue ~~such~~or ~~additional~~hardware revenue, ~~capital~~as ~~will~~appropriate. beRevenue ~~available,~~associated orwith ~~available~~the onlicensing ~~terms~~of ~~that~~Visual ~~are~~IP ~~reasonable~~Insight oris ~~acceptable~~primarily classified toas ~~the~~software ~~Company~~revenue. IfSales ~~the~~of ~~Company~~technical issupport, ~~unable~~professional toservices ~~raise~~and ~~sufficient~~training ~~cash, the~~for ~~business~~all ~~and~~products ~~financial~~are ~~condition~~classified ofas ~~the~~support ~~Company could be materially~~ and ~~adversely~~services ~~affected~~revenue.

14 Cost of revenue and gross profit. Cost of revenue includes both software and hardware cost of revenue. Cost of revenue related to software sales has not been significant. Cost of revenue consists primarily of the direct costs of hardware purchased from contract manufacturing firms, shipping and warehouse costs, warranty repair costs and overhead expenses related to manufacturing operations. Support and services cost of revenue primarily consists of outsourced depot repair and costs associated with the employees who provide technical assistance, training and professional services.

~~Table~~ Operating ~~of Contents~~expenses.

In Research ~~addition,~~and ~~under~~development ~~the~~expense. ~~terms~~Research ofand ~~the~~development ~~Debentures,~~expense aconsists ~~number~~primarily of ~~events could trigger the Debenture~~ ~~holders’~~research ~~right~~and todevelopment ~~force~~staff ~~early~~compensation, ~~repayment~~outsourced ofdevelopment, ~~115%~~testing ofservices ~~the outstanding principal plus accrued~~ and ~~unpaid interest owed under the Debentures~~prototype materials. ~~Events constituting a triggering event include:~~

• Sales ~~default~~and bymarketing ~~the~~expense. ~~Company~~Sales onand ~~other~~marketing ~~indebtedness~~expense orconsists ~~obligations~~primarily ~~under~~of ~~any~~sales ~~other~~and marketing ~~debenture~~compensation, ~~mortgage~~commissions, ~~credit~~travel ~~agreement~~and orentertainment ~~other~~costs ~~facility,~~and ~~indenture~~the ~~agreement,~~costs ~~factoring~~of ~~agreement~~trade orshows and other ~~instrument~~marketing under which there may be issued, or by which there may be secured or evidenced, any indebtedness for borrowed money or money due under any long term leasing or factoring arrangement in an amount exceeding $500,000;programs.

• General ~~failure~~and byadministrative ~~the~~expense. ~~Company~~General toand ~~have~~administrative ~~its~~expense ~~common~~consists ~~stock~~primarily ~~listed~~of those oncosts anassociated ~~eligible~~with ~~market;~~executive management, finance, accounting, legal, information technology and other administrative activities.

•Three ~~bankruptcy~~months ofended ~~the~~June 30, ~~Company;~~2004 compared to three months ended June 30, 2005

• The ~~engagement~~following bytable ~~the~~presents ~~Company~~revenue inby ~~certain~~product ~~change in control, sale of assets or redemption transactions; and~~line:

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


	Three Months Ended
	June 30,
	2004		2005
	(unaudited, in thousands)
UpTime:
Visual UpTime	$	9,588	$	53
Visual UpTime Select		2,440		11,022
IP InSight		741		354

Continuing products		12,769		11,429

Royalties		54		9

Total revenue	$	12,823	$	11,438

~~The aggregate amount of the Debentures is reflected in the accompanying~~18 balance sheets as a current liability of $10.5 million and $9.0 million, net of unamortized debt discount of approximately $1.8 million and $1.2 million, as of December 31, 2003 and June 30, 2004, respectively. The net amount represents the fair market value after allocating the proceeds to the various additional components of the debt. Approximately $2.1 million in proceeds from the Debentures were allocated to the value of the warrants. The fair value of the warrants was determined using the Black-Scholes valuation model with the following assumptions: no dividend yield, expected volatility of 129%, risk-free interest rate of 4.85% and a term of five years. Approximately $300,000 in proceeds from the Debentures was allocated to the value of the rights of the holders to purchase shares of preferred stock, which expired in 2002, as determined by an appraisal. On the date of issuance of the Debentures, the conversion price of the Debentures, after taking into consideration the allocation of proceeds to the warrants and Preferred Stock Rights, was less than the quoted market price of the Company’s common stock. Accordingly, approximately $1.0 million in proceeds from the Debentures was allocated to additional paid-in capital to recognize this beneficial conversion feature. The discount on the Debentures resulting from the allocation of proceeds to the value of the warrants, Preferred Stock Rights and beneficial conversion is being amortized as a charge to interest expense over the four-year period until the Debentures become due in March 2006. Debt issuance costs of approximately $900,000 were deferred and are being amortized over the term of the Debentures. Because of the early payment of $1.5 million of the outstanding Debentures in June 2004, the ratable, remaining portion of discount and debt issuance costs of $0.3 million associated with this $1.5 million was amortized immediately and reflected as other expense in the Statements of Operations for the three and six months ended June 30, 2004.

4. The ~~Commitments~~following table presents the software, hardware and ~~Contingencies~~support and services revenue attributable to customers that individually represented more than 10% of our total revenue for each period presented:

In January 2004, the Company received notice that a lawsuit had been filed by Paradyne Networks, Inc. (“Paradyne”) of Largo, Florida, in the United States District Court for the Middle District of Florida, Tampa


	Three Months Ended
	June 30,
	2004		2005
	(unaudited, in thousands)
AT&T	$	3,056	$	2,663
Sprint		3,019		2,661
MCI		2,925		4,076
All other customers (each individually less than 10%)		3,823		2,038

Total revenue	$	12,823	$	11,438

15Revenue, cost of revenue, and gross profit

~~Table~~ The table below sets forth the changes in total revenue, cost of ~~Contents~~revenue and gross profit:

Division (the “Court”), seeking damages, and injunctive and declaratory relief, for the Company’s alleged infringement of patents owned by Paradyne Corporation, a subsidiary of Paradyne.


	Three Months Ended
	June 30,
	(unaudited, in thousands, except percentage data)
											Increase
	2004		%*			2005		%*			(Decrease)			%**
Revenue:
Hardware	$	9,091		70.9	%	$	3,990		34.9	%	$	(5,101	)		(56.1	)%
Software		1,514		11.8			5,413		47.3			3,899			257.5
Support and services		2,218		17.3			2,035		17.8			(183	)		(8.3	)

Total revenue		12,823		100.0			11,438		100.0			(1,385	)		(10.8	)

Cost of revenue:
Product		3,745		29.2			2,880		25.2			(865	)		(23.1	)
Support and services		257		2.0			195		1.7			(62	)		(24.1	)

Total cost of revenue		4,002		31.2			3,075		26.9			(927	)		(23.2	)

Gross profit	$	8,821		68.8	%	$	8,363		73.1	%	$	(458	)		(5.2	)%

On* ~~May~~Denotes ~~14, 2004,~~% ~~the Court granted the Company’s motion to dismiss the case for lack~~ of ~~subject~~total ~~matter~~revenue ~~and personal jurisdiction and denied Paradyne’s motion~~ for ~~leave to amend its complaint and its motion for preliminary injunction. Paradyne did not appeal~~ the ~~decision~~period.

In** aDenotes ~~related~~% ~~matter,~~change ~~one~~from of2004 ~~the Company’s~~to ~~subsidiaries, Visual Networks Operations, Inc~~2005.~~, filed a lawsuit in United States District Court for the District of Maryland, Southern Division, against Paradyne Corporation. This lawsuit requests declaratory judgment that Visual~~ UpTime and Visual IP InSight do not infringe certain patents owned by Paradyne Corporation and alleges that Paradyne’s assertion of its patents against the Company is baseless and has been for the sole purpose of obtaining an unfair competitive advantage, and that Paradyne has infringed certain patents owned by the Company. Paradyne filed counterclaims alleging the Visual Networks, Inc. infringement of its patents, mirroring the Florida claims.

~~Despite~~ The ~~the~~table ~~Company’s~~below ~~belief~~sets ~~that~~forth ~~its~~the ~~products~~changes doin ~~not~~product ~~infringe upon Paradyne’s patents and that Paradyne’s claims are frivolous and without merit~~revenue, ~~the~~product ~~conduct~~cost of ~~the~~revenue ~~litigation is expensive~~ and ~~may divert the Company’s resources from other activities, which could have a material adverse effect on the~~product ~~Company’s~~gross ~~business and results of operations.~~ profit:

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


	Three Months Ended
	June 30,
	(unaudited, in thousands, except percentage data)
	2004		%*			2005		%*			Increase			%**
Product revenue:
Hardware	$	9,091		85.7	%	$	3,990		42.4	%	$	(5,101	)		(56.1	)%
Software		1,514		14.3			5,413		57.6			3,899			257.5

Total product revenue		10,605		100.0			9,403		100.0			(1,202	)		(11.3	)

Product cost of revenue		3,745		35.3			2,880		30.6			(865	)		(23.1	)

Product gross profit	$	6,860		64.7	%	$	6,523		69.4	%	$	(337	)		(4.9	)%

~~Litigation~~* ~~costs~~Denotes ~~are~~% ~~expensed~~of asproduct ~~incurred.~~revenue for the period.

~~Item~~** 2.Denotes ~~Management’s~~% ~~Discussion~~change ~~and~~from ~~Analysis~~2004 ofto ~~Financial Condition and Results of Operations~~2005.

~~This Management’s Discussion and Analysis of Financial Condition and Results of Operations may contain forward-looking~~19 statements that involve risks and uncertainties. Under the section “Risk Factors”, we have described what we believe to be some of the major risks related to these forward-looking statements, as well as the general outlook for our business. Investors should review these risk factors and the rest of this Quarterly Report in combination with the more detailed description of our business in our 2003 Annual Report on Form 10-K for a more complete understanding of the risks associated with an investment in our common stock.

~~Overview~~ The table below sets forth the changes in service revenue, service cost of revenue and service gross profit:

We design, manufacture, sell, and support performance management platforms for communications networks. We have two product lines, UpTime and IP InSight.


	Three Months Ended
	June 30,
	(unaudited, in thousands, except percentage data)
											Increase
	2004		%*			2005		%*			(Decrease)			%**
Support and services	$	2,218		100.0	%		2,035		100.0			(183	)		(8.3	)

Support and services cost of revenue		257		11.6			195		9.6			(62	)		(24.1	)


Support and services gross profit	$	1,961		88.4	%	$	1,840		90.4	%	$	(121	)		(6.2	)%

~~These~~* ~~product~~Denotes ~~lines~~% ~~allow~~of ~~businesses~~support and ~~organizations (which we call enterprises), and their providers of network~~ services ~~(which~~revenue wefor ~~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~~period. ~~of service being provided is meeting those~~

16** Denotes % change from 2004 to 2005.

~~Table of Contents~~Revenue

~~standards~~ Software ~~agreed~~revenue ~~upon~~increased byfrom ~~the~~period ~~service~~to ~~provider~~period ~~and~~as ~~its~~we ~~enterprise~~have ~~customer.~~largely ~~These~~transitioned ~~platforms~~to ~~also~~Visual UpTime ~~help~~Select, ~~enterprises~~which tohas ~~understand~~unbundled ~~how their~~ software ~~applications~~ and ~~users~~hardware ~~are~~components. ~~using~~This ~~the~~trend ~~network,~~may ~~the~~be ~~performance~~particularly true ~~those~~throughout ~~applications~~2005 ~~and~~compared ~~users~~to ~~are experiencing~~2004, ~~and~~where ~~required network capacity. Our platforms constantly monitor~~ the ~~data~~full-year ~~traffic~~effect ~~traveling~~of ~~between~~Visual ~~service~~UpTime ~~providers’~~Select ~~and~~sales ~~enterprises’~~will ~~networks.~~be ~~Network~~reflected ~~operators~~in ~~using~~ our ~~platforms~~operating ~~can~~results. ~~quickly~~Revenue ~~identify~~related ~~and~~to ~~isolate~~Visual ~~network~~UpTime ~~problems~~software ~~without~~was ~~dispatching personnel to remote sites~~$0.4 million Byduring ~~learning~~the ~~how~~second ~~much~~quarter ~~traffic~~of is2004. ~~traveling~~No onrevenue ~~the~~related ~~service~~to ~~provider~~Visual ~~network~~UpTime ~~and~~software was ~~understanding~~recorded during the ~~characteristics~~second quarter of ~~that~~2005. ~~traffic,~~Revenue ~~network~~related ~~operators~~to ~~can~~Visual ~~efficiently~~UpTime ~~address~~Select ~~bandwidth~~software ~~capacity~~was $1.1 million and ~~response time issues~~$5.4 million ~~Although~~during ~~our~~the ~~products~~second doquarter ~~not currently perform any active control~~ of ~~networks~~2004 orand ~~applications~~2005, ~~they are categorized as “performance management” tools and we may refer to our products as those that “manage” networks~~respectively.

~~UpTime~~ Hardware ~~manages~~revenue decreased from period to period primarily due to the ~~performance~~transition offrom ~~application~~Uptime to ~~delivery~~UpTime onSelect. ~~private~~In ~~data~~addition, ~~networks~~hardware unit sales to AT&T and ~~consists~~Sprint were lower primarily due to changes in procurement practices and inventory investment possibly as a result of pending consolidation in the telecommunications industry. Revenue related to Visual UpTime® hardware was $7.8 million and $0.1 million during the second quarter of 2004 and 2005, respectively. Revenue related to Visual UpTime® Select™ hardware was $1.3 million ~~UpTime~~and is$3.9 million ~~our~~during ~~original~~the ~~flagship~~second quarter ~~product~~of ~~suite.~~2004 and 2005, respectively.

The average price of a Visual UpTime Select ~~was~~ASE ~~introduced~~is inlower ~~October~~than ~~2003~~the asaverage ~~the~~price ~~successor~~of toa Visual UpTime ASE. This is due to Visual UpTime Select’s ~~offers~~unbundled asoftware ~~flexible,~~and ~~software-based~~hardware ~~solution~~components. ~~that~~When ~~enterprise~~viewed ~~customers~~on a comparable basis, ~~service~~the ~~providers~~effective ~~and~~average ~~systems~~price ~~integrators~~(software ~~can~~plus ~~cost-effectively~~separately ~~implement~~purchased hardware) ~~and~~of ~~incrementally~~a ~~enhance~~Visual inUpTime ~~step~~Select ~~with~~ASE approximated the ~~unique~~effective ~~and~~average ~~changing~~price ~~needs~~ of ~~their~~a ~~dynamic~~Visual ~~IT environments~~UpTime ASE. We ~~recorded~~are ~~initial~~unable to predict how future Visual UpTime Select ~~revenue~~pricing inwill compare with historical ~~the~~Visual ~~three~~UpTime ~~months~~pricing ~~ended~~on ~~June~~a ~~30,~~comparable ~~2004~~basis.

~~Visual~~ We IPexpect ~~InSight®~~that ishardware arevenue ~~software-based~~will ~~service~~decrease ~~performance~~as ~~management platform~~a ~~for~~percentage ~~public~~of IPrevenue ~~networks.~~compared ~~It enables service providers and enterprises~~ to ~~manage~~2004 IPas we ~~connectivity~~have ~~and~~largely ~~accessibility~~transitioned to IPVisual ~~network~~UpTime ~~services~~Select, ~~from~~which ~~the~~has ~~end-user’s~~unbundled ~~perspective.~~hardware Itand ~~helps manage IP connectivity independent of IP access~~software ~~technologies~~components.

