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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED JUNE 30, 1996

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 0-19366

BAY NETWORKS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 04-2916246
(STATE OR JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)

4401 GREAT AMERICA PARKWAY
SANTA CLARA, CALIFORNIA 95054
(Address of principal executive offices)
TELEPHONE: (408) 988-2400

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
COMMON STOCK, $.01 PER SHARE PAR VALUE
PREFERRED STOCK PURCHASE RIGHTS

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
NONE

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. Yes ___ No x

The aggregate market value of voting stock held by non affiliates of the
registrant was approximately $156,567,400 as of August 30, 1996, based upon the
closing sale price per share of the registrant's Common Stock as reported on the
New York Stock Exchange on such date. Shares of Common Stock held by each
executive officer and director and by each person who owns 10% or more of the
outstanding Common Stock have been excluded in that such persons may be deemed
to be affiliates. This determination of affiliate status is not necessarily
conclusive for other purposes. As of August 30, 1996, 188,261,874 shares of
Common Stock, $.01 per share par value, of the registrant were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Bay Networks, Inc. Proxy Statement for the 1996 Annual
Meeting of Stockholders to be held on October 17, 1996 are incorporated by
reference into Part III of this Annual Report on Form 10-K where indicated.

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2

PART I

ITEM 1. BUSINESS

GENERAL

Bay Networks, Inc. (the "Company") develops, manufactures, markets and
supports a comprehensive line of data networking products and services,
including high-speed routers, switches, intelligent hubs, remote and internet
access solutions and sophisticated management software providing network design
and configuration solutions. These products enable end users to build or enhance
their data network systems, including all levels from small local area networks
to large enterprise-wide information infrastructures.

In October 1994, SynOptics Communications, Inc. ("SynOptics") and Wellfleet
Communications, Inc. ("Wellfleet") effected a strategic combination of the two
companies through the merger of a wholly-owned subsidiary of Wellfleet with and
into SynOptics (the "Combination"). In connection with the Combination,
Wellfleet changed its name to Bay Networks, Inc. On May 15, 1995, the Company
acquired Centillion Networks, Inc. a leading provider of Token Ring and Token
Ring-to-ATM switching products.

On December 15, 1995, the Company acquired Xylogics, Inc. ("Xylogics"), a
technology and market leader in enterprise remote access, offering remote users
and offices transparent corporate-wide access to networking resources. On March
13, 1996, the Company acquired all of the outstanding shares of Performance
Technology, Inc., a privately held company headquartered in San Antonio, Texas
and a leader in developing LAN-to-Internet access technology, providing small
offices and small-to-medium-sized businesses easy, secure access to the
Internet. On March 31, 1996, the Company acquired substantially all of the net
assets of Armon Networking, Ltd., headquartered in Tel Aviv, Israel, a
technology developer of RMON-based distributed analysis tools and multi-segment
LAN probes. In June 1996, the Company signed a definitive agreement to acquire
the Digital Signal Processing (DSP) modem business of Penril DataComm Networks,
Inc., a provider of advanced DSP-based modems and remote access products. The
closing of the transaction is currently expected to be in the quarter ending
December 31, 1996. See Management's Discussion and Analysis of Financial
Condition and Results of Operations and Note 2 to the Consolidated Financial
Statements included herein.

The Company's products connect and interconnect multiple types of LANs,
comprised of computer equipment from the same or different manufacturers, to
form an internetworked system. These products connect computers to form LANs,
interconnect LANs located in a single facility and, through WAN connections, may
connect LANs dispersed around the world. The internetworking of these networks
enables computer users operating different types of equipment in different
locations to communicate, exchange data and share other computing resources.

The Company is a Delaware corporation incorporated in May, 1986. The
Company's principal offices are located at 4401 Great America Parkway, Santa
Clara, California 95054.

Trademarks of Bay Networks, Inc. appear in this document. Other trademarks,
brand, product, or company names may be the property of others.

RECENT DEVELOPMENTS

On September 3, 1996, the Company signed a definitive agreement to acquire
all the outstanding shares of LANcity Corporation ("LANcity"), a provider of
advanced cable modem technology, in exchange for $59.0 million. The acquisition
is subject to LANcity shareholder approval and is scheduled to close during the
quarter ending September 30, 1996. The acquisition will be accounted for as a
purchase. Based on preliminary estimates, the Company expects to allocate
approximately one-half of the purchase price to in-process research and
development, which will be charged to expense upon the closing of the
transaction.

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NETWORKING SOLUTIONS

Organizations are increasingly seeking to internetwork their disparate,
often incompatible, LANs and WANs to share information and computing resources
across the organization for applications such as electronic mail, sharing of
databases, multi-site engineering and product development, transaction
processing and electronic image transfer. Enterprise-wide networks facilitate
efficient and rapid data communications among connected work groups, departments
and locations and provide for more effective utilization of information and
computer resources. In addition, as the computing paradigm migrates to
client-server architectures, enterprise-wide networks are the enabler that
allows those technologies to be implemented by organizations. The
internetworking of LANs and WANs into enterprise-wide networks requires data
communications products which efficiently, reliably, and quickly transmit data
to appropriate locations on different networks, reconcile incompatible LAN and
WAN standards between networks and manage large, complex internetworks.

To meet these internetworking needs, the Company has developed a family of
computer networking products including hubs, routers, switches, and network
management software. The Company's hub products, which reside at the center of
networks and serve as a control and consolidation point for network activity,
integrate connectivity, network management and internetworking products into a
structured network solution that emphasizes network management scalability and
manages complexity across the network.

As network demands continue to increase, switching delivers the performance
required to support the emerging image processing, animation, modeling,
scientific and multimedia applications of the future. The Company's router
products choose the optimal path to interconnect LANs or to route data to the
WAN. These products enhance network segmentation and security, improve
reliability (since alternative paths can be used) and increase bandwidth
utilization (since the best path between source and destination is chosen by a
router).

Organizations are experiencing a shift from departmental-only to
enterprise-wide remote access and the need for applications and network
infrastructure that are remote access-ready as a result of increased business
mobility, the move to telecommuting, reduced cost of ownership of both product
and WAN services, and widespread adoption of remote access standards. Remote and
internet access products extend the backbone network beyond the branch office,
bringing remote users closer to the enterprise and permit connection to the
corporate LAN so users can work anywhere -- at home, in a hotel or in a remote
office -- at any time. Users can access electronic mail, databases and file
servers as if they were directly included within the network.

PRODUCTS

The Company's product lines include a broad family of internetworking
products, including routers, hubs, switches, remote and internet access
solutions, and network management technologies. These products encompass LAN and
WAN components, which allow the Company to offer a solution to communicate
network data worldwide, managed from a single network management software
platform which supports the Company's product lines.

The Company's product strategy is focused on weaving LAN connectivity,
management and internetworking solutions into a flexible network fabric capable
of supporting large, diverse enterprise networks. The center of this strategy is
the intelligent hub, which acts as a central control point for network
connections, management and growth. The intelligent hub incorporates the
hardware and software required to connect computing devices to structured
networks using various cabling types and media-access methods, switches, bridges
and routers that enable the internetworking of various network segments into
enterprise networks. Integrated network management software products facilitate
network operation by diagnosing and solving network problems. The categories of
the Company's product lines are described below.

Connectivity Products, which include intelligent hubs and related host
modules and transceivers, enable computing devices to communicate over networks.
Intelligent hubs provide integrated connectivity and centralized management by
supporting ethernet, token ring and fiber distributed data interface ("FDDI")
protocols, or any combination of the three in the same hub. Transceivers provide
an interface between the

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computing devices and cabling systems and are implemented either as units
external to the computer or as integrated circuits on network cards.

Network Management Products distribute management intelligence throughout
geographically dispersed networks and enable network administrators to monitor
and control the network. The open, standards-based network management products
are comprised principally of intelligent modules which resides within hubs,
sophisticated management software which resides on intelligent modules and
advanced software application programs which reside on network management
computer consoles. Through a combination of hardware and software components,
intelligent network management modules gather network information close to the
source of data activity, reduce it into meaningful information within the hub,
and forward the data to a central network management console attached to the
network. The actual management of data takes place in the hub, relieving the
burden on central network management resources and enabling networks to grow
along with the expansion of the business.

