FOOL CONFERENCE CALL SYNOPSIS*
By Debora Tidwell (TMF Debit)

Bay Networks
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4401 Great American Parkway
Santa Clara, CA 95054
(408) 988-2400
http://www.baynetworks.com

ALEXANDRIA, VA (July 23, 1997)/FOOLWIRE/ --- Bay Networks released their fourth quarter and fiscal year-end 1997 earnings after the market close yesterday. For the fourth quarter, the company reported record level revenue of $543.0 million, an increase of 1.4% from $535.5 million for the corresponding quarter of the preceding year. Net loss for the fourth quarter was $(118.0) million, or $(0.59) per share; these results included a charge of $148.5 million for the write-off of in-process research and development associated with the acquisitions of Rapid City Communications and ISOTRO Network Management, Inc. which the company finalized during the quarter. Excluding this charge, net income and earnings per share in the fourth quarter would have been $30.5 million and $0.15, respectively.

QUARTER RESULTS. Revenue for fiscal year 1997 was $2,093.1 million, a 1.8% increase compared to revenue of $2,056.6 million for fiscal year 1996. Net loss and loss per share for fiscal year 1997 were $(285.0) million and $(1.46), respectively. Fiscal year 1997 results included charges relating to merger and acquisition activities, business alignment, and restructuring and severance. Excluding these charges, net income and earnings per share for fiscal year 1997 would have been $118.6 million and $0.59, respectively. For fiscal year 1996 net income and earnings per share were $206.3 million and $1.04, respectively. The fiscal year 1996 income results include charges for write-offs of in-process research and development and merger-related activities. Excluding these charges, fiscal year 1996 net income and earnings per share would have been $251.3 million and $1.26, respectively.

RESULTS VERSUS EXPECTATIONS. Overall in the fourth quarter they are pleased with the results and are pleased that they did what they said they would do for the quarter. During the last conference call they said that revenue would be flattish and that operating expenses would not grow in the quarter. It turned out that revenue results exceeded their expectations and hit a new high for the company, growing 6% sequentially. This is basically the result of strong acceptance of Bay's new products. Secondly, the expense management was excellent and operating expenses were flat sequentially.

ADAPTIVE NETWORKING STRATEGY COMPLETED. During the quarter they completed their adaptive networking strategy and communicated it. They presented it to more than 1500 customers around the world and the reception, understanding, and support of their strategy by the customers has been very positive. During the quarter they also completed the acquisition of Rapid City Communications. The Rapid City team brings to Bay Networks leading layer 3 routing switch technology and leading gigabit Ethernet technology. These are both important additions to Bay's family of routing/switching solutions and they deliver on Bay's adaptive networking commitments.

REVENUE BY GEOGRAPHY. Not only did the company report record revenue, they also recorded bookings of over $600 million which was also a record. Expense management remains strong. The balance sheet which was strong at the end of the third quarter became stronger still. The $543 million in revenue was better performance than they had anticipated. All geographies performed well. The US accounted for 66% of their revenue, a small uptick from last quarter. Europe was 22% of their revenue, performing well and seeming to counter some industry trends. It's the same percentage of revenue as last quarter. The rest of the world accounted for 12% of revenues. The only geography with any type of downturn was Japan which had a particularly strong quarter in the third quarter.

REVENUE BY PRODUCT CATEGORY. By major product category, shared media accounted for 35% of their business, switching accounted for 26% of their business, routing accounted for 23%, remote access accounted for 6%, and service accounted for 10%. Shared media revenue declined but was substantially better than expected. Router revenue declined slightly, but bookings increased sequentially. Switch revenue grew aggressively with sequential growth quarter-to-quarter of almost 40%. Bookings were strong at over $600 million.

GROSS MARGINS. The gross margin rate declined approximately 1 point as they had guided last quarter. The decline was due primarily to product mix at the highest level -- the decline in router revenue as a percentage of total and the decline in shared media revenue as a percentage of total. They think average selling prices remained relatively firm, the market wasn't characterized by dramatically higher levels of discounts so they don't think that the price level was a major factor in their margin change. Again this quarter, each of their major product categories showed some margin improvement. Switching margins have gone from a weak product category in terms of margin generation to the point where they are now contributing margins at the corporate average. Switching margins have been improving steadily and significantly quarter after quarter. Operating expense was flat sequentially. They think this was good performance particularly considering the strong revenue performance. They recorded approximately $7 million more in commissions this quarter associated with the very substantial improvement in revenue performance and accelerators in the commission schedules for the sales force that reward them substantially for exceeding quotas.