We Support ~~market~~and ~~our~~services ~~products~~revenue todecreased ~~enterprises,~~from ~~service providers,~~period ~~and~~to ~~systems~~period ~~integrators.~~due ~~Network~~to ~~performance~~decreased isVisual ~~critical~~IP Insight tomaintenance ~~enterprises~~revenue ~~because~~of ~~networks~~$0.4 million, ~~enable~~down ~~applications~~from ~~that~~$0.7 million ~~are~~during ~~vital~~the tosecond anquarter ~~enterprise’s~~of 2004 ~~operations~~to $0.3 million ~~Enterprises~~during ~~require~~the ~~tools~~second toquarter ~~ensure~~of ~~the~~2005, ~~availability~~due ofto ~~their~~technical ~~networks~~support ~~and~~contracts ~~the~~which ~~applications~~were ~~those~~not ~~networks~~renewed. ~~support,~~Visual toUpTime ~~predict~~ and ~~validate~~Visual ~~network~~UpTime ~~performance,~~Select services were $1.5 million and to$1.7 million ~~optimize~~during the ~~price/performance~~second ~~ratio~~quarter of ~~their~~2004 ~~networks.~~and 2005, respectively.

~~Service~~ We ~~providers~~expect ~~and systems integrators use our products to create services~~ that ~~are~~support ~~differentiated from their competitors~~ and ~~to reduce their operating and other costs associated with initiating and providing~~ services ~~for~~revenue ~~their~~will ~~customers.~~follow ~~Our~~the ~~major~~same ~~service~~trend ~~provider~~as ~~customers~~product ~~include,~~revenue ~~among~~in the ~~others: AT&T, MCI, SBC, Sprint and Verizon~~future.

WeGross ~~incurred net losses in 2003 through the six months ended June 30, 2004. Our 2003 revenue was adversely affected by a~~profit continued slowdown in the global economy and depressed end-user information technology spending. These factors contributed to significant competitive pressure on the average selling price of our products, tighter service provider inventory control and the loss of business to competitors.

In Gross ~~line~~profit ~~with the general economic recovery~~ and ~~the~~Gross ~~increased~~profit ~~end-user~~on ~~information~~products ~~technology~~as ~~spending~~a bypercentage ~~enterprises~~of inrevenue ~~2004,~~increased wefrom ~~have~~period ~~recorded~~to period ~~sequential~~as ~~quarterly~~sales ~~revenue~~of ~~improvement~~high ~~since~~margin ~~the~~software ~~three~~increased ~~months~~as ~~ended~~we ~~September~~have ~~30,~~largely ~~2003.~~transitioned ~~Despite~~to ~~this~~Visual ~~sequential~~UpTime ~~improvement~~Select, ~~there~~which ~~can~~has beunbundled nohardware ~~assurance that there will be continued revenue growth~~ and~~/or~~ asoftware ~~return to profitability~~components.

17 20

~~Table~~Operating ~~of Contents~~expenses

~~Results~~ The oftable ~~Operations~~below sets forth the changes in operating expenses:

The primary statements of operations components are:


	Three Months Ended
	June 30,
	(unaudited, in thousands, except percentage data)
											Increase
	2004		%*			2005		%*			(Decrease)			%**
Operating expenses:
Research and development	$	2,391		18.7	%	$	2,198		19.2	%	$	(193	)		(8.1	)%
Sales and marketing		3,968		30.9			4,298		37.5			330			8.3
General and administrative		2,278		17.8			1,528		13.4			(750	)		(32.9	)
Restructuring		—		—			716		6.3			716			100.0

Total operating expenses	$	8,637		67.4	%	$	8,740		76.4	%	$	103			1.2	%

~~Revenue.~~* ~~Our~~Denotes ~~revenue~~% ~~consists~~ of ~~three~~total ~~types: hardware, software, and support and services. The sale of licenses is classified as software~~ revenue. ~~The~~for ~~sale of~~ the ~~hardware component of the Visual UpTime and Visual UpTime Select platforms, the analysis service element (“ASE”), is classified as hardware~~period. ~~UpTime sales are primarily hardware. In contrast, UpTime~~ Select sales have unbundled hardware and software components and such sales are reflected under hardware and/or software as appropriate. Sales of IP InSight are primarily classified as software. Sales of discontinued products are software ~~revenue.~~** ~~Sales~~Denotes of% ~~technical~~change ~~support,~~from ~~professional~~2004 ~~services~~to ~~and training for all of our products are classified as support and services revenue~~2005.

~~Cost~~ Research ofand ~~revenue~~development and ~~gross~~general ~~profit.~~and ~~Cost~~administrative ofexpense ~~revenue~~decreased ~~consists~~from ofperiod ~~contract~~to period ~~manufacturing~~primarily ~~costs,~~due ~~component~~to ~~parts,~~reduced ~~warehouse~~employee ~~costs, direct~~ compensation ~~costs~~, ~~warranty,~~including ~~other~~salaries ~~contractual~~and ~~obligations,~~fringe ~~royalties~~benefits, ~~license~~as ~~fees~~a result ~~and other overhead expenses related to the manufacturing operations. Product cost~~ of ~~revenue includes both hardware and software cost of revenue in~~ the ~~accompanying consolidated~~workforce ~~statements~~reduction ofthat ~~operations.~~occurred ~~Cost~~on ~~of revenue related to software sales has not been significant. Support and services cost of revenue includes outsourced benchmark services~~April 6, ~~professional services and technical support costs~~2005.

~~Operating~~ Sales ~~expenses~~and marketing expense increased from period to period primarily due to increased professional services costs associated with international certification of our product suite. The workforce reduction that occurred on April 6, 2005 did not have a material impact on sales and marketing expense.

~~Research~~Other ~~and development expense. Research and development expense~~items ~~consists primarily of research and development staff compensation, depreciation of test and development equipment, outsourced software development costs and costs of prototype materials.~~

~~Sales~~ The ~~and~~table ~~marketing~~below ~~expense.~~sets ~~Sales~~forth ~~and~~the ~~marketing~~changes ~~expense~~in ~~consists of sales and marketing staff compensation, commissions, pre-sales support, travel and entertainment, trade shows and~~ other ~~marketing programs.~~ items:

General and administrative expense. General and administrative expense consists of the costs of executive management, finance, administration and other activities.


	Three Months Ended
	June 30,
	(unaudited, in thousands, except percentage data)
													Increase
	2004			%*			2005			%*			(Decrease)			%**
Other expense	$	(262	)		(2.0	)%	$	(547	)		(4.8	)%	$	285			108.8	%
Interest income		35			0.3			46			0.4			11			31.4
Interest expense		(371	)		(2.9	)		(291	)		(2.5	)		(80	)		(21.6	)

~~Three~~* ~~months~~Denotes ~~ended~~% ~~June~~of ~~30,~~total ~~2003~~revenue ~~compared~~for tothe ~~three~~period. ~~months ended June 30, 2004~~

~~The~~** ~~following~~Denotes ~~table presents~~% ~~revenue~~change byfrom ~~product~~2004 ~~line:~~to 2005.

	Three Months EndedJune 30, (unaudited, in thousands)
	2003		2004
UpTime
Visual UpTime	$	8,523	$	9,588
Visual UpTime Select		—		2,440
IP InSight		1,120		741
Continuing products		9,643		12,769
Discontinued products		23		—
Royalties		107		54
Total revenue	$	9,773	$	12,823

Other expense increased from period to period due to accelerated amortization of debt discount and debt issuance costs associated with the early repayment of $7.0 million of senior secured convertible debentures (“Debentures”) in 2005 compared with the early repayment of $1.5 million of Debentures in 2004.

18 Interest expense decreased from period to period due to reduced interest expense associated with the lower outstanding Debentures balance, which were $9.0 million and $2.0 million at June 30, 2004 and 2005, respectively.

~~Table of Contents~~21

~~The~~Six ~~following~~months ~~table~~ended ~~presents the hardware~~June 30, ~~software,~~2004 ~~and~~compared ~~support and services revenue attributable~~ to ~~customers~~ ~~that~~six ~~individually~~months ~~represented~~ended ~~more~~June 30, ~~than 10% of our total revenue for each period presented:~~ 2005

	Three Months EndedJune 30, (unaudited, in thousands)
	2003		2004
AT&T	$	3,274	$	3,056
Sprint		1,943		3,019
Interlink Communications Systems		933		*
MCI		982		2,925
All other customers (each individually less than 10%)		2,641		3,823
Total revenue	$	9,773	$	12,823

The following table presents revenue by product line:

* Less than 10%


	Six Months Ended
	June 30,
	2004		2005
	(unaudited, in thousands)
UpTime:
Visual UpTime	$	20,644	$	936
Visual UpTime Select		2,440		19,360
IP InSight		1,469		692

Continuing products		24,553		20,988

Royalties		111		14

Total revenue	$	24,664	$	21,002

~~Revenue,~~ The ~~cost~~following oftable ~~revenue~~presents the software, hardware, and ~~gross~~support ~~profit~~and services revenue attributable to customers that individually represented more than 10% of our total revenue for each period presented:

The table below sets forth the changes in total revenue, cost of revenue and gross profit:


	Six Months Ended
	June 30,
	2004		2005
	(unaudited, in thousands)
AT&T	$	4,246	$	5,777
SBC		5,119		*
Sprint		4,847		4,229
MCI		4,788		5,397
All other customers (each individually less than 10%)		7,664		5,599

Total revenue	$	26,664	$	21,002

	Three Months Ended June 30, (unaudited, in thousands, except percentage data)
	2003		%*		2004		%*		Increase (decrease)			%**
Revenue
Hardware	$	6,572	67.3	%	$	9,091	70.9	%	$	2,519		38.3	%
Software		732	7.5			1,514	11.8			782		106.8
Support and services		2,469	25.2			2,218	17.3			(251	)	(10.2	)
Total revenue		9,773	100.0			12,823	100.0			3,050		31.2
Cost of revenue
Product		2,306	23.6			3,745	29.2			1,439		62.4
Support and services		259	2.6			257	2.0			(2	)	(0.8	)
Total cost of revenue		2,565	26.2			4,002	31.2			1,437		56.0
Gross profit	$	7,208	73.8	%	$	8,821	68.8	%	$	1,613		22.4

* Denotes less than 10% of total revenue for the period.

*Revenue, ~~Denotes~~cost % of ~~total~~ revenue, ~~for~~and ~~the~~gross ~~period~~profit

** The ~~Denotes~~table %below ~~change~~sets ~~from~~forth ~~2003~~the tochanges ~~2004~~in total revenue, cost of revenue and gross profit:

The table below sets forth the changes in product revenue, product cost of revenue and product gross profit:


	Six Months Ended
	June 30,
	(unaudited, in thousands, except percentage data)
											Increase
	2004		%*			2005		%*			(Decrease)			%**
Revenue:
Hardware	$	18,621		75.5	%	$	8,498		40.5	%	$	(10,123	)		(54.4	)%
Software		1,666		6.8			8,542		40.6			6,876			412.7
Support and services		4,377		17.7			3,962		18.9			(415	)		(9.5	)

Total revenue		24,664		100.0			21,002		100.0			(3,662	)		(14.8	)

Cost of revenue:
Product		6,783		27.5			6,065		28.9			(718	)		(10.6	)
Support and services		542		2.2			409		1.9			(133	)		(24.5	)

Total cost of revenue		7,325		29.7			6,474		30.8			(851	)		(11.6	)

Gross profit	$	17,339		70.3	%	$	14,528		69.2	%	$	(2,811	)		(16.2	)%

	Three Months Ended June 30, (unaudited, in thousands, except percentage data)
	2003		%*		2004		%*		Increase (decrease)		%**
Product revenue
Hardware	$	6,572	90.0	%	$	9,091	85.7	%	$	2,519	38.3	%
Software		732	10.0			1,514	14.3			782	106.8
Total product revenue		7,304	100.0			10,605	100.0			3,301	45.2
Product cost		2,306	31.6			3,745	35.3			1,439	62.4
Product gross profit	$	4,998	68.4	%	$	6,860	64.7	%	$	1,862	37.3

* Denotes % of total revenue for the period.

** Denotes % ofchange ~~product~~from ~~revenue~~2004 ~~for~~to ~~the period~~2005.

** Denotes % change from 2003 to 200422

19 The table below sets forth the changes in product revenue, product cost of revenue and product gross profit:


	Six Months Ended
	June 30,
	(unaudited, in thousands, except percentage data)
	2004		%*			2005		%*			Increase			%**
Product revenue:
Hardware	$	18,621		91.8	%	$	8,498		49.9	%	$	(10,123	)		(54.4	)%
Software		1,666		8.2			8,542		50.1			6,876			412.7

Total product revenue		20,287		100.0			17,040		100.0			(3,247	)		(16.0	)

Product cost of revenue		6,783		33.4			6,065		35.6			(718	)		(10.6	)

Product gross profit	$	13,504		66.6	%	$	10,975		64.4	%	$	(2,529	)		(18.7	)%

~~The~~* ~~table~~Denotes ~~below~~% ~~sets~~of ~~forth~~product ~~the changes in service~~ revenue, ~~service~~for ~~cost~~the ~~of revenue and service gross~~period. ~~profit:~~

	Three Months Ended June 30, (unaudited, in thousands, except percentage data)
	2003		%*		2004		%*		Increase (decrease)			%**
Support and services revenue	$	2,469	100.0	%	$	2,218	100.0	%	$	(251	)	(10.2	)%
Support and services cost of revenue		259	10.5			257	11.6			(2	)	(0.8	)
Support and services gross profit	$	2,210	89.5	%	$	1,961	88.4	%	$	(249	)	(11.3	)

** Denotes % change from 2004 to 2005.

* The ~~Denotes~~table %below ofsets ~~support~~forth ~~and~~the ~~services~~changes in service revenue, ~~for~~service ~~the~~cost ~~period~~of revenue and service gross profit:

** Denotes % change from 2003 to 2004


	Six Months Ended
	June 30,
	(unaudited, in thousands, except percentage data)
											Increase
	2004		%*			2005		%*			(Decrease)			%**
Support and services	$	4,377		100.0	%		3,962		100.0			(415	)		(9.5	)

Support and services cost of revenue		542		12.4			409		10.3			(133	)		(24.5	)


Support and services gross profit	$	3,835		87.6	%	$	3,553		89.7	%	$	(282	)		(7.4	)%

~~Revenue~~* Denotes % of support and services revenue for the period.

•** ~~Hardware~~Denotes ~~revenue~~% ~~increased~~change from ~~period~~2004 to ~~period due to higher UpTime and UpTime Select hardware sales to MCI, Sprint and other customers who placed higher orders in 2004~~2005.

~~• Software revenue increased from period to period primarily due to UpTime Select software sales which began in 2004.~~Revenue

• Software ~~Support and services~~ revenue ~~decreased~~increased from period to period ~~due~~as we have largely transitioned to ~~lower~~Visual UpTime ~~technical~~Select, ~~support~~which has unbundled software and hardware components. This trend may be particularly true throughout 2005 compared to 2004, where the full-year effect of Visual UpTime Select sales will be reflected in our operating results. Revenue related to Visual UpTime software was $0.5 million during the six months ended June 30, 2004. No revenue ~~from~~related ~~customers~~to ~~offering~~Visual ~~managed~~UpTime ~~services~~software was recorded during the six months ended June 30, 2005. Revenue related to Visual UpTime Select software was $1.1 million and $8.4 million during the six months ended June 30, 2004 and 2005, respectively.

~~Cost~~ Insignificant ofrevenue related to Visual IP Insight software was recorded during the six months ended June 30, 2004. Revenue related to Visual IP Insight software was $0.1 million during the six months ended June 30, 2005. Visual IP Insight revenue often fluctuates due to the timing of orders.

• Hardware ~~Product cost of~~ revenue ~~increased~~decreased from period to period inprimarily ~~conjunction~~due ~~with~~to ~~increased~~the transition from Uptime to UpTime Select. In addition, hardware unit sales to SBC and Sprint were lower primarily due to changes in procurement practices and inventory investment possibly as a result of ~~higher~~pending consolidation ~~cost~~in the telecommunications industry. Revenue related to Visual UpTime hardware ~~products~~was $17.3 million and $0.9 million during the six months ended June 30, 2004 and 2005, respectively. Revenue related to Visual UpTime Select hardware was $1.3 million and $7.6 million during the six months ended June 30, 2004 and 2005, respectively.