Using the Simple Network Management Protocol ("SNMP"), which ensures
compatibility with other management systems that may already be in place in a
particular networking environment, the Company's network management products
address a wide variety of diverse environments. The Optivity network management
system works with DOS and UNIX network management platforms from International
Business Machines Corporation, Hewlett-Packard Company, Inc., Novell, Inc. and
Sun Microsystems, Inc. Additionally, the Company offers application software
products which automate operational functions and facilitate design and
management of a network. The flexibility of these software products enable them
to interface in an array of multi-vendor environments.

Internetworking Products are modular devices integrated into intelligent
hubs or stand-alone devices which provide links between independent LAN segments
and control the flow of data on the LAN. The devices connect data traffic
between linked networks and forward packets of data destined for other locations
throughout the network. The Company's internetworking product lines include
local and remote bridges, local and remote routers, and switches. Bridges, which
are protocol-independent, are the simplest method of connecting LAN segments.
Bridges sort through all traffic on a network, and decide whether to send it to
the remainder of the network.

As networks grow in both size and complexity, routers provide additional
intelligence in connecting individual networks. Unlike bridges, routers actually
examine the protocol of the data packets which permits protocol filtering and
security control. The Company offers a family of scalable and highly flexible
router products that concurrently provide bridging and multi-protocol routing
functions in modular and stackable forms. The Backbone Node ("BN") products are
designed to satisfy the throughput and/or availability requirements of the most
demanding enterprise internetworks. The Backbone Node provides complete fault
resiliency with redundant processor interconnects, power supplies, and software
image storage in combination with its symmetric multiprocessor architecture.

The Company also offers a modular, stackable router, which is designed to
provide seamless integration of multiple units stacked together, performing as a
single router. This modular product offers scalability for expanding sites
requiring remote, regional or departmental access to the corporate network.

Switching Products interconnect LANs by supporting multiple parallel
communications and eliminating LAN bandwidth congestion. These products offer
connectivity to LAN and WAN technologies such as asynchronous transfer mode
("ATM"), FDDI and token ring, as well as a full suite of networking protocols
for high-speed LAN and switching environments.

In fiscal 1995, the Company introduced BaySIS (Bay Switched Internetworking
Services), a new networking architecture that combines switching technology with
traditional shared-media hub and router technology. The resulting
switched-internetworking architecture permits the customer to migrate from their
existing technology in a controlled, reliable and cost-effective manner.

Remote and Internet Access Products, including Remote Annex analog remote
access servers, Nautica ISDN router products and Instant Internet internet
access server, which are key to on-line access

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to corporate information and services such as the Internet, extend the backbone
network beyond the branch office, bringing remote users closer to the
enterprise.

The Remote Annex family of products, which are highly scalable and are
offered in a variety of configurations, provide users with transparent dial-in
access to Ethernet LANS. Users can access electronic mail, data bases and file
servers residing on Novell NetWare, TCP/IP and AppleTalk LANs as if they were
directly included with the network.

ISDN is a digital telephone connection that accommodates high bandwidth
transmissions such as graphics, images or large text files and provides an
immediate, high speed, reliable connection to network resources. The Nautica
series of ISDN routers support a wide range of routed protocols including Novell
IPX/SPX, TCP/SP, Netbios, Microsoft WINS and Banyan Vines as well as the OSPF
and RIP2 routing protocols. These products provide bandwidth-on-demand,
dial-on-demand, data compression security, configuration and network management
features.

Instant Internet provides small offices and small-to-medium-sized
businesses easy, secure access to the internet, by providing an all-in-one unit
to connect NetWare, Windows '95 and Windows NT users directly to the internet
without requiring any time-consuming changes to LAN clients or servers.

SALES CHANNELS

The Company's global market strategy emphasizes the support of sales and
service through a network of value added resellers ("VARs"), distributors,
networking OEMs and, through its domestic field sales force, directly to major
customers. The goal of the multi-channel strategy is to offer the Company
flexibility to meet specific needs and furnish the Company with broad coverage
of worldwide markets.

Value Added Resellers. VARs integrate the Company's products, along with
products sold by other LAN and WAN vendors, into turnkey networking systems that
are sold directly to end users. VARs also sell the Company's products as
stand-alone units. The Company provides support to the VAR network through its
field sales force and customer service organization, so that in addition to
sales generated independently, VAR sales are also the result of sales leads
generated by the Company's direct marketing efforts. Sales to VARs are made at
discounts based on purchase volumes and other incentive programs. VARs may
choose to procure the the Company products they resell by purchasing directly
from the Company or from its distributors as described below.

Distributors. The Company also sells its products to distributors who
typically resell to VARs or other dealers. Distributors must meet certain
criteria that are substantially different from those which the Company's VARs
must meet. The Company's distributors generally provide a minimal level of
systems integration. Distributors purchase at standard discounts based on
certain incentive programs. The Company offers additional sales and marketing
programs to assist those VARs and dealers who purchase through distributors in
promoting, selling and supporting the Company's products.

The Company's VARs and distributors may carry other products which are
complementary to, or compete with those of the Company, and these non-exclusive
VARs and distributors may choose to give higher priority to products of other
suppliers or competitors.

Field Sales Force. The Company's field sales force manages its sales
activities through multi-channel distribution strategies. The Company's
customers include end-users of large, complex, enterprise-wide networks, who
typically provide their own systems integration. The field sales and technical
support force also provides training and technical support to the Company's
VARs, distributors and end-users.

Marketing. The Company has implemented several marketing programs designed
to support the sale of its products through broad-scale reseller distribution
(two-tier distributors and direct resellers), generate sales leads for its
distribution channels and enhance brand name recognition. The Company's
marketing activities include frequent participation in industry trade shows and
seminars, advertisements in major trade publications worldwide, publications of
technical articles in the trade press, the distribution of sales literature and

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product specifications and ongoing communications with its installed base of
end-user customers. The Company's reseller and distribution programs include
incentives and benefits such as Co-op and reseller marketing programs.

CUSTOMERS AND BACKLOG

The Company's product backlog on June 30, 1996, was approximately $120
million as compared to product backlog on June 30, 1995, of approximately $231
million. The Company includes in its backlog only orders confirmed with a
purchase order for products to be shipped within six months. Because of the
generally short cycle between order and shipment, and occasional customer
changes in delivery schedules or cancellation of orders which are made without
significant penalty, the Company does not believe that its backlog as of any
particular date is necessarily indicative of actual net sales for any future
period. One reseller, Anixter Inc., a wholly-owned subsidiary of Anixter
International, Inc., accounted for approximately 13% ($263.0 million), 14%
($198.0 million) and 14% ($162.0 million) of the Company's revenue in fiscal
1996, fiscal 1995 and fiscal 1994, respectively.

The Company has attempted to reduce its product manufacturing lead times
and its backlog of orders. To the extent that backlog is reduced during any
particular period, it could result in more variability and less predictability
in the Company's quarter to quarter revenue and operating results. If
manufacturing lead times are not reduced, the Company's customers may cancel, or
not place, orders if shorter lead times are available from other manufacturers.
In addition, the Company's ability to meet customer demand may also be dependent
on the ability of the Company to increase manufacturing levels for new products
to volumes based on anticipated orders by the market.

CUSTOMER SUPPORT, SERVICE AND WARRANTY

The Company services, repairs and provides technical support for its
products. A significant portion of the Company's service and support activities
is related to software and network configuration and is provided by the
Company's assistance centers. The Company has contracted with third parties to
supplement service provided directly by the Company for on-site hardware
maintenance. International service is provided primarily by distributors,
supplemented with phone support centers in France, Japan and Australia. The
Company sells products to end-users with warranty periods of up to twelve months
from the date of shipment for domestic sales and up to fifteen months from the
date of shipment for international export sales. Following the expiration of the
warranty period, if any, the Company offers services under maintenance contracts
or on a time and materials basis. The Company also provides on-site network
support services such as system installation, network integration services and
technical consulting.