OPERATING INCOME. Operating income, exclusive of one-time charges was $40 million or 7.4% of revenue. The tax rate in the quarter was favorable. They indicated in the call last quarter that they thought they would have a favorable tax rate. The quarterly tax rate was 30.3% which brought the full-year rate to 34%. Net income was $30 million, up 50% from the prior quarter. On the balance sheet, cash and investments increased $119 million. $25 million of that was from stock option exercise, the rest was from operating profit and improved working capital management. Inventory turns improved to 7.7 times, up 0.5 from the third quarter. Days sales outstanding decreased. Revenue came in more linearly this quarter than in the prior quarter. Days sales outstanding were 47 days. Their channel inventory decreased two weeks to just over 6 weeks. Headcount grew about 3% from 5,784 to 5,960 but the turnover rate remained the same as last quarter which was a little higher than they would like, ideally.

EXPECTATIONS. They have already noted that bookings were high. They cautioned people against taking that number and running with it. They expect bookings to follow a normal seasonal pattern and historically Bay has experienced a $50-70 million decline in bookings during the Summer months, or the quarter ending in September. They expect to experience a similar effect this quarter so they are working to deliver a sequential revenue increase in the face of this seasonal pattern. They want to be able to deliver the revenue increase and a book-to-bill ratio of 1:1 if possible. They believe gross margins are likely to improve modestly this quarter. That will be true because they expect to have continued improvement in the revenue contribution of the new higher margin products that they have just begun delivering. And, they expect to start delivering some new products in the coming quarter which will have better margins. On the operating expense line, they expect R&D spending to grow, probably faster than revenue next quarter because of the acquisitions which will add approximately $5 million per quarter to operating expenses, mostly in R&D. In SG&A expense they expect to continue to manage those tightly and, in total, spending may grow slightly in dollars but they hope to hold it flat as a percentage of revenue.

WORKING TO DELIVER SEQUENTIAL EARNINGS GROWTH. They will be working to deliver sequential growth in earnings per share. That may seem automatic from what they have said, but the tax rate is going to increase from 30.4% to the full indicated tax rate for 1998 which would be about 36%. So, they are going to need growth in operating profit. They think that is likely but it is going to depend to some extent on the improvement in margins that they are forecasting.

EXPECTATIONS FOR FY98. For the full year, they would expect that revenue growth rates would improve as they go through the year because of the power of the new products they are introducing and the growing importance of switching and remote access, high growth rates on those product areas and those product areas become more important contributors to their total revenue picture. They expect gross margins to improve, but in a narrow range with incremental improvements coming primarily from the introduction of new products and with the cost savings they are able to achieve in material costs and components and in their conversion costs to probably being offset significantly by declines in prices. In operating expenses, R&D expense is programmed to increase as fast or slightly faster than revenue for the year but they think there will only be small dollar growth in SG&A expenses. So, they should make significant progress in terms of their ratios of spending to revenue in SG&A costs. They expect the balance sheet to continue to show improvement for the full year and be a very strong cash generator with continued emphasis on inventory through receivables management.

KEY WINS IN THE QUARTER. AT&T is now standardizing on the Bay ATM backbone including Bay's hubs, routers, and switches. Bay displaced Cisco and Cabletron because of the technical solutions they offer. Hartford and Harris Group has bought competitors' routers and switches until recently. Now Hartford's corporate standard is Bay. Bay beat out Cisco because of their technical lead and the innovative solutions they offer. Lucent Technologies recently selected Bay for the total infrastructure support for their SAP implementation. The result will be a full ATM backbone including Bay hubs, routers, and switches. Again they beat out Cisco and Cabletron. Lucent chose Bay because of their ATM functionality, because of the robustness of their architecture, and because of their price per port advantage. Mercury and Harrison is a new customer and is a big Bay win in which they beat out Cisco. Mercury purchased several million dollars of Bay routing equipment for an innovative imaging application. They beat out Cisco because of the superiority of their technology, in particular their performance in network manageability. Telecom Indonesia is another new customer for Bay. This is a centralized service intended to provide all ISPs in Indonesia a dial-access backbone so that the ISPs can realize the economies of scale and low cost entry point. They beat out Shiva and Cisco and are offering substantial discounts. At the Scientific Academic and Research Network in Manila, Bay signed a deal recently to supply routers for their backbone to connect thousands of secondary and tertiary schools to the Internet. So, they are happy to say that their customers are responding very positively to the new Bay Networks.