~~Gross profit~~ 23

• The ~~Gross~~average ~~profit~~price onof ~~products~~a asVisual aUpTime ~~percentage~~Select ofASE ~~revenue~~is ~~decreased~~lower ~~from~~than ~~period~~the toaverage ~~period~~price ~~primarily~~of a Visual UpTime ASE. This is due to aVisual ~~change~~UpTime inSelect’s ~~the~~unbundled ~~mix~~software ofand hardware ~~product sold~~components. ~~The~~When viewed ~~lower~~on ~~margin~~a ~~from~~comparable abasis, ~~less~~the ~~favorable~~effective average price (software plus separately purchased hardware) ~~product~~of ~~mix~~a ~~was~~Visual ~~partially~~UpTime ~~offset~~Select byASE approximated the ~~effect~~effective average price of ~~the~~a ~~greater~~Visual ~~relative~~UpTime ~~percentage~~ASE. ofWe ~~high~~are ~~margin~~unable ~~software~~to ~~sales~~predict how future Visual UpTime Select pricing will compare with historical Visual UpTime pricing on a comparable basis.

~~Operating~~ We ~~expenses~~expect that hardware revenue will decrease as a percentage of revenue compared to 2004 as we have largely transitioned to Visual UpTime Select, which has unbundled software and hardware components.

~~The~~ Support ~~table~~and ~~below~~services ~~sets~~revenue ~~forth~~decreased from period to period due to decreased Visual IP Insight maintenance revenue of $0.9 million, down from $1.4 million during the ~~changes~~six inmonths ~~operating~~ended June 30, ~~expenses:~~2004 to $0.6 million during the six months ended June 30, 2005, due to technical support contracts which were not renewed. Visual UpTime and Visual UpTime Select services were $2.9 million and $3.4 million during the six months ended June 30, 2004 and 2005, respectively.

	Three Months Ended June 30, (unaudited, in thousands, except percentage data)
	2003		%*		2004		%*		Increase (decrease)			%**
Operating expenses
Research and development	$	2,572	26.3	%	$	2,391	18.6	%	$	(181	)	(7.0	)%
Sales and marketing		3,437	35.2			3,968	31.0			531		15.5
General and administrative		1,512	15.5			2,278	17.8			766		50.7
Total operating expenses	$	7,521	77.0	%	$	8,637	67.4	%	$	1,116		14.8

We expect that support and services revenue will follow the same trend as product revenue in the future.

*Gross ~~Denotes % of total revenue for the period~~profit

** Gross ~~Denotes~~profit %and ~~change~~Gross profit on products as a percentage of revenue decreased from ~~2003~~period to period ~~2004~~as fixed overhead costs remained constant while revenue levels decreased.

20Operating expenses

~~Table~~ The oftable ~~Contents~~below sets forth the changes in operating expenses:

• Research and development expense decreased from period to period. A $0.3 million decrease in outside services and depreciation was offset by a $0.1 million increase in incentive compensation and fringe benefits.


	Six Months Ended
	June 30,
	(unaudited, in thousands, except percentage data)
											Increase
	2004		%*			2005		%*			(Decrease)			%**
Operating expenses:
Research and development		5,061		20.5	%		4,745		22.6	%	$	(316	)		(6.2	)%
Sales and marketing		7,772		31.5			7,965		37.9			193			2.5
General and administrative		4,452		18.1			3,900		18.6			(552	)		(12.4	)
Restructuring		—		—			716		3.4			716			100.0

Total operating expenses	$	17,285		70.1	%	$	17,326		82.5	%	$	41			0.2	%

•* ~~Sales~~Denotes ~~and~~% ~~marketing~~of ~~expense~~total ~~increased~~revenue ~~from~~for ~~period~~the to period ~~primarily due to sales incentive compensation which increased by $0~~.~~5 million due to the higher 2004 revenue level.~~

•** ~~General~~Denotes ~~and~~% ~~administrative~~change ~~expense increased~~ from ~~period~~2004 to ~~period primarily due to greater professional service expense relating to accounting and legal fees~~2005.

~~Other~~ Research ~~items~~and development and general and administrative expense decreased from period to period primarily due to reduced employee compensation, including salaries and fringe benefits, as a result of the workforce reduction that occurred on April 6, 2005.

Sales and marketing expense increased from period to period primarily due to increased professional services costs associated with international certification of our product suite. The workforce ~~table~~reduction ~~below~~that ~~sets~~occurred ~~forth~~on ~~the~~April 6, ~~changes~~2005 indid ~~other~~not ~~items:~~have a material impact on sales and marketing expense.

	Three Months Ended June 30, (unaudited, in thousands, except percentage data)
	2003			%*		2004			%*		Increase (decrease)			%**
Other expense	$	—		—	%	$	(262	)	(2.0	)%	$	(262	)	—	%
Interest income		28		0.3			35		0.3			7		25.0
Interest expense		(392	)	(4.0	)		(371	)	(2.9	)		21		5.4

*Other ~~Denotes % of total revenue for the period~~items

** The ~~Denotes~~table %below ~~change~~sets ~~from~~forth ~~2003~~the tochanges ~~2004~~in other items:

• Other expense in 2004 reflects the accelerated amortization of debt discount and debt issuance costs associated with the $1.5 million Debenture repayment.


	Six Months Ended
	June 30,
	(unaudited, in thousands, except percentage data)
													Increase
	2004			%*			2005			%*			(Decrease)			%**
Other expense	$	(262	)		(1.1	)%	$	(547	)		(2.6	)%	$	285			108.8	%
Interest income		62			0.3			101			0.5			39			62.9
Interest expense		(758	)		(3.1	)		(620	)		(3.0	)		(138	)		(18.2	)

~~Six~~* ~~months~~Denotes ~~ended~~% ~~June~~of ~~30,~~total ~~2003~~revenue ~~compared~~for tothe ~~six months~~period. ~~ended June 30, 2004~~

~~The~~** ~~following~~Denotes ~~table~~% ~~presents revenue~~change byfrom ~~product~~2004 ~~line:~~to 2005.

	Six Months EndedJune 30, (unaudited, in thousands)
	2003		2004
UpTime
Visual UpTime	$	16,750	$	20,644
Visual UpTime Select		—		2,440
Visual IP InSight		1,981		1,469
Continuing products		18,731		24,553
Discontinued products		57		—
Royalties		189		111
Total revenue	$	18,977	$	24,664

Other expense increased from period to period due to accelerated amortization of debt discount and debt issuance costs associated with the early repayment of $7.0 million of Debentures during the six months ended June 30, 2005 compared with the early repayment of $1.5 million of Debentures during the six months ended June 30, 2004.

21 Interest expense decreased from period to period due to reduced interest expense associated with the lower outstanding Debentures balance, which were $9.0 million and $2.0 million at June 30, 2004 and 2005, respectively.

~~Table~~Liquidity ofand ~~Contents~~Capital Resources

~~The~~ We ~~following~~require ~~table~~substantial ~~presents~~working ~~the~~capital ~~hardware~~to fund our business, ~~software~~particularly to finance inventories, accounts receivable, research and ~~support~~development activities, operating expenses and capital ~~services~~expenditures. Through June 30, 2005, we have financed our operations and capital expenditures primarily with the proceeds from our initial public offering (completed in February 1998), cash provided by operating activities, bank borrowings, and the proceeds from the issuance of the Debentures. Our future capital requirements will depend on many factors, including the rate of future revenue ~~attributable~~growth, toif any, and the acceptance of our Visual UpTime Select product suite by our customers. If cash provided by currently available sources is not sufficient, we will be required to further reduce our expenditures for operations and/or to seek additional capital through other means that ~~individually~~may ~~represented~~include ~~more~~additional ~~than~~borrowings ~~10%~~and/or the sale of equity securities or the sale of assets. There can be no assurance that additional capital will be available, or available on terms that are reasonable or acceptable to us, and our ~~total~~business and financial condition may be materially and adversely affected. Based on our cash balance and our revenue and expense expectations, we believe that we will have sufficient cash to operate for ~~each~~at ~~period~~least ~~presented:~~the next twelve months.

	Six Months EndedJune 30, (unaudited, in thousands)
	2003		2004
AT&T	$	6,565	$	4,246
SBC		*		5,119
Sprint		4,023		4,847
Interlink Communications Systems		1,974		*
MCI		*		4,788
All other customers (each individually less than 10%)		6,415		7,664
Total revenue	$	18,977	$	26,664

On April 6, 2005, we announced a plan to realign our cost structure with an adjusted business model which reflects the changes within our distribution channels and the anticipated future revenue stream. The reorganization included a workforce reduction of approximately 25 employees throughout the Company. In connection with this plan, we recorded a restructuring charge of $716,000 during the three months ended June 30, 2005. The charge consisted primarily of employee termination costs, including severance and other benefits.

* At ~~Less~~June 30, ~~than~~2005, ~~10%~~our principal source of liquidity was our existing balance of cash and cash equivalents of $4.3 million.

~~Revenue~~ Our operating activities consumed $5.1 million in cash and cash equivalents for the six months ended June 30, ~~cost~~2005. The primary use of ~~revenue~~cash affecting operating activities was the $3.9 million net loss. Accounts payable and accrued expenses decreased $2.3 million primarily due to payments made during the six months ended June 30, 2005 for bonus and ~~gross~~commissions ~~profit~~earned in 2004 as well as other payments for operations.

Our financing activities consumed $1.7 million in cash and cash equivalents for the six months ended June 30, 2005. The ~~table~~primary ~~below~~use ~~sets~~of ~~forth~~cash affecting financing activities was the ~~changes~~$7.0 million repayment inof ~~total~~Debentures. ~~revenue,~~This ~~cost~~was offset by proceeds of ~~revenue~~$4.0 million from the line of credit agreement entered into with SVB (the “June 2005 Facility”) to provide additional capital for the repayment of Debentures. We received $1.3 million for the exercise of stock options and ~~gross~~issuance ~~profit:~~of common stock under the employee stock purchase plan.

	Six Months Ended June 30, (unaudited, in thousands, except percentage data)
	2003		%*		2004		%*		Increase(decrease)			%**
Revenue
Hardware	$	13,146	69.3	%	$	18,621	75.5	%	$	5,475		41.6	%
Software		1,028	5.4			1,666	6.8			638		62.1
Support and services		4,803	25.3			4,377	17.7			(426	)	(8.9	)
Total revenue		18,977	100.0			24,664	100.0			5,687		30.0
Cost of revenue
Product		4,284	22.6			6,783	27.5			2,499		58.3
Support and services		535	2.8			542	2.2			7		1.3
Total cost of revenue		4,819	25.4			7,325	29.7			2,506		52.0
Gross profit	$	14,158	74.6	%	$	17,339	70.3	%	$	3,181		22.5

* On ~~Denotes~~August 5, %2005, we entered into a definitive agreement under which we will issue $10 million in senior secured convertible notes (the “2005 Notes”). The 2005 Notes will be secured by a blanket lien against all of ~~total~~our ~~revenue~~assets and will be convertible at any time by the investors into our common stock at a conversion price of $1.45 per share, which, if fully converted, represents 6,896,552 shares of our common stock. The conversion price adjusts upon the occurrence of certain events including, among other things, our issuance of equity securities or securities convertible into our equity securities at a price less than the conversion price then in effect. We will have registration obligations with respect to the common stock issuable upon conversion. Shareholder approval will also be required for certain aspects of the ~~period~~transaction which we will seek following the closing of the sale.

** Under ~~Denotes~~the %terms ~~change~~of ~~from~~the ~~2003~~2005 Notes, a number of events could trigger the note holders’ right to ~~2004~~force early repayment of the outstanding principal plus accrued and unpaid interest owed under the 2005 Notes. Events constituting an event of default include:

~~The~~• ~~table~~default ~~below~~by ~~sets~~the ~~forth~~Company ~~the~~on ~~changes~~other indebtedness in ~~product~~an ~~revenue~~amount exceeding $100,000; ~~product~~• ~~cost~~a final, non-appealable judgment or judgments rendered against the Company exceeding $250,000 in aggregate; • failure to meet certain covenants as defined by the terms of ~~revenue~~the 2005 Notes; • bankruptcy of the Company; and ~~product~~• ~~gross~~certain ~~profit:~~other failures by the Company to perform obligations under the 2005 Notes and/or the related agreements.

	Six Months Ended June 30, (unaudited, in thousands, except percentage data)
	2003		%*		2004		%*		Increase(decrease)		%**
Product revenue
Hardware	$	13,146	92.7	%	$	18,621	91.8	%	$	5,475		41.6	%
Software		1,028	7.3			1,666	8.2			638		62.1
Total product revenue		14,174	100.0			20,287	100.0			6,113		43.1
Product cost		4,284	30.2			6,783	33.4			2,499		58.3
Product gross profit	$	9,890	69.8	%	$	13,504	66.6	%	$	3,614	$	36.5

The proceeds from the issuance of the 2005 Notes will be used to pay off in full (a) the outstanding $2.0 million of Debentures (see Note 3 of Notes to the Consolidated Financial Statements) and (b) the June 2005 Facility and terminate the June 2005 Facility (see Note 2 of Notes to the Consolidated Financial Statements). The remaining proceeds will be used for working capital and general corporate purposes. The 2005 Notes will mature on December 31, 2007. We will not have a prepayment right with respect to the 2005 Notes.

* In ~~Denotes~~connection %with the issuance of ~~product~~the ~~revenue~~2005 ~~for~~Notes, which will be convertible into equity at a lower price than the ~~period~~then-effective exercise price of the warrants issued in connection with the Debentures (the “2002 Warrants”) (see Note 3 of Notes to the Consolidated Financial Statements), the exercise price of the 2002 Warrants will be adjusted from $4.2755 per share to $3.8962 per share in accordance with the terms of the 2002 Warrants. The holders of the 2002 Warrants will also be entitled to an additional 80,691 warrants so that the total outstanding number of 2002 Warrants will be increased to 909,552. The 2002 Warrants expire on March 25, 2006.

** Future ~~Denotes~~minimum %payments, ~~change~~assuming ~~from~~no ~~2003~~additional toearly ~~2004~~Debenture repayments, at June 30, 2005 under the Debentures and non-cancelable operating leases are as follows (in thousands):


	Debentures			Operating Leases
2005		50			816
2006		2,023			1,132
2007		—			1,161
2008		—			1,170
Thereafter		—			1,181

Total minimum payments		2,073		$	5,460

Interest element of payments		(73	)

Present value of future minimum payments		2,000
Unamortized debt discount		(112	)

Total Debentures	$	1,888

~~Table~~ We have a subtenant occupying a portion of ~~Contents~~our office space under a sublease that expires in December 2005. This sublease runs co-terminus with our lease on that office space. Future minimum lease payments due from the sublessee are $0.1 million as of June 30, 2005.

~~The~~ We ~~table~~are ~~below~~involved ~~sets~~in ~~forth~~a ~~the~~lawsuit ~~changes~~ in ~~service~~which ~~revenue~~we are claiming that (i) our products do not infringe upon patents owned by a competitor, ~~service~~which ~~cost~~patents we are arguing are invalid and unenforceable, and (ii) the competitor has infringed upon certain patents owned by us. The competitor has filed counterclaims alleging our infringement of ~~revenue~~its patents and ~~service~~unenforceability ~~gross~~of two of our patents ~~profit:~~in the lawsuit.