RESEARCH AND DEVELOPMENT

The Company has devoted significant resources to research and development,
spending $213.5 million, $145.3 million and $117.6 million during the fiscal
years ended June 30, 1996, 1995 and 1994, respectively.

During fiscal 1996, the Company continued development of enhancements to
its current products and to the development of new products in the areas of
emerging technologies such as ATM, remote access, switched internetworking
technologies, and the integration of voice, video and data networking. The
Company plans to continue its commitment to research and development in fiscal
1997, as the Company believes that the markets for its products are
characterized by rapid rates of technological innovation for both hardware and
software.

MANUFACTURING

The Company's manufacturing operations are located at its Santa Clara and
Sunnyvale, California; Billerica and Burlington, Massachusetts; Tel Aviv, Israel
and San Antonio, Texas facilities. The Company uses contract manufacturers in
the United Kingdom for its Nautica(TM) product line to meet product demands for
the United Kingdom market.

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The Company's manufacturing process consists of purchasing; automated,
semi-automated and manual assembly; burn in processing; in-circuit testing;
final assembly and test; and inspection.

Most of the components used in the Company's products are available from
more than one supplier. Failure of the Company's vendors to supply required
items could have a material adverse effect upon the Company's business. The
Company seeks to maintain an inventory level sufficient to meet its anticipated
short-term production needs. In the past, the Company has paid premiums to
secure adequate supplies of components, and it could become necessary to make
such payments again in the future.

COMPETITION

The data networking industry has grown in the past few years, however, the
Company's revenue may fluctuate year over year or any quarter over quarter based
on competition and customers waiting for anticipated product introductions. The
networking industry is highly competitive and competition is expected to
intensify and could adversely affect the Company's future results. Networking
and communications suppliers compete in areas such as: conformity to existing
and emerging industry standards; interoperability with other networking
products; the ability to run Ethernet, token ring and FDDI networks on most
common cabling systems; network management capabilities; ease of use;
scalability; price; performance; reliability; product features; technical
support; marketing expertise; and product innovation.

There are many companies competing in various segments of the intelligent
hub, switching, router and remote access network markets. The Company's
principal competitors include Ascend Communications, Cabletron Systems, Inc.,
Cascade Communications, Cisco Systems, Inc., Digital Equipment Corporation, Fore
Systems, Inc., Hewlett-Packard Company, Inc., International Business Machines
Corporation and 3Com Corporation, among others. Several of the Company's
competitors have greater name recognition, more extensive engineering,
manufacturing and marketing capabilities, and greater financial, technological
and personnel resources than those available to the Company. In addition,
certain companies in the networking industry have expanded their product lines
or technologies in recent years as a result of acquisitions. Specifically, 3Com
Corporation acquired Chipcom Corporation and Cisco Systems, Inc. recently
acquired Stratacom, Inc. Cisco Systems, Inc. also recently announced its
intention to acquire Telebit Corporation. There can be no assurance that the
Company will be able to compete successfully in the future with existing or new
competitors.

With industry standards established and new standards emerging, more
companies have developed standards-based products and have sought to compete on
the basis of price. Pressures from competitors offering lower priced products
could result in future price reductions for the Company's products.

PROPRIETARY RIGHTS AND LICENSES

The Company currently relies upon a combination of patents, copyrights,
trademarks and trade secret laws to establish and protect its proprietary rights
in its products. The Company maintains as proprietary the software and other
portions of the technology incorporated in its network management and other
products, and may license that technology to others as necessary. There can be
no assurance that the steps taken by the Company in this regard will be adequate
to prevent misappropriation of its technology or that the Company's competitors
will not independently develop technologies that are substantially equivalent or
superior to the Company's technology. In addition, the laws of some foreign
countries do not protect the Company's proprietary rights to the same extent as
do the laws of the United States. The Company has a number of patents and may
apply for additional patents. There can be no assurance that patents will issue
from any applications filed by the Company or that, if patents do issue, the
claims will be sufficiently broad to protect the technology invented by the
Company. In addition, no assurance can be given that any patents issued to the
Company will not be challenged, invalidated or circumvented or that the rights
granted thereunder will provide competitive advantages.

Because of the existence of a large number of patents in the networking
field and the rapid rate of issuance of new patents or new standards that may
issue or to obtain important technology, it may be necessary for the Company to
enter into technology licenses from others. Such licenses could impact the

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Company's operating results, and there is no assurance that the Company will be
able to license such technology.

EMPLOYEES

As of June 30, 1996, the Company employed 5,758 persons, including regular,
temporary and contract employees, none of whom is represented by a labor union.
The Company has experienced no work stoppages and considers its employee
relations to be positive.

ITEM 2. PROPERTIES

The Company's principal executive facility is located at the Company's
corporate headquarters in Santa Clara, California. The Company has eastern
operations located in Billerica and Burlington, Massachusetts. The Company has
administrative, sales and marketing, product development, manufacturing and
support facilities at both locations.

The Santa Clara facilities consist of approximately 1,021,975 square feet
under leases that expire from April, 1999 to November, 2002. The Company has an
option to renew certain of these leases for two additional five-year terms. The
Company's Massachusetts facilities consist of approximately 663,963 square feet
under leases that will expire through February, 2001 and the Company has an
option to renew certain of these leases for various terms. The Company has
additional fiscal year 1997 lease commitments in Billerica, Massachusetts, of
approximately 165,000 square feet.

A subsidiary of the Company has a fifty percent interest in a limited
partnership which owns one of the Company's manufacturing facilities. Of the
above total, the Company leases 118,000 square feet from the limited
partnership. The Company has, also included in the above total, approximately
405,113 square feet of space in other manufacturing buildings in Sunnyvale and
Santa Clara, California, and Billerica, Massachusetts.

The Company acquired additional manufacturing, research and development
operations during fiscal year 1996. Bay Networks Israel (1996) Ltd., which
acquired the business of Armon Networking, Ltd. in Tel Aviv, Israel occupies
27,975 square feet and Performance Technology, Inc. in San Antonio, Texas,
occupies 19,413 square feet.

Some of the Company's manufacturing and distribution facilities, as well as
a portion of the Company's research and development, and sales and
administrative functions, are located in areas of seismic risk. The Company's
future operating results could be materially affected by a major earthquake.

The Company leases and occupies sales and service offices in 36 states
throughout the United States and Puerto Rico and 34 countries worldwide. The
Company's worldwide operations are located in Argentina, Australia, Austria,
Belgium, Brazil, Canada, Cayman Islands, China, Colombia, Denmark, Finland,
France, Germany, Hong Kong, India, Indonesia, Israel, Italy, Japan, Korea,
Malaysia, Mexico, the Netherlands, New Zealand, Norway, Portugal, Russia,
Singapore, South Africa, Spain, Sweden, Switzerland, Taiwan, Thailand, United
Arab Emirates and the United Kingdom.

ITEM 3. LEGAL PROCEEDINGS

From time to time, as a normal incidence of the nature of the Company's
business, various claims, charges and litigation are asserted or commenced
against the Company. In the opinion of management, final judgments from such
claims, charges and litigation, if any, against the Company would not have a
material adverse effect on its consolidated financial position, results of
operations or cash flows.

At various times the Company has been approached by others claiming to hold
valid patents applicable to its products, who have offered to license the
patented technology. The Company may enter into such licensing agreements or may
vigorously contest such claims, depending upon the specific circumstances.

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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of the security holders during the
fourth quarter ended June 30, 1996.

