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Bay to miss numbers for quarter

The networking company says its third-quarter revenues and profits will fall short, citing weaker than anticipated demand.

Shares in Bay Networks (BAY) climbed in early morning trading today, buoyed by a round of "buy" recommendations from Wall Street analysts.

Yesterday, Bay announced that its third-quarter revenues and profits will fall short of expectations, citing weaker-than-anticipated demand for a broad range of products as confusion in the marketplace took hold.

The announcement comes after several analysts lowered their estimates on the company earlier in the day, acting on jitters over whether revenues will fall short due to steep price-cutting on its Ethernet switches.

This morning, Bay shares soared by more than 8 percent, to reach 26, after Donaldson Lufkin and Jenrette upgraded its rating for Bay to buy from market perform.

Shares of Bay yesterday fell 10 percent in composite trading on the New York Stock Exchange, to close at 24, down 2-11/16 for the day. Although there was weakness in networking in general yesterday, the sector had shown signs of recovery from its December and January lows, as analysts stepped on board with raised earnings estimates and "buy" recommendations.

Bay's announcement comes as it fights to enter the second phase of its turnaround, in which it hoped to expand its market share. In the first phase, the company was able to stabilize its eroding financial performance.

The networking company said it expects third-quarter revenues to come in at $580.5 million, down 10 percent from the previous quarter but up from $513 million reported a year ago. Analysts had expected revenues of between $645 million and $658 million for the third quarter.

Bay's third-quarter net operating income also is expected to fall below the levels achieved in the previous quarter. The company said that it will take a $154 million charge for its acquisitions of New Oak Communications and Netsation.

Outside of facing its traditionally weak third quarter and having to contend with steep price cuts on its switches, Bay's financial performance also has been affected by the continued confusion by corporate clients over using ATM (asynchronous transfer mode) vs. Gigabit Ethernet switches. Bay also cited confusion over the new modem standards, and competitor Cisco's attempts to freeze the market by promising future Gigabit-speed switches, which caused Bay customers to postpone purchases as they weighed which technology to choose.

"Too many of our customers' decisions were getting delayed," said David House, Bay's chairman, chief executive, and president. "If the average decision-making process is lengthened by two weeks...[that hurts us] for the quarter."

House noted, however, that Bay expects its historically strong fourth quarter to produce revenues that will surpass those of the December quarter. He also pointed out that Bay has a number of new products that will be rolled out during the fourth quarter.

"Today, we are doing well in our development schedule and performance dates," House said. "We have a bunch of stuff in the pipeline that we'll see in the coming quarters."

Three analysts downgraded their Bay earnings estimates for the current quarter and for fiscal 1998 overall. In one case, an analyst set a new low range for the company's fiscal-year outlook.

"What was significant about today was all three estimates were slightly higher than the mean estimate, but now are to a point to where they are below and plowing new ground," said Chuck Hill, a First Call spokesman.

Analysts' consensus for the quarter is still a mean of 28 cents a share, despite the downgrades. But for fiscal 1998, the new mean has dropped to $1.09 a share from $1.10.

SoundView Financial, for example, lowered its third-quarter earnings estimates on Bay to 25 cents a share from 30 cents, and its fiscal 1998 estimate to $1.03 a share from $1.14. Hill said another analyst lowered his fiscal 1998 estimate on the company from $1.10 a share to $1.01--a new low.

Despite the recent earnings cuts, however, analysts are largely bullish on Bay, with most recommending a "buy" on its stock.

"It's not like there is anything fundamentally wrong with Bay," said Michael Cristinziano, an analyst with Gerard Klauer Mattison, prior to Bay's announcement. "But it was just more aggressive with pricing in the 10/100 switches."

Scott Heritage, an analyst with UBS Securities, agreed that Bay will be hurt this quarter from slashing the prices of its 10/100 Ethernet switches by more than a third.

"These switches have been a hot area for Bay in the last several quarters," Heritage said. "I think there will be continued pricing pressure on revenue growth in the 10/100 switching area for the next quarter, too."

Meanwhile, competitor Cisco (CSCO) may be more immune than Bay from any downturn in the networking sector, as its products deal with the higher end of the market, which is less sensitive to price wars, Cristinziano said.

"The jury is still out on whether Bay's performance is indicative of the sector," he added. "This may be specific to Bay and its timing of orders."