	Six Months Ended June 30, (unaudited, in thousands, except percentage data)
	2003		%*		2004		%*		Increase(decrease)			%**
Support and services revenue	$	4,803	100.0	%	$	4,377	100.0	%	$	(426	)	(8.9	)%
Support and services cost of revenue		535	11.1			542	12.4			7		1.3
Support and services gross profit	$	4,268	88.9	%	$	3,835	87.6	%	$	(433	)	(10.1	)

Despite our belief that our products do not infringe upon the competitor’s patents and that the competitor’s claims are frivolous and without merit, the defense of these claims is expensive and may divert our resources from other activities, which could have a material adverse effect on our business and results of operations. At this point in the litigation, the likelihood of any outcome cannot be determined and the adverse effect, if any, cannot be estimated.

* We ~~Denotes~~have %commitments related to inventory purchased by certain suppliers on our behalf. If such inventory is not used within a specified period of ~~support~~time ~~and~~or ~~services~~we ~~revenue~~discontinue a product for which the suppliers ~~period~~have made purchases or we terminate a relationship with the supplier for which we have set minimum inventory requirements, we are required to purchase the excess inventory from the suppliers. Additionally, if we cancel a purchase order placed with a supplier, we may be subject to certain costs and fees. At June 30, 2005, anticipated demand exceeds the supply of inventory. As such, we do not have a liability recorded at June 30, 2005 for inventory purchase commitments.

** Denotes % change from 2003 to 200426

~~Revenue~~ We do not engage in any off-balance sheet financing arrangements. In particular, we do not have any so-called limited purpose entities, which include special purpose entities and structured finance entities.

•Critical ~~Hardware~~Accounting ~~revenue~~Policies ~~increased from period to period due to higher UpTime~~ and ~~UpTime Select hardware sales to SBC, MCI and Sprint. These increases were partially offset by decreased revenue from AT&T in 2004.~~Estimates

• The ~~Software~~preparation ~~revenue~~of ~~increased~~consolidated ~~from~~financial ~~period~~statements requires us to ~~period~~make ~~primarily~~estimates ~~due~~and judgments tothat ~~UpTime~~affect ~~Select~~the ~~software~~reported ~~sales~~amounts ~~which~~of ~~began~~assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. Those policies are described in our 2004 Annual Report on Form 10-K. On an ongoing basis, we re-evaluate our estimates, including those related to bad debts, inventory, investment, income taxes, warranty obligations, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Among other things, these estimates form the basis for judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We consider our critical accounting policies to be the following:

• Revenue Support and services revenue decreased from period to period due to both lower technical support revenue from customers offering managed services and decreased technical support revenue associated with IP Insight.Recognition

~~Cost~~ We recognize revenue from, the licensing of software, the sale of hardware and the provision of support and other services. Our revenue recognition policies follow the American Institute of Certified Public Accountants Statement of Position (“SOP”) No. 97-2, “Software Revenue Recognition” and SEC Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition,” which summarizes existing accounting literature and requires that four criteria be met prior to the recognition of revenue. Our accounting policies regarding revenue recognition comply with the following required criteria (see Note 1 of Notes to Consolidated Financial Statements): 1) persuasive evidence of an arrangement exists; 2) delivery has occurred; 3) the fee is fixed or determinable; and 4) collectibility is probable. The third and fourth criteria may require us to make significant judgments or estimates, including the determination of the fair value of the undelivered elements of a sale. Historically, the revenue reserves that we have established relating to estimated returns associated with customer acceptance rights and price protection credits have been adequate. We have not provided any concessions or written off any accounts receivable relating to extended payment term arrangements. If we were to use new multiple element arrangements in our future sales efforts, a determination of the objective evidence of the fair value of the undelivered elements will be necessary and an inability to provide objective evidence could impact our ability to recognize revenue.

• Reserve ~~Product~~for ~~cost~~Inventory ~~of revenue increased from period to period in conjunction with higher hardware sales.~~Obsolescence

~~Gross~~ Because ~~profit~~of the lead times required to obtain manufactured proprietary hardware, we must maintain sufficient quantities of inventory for all of our products to meet expected demand. If actual demand is lower than forecasted, we may not be able to dispose of our inventory at prices exceeding its cost. In addition, hardware model upgrades may result in excess quantities of obsolete models. It is our practice to write down the value of excess and obsolete inventory to the lower of cost or market value based on the number of items that we expect to sell within a one-year period. We review the adequacy of our inventory reserves based on current quantities of hardware in stock, historical sales trends, sales forecasts and certain customer demand and make appropriate inventory valuation adjustments. If future demand is lower than currently estimated, additional valuation adjustments to our inventory may be required. Historically, we have not been required to record significant inventory write-offs of amounts in excess of our reserves.

•Allowance ~~Gross~~for ~~profit~~Doubtful ~~on products as a percentage of revenue decreased from period to period due to a change in the mix of hardware product sold and the slightly lower relative percentage of high margin software sales.~~Accounts

~~Operating~~ We ~~expenses~~grant credit terms without collateral to our customers. The accounts receivable balance reflects an allowance to state the balance at its estimated net realizable value that is based on assessments of the collectibility of certain problem accounts and a review of historical write-off trends at the end of each reporting period. If future events occur that negatively impact our customers, additional accounts receivable write- downs may be required. As our sales expansion strategies include the identification of alternative North America sales channels and international sales opportunities, we expect that the allowance for doubtful accounts will increase in the future.

~~The table below sets forth the changes in operating~~27 ~~expenses:~~

	Six Months Ended June 30, (unaudited, in thousands, except percentage data)
	2003		%*		2004		%*		Increase(decrease)			%**
Operating expenses
Research and development	$	5,319	28.0	%	$	5,061	20.5	%	$	(258	)	(4.9	)%
Sales and marketing		6,880	36.2			7,772	31.5			892		13.0
General and administrative		2,460	13.0			4,452	18.1			1,992		81.0
Total operating expenses	$	14,659	77.2	%	$	17,285	70.1	%	$	2,626		17.9

Warranty

* We ~~Denotes~~provide %for the estimated cost of ~~total~~product warranties at the time revenue is recognized. We utilize extensive product quality programs and processes including the active monitoring and evaluation of the quality of our component suppliers and contract manufacturers. Our warranty obligation calculation is based on historical product failure rates and material usage and services delivery costs incurred in correcting a product failure. Should actual product failure rates, material usage, or service costs differ from our estimates, revisions to the estimated warranty liability would be required. Our standard warranty term of one year for Visual UpTime Select hardware has been reduced from our historical warranty terms. Our warranty obligation should decrease over time as the ~~period~~warranty terms for older hardware units expire. We account for and disclose our obligations for warranties in accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires the accounting for and disclosure of guarantees and clarifies the requirements of FASB No. 5, “Accounting for Contingencies.”

** Deferred ~~Denotes~~Tax %Valuation ~~change from 2003 to 2004~~Allowance

23 We calculate the deferred tax valuation allowance in accordance with the provisions of Statement of Financial Accounting Standard No. 109, “Accounting for Income Taxes” (“SFAS No. 109”) which requires an assessment of both positive and negative evidence when measuring the need for a valuation allowance. Recent evidence, such as operating results during recent years, is given more weight when assessing whether the level of future profitability needed to recognize the deferred assets will be achieved. Our cumulative loss in the last five years represents sufficient negative evidence to require a full valuation allowance under the provisions of SFAS No. 109. We intend to maintain a full valuation allowance until sufficient positive evidence exists to support the reversal of any portion of the allowance.

~~Table~~Risk ~~of Contents~~Factors

• Investing ~~Research~~in ~~and~~our ~~development~~securities ~~expense~~involves ~~decreased~~a ~~from~~high ~~period~~degree toof ~~period~~risk. asIn aaddition ~~$0.5~~to ~~million~~the ~~decrease~~other information contained in ~~outside~~this ~~services~~Quarterly ~~and~~Report ~~depreciation~~on ~~was~~Form ~~partially~~10-Q, ~~offset~~you byshould aconsider ~~$0.2~~the ~~million~~following factors ~~increase~~before investing in ~~incentive~~our ~~compensation and fringe benefits~~securities.

• We ~~Sales~~are ~~and~~highly ~~marketing~~dependent ~~expense~~on ~~increased from period to period as a $1.3 million increase in~~ sales ~~incentive compensation due~~ to ~~the~~telecommunications ~~higher~~service ~~2004 revenue level was partially offset by a $0~~providers.~~2 million decrease in travel and a $0.2 million decrease in payroll.~~

• Our ~~General~~primary sales and ~~administrative~~marketing ~~expense~~strategy ~~increased~~has ~~from~~predominantly ~~period~~revolved around sales to telecommunications ~~period~~service ~~primarily~~providers. ~~due~~We expect that a significant portion of future revenue will be attributable to sales of Visual UpTime Select to service providers. The loss of or substantial decrease in business from any one of our service provider customers, which together have historically provided a $1majority of our revenue, could result in a substantial loss of revenue that could have a material adverse effect on our business and results of operations.6 ~~increase~~Business combinations, such as the prospective MCI-Verizon and AT&T-SBC mergers, would represent significant reductions in ~~professional~~the number of our service ~~expense~~provider ~~relating~~channels. The impact that these combinations may have on our revenue is uncertain. Existing service provider customers are not easily replaced because of the relatively few participants in that market. High barriers to ~~accounting~~entry due to extraordinary capital requirements and ~~legal~~the ~~fees~~possibility that existing service providers may merge or fail may further reduce their numbers. Furthermore, the small number of network service providers means that the reduction, delay or cancellation of orders or a ~~$0.3~~delay ~~million~~in ~~increase~~shipment of our products to any one service provider customer could have a material adverse effect on our revenue in ~~incentive~~any ~~compensation,~~given quarter. ~~and~~Our anticipated dependence on sizable orders from a $0limited number of service provider customers will make the relationship between us and each service provider critically important to our business.1 ~~million~~Further, ~~increase~~because our agreements do not contain minimum purchase requirements, there can be no assurance of significant business with our service provider customers on an ongoing basis. With the introduction of Visual UpTime Select, we anticipate that we will see growth in ~~deferred~~revenue from ~~compensation~~our value added reseller channel, although there can be no assurance that such growth will occur.

~~Other items~~ 28

~~The~~ If ~~table~~cash ~~below~~provided ~~sets~~by ~~forth~~currently ~~the~~available ~~changes~~sources inis not sufficient, we will be required to further reduce our expenditures for operations and/or to seek additional capital through other means ~~items:~~which may not be available or available on terms that are reasonable or acceptable to us.

	Six Months Ended June 30, (unaudited, in thousands, except percentage data)
	2003			%*		2004			%*		Increase(decrease)			%**
Other income (expense)	$	452		2.4	%	$	(262	)	(1.1	)%	$	(714	)	(158.0	)%
Interest income		65		0.3			62		0.3			(3	)	(4.6	)
Interest expense		(785	)	(4.1	)		(758	)	(3.1	)		27		3.4

Our future capital requirements will depend on many factors, including the rate of future revenue growth, if any, and the acceptance of our Visual UpTime Select product suite by our customers. If cash provided by currently available sources is not sufficient, we will be required to further reduce our expenditures for operations and/or to seek additional capital through other means that may include additional borrowings and/or the sale of equity securities or the sale of assets. There can be no assurance that additional capital will be available or available on terms that are reasonable or acceptable to us, and our business and financial condition may be materially and adversely affected. Based on our cash balance and our revenue and expense expectations, we believe that we will have sufficient cash to operate for at least the next twelve months.

* The ~~Denotes~~ongoing %patent oflitigation ~~total~~between ~~revenue~~us ~~for~~and ~~the~~Paradyne, ~~period~~and any other potential intellectual property litigation, could have a significant detrimental effect on our business.

** Despite ~~Denotes~~our %belief ~~change~~that our products do not infringe upon Paradyne’s patents and that Paradyne’s claims are frivolous and without merit, the conduct of this litigation is expensive and may divert our resources from ~~2003~~other toproductive ~~2004~~activities, which could have a material adverse effect on our 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.

• Additionally, ~~Other~~if ~~income~~others (claim that our products infringe upon their intellectual property rights, whether the claims are valid or not, we may be forced to incur significant litigation expense), inpay ~~2003~~damages, ~~reflected~~delay product shipments, re-engineer our products or acquire licenses to the claimant’s ~~gain~~intellectual property. We may be unable to develop non-infringing technology or to obtain licenses on commercially reasonable terms. We expect that these claims may become more common as the ~~sale~~number of products in the network management industry increases and the functionality of these products further overlaps. If a ~~previously~~claimant ~~written-off~~is ~~investment~~successful in a lawsuit arising from such a claim, it could have a material adverse effect on our business. ~~2004~~Adverse ~~expense~~publicity ~~reflects~~related ~~accelerated~~to ~~amortization~~any intellectual property litigation also could harm (i) the sale of ~~debt~~our ~~discount~~products and ~~debt~~damage our ~~issuance~~competitive ~~costs~~position; ~~associated~~(ii) the ~~with~~market ~~the~~for ~~$1.5~~our ~~million~~common ~~Debenture~~stock; ~~repayment~~and (iii) our ability to obtain additional capital, lines of credit or other borrowings on terms acceptable to us.

~~Liquidity and Capital Resources~~ 29

At We ~~June~~rely ~~30, 2004,~~on ~~our~~outsourced ~~principal~~contract ~~source~~manufacturing ofservices ~~liquidity was our existing balance of cash~~ and ~~cash~~primarily ~~equivalents~~from ofa ~~$13.6~~new ~~million and our restricted short-term investments of $0~~single provider.~~5 million.~~

~~Our~~ We ~~operating~~have ~~activities~~outsourced ~~consumed~~the ~~$2.9~~manufacture ~~million~~of ~~and~~our ~~$1.7~~hardware ~~million~~components into ~~cash~~a ~~and~~single ~~cash~~contract manufacturer. ~~equivalents~~We ~~for~~derive ~~the~~a ~~six~~substantial ~~months~~portion ~~ended~~of ~~June 30,~~our ~~2003~~revenue ~~and~~from ~~2004,~~the ~~respectively~~sale of our hardware components. AThe ~~major~~contract ~~factor~~manufacturer ~~affecting~~could ~~operating~~decide ~~activities~~to intighten ~~2003~~or ~~was~~eliminate ~~the~~our ~~$2.6~~credit ~~million~~terms ~~decrease~~due into concerns ~~accounts~~about ~~payable~~our ~~and~~perceived ~~accrued~~financial ~~expenses~~condition, ~~reflecting~~suspend ~~the~~or ~~downward~~fail ~~trend~~to inship ~~operating~~products, ~~expenses~~and inincrease prices ~~the~~due ~~first~~to ~~half~~our offailure ~~2003.~~to meet volume expectations.

~~Major~~ On ~~factors~~March 25, ~~affecting~~2005, ~~operating~~we ~~activities~~received inwritten ~~2004~~notice ~~included~~from ~~the~~Celestica ~~$2.3~~Corporation (“Celestica”) that ~~million~~Celestica ~~increase~~has inexercised ~~accounts~~its ~~receivable~~right ~~and~~to terminate the $Agreement for Electronic Manufacturing Services dated March 1.3, ~~million~~2000, ~~decrease~~between inVisual ~~inventory~~Networks Operations, Inc. ~~The~~(“VNO”), ~~increase~~a inwholly-owned ~~accounts~~operating subsidiary ~~receivable~~and ~~was~~Celestica ~~due~~(the to“Services ~~increasing~~Agreement”). ~~revenue,~~The notice states that the ~~timing~~effective date of termination ~~billings~~of in the ~~three~~Services ~~months~~Agreement ~~ended~~will ~~June~~be 30October 17, ~~2004,~~2005. ~~and~~Pursuant ~~accelerated~~to ~~collections~~the atServices ~~the~~Agreement, ~~end~~Celestica has served as our primary manufacturer of ~~2003~~electronic products. ~~The~~Celestica ~~$1.3~~has ~~million~~indicated that ~~decrease~~it inwill manufacture electronic products for us pursuant to the Services Agreement through September 2005.