MANAGEMENT

The executive officers of the Company are as follows:

NAME/POSITION AGE BUSINESS EXPERIENCE
- - ------------------------- --- ----------------------------------------------------------

Andrew K. Ludwick 50 Mr. Ludwick, a founder of SynOptics, served as President,
President, Chief Chief Executive Officer and a director of the Company
Executive since October 1994 and served as President, Chief
Officer and Director Executive Officer and a director of SynOptics from its
inception June 1985 to October 1994. From June 1969 to
June 1985, Mr. Ludwick served in various positions in
marketing, market planning, sales operations, and
corporate strategy at Xerox Corporation.
Paul J. Severino 49 Mr. Severino, a founder of Wellfleet, has served as
Chairman of the Board and Chairman of the Board of the Company since October 1994
Director and served as President and Chief Executive Officer and a
director from Wellfleet's inception in 1985 to October
1994. Prior to founding Wellfleet, Mr. Severino was a
founder and President of Interlan, Inc. from 1981 to 1985.
Interlan was sold to Micom Systems, Inc. in 1985, at which
time Mr. Severino became a Vice President of Micom. Mr.
Severino is also a director of Data Translation, Inc., a
supplier of data acquisition and image processing products
for desktop computers, and the Massachusetts Technology
Development Corporation (MTDC).
Ronald V. Schmidt 52 Dr. Schmidt, a founder of SynOptics, has served as the
Executive Vice President, Executive Vice President and Chief Technical Officer of
Chief Technical Officer the Company since October 1994 and as a director since May
and 1996. Dr. Schmidt served as Senior Vice President, Chief
Director Technical Officer and a director of SynOptics from its
inception in June 1985 to October 1994. Prior to June
1985, he served as a Research Fellow from June 1981 to
November 1985 at Xerox Corporation's Palo Alto Research
Center (Xerox "PARC"). Prior to serving at Xerox PARC, Dr.
Schmidt spent seven years at AT&T's Bell Laboratories
where he was a member of the technical staff performing
research in fiber communications. He is currently a Fellow
of the IEEE.
Jeffry R. Allen 44 Mr. Allen has served as Senior Vice President of
Senior Vice President, Operations since November 1995. Mr. Allen most recently
Operations served as Vice President and Controller of the Company
from October 1994 to November 1995. From December 1990 to
October 1994, Mr. Allen held various positions at
SynOptics, the latest of which was Vice President and
Controller. Before joining SynOptics, he held various
positions from December 1973 to November 1990 at
Hewlett-Packard Company, Inc., the latest of which was
Controller of the Information Networks Group.

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NAME/POSITION AGE BUSINESS EXPERIENCE
- - ------------------------- --- ----------------------------------------------------------

Lloyd Carney 34 Mr. Carney joined the Company in July 1990 as Director of
Vice President, Worldwide Technical Operations in the manufacturing organization of
Customer Service Wellfleet. He held this position until April 1993 when he
assumed the position of Vice President, Worldwide Customer
Service. Prior to joining the Company, Mr. Carney was Test
Engineering Manager and had new product introduction
responsibilities at Proteon Inc. Prior to Proteon, Mr.
Carney held various engineering and project management
positions at Prime Computer, Inc.
Richard D. Eyestone 50 Mr. Eyestone joined the Company in July 1991 as the
Senior Vice President, Southern Regional Manager. He held the position of
Product and Market Regional Vice President- Southern Region from November
Management, Enterprise 1994 until July 1995 and Vice President of U.S. Sales from
Business Unit July 1995 until May 1996 when Mr. Eyestone assumed the
position of Senior Vice President of Market and Product
Management for the Company's Enterprise Business Unit.
Prior to joining the Company, Mr. Eyestone held various
sales management positions at PictureTel Corporation and
Masscomp, Inc.
Michael J. Grady 47 Mr. Grady joined the Company as Vice President,
Senior Vice President of Engineering, in August 1992 and has served as Senior Vice
Engineering, Enterprise President of Engineering, Enterprise Business Unit since
Business Unit May 1996. From 1980 to July 1992, Mr. Grady held various
positions within the Engineering and Customer Support
areas at Stratus Computer, Inc., the latest of which was
Vice President, Customer Service and Technical Support and
prior to that, Vice President, Major Account Engineering.
Prior to working for Stratus Computer Inc., Mr. Grady held
various positions at Honeywell Information Systems.
Vito E. Palermo 32 Mr. Palermo has served as Vice President and Controller
Vice President since November 1995. He joined the Company in June 1992 as
and Controller Manufacturing and Customer Service Controller, served as
Corporate Accounting and Financial Planning Manager from
October 1993 to September 1994 and was promoted to
Director of Finance, Hub Product Business Unit in October
1994. Prior to joining the Company, Mr. Palermo held
several financial management positions at Digital
Equipment Corporation from September 1986 to May 1992.

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NAME/POSITION AGE BUSINESS EXPERIENCE
- - ------------------------- --- ----------------------------------------------------------

Gary Rogers 39 Mr. Rogers joined the Company in 1992 as Director of
Vice President, Reseller Sales. He held the position of Vice President,
International Sales European Operation from March 1994 until July 1996, when
Mr. Rogers assumed position of Vice President,
International Sales. Prior to joining the Company, Mr.
Rogers was Vice President, Sales at Wavetracer, Inc. from
1990 until 1992, and held various sales management
positions at ImagiTex, Inc. from 1987 until 1990, the
latest of which was Vice President U.S. Sales.
William J. Ruehle 54 Mr. Ruehle has served as Executive Vice President and
Executive Vice President Chief Financial Officer of the Company since October 1994
and Chief Financial and served as Vice President and Chief Financial Officer
Officer of SynOptics from July 1987 to October 1994. From January
1979 to June 1987, he served as a Vice President and Chief
Financial Officer of Acrian, Inc., a microwave
semiconductor manufacturer. He began his career in
corporate finance at CBS, Inc.
Bruce I. Sachs 36 Mr. Sachs joined the Company in December 1995 as
Executive Vice President, President, Xylogics Business Unit and as Executive Vice
Internet/Telecom President, Internet/Telecom Business Unit since May 1996.
Business Unit Mr. Sachs served as President and Chief Executive Officer
& President, Xylogics of Xylogics from August 1993 to December 1995. He joined
Business Unit Xylogics in May 1989 as Director of Engineering,
Communications Products, was promoted to Vice President of
Engineering in March 1991 and served as Executive Vice
President from December 1992 to August 1993. From May 1985
to February 1989 he was the Director of Engineering,
Transmission Products at Infinet, Inc.
Gene Wahlberg 43 Mr. Wahlberg joined the Company in October 1990 as a
Vice President, National Account Manager for the Southwest Region. He held
U.S. Sales positions as Southwest Sales Manager, Central Region
Director and Regional Vice President, Central Region
through May 1996 when he assumed the position of Vice
President, U.S. Sales. Prior to joining the Company, Mr.
Wahlberg was a principal in a manufacturing representative
company for 5 years and held various Sales Management
positions at Mostek Corporation.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

STOCK MARKET INFORMATION (UNAUDITED)

The following tables set forth, for the periods indicated, the high and low
closing prices for the Company's common stock as reported by The Nasdaq Stock
Market and the New York Stock Exchange. The Company began trading on the New
York Stock Exchange on February 29, 1996. The prices shown for the period that
the Company's common stock was traded on The Nasdaq Stock Market represent
quotations among dealers without adjustments for retail markups, markdowns, or
commissions and may not represent actual transactions.

Fiscal Year Ended June 30, 1996 HIGH LOW
----------------------------------------------------------------- ------ ------

First quarter.................................................. $37.33 $27.17
Second quarter................................................. $48.42 $33.58
Third quarter.................................................. $47.88 $28.38
Fourth quarter................................................. $36.75 $25.00
Fiscal Year Ended June 30, 1995 High Low
----------------------------------------------------------------- ------ ------
First quarter.................................................. $16.83 $12.79
Second quarter................................................. $20.33 $12.83
Third quarter.................................................. $25.75 $18.71
Fourth quarter................................................. $27.59 $22.46

As of June 30, 1996, the Company had approximately 4,332 stockholders of
record. To date, the Company has not paid any cash dividends on its capital
stock, and there can be no assurances that the Company will do so.