ENCOURAGING PROSPECTS GOING FORWARD. They are encouraged by Bay's prospects. On the sales front, their sales force is clearly re-energized. They are seeing repeat orders from existing customers and are winning new ones, often because of performance, reliability, robustness, and their network management leadership. Their asset networking strategy of IP triple-charging existing networks is understood and supported by their customers. Their new products are starting to hit the market and are being well accepted. The new products will fuel their revenue growth as they roll into fiscal 1998. Delivery of these products will require a real focus on execution. This is a highly competitive market. Their competitors will clearly react to Bay's resurgeance. They are entering a seasonally weak quarter which will really limit their ability to grow revenue.

ROUTING MARKET. They were asked to talk about the routing market and routing growth. They answered that there are going to be some interesting dynamics in the whole routing business going forward with the emergence of layer 3 switches. They are currently delivering their switch node product which is their first entry into that product line. Their second entry is the Rapid City acquisition switch.

SWITCHED NODE PRODUCT. They were asked about the actual sales of the switched node product and whether it is meeting expectations or not. They responded that there is a long educational process involved here so their expectations are more modest. The 350T is a pretty straightforward product to sell, fits in its existing category, lines up very well against competitive products, is a good replacement product for some of their competitors' products, and is a significant improvement in Bay's overall product offering. Switch node is a whole new category of product and requires a lot of trials and tests. They are going to have to demonstrate this product. This quarter they are out on a big program to put switch nodes into people's systems on a trial basis.

CONTRIBUTORS TO GROSS MARGIN IMPROVEMENTS. They were asked to break down the contribution from both new products and improved efficiencies in terms of their outlook for improved gross margins. They answered that they think prices will tend to trend down with component prices. They will have manufacturing producivity improvements and they have a manufacturing plan for the year which goes a long way to holding costs down. The major impetus for margin improvement going forward has to come from new products which are at higher margins. The Q1 margins will improve primarily because the new products will have better margins than the margins of the products they are replacing. But, this hasn't happened to the degree that they are going to take their margin from 50% to 55% or something like that. They are still within a narrow range.

SHARED MEDIA. They were asked why shared media was so strong. They responded that shared media did better than expected both from a revenue and a booking point of view. They have a greater emphasis on 100-megabit product and so they have some new products at the low end coming. They are working hard to maximize the revenue from shared. They think that the enthusiasm of the sales force and the drive effects of their other products were factors.

OUTLOOK VERSUS INDUSTRY STANDARD PERCENTAGES. They were asked when their gross margins would match industry standards. They responded that they are allocating above industry average amounts to R&D and are holding tight control on SG&A expenses. They feel that the new technologies coming out are worth the extra R&D investment, but that obviously impacts gross margins.

MINDSHARE TURNAROUND STRATEGY. They were asked about a statement they made to their employees to be prepared for Bay to be a $100 stock and what steps they have taken to restore confidence in Bay on Wall Street and with MIS people. They responded that they think the first group you have to turn around is your employees and their emphasis from the beginning was on the employees. They think there is a renewed confidence among employees. The next group that is going to get the message is the customers and they are beginning to see that kind of enthusiasm and reception as indicated at least partially by their strong bookings this quarter. When the customers are on board, they expect the press and analysts to come on board but feel it makes no sense to talk to Wall Street until the other groups are together.

EUROPE. They were asked to talk about the European environment in light of comments that competitors are seeing weakness there. They responded that they think they have a renewed engagement with their channels throughout Europe with a particular focus in Germany with a new country manager and a strong engagement with their channels there. The environment there is similar to the environment they are finding in America and the other markets in that the customers are anxious to hear about Bay's adaptive networking and the layer 3 routing products.

* A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event. Note: Statements made by a company other than historical information may constitute forward-looking statements for which the company can claim protection under the Safe Harbor Act. Please consult the company's filings with the SEC for information on risk factors which might cause actual results to differ materially from the information contained in these forward-looking statements.