24 On June 6, 2005, VNO entered into a Professional Service Agreement (the “Agreement”) with Plexus Services Corp. (“Plexus”). Pursuant to the Agreement, Plexus will serve as our primary contract manufacturer and will be responsible for the manufacture of our hardware appliances from prototype development through high-volume production. The initial term of the Agreement is three years and the Agreement shall be automatically renewed for successive one year terms unless either party terminates. Beginning in September 2005, Plexus will manufacture substantially all of our hardware appliances.

~~Table~~ The change in contract manufacturers could result in substantial production delays which could require us to pay substantially higher prices in order to complete delivery of ~~Contents~~customers’ orders, having a material adverse effect on our revenue and gross profit. In addition, the quality of Plexus’s product is unknown. If the quality of Plexus’s product does not meet our requirement, we may be required to pay substantially higher prices in order to complete delivery of customers’ orders, having a material adverse effect on our revenue and gross profit. We could also experience an increase in inventory levels during the transition from Celestica which could negatively affect our liquidity.

~~inventory~~ We ~~reflected~~may ~~greater~~not ~~hardware~~be ~~demand~~able ~~from~~to ~~our~~obtain ~~customers~~critical ~~combined~~hardware ~~with longer subcontract manufacturer production lead times~~components.

Our ~~investing~~contract ~~activities~~manufacturer ~~provided~~purchases ~~cash~~a ~~and~~number ~~cash~~of ~~equivalents~~critical ofcomponents $0from vendors for which alternative sources are not currently available.1 ~~million~~Delays or interruptions in the supply of these ~~and~~components $0could result in delays or reductions in product shipments.6 ~~million~~The ~~for~~purchase of these components from outside suppliers on a sole source basis subjects us to risks, including the continued ~~six~~availability ~~months~~of ~~ended~~supplies, ~~June~~price 30increases and potential quality assurance problems. While alternative suppliers may be available, ~~2003~~these suppliers must be identified and ~~2004~~qualified. We cannot be certain that any such suppliers will meet our required qualifications or that alternative suppliers can be identified in a timely fashion, ~~respectively~~if at all. ~~Proceeds~~Our ~~from~~contract ~~certificate~~manufacturers may not be able to obtain sufficient quantities of ~~deposit~~these ~~liquidations~~components ~~were~~on $0the same or substantially the same terms.5 Consolidations involving suppliers could further reduce the number of component alternatives and $1affect the cost of such supplies.0 ~~million~~An increase in the ~~six~~cost ~~months~~of ~~ended~~such ~~June~~supplies ~~30,~~could ~~2003~~make ~~and~~our products ~~2004~~less competitive. Production delays, ~~respectively~~lower ~~(see~~margins ~~Note~~or 2less ofcompetitive ~~Notes~~product topricing ~~Consolidated~~could ~~Financial~~have ~~Statements).~~a material adverse effect on our business and results of operations.

~~Our~~ We ~~financing~~may ~~activities provided~~experience ~~cash~~difficulties ~~and cash equivalents of $0.2 million for the six months ended June 30, 2003 and used cash and cash equivalents of $1.0 million~~ in ~~the~~migrating ~~six~~customers ~~months ended June 30, 2004. Changes in cash related~~ to ~~2004~~Visual ~~activities~~UpTime ~~primarily relate to the repayment of $1~~Select.~~5 million in Debentures (see Note 3 of Notes to Consolidated Financial Statements).~~

~~Future~~ Visual ~~minimum~~UpTime ~~payments,~~Select ~~assuming~~is nobased ~~further~~on ~~early~~a ~~Debenture~~new ~~payments,~~licensing asmodel ofand ~~June~~includes ~~30,~~significant ~~2004~~new technological ~~under~~innovations. ~~the~~We ~~Debentures~~have sales and ~~non-cancelable~~technical ~~operating~~obstacles ~~leases~~to ~~are~~overcome asrelated to ~~follows~~upgrading ~~(unaudited~~Visual UpTime customers to Visual UpTime Select. These obstacles may delay new orders, slow product deployment or result in ~~thousands):~~other unforeseen challenges with otherwise negative impacts.

	Debentures			Operating Leases
2004	$	225		$	817
2005		450			1,604
2006		9,113			1,116
2007		—			1,144
2008		—			1,170
Thereafter		—			1,181
Total minimum payments		9,788		$	7,032
Interest element of payments		(788	)
Present value of future minimum payments		9,000
Unamortized debt discount		(1,171	)
Total Debentures	$	7,829

We Substantial ~~have~~dilution ato ~~subtenant occupying a portion of~~ our ~~office~~common ~~space~~stockholders ~~under~~could aresult ~~sublease~~if ~~that~~the ~~expires~~holders inof ~~December~~our financing ~~2004.~~instruments ~~Future~~convert ~~minimum lease payments due from~~ the ~~sublessee~~instruments ~~are~~into ~~approximately~~common $0stock.~~2 million as of June 30, 2004.~~

The ~~terms~~2005 ofNotes in the ~~Debentures~~amount ~~provide for a number~~ of ~~events~~$10.0 million ~~that~~will ~~could~~be ~~trigger the~~convertible ~~Debenture~~into ~~holders’~~shares ~~right~~of toour ~~force~~common stock ~~early~~(see ~~payment~~Note of5 ~~115%~~ of ~~the~~Notes ~~outstanding~~to ~~principal~~Consolidated ~~plus~~Financial ~~accrued and unpaid interest~~Statements). The ~~terms~~2005 ~~also~~Notes ~~included~~may ~~financial~~be ~~targets~~converted at ~~related~~any totime ~~our~~by ~~financial~~the ~~performance,~~investors ~~which~~into wecommon ~~did~~stock ~~not~~of ~~meet~~the ~~for~~Company ~~2003.~~at As a ~~result,~~ ~~the~~conversion ~~Debenture~~price ~~holders~~of ~~may~~$1.45 ~~require~~per share, ~~that we pay~~which, inif ~~whole~~fully orconverted, inrepresents ~~part~~6,896,552 atshares ~~any~~of ~~time~~the ~~and~~Company’s ~~from~~common ~~time~~stock. toThe conversion ~~time,~~price ~~the~~adjusts ~~outstanding~~upon ~~principal~~the ~~amount~~occurrence of ~~their~~certain ~~Debenture~~events ~~holdings~~including, ~~plus~~among ~~accrued~~other ~~interest.~~things, ~~Each~~the Company’s ~~early~~issuance ~~payment,~~of ifequity ~~any,~~securities ~~may~~or besecurities ~~made~~convertible ininto ~~cash~~equity ~~or common~~securities ~~stock,~~of the Company at ~~our~~a ~~option,~~price ~~provided~~less ~~certain~~than ~~conditions~~the ~~are~~conversion ~~satisfied,~~price ~~which~~then wein ~~currently satisfy~~effect. IfSubstantial wedilution ~~choose~~ to ~~issue~~ our common ~~stock~~stockholders tocould ~~pay~~result if the ~~debt,~~holders ~~our~~of ~~stockholders~~the ~~could~~2005 beNotes ~~subject~~convert tothe ~~significant~~notes ~~dilution.~~into common stock.

On In ~~May~~connection ~~11,~~with ~~2004,~~the weissuance ~~received~~of athe ~~definitive~~2005 Notes, ~~binding~~which ~~notice~~will ~~from~~be ~~two~~convertible ~~Debenture~~into equity at a ~~holders~~lower ~~requesting~~price than the ~~repayment~~then-effective inexercise ~~full~~price of anthe ~~aggregate~~2002 ofWarrants ~~$1.~~(see Note 5 ~~million~~of Notes to the Consolidated Financial Statements), the exercise price of ~~our~~the 2002 Warrants will be adjusted from $104.52755 ~~million~~per ~~outstanding~~share ~~Debentures~~to $3.8962 ~~Pursuant~~per toshare ~~this~~in ~~notice,~~accordance onwith ~~June~~their ~~11,~~terms. ~~2004,~~The weholders ~~paid~~of ~~$1.5~~the ~~million~~2002 Warrants inwill ~~cash~~also be entitled to ~~these~~an ~~two~~additional ~~Debenture~~80,691 ~~holders.~~number ~~Outstanding~~of ~~Debentures~~warrants ~~are~~so the total outstanding $9number of 2002 Warrants will be increased to 909,552.0 ~~million~~The at2002 ~~June~~Warrants 30expire on March 25, ~~2004~~2006.

~~Should~~ We wehave ~~receive~~an ~~any~~accumulated ~~further payment~~deficit requests, we intend to carefully evaluate and balance liquidity concerns with dilution considerations and make each determination on a case-by-case basis. If we choose to pay a Debenture holder with shares of ~~our common stock and the per share issuance price of the stock is less than~~ $3477.~~5163, the conversion price of any outstanding Debentures would be adjusted downward to the issuance price of such stock~~0 million.

25 Our net losses since 2000 have resulted in an accumulated deficit of $477.0 million at June 30, 2005. This accumulated deficit could affect our ability to raise equity financing, arrange bank financing or arrange credit from suppliers on reasonable or acceptable terms.

~~Table~~ We ofmay ~~Contents~~not be profitable in the future.

In Our ~~addition,~~ability ~~under~~to ~~the~~generate ~~terms~~operating ofincome in the ~~warrants~~future ~~held~~is bydependent ~~the~~on ~~Debenture~~our ~~holders~~success in growing revenue and managing operating expenses. Market conditions, ancompetitive ~~issuance~~pressures, ofand ~~shares~~other factors ~~below~~beyond ~~the~~our ~~exercise~~control, ~~price~~may ofadversely ~~the~~affect ~~warrants~~our ~~would~~ability ~~cause~~to adequately sustain revenue in the ~~exercise~~future. ~~price~~In particular, our ability to sustain revenue may be ~~adjusted~~negatively affected by our dependence on aour ~~weighted-average~~service ~~basis~~provider customers. ~~Based~~Pressure ~~upon~~on ~~our~~capital ~~current~~expenditures ~~revenue~~ and ~~expense~~the ~~expectations,~~decline weof ~~believe~~the telecommunications ~~that~~industry wemay ~~would~~delay ~~have~~the ~~sufficient~~roll-out ~~operating~~of ~~capital~~new ~~for~~services atbased ~~least~~on ~~the~~our ~~next~~products ~~twelve~~offered ~~months~~by our service provider customers. Any potential reduction in demand for value added services or products, which our products support, from the ~~event~~service weproviders’ ~~paid~~customers, directly impacts the purchase ~~remaining~~volume of our products and may impact our ability to sustain revenue. We may be required $9to further reduce operating expenses if future revenue projections fall short of expectations.0 ~~million~~Our operating inexpenses ~~Debentures~~include insubstantial ~~cash~~fixed components which cannot be reduced quickly. If anticipated revenue levels are below expectations, operating results are likely to be materially and adversely affected because we may not be able to reduce operating expenses on a timely basis.

~~The~~ Our ~~following~~current ~~table outlines~~stock ~~the~~compensation ~~number~~expense ofnegatively ~~shares~~impacts ~~into~~our ~~which~~earnings, ~~the~~and ~~Debentures~~when ~~would be convertible if~~ we ~~issue~~are required ~~additional~~to ~~equity~~report ~~(including~~the ~~for~~fair ~~payment~~value of ~~the~~employee ~~Debentures)~~stock atoptions ~~prices specified,~~ as ~~well~~an asexpense ~~the~~in ~~total~~conjunction ~~percent~~with ofa ~~the~~new accounting ~~outstanding~~standard, ~~shares~~our ofreported ~~the~~financial ~~Company~~performance ~~that~~will ~~such shares~~be ~~would~~adversely ~~represent upon conversion~~affected, ~~calculated~~which ~~using~~may ~~the~~cause our ~~number~~stock ofprice ~~shares~~to ~~outstanding as of August 9, 2004:~~ decline.

Decline	IssuancePrice		DebentureShares(1)	% of Company
No anti-dilution		—	2,559,509	7.1	%
25%	$	2.6372	3,412,679	9.3	%
50%	$	1.7582	5,119,018	13.3	%
75%	$	0.8791	10,238,036	23.5	%

Under our current accounting practice for stock options granted to employees, stock compensation expense is recorded to the extent the current market price of the underlying stock exceeds the exercise price on the date of grant. In December 2004, the Financial Accounting Standards Board issued SFAS No. 123R, “Share-Based Payment”. SFAS No. 123R establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. This statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123R requires that the fair value of such equity instruments be recognized as an expense in the historical financial statements as services are performed. Prior to SFAS No. 123R, only certain pro forma disclosures of fair value were required. In accordance with a recently-issued Securities and Exchange Commission rule, companies will be allowed to implement SFAS No. 123R as of the beginning of the first interim or annual period that begins after June 15, 2005. We currently expect to adopt SFAS No. 123R on January 1, 2006. The adoption of SFAS No. 123R is expected to have a material effect on our financial statements by depressing net income, possibly causing our stock price to decline.

~~(1)~~ Our ~~These~~long ~~numbers~~sales ~~and~~cycle, ~~percentages~~which ~~reflect~~has ~~our~~had ~~repayment~~a inmedian ~~cash~~length of ~~$1.5~~approximately ~~million~~five ofto ~~the~~six ~~Debentures~~months, requires inus ~~June~~to ~~2004~~expend significant resources on potential sales opportunities that may never be consummated.

~~The~~ Our ~~warrants~~sales cycles are ~~subject~~relatively tolong ~~weighted~~because ~~average~~large ~~anti~~enterprises, our target end-~~dilution~~user ~~protection~~market, frequently ~~which~~experience delays in making significant capital expenditures on complicated systems. For ~~would~~enterprise ~~decrease~~customers, ~~the~~our ~~exercise~~historical ~~price~~sales ~~and~~cycle ~~increase~~has ~~the~~a ~~number~~median of ~~shares~~approximately ~~issuable~~five ~~under~~to ~~the~~six ~~warrants~~months. This ~~These~~extended ~~changes~~cycle ~~would~~increases bethe ~~determined~~risk ~~once~~that a potential customer might lower its capital expenditures or change product functionality requirements during the ~~total~~sales ~~investment~~process. ~~amount~~Because we are required to commit substantial sales and ~~price~~marketing ~~per~~resources ~~share~~during ofthis extended time period without any ~~future~~assurance ~~equity~~of consummating ~~issuance~~an ~~were~~eventual ~~known.~~sale, we risk incurring significant expense without generating any associated revenue.

~~In order to provide us with additional capital resources in the event the~~31 Debentures are paid in full, we entered into a $6.0 million line of credit with Silicon Valley Bank (“SVB”). Borrowings under the line of credit would be available only for working capital purposes once the Debentures are fully paid (see Note 2 of Notes to Consolidated Financial Statements).

We Failure ~~are involved~~to inadapt ato ~~lawsuit~~rapid intechnological ~~which~~change we are litigating (i) our claims that a competitor’s products infringe patents held by us; (ii) claims by that competitor that our products infringe patents held by that competitor; and (iii) our claim that the competitor’s assertion of its patents against us is an unfair trade practice. Despite our belief that our claims are correct and that our position will ultimately be vindicated, the conduct of this litigation is expensive and may divert our resources from other activities, which could ~~have~~adversely aaffect ~~material adverse effect on~~ our ~~business~~ability ~~and~~to ~~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~~compete ~~be estimated~~effectively.