ITEM 6. SELECTED FINANCIAL DATA

AS OF OR FOR THE YEAR ENDED JUNE 30,
In thousands, except per share --------------------------------------------------------------
amounts 1996 1995(1) 1994(1) 1993(1) 1992(1)
- - ------------------------------------ ---------- ---------- ---------- -------- --------

Revenue............................. $2,056,634 $1,403,595 $1,136,393 $926,154 $507,013
Income before provision for income
taxes(2).......................... 351,816 220,673 208,221 174,303 86,241
Provision for income taxes.......... 145,491 91,687 83,843 71,023 28,981
Net income.......................... 206,325 128,986 124,378 103,280 57,260
Net income per share................ 1.04 0.69 0.69 0.58 0.34
Total assets........................ 1,506,535 1,155,046 848,496 700,203 374,153
Working capital..................... 816,016 696,085 585,508 479,974 248,980
Long-term debt...................... 110,147 113,430 110,283 110,431 436
Stockholders' equity................ 1,094,695 770,086 583,721 458,025 296,506

- - ---------------
(1) All amounts and per share data for prior periods have been retroactively
restated to reflect the acquisition of Xylogics, Inc. in a pooling of
interests transaction effective December 15, 1995. (See Note 2 to Notes to
Consolidated Financial Statements.) All per share data applicable to prior
periods have also been retroactively restated to reflect a three-for-two
stock split, in the form of a stock dividend, effective November 24, 1995.

(2) Includes charges of $39.7 million, $6.7 million, $17.9 million and $17.9
million for the years ended June 30, 1996, 1995, 1994 and 1993,
respectively, for in-process research and development charges resulting
from acquisitions and $10.2 million and $63.4 million for the years ended
June 30, 1996 and 1995 for merger related expenses.

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ITEM 7.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

Business Environment and Risk Factors. The following discussion should be
read in conjunction with the consolidated financial statements and related notes
included elsewhere herein as well as the section below under the heading "Risk
Factors That May Affect Future Results". The Company's future operating results
may be affected by various trends and factors which are beyond the Company's
control. These include, among other factors, changes in general economic
conditions, rapid or unexpected changes in technologies and uncertain business
conditions that affect the data networking industry. Accordingly, past results
and trends should not be used by investors to anticipate future results or
trends.

With the exception of historical information, the matters discussed below
under the headings "Results of Operations" and "Liquidity and Capital Resources"
may include forward-looking statements that involve risks and uncertainties. The
Company wishes to caution readers that a number of important factors, including
those identified in the section entitled "Risk Factors That May Affect Future
Results," as well as factors discussed elsewhere in this report and in the
Company's other reports filed with the Securities and Exchange Commission, could
affect the Company's actual results and cause actual results to differ
materially from those in the forward-looking statements.

Results of Operations

Revenue. Revenue increased 46.5% to $2,056.6 million in fiscal 1996 as
compared to $1,403.6 million in fiscal 1995 and $1,136.4 million in fiscal 1994.
The growth in revenue in fiscal 1996 was attributable to market growth and
strong demand for the Company's products. This growth was a result of worldwide
unit volume increases for virtually all of the Company's product lines. While
sales in all major product areas increased, the highest percentage increase was
in the switching product line; the Company's new products in the remote access
market, including the Xylogics' Nautica line, were particularly well received in
those markets. Revenue from the router product line grew over fiscal 1995 as
sales to the telecommunications industry increased. The increase in revenue in
fiscal 1995 was attributable to growth in market demand for the Company's
products with growth across all of the Company's product lines. The Company has
continued to increase revenue through execution of its multi-channel
distribution strategy and growth in international operations.

International revenue was $716.5 million or 34.8% of total revenue in
fiscal 1996, compared to $458.4 million or 32.7% of total revenue and $345.7
million or 30.4% of total revenue in fiscal 1995 and fiscal 1994, respectively.
The increase in each period was primarily due to the Company's international
expansion and growth in the Asia/Pacific market, as well as continued growth in
the European market. The Company continues to emphasize the multi-channel sales
strategy which consists of qualified resellers, distributors and dealers. The
Company's international revenue was primarily denominated in U.S. dollars. The
effect of foreign exchange rate fluctuations did not have a significant impact
on the Company's operating results in any period.

Revenue in past periods may not be indicative of revenue in the future,
which may be affected by other business environment and risk factors previously
discussed, as well as other factors included elsewhere herein.

Gross Profit. Gross profit was $1,111.3 million or 54.0% of revenue in
fiscal 1996, compared to $772.6 million or 55.0% of revenue and $630.7 million
or 55.5% of revenue in fiscal 1995 and fiscal 1994, respectively. The gross
profit increase was due to sequentially higher worldwide unit volume each year.
The gross margin percentage decline in fiscal 1996 was affected by several
factors: a product mix shift towards shared media, including increased volumes
of stackable Ethernet products, and additional reserves for excess inventory as
a result of product transitions that occurred in fiscal 1996. The decline was
partially offset by manufacturing cost reductions, reductions in material
premium charges, and increased router sales which carry higher margins. The
decline in fiscal 1995 was primarily from competitive list price reductions,
product mix shifts toward non-modular products which carry lower margins, and
price increases on certain components.

The Company believes there is a risk that gross margin percentages may
decline if the product mix continues to shift towards non-modular products and
competition continues to increase. The Company expects

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market emphasis on lower margin routers and high-speed switching products in the
future. Other factors, including changes in material and labor costs and
distribution channels, may also have an adverse effect on gross margin
percentages in the future.

Operating Expenses. Research and development spending grew by 46.9% to
$213.5 million in fiscal 1996 from $145.3 million in fiscal 1995 and 23.6% from
$117.6 million in fiscal 1994 as compared with fiscal 1995, although the
percentage of revenue of 10.4% remained constant for each fiscal year. The
increase in expense relates to the Company's continued development of
enhancements to its current products and to the development of new products and
addition of personnel through hiring and through acquisitions and business
combinations. During the year, the Company continued development of new products
in the areas of emerging technologies such as ATM, remote access, switched
internetworking technologies, and the integration of voice, video and data
networking. The Company plans to continue its commitment to research and
development in fiscal 1997, as the Company believes that the markets for its
products are characterized by rapid rates of technological innovation for both
hardware and software. Research and development expenses may increase in
absolute dollars in future periods, and such expenditures may vary as a
percentage of revenue. There can be no assurance that the Company's research and
development efforts will result in commercially successful new technology and
products in the future, and those efforts may be affected by other factors noted
below.

Selling and marketing expenses were $452.3 million or 22.0% of revenue in
fiscal 1996, compared to $302.5 million or 21.6% of revenue and $246.8 million
or 21.7% of revenue in fiscal 1995 and fiscal 1994, respectively. The increase
in expense in both fiscal 1996 and fiscal 1995, as compared with the prior
fiscal year, was primarily related to the increased costs associated with larger
sales and sales support staffs, commission expenses resulting from higher sales
levels, expansion of the Company's sales and marketing programs, and investments
related to new product launches and entry into new markets worldwide. The
Company's investment in its sales, marketing and support staff may vary as a
percentage of revenue in the future.

General and administrative expenses were $72.2 million or 3.5% of revenue
in fiscal 1996, compared to $55.7 million or 4.0% of revenue and $47.5 million
or 4.2% of revenue in fiscal 1995 and fiscal 1994, respectively. The absolute
dollar increase in general and administrative expenses each year related to the
addition of personnel, and expenditures related to both domestic and
international facilities and information technology needed to support the growth
in the Company's business. General and administrative expenses may vary as a
percentage of revenue in the future.

In fiscal 1996, the Company acquired all of the outstanding shares of
Performance Technology, Inc., a developer of LAN-to-Internet access technology,
for a total purchase price of $12.6 million, and substantially all of the net
assets of Armon Networking, Ltd., a technology developer of RMON-based
distributed analysis tools and multi-segment LAN probes, for a total purchase
price of $34.2 million. Approximately $39.7 million was charged to in-process
research and development related to internetworking technologies associated with
these acquisitions.

The Company incurred in-process research and development expenses of $6.7
million and $17.9 million related to the acquisitions of Scorpion Ltd. and Coral
Network Corporation in fiscal 1995 and 1994, respectively.

In June 1996, the Company signed a definitive agreement to acquire the
Digital Signal Processing (DSP) modem business of Penril DataComm Networks,
Inc., a provider of advanced DSP-based modems and remote access products. Based
on preliminary estimates, the Company expects to allocate approximately $60
million to $65 million of the total purchase price, which is based on a fixed
formula, to in-process research and development, which will be charged to
expense upon the closing of the transaction, currently expected to be in the
quarter ending December 31, 1996.