We The ~~have~~market ~~commitments~~for ~~related~~our toproducts ~~inventory purchased~~is characterized by ~~certain~~rapid ~~suppliers~~changes, onincluding ~~our~~continuing ~~behalf~~advances in technology, frequent new product introductions, changes in customer requirements and preferences and changes in industry standards. If ~~such~~we ~~inventory~~are isunable ~~not~~to ~~used~~develop ~~within~~and introduce new products and product enhancements in a ~~specified~~timely ~~period~~fashion ofthat ~~time~~accommodate orfuture changes, we ~~discontinue~~will alikely ~~product~~lose customers ~~for~~and business which ~~the~~could ~~suppliers~~ have ~~made~~a ~~purchases~~material oradverse weeffect ~~terminate~~on aour ~~relationship~~business, ~~with~~financial condition ~~the~~and ~~supplier~~results ~~for~~of ~~which~~operations. weThe ~~have set~~introduction ~~minimum~~of ~~inventory~~new ~~requirements~~technologies, weadvances ~~are~~in ~~required~~techniques for tonetwork ~~purchase~~services, the ~~excess~~integration ~~inventory~~of ~~from~~service ~~the~~level ~~suppliers.~~management ~~Additionally,~~functionality ifinto weother ~~cancel~~network hardware acomponents ~~purchase~~and ~~order~~improvements ~~placed~~to ~~with~~the ainfrastructure ~~supplier,~~of wethe ~~may~~Internet could render our products obsolete or unmarketable. There can be ~~subject~~no assurance that (i) there will continue to ~~certain~~be ~~costs~~a need ~~and~~for ~~fees.~~our Asproducts; of(ii) our ~~June~~existing ~~30,~~products ~~2004,~~will continue to compete successfully; (iii) our ~~anticipated~~future ~~demand~~product ~~exceeds~~offerings will keep pace with the ~~supply~~technological ofchanges ~~inventory.~~implemented Asby ~~such,~~our competitors; we(iv) our doproducts ~~not~~will ~~have~~satisfy aevolving ~~liability~~industry ~~recorded~~standards asor preferences of ~~June~~existing or ~~30,~~prospective ~~2004~~customers; ~~for~~or ~~inventory~~(v) we ~~purchase~~will ~~commitments.~~be successful in developing and marketing products for any future technology.

26 We face growing competition from several market segments that could make it difficult for us to acquire and retain customers.

~~Table~~ We face competition from several market segments whose functionality our products integrate. We expect competition in each of ~~Contents~~these market segments to intensify in the future. In addition, consolidation between competitors in various market segments (such as Concord-Computer Associates) could intensify competition. Our primary current competitors include, or in the future may include, the following: Adtran, Brix, Concord, Kentrox, Lucent Technologies, NetScout, Packeteer, and Paradyne. Our competitors vary in size and in the scope and breadth of the products and services that they offer. While we intend to compete by offering superior features, performance, reliability and flexibility at competitive prices and on the strength of our relationships with service providers, many of these competitors have greater financial, technical, marketing and other resources than us, and some have well-established relationships with our current and potential customers. As a result, these competitors may be able to respond to new or emerging technologies and changes in customer requirements more effectively than us, or devote greater resources than us to the development, promotion and sale of products. In addition, we believe that competitors from one or more of our market segments could partner with each other to offer products that supply functionality approaching that provided by Visual UpTime Select. Increased competition may result in price reductions, reduced profitability and loss of market share, any of which could have a material adverse effect on our business and results of operations.

We Errors ~~do not engage~~ in ~~any~~our ~~off-balance~~products ~~sheet~~or ~~financing~~services ~~arrangements.~~could Indiscourage ~~particular~~customers, wedamage doour ~~not~~reputation ~~have~~and ~~any~~delay ~~so-called~~product ~~limited~~development ~~purpose entities, which include special purpose entities~~ and ~~structured finance entities~~enhancement.

We Products ~~require substantial working capital to fund our business, particularly to finance inventories, accounts receivable, research~~ and ~~development activities,~~services ~~operating~~as ~~expenses~~complex ~~and~~as ~~capital~~those ~~expenditures.~~which ~~To date,~~ we ~~have~~offer ~~financed~~may ~~our~~contain ~~operations~~undetected ~~and~~errors ~~capital expenditures primarily with the proceeds from our initial public offering (completed in February 1998), cash provided by operating~~or ~~activities,~~failures ~~bank~~when ~~borrowings,~~first ~~and~~introduced ~~the~~or ~~proceeds~~as ~~from~~new ~~the~~versions ~~issuance~~are ~~of the Debentures~~released. ~~Our~~There ~~future~~can ~~capital~~be ~~requirements~~no ~~will~~assurance ~~depend on many factors~~that, despite ~~including~~testing ~~the~~by ~~timing~~us and ~~nature~~by ofcurrent ~~payment~~and onpotential ~~the Debentures~~customers, ~~the~~errors ~~rate~~will ofnot ~~future~~be ~~revenue~~found ~~growth,~~in ~~if any,~~new products and ~~the~~services ~~acceptance~~until ofcommercial ~~our~~shipments ~~new~~have ~~Visual UpTime Select product suite by our customers~~commenced. ~~Other~~Such ~~relevant~~errors ~~factors~~can ~~include gross profit and operating expense levels, including product research and development, sales and marketing and general and~~substantially ~~administrative~~delay ~~expenses.~~the Iftime ~~cash~~until ~~provided by currently available sources is not sufficient,~~ we ~~will~~are beable ~~required~~ to ~~further~~generate ~~reduce~~revenue ~~our~~from ~~expenditures~~new ~~for~~product ~~operations~~releases and~~/or~~ tocould ~~seek~~force ~~additional~~us to ~~capital~~divert ~~through other means that may include~~ additional ~~borrowings~~ ~~and/or~~development ~~the~~resources ~~sale~~to ofcorrect ~~equity securities or~~ the ~~sale of assets~~errors. ~~Furthermore,~~If ~~our~~such ~~access~~errors toare ~~the~~detected ~~SVB~~after shipments ~~line of credit may be limited if we~~ have anbeen ~~insufficient borrowing base or if we cannot meet the financial and other covenants required by the facility. Under those circumstances~~made, ~~there~~then ~~can~~our bereputation nomay ~~assurance that additional capital will~~ be ~~available~~damaged, ~~or available on terms that are reasonable or acceptable to us,~~ and ~~our~~we ~~business and financial condition~~ may beincur ~~materially~~substantial ~~and adversely~~costs ~~affected.~~covering warranty claims.

~~Critical~~ In ~~Accounting~~our ~~Policies~~research and ~~Estimates~~development spending plan, we plan for a certain level of engineering activity associated with “sustaining issues.” “Sustaining issues” include fixing problems in released products that were not identified in the development and testing cycle. During any period, if more sustaining issues arise than anticipated, we may have to divert resources away from scheduled product development and enhancement activities. A delay in product development and enhancement activities could have a material adverse effect on our future revenue and operating results.

~~The preparation of consolidated financial statements requires us to make~~32 estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. Those policies are described in our 2003 Annual Report on Form 10-K. On an ongoing basis, we re-evaluate our estimates, including those related to bad debts, inventory, investment, income taxes, warranty obligations, and contingencies and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Among other things, these estimates form the basis for judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. During the first six months of 2004, re-evaluation of certain estimates led to the effect described below.

~~Reserve~~ We ~~for~~have ~~Inventory~~anti-takeover ~~Obsolescence~~protections that may delay or prevent a change in control that could benefit our stockholders.

~~Because~~ Terms of ~~the lead times required to obtain manufactured product, we must maintain sufficient quantities of inventory for all of~~ our ~~products~~certificate ~~to meet expected demand. If actual demand is much lower than forecasted, we may not be able to dispose~~ of ~~our~~incorporation ~~inventory at or above its cost. We write down the value of estimated excess~~ and ~~obsolete~~bylaws ~~inventory~~make toit ~~the~~more ~~lower~~difficult offor ~~cost or market value. The~~another ~~estimates~~individual ~~are based on historical trends, forecasts and specific customer~~ or ~~transaction~~company ~~information. It is generally our policy~~ to ~~write~~acquire ~~down~~control ~~inventory based on the number~~ of ~~items~~our ~~that~~company, weeven doif ~~not expect to sell within~~ a ~~one~~change ~~year~~of ~~period.~~control Ifwould ~~future~~benefit ~~demand is lower than currently estimated, additional write-downs of~~ our ~~inventory may be required~~stockholders. ~~During~~These ~~the~~terms ~~first six months of 2004, we recorded a charge of $0.4 million related to excess and obsolete inventory.~~ include:

27• our board of directors, without stockholder approval, may issue up to 5,000,000 shares of preferred stock on terms that they determine, including terms that delay or prevent the change in control of our company, make removal of management more difficult or depress the price of our stock; • certain provisions of our certificate of incorporation and bylaws and of Delaware law could delay or make more difficult a merger, tender offer or proxy contest; • we are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law which prohibits a publicly held Delaware corporation from engaging in a “business combination” with an “interested stockholder” for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner; • our board of directors is “staggered” so that only a portion of its members are elected each year; • only our board of directors, our chairman of the board, our president, or stockholders holding a majority of our stock can call special stockholder meetings; and • special procedures must be followed in order for stockholders to present proposals at stockholder meetings.

~~Table~~Item 3. ofQualitative ~~Contents~~and Quantitative Disclosures About Market Risk

~~Risk~~ On ~~Factors~~August 5, 2005, we entered into an agreement to issue debt in the form of the senior secured convertible notes discussed in Note 5 of Notes to Consolidated Financial Statements. The notes will bear interest at a fixed annual rate of 5% and we will not have a right to prepay the notes prior to their maturity. Our investment policy restricts us to investing only in investment-grade securities, and we may be exposed to market risk from interest rate changes. A failure of these investment securities to perform at their historical levels could reduce the interest income realized by us.

~~Investing~~ While insubstantially ~~our~~all ~~securities~~of ~~involves~~our aproduct ~~high~~sales ~~degree~~to ofdate ~~risk.~~have Inbeen ~~addition~~made to customers in the ~~other~~United States, ~~information~~we ~~contained~~plan to sell our products to international customers at prices denominated in ~~this~~United States ~~quarterly~~dollars. ~~report~~However, ~~including~~if ~~the~~we ~~reports~~commence selling material volumes of product to such customers at weprices ~~incorporate~~not bydenominated ~~reference~~in United States dollars, ~~you~~we ~~should~~intend ~~consider~~to ~~the~~adopt ~~following~~a ~~factors~~strategy ~~before~~to ~~investing~~hedge against fluctuations in ~~our~~foreign ~~securities~~currency.

~~Our~~Item 4. ~~Debenture~~Controls ~~holders now have the right to demand payment of any or all of our Debentures at any time~~ and ~~from time to time.~~ Procedures

~~Because~~ Our wemanagement, ~~did~~including ~~not~~our ~~meet~~principal ~~the~~executive ~~financial~~and ~~targets~~principal ~~for~~financial ~~2003 under our Debentures~~officers, ~~the Debenture holders may require that we pay~~has ~~any~~evaluated ~~or all of~~ the ~~outstanding~~effectiveness ~~principal amount~~ of ~~their~~our ~~Debentures~~disclosure ~~plus~~controls ~~accrued interest at any time~~ and ~~from~~procedures ~~time~~as ~~to time. The choice~~ of ~~whether~~June 30, to2005. ~~pay~~Our disclosure ~~all~~controls ~~common~~and ~~stock~~procedures orare ~~all~~designed ~~cash~~to isprovide inreasonable ~~our~~assurance ~~absolute~~that ~~discretion~~the information ~~provided~~required weto ~~meet~~be ~~certain~~disclosed ~~criteria specified~~ in ~~the~~this ~~Debentures,~~Quarterly ~~which~~Report weon ~~currently~~Form ~~meet.~~10-Q Ifhas webeen ~~choose~~appropriately recorded, ~~to pay any such demand with common stock~~processed, summarized and ~~the~~reported. ~~issue~~Based ~~price~~on ofthat ~~such shares is below the then-current conversion price of the Debentures~~evaluation, ~~the~~our ~~conversion~~principal ~~price~~executive ofand principal ~~the~~financial ~~Debentures~~officers ~~is immediately~~have ~~reset~~concluded tothat ~~such~~our ~~lower~~disclosure ~~price~~controls and ~~the~~procedures ~~exercise~~are effective ~~price~~at of the ~~warrants~~reasonable ~~and~~assurance ~~the number of shares issuable upon exercise would be adjusted on a weighted-average basis~~level.

If Our wemanagement, ~~choose~~including toour ~~pay~~principal ~~any~~executive ~~such~~and ~~demand~~principal ~~with~~financial ~~cash~~officers, ~~and~~has evaluated weany dochanges ~~not~~in ~~have~~our ~~sufficient~~internal ~~cash~~control toover ~~both~~financial ~~pay~~reporting ~~amounts~~that ~~and~~occurred toduring ~~fund ongoing~~the ~~operations~~quarterly period ended June 30, we2005, ~~may~~and behas ~~required~~concluded tothat ~~seek~~there ~~additional~~was ~~capital~~no ~~through~~change athat ~~sale~~occurred during ofthe ~~assets,~~quarterly ~~sale~~period ofended ~~additional~~June 30, ~~securities~~2005 orthat ~~through~~has ~~additional~~materially ~~borrowings~~affected, ~~none~~or ofis ~~which~~reasonably likely ~~may~~to bematerially ~~available~~affect, onour ~~terms~~internal ~~acceptable~~control toover financial usreporting.

~~The ongoing patent litigation between us and Paradyne, and any other potential~~33 ~~intellectual property litigation, could have a significant detrimental effect on our business.~~

~~Despite~~PART ~~our~~II ~~belief~~— ~~that~~OTHER ~~our products do not infringe Paradyne’s patents and that Paradyne’s claims are frivolous and without merit, the conduct~~INFORMATION of this litigation is expensive and may divert our resources from other productive activities, which could have a material adverse effect on our 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.

Additionally, if others claim that our products infringe on their intellectual property rights, whether the claims are valid or not, we may be forced to incur significant litigation expense, pay damages, delay product shipments, re-engineer our products or acquire licenses to the claimant’s intellectual propertyItem 1. WeLegal ~~may be unable to develop non-infringing technology or to obtain licenses on commercially reasonable terms. We expect that these claims may~~Proceedings become more common as the number of products in the network management industry increases and the functionality of these products further overlaps. If a claimant is successful in a lawsuit arising from such a claim, it could have a material adverse effect on our business. Adverse publicity related to any intellectual property litigation also could harm (i) the sale of our products and damage our competitive position; (ii) the market for our common stock; and (iii) our ability to obtain additional capital, lines of credit or other borrowings on terms acceptable to us.

28 In January 2004, the Company received notice that a lawsuit had been filed by Paradyne Networks, Inc. (“Paradyne Networks”) of Largo, Florida, in the United States District Court for the Middle District of Florida, Tampa Division (the “Florida Court”) against the Company, seeking damages and injunctive relief, for the Company’s alleged infringement of patents owned by Paradyne Corporation (“Paradyne”), a subsidiary of Paradyne Networks.

~~Table~~ On May 14, 2004, the Florida Court granted the Company’s motion to dismiss the case for lack of ~~Contents~~subject matter jurisdiction and denied Paradyne Networks’ motion for leave to amend its complaint and its motion for preliminary injunction. Paradyne Networks did not appeal the decision.

We In ~~may~~a ~~experience~~related ~~difficulties~~matter, one of the Company’s subsidiaries, Visual Networks Operations, Inc. (“VNO”), filed a lawsuit in ~~migrating~~United ~~its~~States ~~customers~~District toCourt for the ~~new~~District of Maryland, Southern Division (the “Maryland Court”), against Paradyne. This lawsuit requests declaratory judgment that Visual UpTime ~~Select~~and ~~product~~Visual ~~suite~~IP InSight do not infringe upon certain patents owned by Paradyne and that those patents are invalid and unenforceable and alleges that Paradyne’s assertion of its patents against the Company is baseless and has been for the sole purpose of obtaining an unfair competitive advantage, and that Paradyne has infringed upon certain patents owned by the Company. Paradyne filed counterclaims alleging that VNO infringes upon its patents, mirroring the Florida claims. On October 15, 2004, Paradyne filed amended counterclaims, adding allegations of willful patent infringement and unenforceability of two of the Company’s patents in the lawsuit. The Maryland lawsuit presently is in the expert discovery phase of the litigation. The Maryland Court conducted a hearing concerning patent claim construction on February 7, 2005 and issued an order on June 15, 2005. A trial date has not yet been scheduled.