As a result of the various business combinations in fiscal 1996 and 1995,
the Company has incurred merger related expenses of $16.1 million and $63.4
million, respectively. These merger related expenses related to transaction
costs, severance related expenses, closing of duplicate facilities, write off of
duplicate inventory and other assets and other costs incident to the
transactions. In fiscal 1996, the Company reversed previously accrued merger
costs of $5.9 million associated with the Wellfleet/SynOptics business
combination

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and the Centillion acquisition. The reduction in the estimated costs were
realized primarily due to the usage of facilities which the Company had
previously planned to vacate. (See Note 2 to the Notes to Consolidated Financial
Statements.)

Net Interest Income and Other. Net interest income and other was $28.5
million, or 1.4% of revenue in fiscal 1996, compared to $21.8 million or 1.6% of
revenue and $7.3 million or 0.6% of revenue in fiscal 1995 and fiscal 1994,
respectively. The increase in absolute dollars in interest income was due to
higher average invested cash and investment balances, which yielded higher
interest income in fiscal year 1996 and 1995.

Income Taxes. The Company's effective income tax rate was 37.5%, 37.8% and
37.6% in fiscal 1996, fiscal 1995 and fiscal 1994, respectively, and excludes
the effect of the in-process research and development charges and certain merger
related expenses which were not deductible for income tax purposes. At June 30,
1996, a valuation allowance of $6.8 million was offset against the net operating
losses and credit carryforwards acquired from Coral Network Corporation,
Centillion Networks, Inc. and Performance Technology, Inc. which are subject to
substantial limitation. Management has concluded that other than the allowance
related to these acquisitions, no valuation allowance is required based on its
assessment that future levels of taxable income will be sufficient to realize
the future tax benefits represented by the deferred income taxes.

Liquidity and Capital Resources. As of June 30, 1996, total cash and
short- and long-term investments totaled $588.2 million, down from $651.6
million at June 30, 1995. Cash generated from operating activities declined to
$105.9 million, compared to $258.1 million and $169.0 million in fiscal 1995 and
fiscal 1994, respectively.

Cash provided from operations decreased from the prior year due to an
increase in income before depreciation and amortization which was more than
offset by increases in accounts receivable and inventory. The increase in
accounts receivable in fiscal 1996 was due to revenue growth, including the
continued expansion in international operations relative to total operations
which typically have longer collection cycles. Days sales outstanding in
receivables were 54 days at June 30, 1996 compared to 40 days at June 30, 1995.
Days sales outstanding may continue to vary, due to, among other things, timing
of product shipments and international expansion. The increase in inventory was
primarily attributable to increasing inventory levels to meet desired
manufacturing lead times and anticipated demand for new product introductions.

The Company used $119.7 million, $298.5 million and $222.3 million for
investing activities in fiscal 1996, fiscal 1995 and fiscal 1994, respectively.
The consumption of cash in fiscal 1996 was due to increases in property, plant
and equipment needed for increased levels of business and the Company's
information technology. The Company expects to spend additional cash related to
additional property, plant and equipment and information technology required to
support the Company's operations in fiscal 1997. Furthermore, the Company
acquired two companies in fiscal 1996, Performance Technology, Inc., for $12.6
million, and Armon Networking, Ltd., for $34.2 million, for the purpose of
entering new markets, including the Internet market. The major investing
activities in fiscal 1995 and fiscal 1994 were primarily attributable to capital
additions to support business operations.

Financing activities provided $44.9 million, $34.3 million and $24.5
million in fiscal 1996, fiscal 1995 and fiscal 1994, respectively. The cash
generated from financing activities was primarily due to cash received in
connection with the issuance of stock under the Company's stock plans, which
resulted in net proceeds of $45.4 million, $34.0 million and $24.4 million,
respectively.

A subsidiary of the Company has outstanding $110 million of convertible
subordinated debentures which bear interest of 5 1/4% per annum, payable
semi-annually, and mature in May 2003. The debentures are convertible at the
option of the holder into the Company's common stock at a conversion price of
$42.61 per share. The Company has reserved 2,581,725 shares of common stock for
the conversion of these debentures. Beginning May 1996, the debentures are
redeemable at the option of the Company, initially at approximately 103.7% and
at decreasing prices thereafter to 100% at maturity. To date, the Company's
management has made no decision whether to redeem the debentures.

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16

The Company believes that it has the financial resources needed to meet
business requirements, including capital expenditures, working capital
requirements, the debt obligations outstanding and operating lease commitments
for facilities at least through the next twelve months.

RISK FACTORS THAT MAY AFFECT FUTURE RESULTS.

As noted above, the foregoing discussion may include forward-looking
statements that involve risks and uncertainties. In addition, Bay Networks
identifies the following risk factors which could affect the Company's actual
results and cause actual results to differ materially from those in the
forward-looking statements.

Risks Related to New Products. The Company's future revenue is dependent
on its ability to successfully develop, manufacture and market products for
customers worldwide. In this regard, future growth is dependent on the Company's
ability to timely and successfully develop and introduce new products, establish
new distribution channels, develop affiliations with leading market participants
which facilitate product development and distribution, and market existing and
new products with service providers, resellers and channel partners, and others.
Also, future revenue may be affected in part by factors which influence the
business of the Company's direct and indirect resellers, such as the resellers'
organization structure, purchasing patterns and inventory levels.

The Company believes that the markets for its products are characterized by
rapid rates of technological innovation for both hardware and software. There
can be no assurance that the Company's research and development efforts will
result in commercially successful new technology and products in the future. In
addition, as the technical complexity of new products increases, it may become
increasingly difficult to introduce new products quickly and according to
schedule.

Risks Related to Recent Developments. The Company recently announced an
internal reorganization and implemented a new information system which it
believes will better serve its customers and the market overall. There can be no
assurances that these actions will achieve the Company's objectives.

Dependence on Personnel. The Company's success depends upon the continued
contributions of its personnel, many of whom would be difficult to replace. The
success of the Company will depend on the ability of the Company to attract and
retain skilled employees. Changes in personnel, therefore, could adversely
affect operating results.

Risks Related to Gross Margin. The Company's gross margin percentage is a
function of the product mix sold in any period. Other factors such as unit
volumes, obsolescence of inventory, heightened price competition, changes in
channels of distribution, shortages in components due to timely supplies of
parts from vendors or ability to obtain items at reasonable prices, and
availability of skilled labor, also may continue to affect the cost of sales and
the fluctuation in gross margin percentages in future periods. In the past, the
Company has paid premiums to secure adequate supplies of components, and it
could become necessary to make such payments again in the future.

Risks Related to Timing of Product Shipments. One of the risks potentially
affecting the Company's operating results is the fact that a substantial portion
of the Company's revenue in any period may result from shipments during the
latter part of a period. Because the Company establishes its operating expense
level based on its operational goals, if shipments in any period do not meet
goals, net profits may be adversely affected.

Risks Related to Backlog. The Company has attempted to reduce its product
manufacturing lead times and its backlog of orders. To the extent that backlog
is reduced during any particular period, it could result in more variability and
less predictability in the Company's quarter to quarter revenue and operating
results. If manufacturing lead times are not reduced, the Company's customers
may cancel, or not place, orders if shorter lead times are available from other
manufacturers. In addition, the Company's ability to meet customer demand may
also be dependent on the ability of the Company to increase manufacturing levels
for new products to volumes required based on anticipated orders by the market.

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Risks Related to Intellectual Property Rights. The Company currently
relies upon a combination of patents, copyrights, trademarks and trade secret
laws to establish and protect its proprietary rights in its products. The
Company maintains as proprietary the software and other portions of the
technology incorporated in its network management and other products, and may
license that technology to others as necessary. There can be no assurance that
the steps taken by the Company in this regard will be adequate to prevent
misappropriation of its technology or that the Company's competitors will not
independently develop technologies that are substantially equivalent or superior
to the Company's technology. In addition, the laws of some foreign countries do
not protect the Company's proprietary rights to the same extent as do the laws
of the United States. The Company has a number of patents and may apply for
additional patents. There can be no assurance that patents will issue from any
applications filed by the Company or that, if patents do issue, the claims will
be sufficiently broad to protect the technology invented by the Company. In
addition, no assurance can be given that any patents issued to the Company will
not be challenged, invalidated or circumvented or that the rights granted
thereunder will provide competitive advantages.