~~Visual~~ Pursuant ~~UpTime~~to ~~Select~~the isterms ~~based~~of a confidential settlement agreement entered into on aMarch 11, ~~new~~2005 ~~licensing~~between ~~model~~Paradyne and ~~includes~~VNO, ~~significant~~Paradyne ~~new~~has ~~technological~~agreed ~~innovations.~~to Wedismiss ~~have~~its ~~sales~~patent ~~and~~claims ~~technical~~against ~~obstacles~~Visual toIP Insight. ~~overcome~~VNO ~~related~~has agreed to ~~upgrading~~dismiss its unfair competition claim against Paradyne with respect to Visual ~~UpTime~~IP ~~customers~~Insight and pay royalties to ~~Visual~~Paradyne ~~UpTime~~through ~~Select.~~the ~~These~~remaining ~~obstacles~~life ~~may~~of ~~delay~~Paradyne’s ~~new~~patents ~~orders,~~in the ~~slow~~amount of 1% of revenue recognized by the Company from the licensing and distribution of Visual ~~deployment~~IP Insight. On March 15, 2005, the Maryland Court approved a Stipulation of ~~our~~Partial ~~products~~Dismissal submitted by ~~our~~the ~~customers~~parties orconcerning ~~result~~the inpatent ~~other~~claims ~~unforeseen~~against ~~challenges~~Visual ~~with~~IP ~~otherwise~~InSight ~~negative~~and ~~impacts.~~the unfair competition claim against Paradyne.

We Despite ~~may~~the Company’s belief that its products do not beinfringe ~~able~~upon toParadyne’s ~~obtain~~patents ~~critical~~and that ~~hardware~~Paradyne’s ~~components~~claims are frivolous and without merit, the defense of these claims is expensive and may divert the Company’s resources from other activities, which could have a material adverse effect 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, if any, cannot be estimated.

~~Our~~ We ~~subcontract~~are ~~manufacturers~~periodically ~~purchase~~ a ~~number~~party ofto ~~critical~~disputes ~~components~~arising from ~~vendors~~normal ~~for~~business ~~which~~activities ~~alternative~~including various ~~sources~~employee-related ~~are not currently available~~matters. ~~Delays~~In ~~or interruptions in~~ the ~~supply~~opinion of ~~these~~our ~~components could result in delays or reductions in product shipments. The purchase of these components from outside suppliers on a sole source basis subjects us to risks~~management, ~~including~~resolution ~~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. We cannot be certain that any such suppliers~~ matters will ~~meet its required qualifications or that alternative suppliers can be identified in a timely fashion, if at all. Our 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 our products less competitive. Production delays, lower margins or less competitive product pricing could have a material adverse effect onupon our ~~business~~financial ~~and~~position ~~results~~or offuture ~~operations.~~operating results.

WeItem 2. ~~rely~~Unregistered onSales ~~two~~of ~~firms~~Equity ~~for~~Securities ~~subcontract~~and ~~manufacturing~~Use ~~services.~~of Proceeds

~~We have outsourced the manufacture of the ASE to two subcontract manufacturing firms~~ None. ~~We derive a substantial portion of our revenue from the sale of ASEs. A subcontract manufacturer could decide to reduce or~~ ~~eliminate the amount of credit extended to us or to stop the shipment of products due to concerns about our financial condition or credit and inventory risk.~~

~~If we are required to establish alternative subcontract manufacturers, there can be no assurances that we would be able to do so, or on acceptable terms~~Item 3. If weDefaults ~~were~~Upon ~~required~~Senior to replace its subcontract manufacturers, we could experience substantial production delays and be required to pay substantially higher prices in order to complete delivery of customers’ orders. Such a delay or priceSecurities ~~increase could have a material adverse effect on our revenue and gross profit.~~

~~Our access to the SVB line of credit may be limited~~ None.

Our access to the SVB line of credit may be limited if we have an insufficient borrowing base or if we cannot meet the financial and other covenants required by the facility. Under those circumstances, there can be no34 ~~assurance that additional capital will be available, or available on terms that are reasonable or acceptable to us, and our business and financial condition may be materially and adversely affected.~~

~~Substantial~~Item 4. ~~dilution~~Submission toof ~~our~~Matters ~~common stockholders could result if we are required~~ to ~~raise~~a ~~additional~~Vote ~~capital through the sale~~ of ~~equity~~Security ~~at less than $4.2755 per share.~~ Holders

~~Debentures~~We ~~outstanding~~held ofour ~~$9.0~~annual ~~million~~meeting ~~are~~of ~~convertible~~stockholders ~~into~~on 2June 1,~~559,509~~ ~~shares of our common stock at the rate of $3~~2005.~~5163~~ ~~per~~The ~~share~~following ~~and~~matters ~~the~~were ~~associated~~voted ~~warrants~~upon ~~are~~at ~~exercisable for 828,861 shares of~~ our ~~common~~annual ~~stock at~~ meeting:

29Proposal I. Three directors were elected to serve for a term of three years, and until their successors are elected and duly qualified, with 88% of the eligible voting shares voting as follows:


	For		Withheld
Edward L. Glotzbach		30,207,121		332,699
Edward H. Kennedy		30,159,183		380,637
Peter J. Minihane		28,731,735		1,808,085

aProposal ~~price of $4~~II.~~2755~~ ~~per share.~~ The ~~Debentures~~selection ~~contain~~of ~~“full~~Grant ~~ratchet”~~Thornton ~~anti-dilution~~LLP ~~price~~as ~~protection.~~our ~~This~~independent ~~means~~accountants ~~that~~for ifthe wefiscal ~~issue~~year ~~additional~~ending ~~shares of~~December ~~common~~31, ~~stock~~2005 inwas ~~connection~~ratified with a88% ~~financing~~of ~~or under other circumstances at a price lower than $3.5163 per share,~~ the ~~Debentures~~eligible ~~would~~voting ~~become convertible into a greater number of~~ shares ofvoting ~~common stock than they are today. Issuances of common stock that do not trigger this anti-dilution protection include: issuances~~ as part of an acquisition or strategic investment, issuances under our stock incentive plan or employee stock purchase plan, issuances or issuances as part of a public offering of more than $30.0 million. follows:

The warrants are subject to weighted average anti-dilution protection which would decrease the exercise price and increase the number of shares issuable under the warrants. These changes would be determined once the total investment amount and price per share of any future equity issuance were known.


For	Against	Abstain

30,334,619	177,644	27,557

WeItem 5. ~~have~~Other ~~an accumulated deficit of $474.8~~Information ~~million.~~

~~Our~~ On ~~operating~~August 5, ~~losses~~2005, ~~since~~the ~~2000~~Company ~~plus~~entered into a definitive agreement under which the Company ~~effects~~will ofissue ~~impairment~~$10 million ~~and~~in ~~restructuring~~senior ~~charges,~~secured ~~amortization~~convertible notes (the “2005 Notes”). The 2005 Notes will be secured by a blanket lien against all of ~~intangible~~the Company’s assets and ~~the~~will ~~write-off~~be ofconvertible ~~in-process~~at ~~research~~any ~~and~~time ~~development~~by ~~have~~the ~~resulted~~investors ininto common anstock ~~accumulated~~of ~~deficit~~the Company at a conversion price of $~~475~~1.745 ~~million~~per atshare, ~~June~~which, 30if fully converted, represents ~~2004~~6,896,552 shares of the Company’s common stock. ~~This~~The ~~accumulated~~conversion ~~deficit~~price ~~could~~adjusts upon the ~~affect~~occurrence ~~our~~of ~~ability~~certain toevents ~~raise~~including, ~~equity~~among ~~financing~~other things, ~~arrange~~the ~~bank~~Company’s ~~financing~~issuance of equity securities or ~~arrange~~securities ~~credit~~convertible ~~from~~into ~~suppliers~~equity onsecurities ~~reasonable~~of orthe ~~acceptable~~Company ~~terms~~at a price less than the conversion price then in effect. The Company will have registration obligations with respect to the common stock issuable upon conversion. Shareholder approval will be required for certain aspects of the transaction which the Company will seek following the closing of the sale.

We Under ~~may~~the ~~not~~terms beof ~~profitable~~the in2005 Notes, a number of events could trigger the ~~future~~note holders’ right to force early repayment of the outstanding principal plus accrued and unpaid interest owed under the 2005 Notes. Events constituting an event of default include:

~~Our~~• ~~ability~~default toby ~~generate operating income in~~ the ~~future~~Company ~~is dependent~~ on ~~our~~other ~~success~~indebtedness in ~~growing~~an ~~revenue~~amount ~~and~~exceeding ~~managing operating expenses. Market conditions~~$100, ~~competitive~~000; ~~pressures,~~• ~~and~~a ~~other factors beyond our control~~final, ~~may~~non-appealable ~~adversely~~judgment ~~affect~~or ~~our~~judgments ~~ability~~rendered toagainst ~~adequately sustain revenue in~~ the ~~future.~~Company Inexceeding ~~particular~~$250,000 ~~our~~in ~~ability~~aggregate; to• ~~sustain~~failure ~~revenue~~to ~~may~~meet becertain ~~negatively~~covenants ~~affected~~as defined by ~~our dependence on our service provider customers. Pressure on capital expenditures and~~ the ~~decline~~terms of the ~~telecommunications~~2005 ~~industry~~Notes; ~~may~~• ~~delay~~bankruptcy ~~the roll-out~~ of ~~new~~the ~~services~~Company; ~~based~~and on• ~~our~~certain ~~products~~other ~~offered~~failures by ~~our service provider customers. Any potential reduction in demand for value added services or products, which our products support, from~~ the ~~service~~Company ~~providers’ customers, directly impacts the purchase volume of our products and may impact our ability~~ to ~~sustain~~perform ~~revenue.~~obligations Weunder ~~believe that we have reduced operating expenses to a sufficient level such that when combined with our anticipated revenue, we will become profitable in~~ the ~~second~~2005 ~~half~~Notes of 2004. In the event that our projections are not correct, we may be required to further reduce our cost structure. Because our operating expenses include substantial fixed costs which cannot be reduced quickly, if revenue levels are below expectations, operating results are likely to be materially and/or ~~adversely affected because we may not be able to reduce operating expenses in sufficient time to compensate for~~ the ~~reduction~~related ~~in revenue~~agreements.

We The ~~are~~proceeds ~~highly~~from ~~dependent~~the onissuance ~~sales~~of the 2005 Notes will be used to ~~telecommunications~~pay ~~service~~off ~~providers~~in full (a) the outstanding $2.0 million of Debentures (see Note 3 of Notes to the Consolidated Financial Statements) and (b) the outstanding amounts under the June 2005 Facility and terminate the June 2005 Facility (see Note 2 of Notes to the Consolidated Financial Statements). The remaining proceeds will be used for working capital and general corporate purposes. The 2005 Notes will mature on December 31, 2007. The Company will not have a prepayment right with respect to the 2005 Notes.

~~Our~~ In ~~primary~~connection ~~sales~~with ~~and~~the ~~marketing~~issuance ~~strategy~~of ~~has~~the ~~predominantly~~2005 ~~revolved~~Notes, ~~around~~which ~~sales~~will tobe ~~telecommunications~~convertible ~~service~~into ~~providers.~~equity Weat ~~expect~~a lower ~~that~~price athan ~~significant portion~~the ofthen-effective ~~our~~exercise ~~revenue~~price inof ~~2004~~the ~~will~~2002 beWarrants ~~attributable~~(see toNote ~~sales~~3 of ~~Visual~~Notes ~~UpTime~~to the Consolidated Financial Statements), ~~Visual~~the ~~UpTime~~exercise ~~Select~~price ~~and~~of ~~Visual~~the IP2002 ~~InSight~~Warrants towill ~~service~~be ~~providers~~adjusted from $4.2755 ~~The~~per ~~loss~~share ofto ~~any~~$3.8962 ~~one~~per ofshare ~~our~~in ~~service~~accordance ~~provider~~with ~~customers,~~the ~~which~~terms ~~together~~of ~~have~~the ~~historically~~2002 ~~provided~~Warrants. aThe ~~majority~~holders of ~~our~~the ~~revenue,~~2002 ~~could~~Warrants ~~result~~will inalso abe ~~substantial~~entitled ~~loss~~to ofan ~~revenue~~additional ~~that~~80,691 ~~could~~warrants ~~have~~so athat ~~material~~the ~~adverse~~total outstanding ~~effect~~number onof ~~our~~2002 ~~business~~Warrants ~~and~~will ~~results~~be ofincreased ~~operations~~to 909,552. ~~Existing~~The ~~service~~2002 ~~provider~~Warrants ~~customers~~expire on March 25, 2006.

30Item 6. Exhibits


Exhibit Number		Description

4.1		Revolving Promissory Note of Visual Networks, Inc. and subsidiaries, dated June 17, 2005.

10.1		Loan and Security Agreement, dated June 17, 2005, by and among Visual Networks, Inc. and subsidiaries and Silicon Valley Bank. *

10.2		Amendment to Employment Agreement, dated April 21, 2005, by and between Visual Networks Operations, Inc. and Lawrence S. Barker.

31.1		Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

~~are~~* ~~not~~Confidential ~~easily~~treatment ~~replaced~~requested ~~because~~for ofcertain ~~the~~portions ~~relatively~~of ~~few~~this ~~participants~~Exhibit inpursuant ~~that market. High barriers~~ to ~~entry~~Rule ~~due~~24b-2 ~~to extraordinary capital requirements and the possibility that existing service providers may merge or fail may further reduce their numbers. Furthermore, the small number~~ of ~~network service providers means that~~ the ~~reduction,~~Securities ~~delay~~Exchange orAct ~~cancellation~~ of orders or a delay in shipment of our products to any one service provider customer could have a material adverse effect on our revenue in any given quarter. Our anticipated dependence on sizable orders from a limited number of service provider customers will make the relationship between us and each service provider critically important to our business. Further1934, ~~because~~as ~~none of our agreements contain minimum purchase requirements~~amended, ~~there~~which ~~can~~portions beare noomitted ~~assurance~~and ~~that~~filed ~~the~~separately ~~issuance~~with ~~of a purchase order will result in significant recurring business. With~~ the ~~introduction~~Securities ofand ~~Visual~~Exchange ~~UpTime Select, we anticipate that we will see growth in revenue from our value added reseller channel, although there can be no assurance that such growth will occur~~Commission.

~~Our long sales cycle, which has had a median length of approximately five to six~~35 ~~months, requires us to expend significant resources on potential sales opportunities that may never be consummated.~~

~~Because of the delays inherent in large enterprises, our target end-user market, making significant capital expenditures on complicated systems, our sales~~SIGNATURES cycles are relatively long. For enterprise customers, our historical sales cycle has a median of approximately five to six months. This extended cycle further increases the risk that a potential customer might suffer a reduction in their capital budgets or a change in their desired functionality during the sales process. Because we are required to commit substantial sales and marketing resources during this extended time period without any assurance of consummating an eventual sale, we risk incurring significant expenses without generating any associated revenue.

~~Failure~~ Pursuant to ~~adapt~~the torequirements ~~rapid~~of ~~technological~~the ~~change~~Securities ~~could~~Exchange ~~adversely~~Act ~~affect~~of ~~our~~1934, ~~ability~~the Company has duly caused this report to ~~compete~~be ~~effectively.~~signed on its behalf by the undersigned thereunto duly authorized.

~~The~~VISUAL ~~market for our products is characterized by rapid changes~~NETWORKS, ~~including continuing advances in technology, frequent new product introductions, changes in customer requirements and preferences and changes in industry standards~~INC. IfBy: we/s/ ~~are~~Lawrence unable to develop and introduce new products and product enhancements in a timely fashion that accommodate future changes, we will likely lose customers and business which could have a material adverse effect on our business, financial condition and results of operationsS. ~~The~~Barker ~~introduction~~Lawrence of new technologies, advances in techniques for network services, the integration of service level management functionality into other network hardware components and improvements to the infrastructure of the Internet could render our products obsolete or unmarketableS. ~~There~~Barker ~~can~~President be no assurance that (i) there will continue to be a need for our products; (ii) our existing products will continue to compete successfully; (iii) our future product offerings will keep pace with the technological changes implemented by our competitors; (iv) our products will satisfy evolving industry standards or preferences of existing or prospective customers; or (v) we will be successful in developing and ~~marketing~~Chief ~~products~~Executive ~~for any future technology.~~ Officer

WeDate: ~~face~~August 9, ~~growing competition from several market segments that could make it difficult for us to acquire and retain customers.~~ 2005

WeBy: ~~face~~/s/ ~~competition~~Donald ~~from several market segments whose functionality our products integrate~~E. WeClarke ~~expect~~Donald ~~competition in each of these market segments to intensify in the future~~E. ~~Our~~Clarke ~~primary~~Executive ~~current~~Vice ~~competitors~~President ~~include,~~and orChief inFinancial ~~the future may include, the following: Brix, Kentrox, Paradyne, Adtran,~~ Officer

31Date: August 9, 2005

~~Table of Contents~~36

Packeteer, NetScout, Lucent Technologies and Concord. Our competitors vary in size and in the scope and breadth of the products and services that they offer. While we intend to compete by offering superior features, performance, reliability and flexibility at competitive prices and on the strength of our relationships with service providers, many of these competitors have greater financial, technical, marketing and other resources than us, and some have well-established relationships with our current and potential customers. As a result, these competitors may be able to respond to new or emerging technologies and changes in customer requirements more effectively than us, or devote greater resources than us to the development, promotion and sale of products. In addition, we believe that competitors from one or more of our market segments could partner with each other to offer products that supply functionality approaching that provided by Visual UpTime Select. Increased competition may result in price reductions, reduced profitability and loss of market share, any of which could have a material adverse effect on our business and results of operations.

Errors in our products or services could discourage customers and damage our reputation.

Products and services as complex as those we offer may contain undetected errors or failures when first introduced or as new versions are released. There can be no assurance that, despite testing by us and by current and potential customers, errors will not be found in new products and services until commercial shipments have commenced. Such errors can substantially delay the time until we are able to generate revenue from new product releases and could force us to divert additional development resources to correct the errors. If such errors are detected after shipments have been made, then our reputation may be damaged, and we may incur substantial costs covering warranty claims.

In our research and development spending plan, we allocate twenty percent of the engineering budget for “sustaining issues.” “Sustaining issues” include fixing problems in released products that were not identified in the development and testing cycle. If during a given period, problems are found that cause the allocation of more than twenty percent of our resources to fixing these problems, then the next round of product feature releases can be delayed by this diversion of resources.

We have anti-takeover protections that may delay or prevent a change in control that could benefit our stockholders.

Terms of our certificate of incorporation and bylaws make it more difficult for another individual or company to acquire control of our company, even if a change of control would benefit our stockholders. These terms include:

• Our board of directors, without stockholder approval, may issue up to 5,000,000 shares of preferred stock on terms that they determine. This preferred stock could be issued quickly with terms that delay or prevent the change in control of our company, make removal of management more difficult or depress the price of our stock;

• certain provisions of our certificate of incorporation and bylaws and of Delaware law could delay or make more difficult a merger, tender offer or proxy contest;

• we are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law which prohibits a publicly held Delaware corporation from engaging in a “business combination” with

an “interested stockholder” for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner;

• our board of directors is “staggered” so that only a portion of its members are elected each year;

• only our board of directors, our chairman of the board, our president, or stockholders holding a majority of our stock can call special stockholder meetings; and

• special procedures must be followed in order for stockholders to present proposals at stockholder meetings.

In addition, the outstanding Debentures may become immediately due and payable upon a change of control, which could have the effect of discouraging an acquisition that might otherwise benefit our stockholders.

Item 3. Qualitative and Quantitative Disclosure About Market Risk

The Debentures bear interest at a fixed annual rate of 5%. We are also exposed to market risk from changes in interest rates. Our investment policy restricts us to investing only in investment-grade securities. A failure of these investment securities to perform at their historical levels could reduce the interest income realized by us.

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

Item 4. Controls and Procedures

Our management, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, performed an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)). Based on that evaluation, the Chief Executive officer and the Chief Financial Officer have concluded that as of June 30, 2004, our disclosure controls and procedures are effective. There have been no significant changes in our internal control or in factors that could significantly affect internal control or in factors that could significantly affect internal controls subsequent to the date we carried out this evaluation.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

In January 2004, we received notice that a lawsuit had been filed by Paradyne Networks, Inc. (“Paradyne”), of Largo, Florida, in the United States District Court for the Middle District of Florida, Tampa Division (the “Court”), seeking damages, and injunctive and declaratory relief, for our alleged infringement of patents owned by Paradyne Corporation, a subsidiary of Paradyne.

On May 14, 2004, the Court granted our motion to dismiss the case for lack of subject matter and personal jurisdiction and denied Paradyne’s motion for leave to amend its complaint and its motion for preliminary injunction. Paradyne did not appeal the decision.

In a related matter, one of our subsidiaries, Visual Networks Operations, Inc., filed a lawsuit in United States District Court for the District of Maryland, Southern Division, against Paradyne Corporation. This lawsuit requests declaratory judgment that Visual UpTime and Visual IP InSight do not infringe certain patents owned by Paradyne Corporation and alleges that Paradyne’s assertion of its patents against us is baseless and has been for the sole purpose of obtaining an unfair competitive advantage, and that Paradyne has infringed certain patents own by us. Paradyne filed counterclaims alleging the Visual Networks Operations, Inc. infringement of its patents, mirroring the Florida claims.

Despite management’s belief that our products do not infringe upon the Paradyne subsidiary’s patents and that Paradyne’s claims are frivolous and without merit, the conduct of the litigation is expensive and may divert our resources from other activities, which could have a material adverse effect on our business and results of operations.

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

Item 2. Changes in Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Submission of Matters to Vote of Security Holders

(a) We held our annual meeting of stockholders on May 26, 2004.

(b) Not applicable.

Proposal I. Two directors were elected to serve for a term of three years, and until their successors are elected and duly qualified, with 83% of the eligible voting shares voting as follows:

	For	Withheld
Lawrence S. Barker	26,932,556	511,974
William H. Washecka	26,928,421	516,109

Proposal II. An amendment of the 2003 Stock Incentive Plan to authorize the issuance of an additional 3,000,000 shares of common stock under the plan was approved.

For		Against		Abstain
11,038,427		3,982,637		451,702

Proposal III. (the selection of PricewaterhouseCoopers LLP as Visual Networks’ independent accountants for the fiscal year ending December 31, 2004 was ratified.

For		Against		Abstain
26,957,657		58,063		428,810

Item 5. Other Information

None.

Item 6.

(a) Exhibits

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

Exhibit		Number Description
3.1$		Amended and Restated Certificate of Incorporation of the Company.
3.1.1@		Certificate of Amendment to Amended and Restated Certificate of Incorporation.
3.2*		Restated By-Laws of the Company.
4.1@@		Registration Rights Agreement, dated as of March 25, 2002, between Visual Networks Inc. and the Purchasers named therein (filed as Exhibit 99.3 to the Form 8-K).
4.2@@		Form of 5% Senior Secured Convertible Debenture of Visual Networks, Inc. due March 25, 2006 (filed as Exhibit 99.2 to the Form 8-K).
4.3@@		Form of Warrant of Visual Networks, Inc., dated March 25, 2002 (filed as Exhibit 99.4 to the Form 8-K).
10.1*		1994 Stock Option Plan.
10.2*		1997 Omnibus Stock Plan, as amended.
10.2.1**		Amendment No. 2 to the 1997 Omnibus Stock Plan (related to Exhibit 10.2).
10.3*		Amended and Restated 1997 Directors’ Stock Option Plan.
10.3.1**		Amendment No. 2 to the 1997 Directors’ Stock Option Plan (related to Exhibit 10.3).
10.4!!		2000 Stock Incentive Plan, as amended.
10.4.1**		Amendment No. 1 to the 2000 Stock Incentive Plan (related to Exhibit 10.4).
10.4.2		Amendment No. 2 to the 2000 Stock Incentive Plan (related to Exhibit 10.4)

10.5*+		Reseller/Integration Agreement, dated August 29, 1997, by and between the Company and MCI Telecommunications Corporation.
10.5.1$$$++		Second Amendment, dated November 4, 1998, to the Reseller/Integration Agreement between the Company and MCI Telecommunications Corporation (relating to Exhibit 10.5).
10.5.2&&		Agreement, dated July 25, 2002, by and between the Company and MCI WorldCom Network Services, Inc.
10.5.3!		Amendment to the Agreement by and between the Company and MCI WorldCom Network Services, Inc. (related to Exhibit 10.5.2).
10.6****++		Master Purchase of Equipment and Services Agreement, dated as of May 22, 2000, between Sprint/United Management Company and the Company.
10.6.1&&&&&		Amendment No. Two to Master Purchase Agreement, dated as of May 23, 2003, between Sprint/United Management Company and the Company (related to Exhibit 10.6).
10.6.2++		Amendment No. Three to Master Purchase Agreement, dated as of March 8, 2004, between Sprint/United Management Company and the Company (related to Exhibit 10.6).
10.7*+		General Agreement for the Procurement of Equipment, Services and Supplies, dated November 26, 1997, between the Company and AT&T Corp.
10.8*		Lease Agreement, dated December 12, 1996, by and between the Company and The Equitable Life Assurance Society of the United States.
10.8.1*		Lease Amendment, dated September 2, 1997, by and between the Company and The Equitable Life Assurance Society of the United States (related to Exhibit 10.8).
10.8.2$$$		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).
10.8.5$$$$		Fifth Lease Amendment, dated December 29, 2003, by and between the Company and TA/ Western, LLC (relating to Exhibit 10.8 and filed herewith).
10.9&&&		2003 Stock Incentive Plan.
10.9.1&&&&&&		Amendment No. 1 to 2003 Stock Incentive Plan (related to Exhibit 10.9).
10.11!!		Lease Agreement, dated April 7, 2000, by and between Visual Networks, Inc. and TA/ Western, LLC.
10.11.1$$$$		Lease Termination Agreement, dated December 29, 2003, by and between the Company and TA/Western, LLC (relating to Exhibit 10.11).
10.20$$		1999 Employee Stock Purchase Plan, as amended April 11, 2001 and January 9, 2002.
10.28&&&&&&		Employment Agreement, dated April 28, 2004, by and between the Company and Lawrence S. Barker.
10.29@@@		Nonstatutory Stock Option Grant Agreement, dated April 28, 2003, by and between the Company and Lawrence S. Barker.
10.29.1&&&&&&		Nonstatutory Stock Option Grant Agreement, dated April 14, 2004, by and between the Company and Lawrence S. Barker.

10.29.2&&&&&&		Nonstatutory Stock Option Grant Agreement, dated April 14, 2004, by and between the Company and Lawrence S. Barker.
10.30!!!		Terms of Employment, dated July 27, 2000, by and between the Company and Steve Hindman.
10.31&&&&		Terms of Employment, dated January 2, 2003, by and between the Company and Wayne Fuller.
10.33@@		Securities Purchase Agreement, dated as of March 25, 2002, between Visual Networks, Inc. and the Purchasers named therein (filed as Exhibit 99.1 to the Form 8-K).
10.36++&		Agreement for Electronic Manufacturing Services, dated March 1, 2000, by and between Visual Networks Operations, Inc. and Celestica Corporation.
10.37**		OEM Software License Agreement between Cisco Systems, Inc. and the Company, dated December 3, 2002.
10.37.1**		Amendment No. 1 to the OEM Software License Agreement between Cisco and the Company, effective December 3, 2002 (related to Exhibit 10.37).
10.39&&&&&		Employment Agreement, dated August 1, 2003, by and between the Company and George J. Roberts.
10.39.1$$$$		Nonstatutory Stock Option Grant Agreement, dated August 19, 2003, by and between the Company and George J. Roberts.
10.40		Employment Agreement, dated June 4, 2004, by and between the Company and Donald E. Clarke.
10.40.1		Nonstatutory Stock Option Grant Agreement, dated July 12, 2004, by and between the Company and Donald E. Clarke.
10.50		Loan and Security Agreement, dated July 22, 2004, by and among Visual Networks, Inc. and its subsidiaries and Silicon Valley Bank.
21.1$$$$		List of subsidiaries of the Company.
31.1		Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
*		Incorporated herein by reference to the Company’s Registration Statement on Form S-1, No. 333-41517.
**		Incorporated herein by reference to the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2002.
***		Incorporated herein by reference to the Company’s Annual Report on Form 10-K for the year endedDecember 31, 1999.
****		Incorporated herein by reference to the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2000.
@		Incorporated herein by reference to the Company’s Registration Statement on Form S-4, No. 333-33946.

@@		Incorporated herein by reference to the Company’s Current Report on Form 8-K filed March 27, 2002.
@@@		Incorporated herein by reference to the Company’s Quarterly Report on Form 10-Q for the three months ended March 31, 2003.
$		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.
$$		Incorporated herein by reference to the Company’s Definitive Proxy Statement on Schedule 14A filed April 24, 2002.
$$$		Incorporated herein by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 1998.
$$$$		Incorporated herein by reference to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.
+		Portions of this Exhibit were omitted and have been filed separately with the Secretary of the Commission pursuant to the Company’s Application Requesting Confidential Treatment under Rule 406 of the Securities Act, filed on December 22, 1997, January 28, 1998 and February 4, 1998.
++		Portions of this Exhibit were omitted and have been filed separately with the Secretary of the Commission pursuant to the Company’s Application Requesting Confidential Treatment under Rule 24b-2 of the Securities Exchange Act.
!		Incorporated herein by reference to the Company’s Quarterly Report on Form 10-Q for the three months ended September 30, 2002.
!!		Incorporated herein by reference to the Company’s Quarterly Report on Form 10-Q for the three months endedJune 30, 2000.
!!!		Incorporated herein by reference to the Company’s Quarterly Report on Form 10-Q for the three months endedJune 30, 2001.
!!!!		Incorporated herein by reference to the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2001.
&		Incorporated herein by reference to the Company’s Quarterly Report on Form 10-Q for the three months ended March 31, 2002.
&&		Incorporated herein by reference to the Company’s Quarterly Report on Form 10-Q for the three months endedJune 30, 2002.
&&&		Incorporated herein by reference to the Company’s Definitive Proxy Statement on Schedule 14A filed April 29, 2003.
&&&&		Incorporated herein by reference to the Company’s Quarterly Report on Form 10-Q for the three months endedJune 30, 2003.
&&&&&		Incorporated herein by reference to the Company’s Quarterly Report on Form 10-Q for the three months ended September 30, 2003.
&&&&&&		Incorporated herein by reference to the Company’s Quarterly Report on Form 10-Q for the three months ended March 31, 2004.

(b) Reports on Form 8-K

(1) On April 22, 2004, we filed a Form 8-K containing the press release issued on April 22, 2004 regarding our financial results for the three months ended March 31, 2004.

(2) On May 11, 2004, we filed a Form 8-K regarding a definitive, binding notice from two debenture holders requesting the repayment in full of an aggregate of $1,500,000 of our outstanding debentures.

(3) On May 14, 2004, we filed a Form 8-K regarding the court’s granting our motion to dismiss in the lawsuit filed by Paradyne Networks, Inc.

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/ Lawrence S. Barker Lawrence S. Barker President and Chief Executive Officer

Date: August 10, 2004

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