Risks Related to New Markets. During 1996, the Company entered new
markets, including the remote access and Internet markets, primarily through the
acquisition of other businesses. The revenue or net profits from these new
markets and businesses has not been material in the past. At present, these new
markets are undeveloped and rapidly changing. If these markets do not develop,
or if the Company's strategies for these markets are unsuccessful, the Company's
operating results may be adversely affected.

Revenue Fluctuations and Competition. The data networking industry has
grown in the past few years, however, the Company's revenue may fluctuate year
over year or any quarter over quarter based on competition and customers waiting
for anticipated product introductions. The networking industry is highly
competitive and competition is expected to intensify and could adversely affect
the Company's future results. Networking and communications suppliers compete in
areas such as: conformity to existing and emerging industry standards;
interoperability with other networking products; the ability to run Ethernet,
token ring and FDDI networks on most common cabling systems; network management
capabilities; ease of use; scalability; price; performance; reliability; product
features; technical support; marketing expertise; and product innovation.

There are many companies competing in various segments of the intelligent
hub, switching, router and remote access network markets. The Company's
principal competitors include Ascend Communications, Cabletron Systems, Inc.,
Cascade Communications, Cisco Systems, Inc., Digital Equipment Corporation, Fore
Systems, Inc., Hewlett-Packard Company, Inc., International Business Machines
Corporation and 3Com Corporation, among others. Several of the Company's
competitors have greater name recognition, more extensive engineering,
manufacturing and marketing capabilities, and greater financial, technological
and personnel resources than those available to the Company. In addition,
certain companies in the networking industry have expanded their product lines
or technologies in recent years as a result of acquisitions. Specifically, 3Com
Corporation acquired Chipcom Corporation and Cisco Systems, Inc. recently
acquired Stratacom, Inc. and announced its intention to acquire Telebit
Corporation, a manufacturer of digital modems. There can be no assurance that
the Company will be able to compete successfully in the future with existing or
new competitors.

Risks Related to Acquisitions. To implement its business plans, the
Company may make further acquisitions in the future. Acquisitions require
significant financial and management resources both at the time of the
transaction and during the process of integrating the newly acquired business
into the Company's

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operations. The Company's operating results could be adversely affected if it is
unable to successfully integrate such new companies into its operations. Certain
acquisitions or strategic transactions may be subject to approval by the other
party's board or shareholders, domestic or foreign governmental agencies, or
other third parties. Accordingly, there is a risk that important acquisitions or
transactions could fail to be concluded as planned. Future acquisitions by the
Company could also result in issuances of equity securities or the rights
associated with the equity securities, which could potentially dilute earnings
per share. In addition, future acquisitions could result in the incurrence of
additional debt, taxes, or contingent liabilities, and amortization expenses
related to goodwill and other intangible assets. These factors could adversely
affect the Company's future operating results and financial position.

Reliance on Resellers and Distributors. VAR and distributor networks have
continued to represent an important part of the Company's overall sales and
distribution strategy. While the Company is not dependent on any single VAR or
distributor, the loss of, or changes in the relationship with or performance by,
several VARs or distributors nevertheless could have a material adverse effect
on the Company's revenue and operating results. The loss of, or changes in the
relationship with or performance by, one or more international distributors
could have a material adverse effect on the Company's revenue and operating
results.

Risks Related to International Sales. International sales may be an
increasingly important contributor to the Company's revenue and net profits. As
a result, operating results are increasingly affected by the risks of such
activities, including economic conditions in the international markets in which
the Company sells its products and political and economic instability,
fluctuations in currency exchange rates, changes in international regulatory
requirements, international staffing and employment issues, tariffs and other
trade barriers, import and export controls and the burden of complying with
foreign laws. Sales into developing nations may fluctuate to a greater extent
than sales to customers in developed nations, as those markets are only
beginning to adopt new technologies and establish purchasing practices. These
risks may adversely affect the Company's future operating results and financial
position.

Risks Related to Government Regulations and Product Certification. The
Company's operations are also subject to laws, regulations, government policies,
and product certification requirements worldwide. Changes in such laws,
regulations, policies, or requirements could affect the demand for the Company's
products or result in the need to modify products, which may involve substantial
costs or delays in sales and could have an adverse effect on the Company's
future operating results.

Risks of Stock Volatility and Absence of Dividends. In recent years, the
stock market in general and the market for technology stocks in particular,
including the Company's common stock, have experienced extreme price
fluctuations. There is a risk that stock price fluctuation could impact the
Company's operations. Changes in the price of the Company's common stock could
affect the Company's ability to successfully attract and retain qualified
personnel or complete necessary business combinations or other transactions in
the future. The Company has never paid any cash dividends on its capital stock,
and there can be no assurance that the Company will do so.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders
Bay Networks, Inc.

We have audited the accompanying consolidated balance sheets of Bay
Networks, Inc. as of June 30, 1996 and 1995, and the related consolidated
statements of income, stockholders' equity and cash flows for each of the three
years in the period ended June 30, 1996. These consolidated financial statements
are the responsibility of the company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits. We did not audit the financial statements of Wellfleet Communications,
Inc., which statements reflect net income constituting approximately 51% of the
related 1994 consolidated financial statement total. Those statements were
audited by other auditors whose report has been furnished to us, and our
opinion, insofar as it relates to data included for Wellfleet Communications,
Inc. is based solely on the report of the other auditors.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.

In our opinion, based on our audits, and for 1994 the report of other
auditors, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Bay
Networks, Inc. at June 30, 1996 and 1995, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
June 30, 1996, in conformity with generally accepted accounting principles.

ERNST & YOUNG LLP

Palo Alto, California
July 19, 1996

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REPORT OF PRICE WATERHOUSE LLP, INDEPENDENT ACCOUNTANTS

The Board of Directors and Stockholders
of Wellfleet Communications, Inc.

In our opinion, the consolidated statements of income, of stockholders'
equity and of cash flows of Wellfleet Communications, Inc. and its subsidiaries
(not presented separately herein) present fairly, in all material respects, the
results of their operations and their cash flows for the year ended June 30,
1994, in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the company's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit of these statements in accordance with
generally accepted auditing standards which require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audit provides a reasonable basis for the opinion expressed
above. We have not audited the consolidated financial statements of Wellfleet
Communications, Inc. for any period subsequent to June 30, 1994.

PRICE WATERHOUSE LLP

Boston, Massachusetts
July 18, 1994

19
21

BAY NETWORKS, INC.

CONSOLIDATED BALANCE SHEETS
(In thousands, except share and par value amounts)

JUNE 30,
-------------------------
1996 1995
---------- ----------

ASSETS
Current assets:
Cash and cash equivalents......................................... $ 315,064 $ 283,913
Short-term investments............................................ 119,093 314,872
Accounts receivable, net of allowance for doubtful accounts of 320,892 177,300
$9,683 at June 30, 1996 and $10,441 at June 30, 1995...........
Inventories....................................................... 239,725 94,600
Deferred income taxes............................................. 74,320 83,260
Other current assets.............................................. 48,615 13,670
---------- ----------
Total current assets........................................... 1,117,709 967,615
Investments......................................................... 154,064 52,864
Property and equipment, net......................................... 211,674 122,179
Other assets........................................................ 23,088 12,388
---------- ----------
Total assets................................................... $1,506,535 $1,155,046
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.................................................. $ 116,894 $ 83,316
Accrued payroll and related costs................................. 63,242 47,573
Accrued expenses.................................................. 23,108 19,784
Accrued marketing costs........................................... 22,019 15,251
Accrued merger costs.............................................. 5,575 15,066
Accrued income taxes.............................................. 4,818 48,968
Accrued warranty.................................................. 19,408 12,495
Deferred revenue.................................................. 46,629 29,077
---------- ----------
Total current liabilities...................................... 301,693 271,530
---------- ----------
Long-term debt...................................................... 110,147 113,430
---------- ----------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.001 par value -- Authorized -- 1,000,000
shares:
Issued and outstanding -- none................................. -- --
Common stock, $.01 par value -- Authorized -- 300,000,000 shares:
Issued and outstanding -- 188,537,072 shares at June 30, 1996 1,885 1,810
and 181,086,596 shares at June 30, 1995.......................
Additional paid-in capital........................................ 474,322 322,704
Retained earnings................................................. 618,488 445,572
---------- ----------
Total stockholders' equity..................................... 1,094,695 770,086
---------- ----------
Total liabilities and stockholders' equity.......................... $1,506,535 $1,155,046
========== ==========

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

20
22

BAY NETWORKS, INC.

CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)

YEARS ENDED JUNE 30,
----------------------------------------
1996 1995 1994
---------- ---------- ----------

Revenue................................................ $2,056,634 $1,403,595 $1,136,393
Cost of sales.......................................... 945,318 630,983 505,666
---------- ---------- ----------
Gross profit......................................... 1,111,316 772,612 630,727
---------- ---------- ----------
Operating expenses:
Research and development............................. 213,521 145,336 117,626
Selling and marketing................................ 452,319 302,496 246,802
General and administrative........................... 72,205 55,734 47,458
In-process research and development.................. 39,713 6,741 17,898
Merger related expenses.............................. 10,231 63,419 --
---------- ---------- ----------
Total operating expenses.......................... 787,989 573,726 429,784
---------- ---------- ----------
Income from operations................................. 323,327 198,886 200,943
Net interest income and other.......................... 28,489 21,787 7,278
---------- ---------- ----------
Income before provision for income taxes............... 351,816 220,673 208,221
Provision for income taxes............................. 145,491 91,687 83,843
---------- ---------- ----------
Net income............................................. $ 206,325 $ 128,986 $ 124,378
========== ========== ==========
Net income per share................................... $ 1.04 $ 0.69 $ 0.69
========== ========== ==========
Weighted average common shares and equivalents......... 198,778 187,659 180,088
========== ========== ==========

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

21
23

BAY NETWORKS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(In thousands)

COMMON STOCK
----------------
NUMBER ADDITIONAL TOTAL
OF PAR PAID-IN RETAINED STOCKHOLDERS'
SHARES VALUE CAPITAL EARNINGS EQUITY
------- ------ ---------- -------- -------------

BALANCES, JULY 1, 1993........................ 167,151 $1,672 $ 232,326 $224,027 $ 458,025
Shares issued under
stock plans, net......................... 4,811 48 24,309 -- 24,357
Tax benefits from stock plan activity....... -- -- 26,292 -- 26,292
Elimination of SynOptics'
net activity for the
six months ended December 31, 1993....... (1,341) (13) (20,348) (28,970) (49,331)
Net income.................................. -- -- -- 124,378 124,378
------- ------ -------- -------- ----------
BALANCES, JUNE 30, 1994....................... 170,621 1,707 262,579 319,435 583,721
Shares issued under
stock plans, net......................... 4,878 48 33,988 -- 34,036
Tax benefits from stock plan activity....... -- -- 13,271 -- 13,271
Shares issued for equity of Centillion...... 5,354 54 11,056 (1,720) 9,390
Shares issued for equity of Scorpion........ 384 3 3,154 -- 3,157
Elimination of Xylogics' net activity for
the three months ended October 31,
1994..................................... (150) (2) (1,344) (1,129) (2,475)
Net income.................................. -- -- -- 128,986 128,986
------- ------ -------- -------- ----------
BALANCES, JUNE 30, 1995....................... 181,087 1,810 322,704 445,572 770,086
Shares issued under
stock plans, net......................... 7,450 75 78,721 (33,409) 45,387
Tax benefits from stock plan activity....... -- -- 72,897 -- 72,897
Net income.................................. -- -- -- 206,325 206,325
------- ------ -------- -------- ----------
BALANCES, JUNE 30, 1996....................... 188,537 $1,885 $ 474,322 $618,488 $ 1,094,695
======= ====== ======== ======== ==========

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

22
24

BAY NETWORKS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)

YEARS ENDED JUNE 30,
-----------------------------------
1996 1995 1994
--------- --------- ---------

Increase (decrease) in cash and cash equivalents
Cash flows provided by operating activities:
Net income.................................................... $ 206,325 $ 128,986 $ 124,378
Adjustments to reconcile net income to cash flows provided by
operating activities:
Depreciation and amortization............................. 82,795 59,202 44,288
In-process research and development....................... 39,713 6,741 17,898
Benefit from deferred income taxes........................ (13,900) (37,596) (11,192)
Accounts receivable....................................... (141,506) (27,783) (48,291)
Inventories............................................... (144,425) 7,648 856
Other current assets...................................... (34,945) (965) (6,402)
Accounts payable.......................................... 31,366 25,200 (14,094)
Accrued expenses.......................................... 22,338 48,363 13,990
Deferred revenue.......................................... 17,552 18,788 3,755
Accrued income taxes...................................... 40,600 29,475 43,812
--------- --------- ---------
Cash flows provided by operating activities............ 105,913 258,059 168,998
--------- --------- ---------
Cash flows used in investing activities:
Expenditures for property and equipment..................... (170,574) (79,512) (74,598)
Purchases of investments.................................... (422,280) (517,868) (246,131)
Proceeds from maturities of investments..................... 469,320 293,457 118,689
Proceeds from sales of investments.......................... 47,539 15,237 --
Acquisition of Armon Networking Ltd., net assets............ (34,231) -- --
Acquisition of Performance Technology, Inc., net of cash
acquired.................................................. (11,583) -- --
Other assets................................................ 2,111 (9,823) (20,269)
--------- --------- ---------
Cash flows used in investing activities................ (119,698) (298,509) (222,309)
--------- --------- ---------
Cash flows provided by financing activities:
Proceeds (payments) from issuance of long-term debt......... (451) 254 157
Purchase of treasury common stock........................... (57,353) (1,272) (891)
Issuance of common stock.................................... 102,740 35,308 25,248
--------- --------- ---------
Cash flows provided by financing activities............ 44,936 34,290 24,514
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents.......... 31,151 (6,160) (28,797)
Net equity of Centillion Networks, Inc. upon combination...... -- 9,390 --
Net equity of Scorpion Ltd. upon acquisition.................. -- 3,157 --
Elimination of SynOptics' net cash activity for the six months
ended December 31, 1993..................................... -- -- 128,700
Elimination of Xylogics, Inc. net cash activity for the three
months ended October 31, 1994............................... -- (2,476) --
Cash and cash equivalents at beginning of year................ 283,913 280,002 180,099
--------- --------- ---------
Cash and cash equivalents at end of year...................... $ 315,064 $ 283,913 $ 280,002
========= ========= =========
Supplemental disclosure of cash flow information:
Interest paid during the year............................... $ 5,927 $ 6,021 $ 6,100
========= ========= =========
Income taxes paid during the year........................... $ 108,881 $ 98,955 $ 51,834
========= ========= =========

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

23
25

BAY NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The consolidated financial statements include the accounts of Bay Networks,
Inc. (Bay Networks or the Company) and its subsidiaries. All significant
intercompany accounts and transactions have been eliminated.

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.

Cash Equivalents, Fair Values of Financial Instruments & Concentration of
Credit Risk

Financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of cash equivalents,
investments and trade receivables.

All of the Company's cash equivalents and investments are classified as
available-for-sale and are reported at fair value with material unrealized gains
and losses, if any, included in stockholders' equity. The fair value of
investments is based on quoted market prices. Realized gains and losses are
included in net interest income and other. Cash equivalents have original
maturities of three months or less. The Company has cash equivalents and
investments with various high quality institutions and, by policy, limits the
amount of credit exposure to any one institution.

The Company sells its products to customers in diversified industries
worldwide. The Company performs on-going credit evaluations of its customers'
financial condition and generally does not require collateral. The Company
maintains reserves for potential credit losses, and such losses have been within
management's expectations and have not been material in any year. The Company's
trade receivables are derived from sales spread across various industries and
various geographical areas.

Foreign Currency Translation

The functional currency of each of the Company's international subsidiaries
is the foreign subsidiary's local currency. Assets and liabilities of the
Company's international operations are translated into U.S. dollars at exchange
rates in effect at the balance sheet date. Income and expense items are
translated at average exchange rates for the period. Accumulated net translation
adjustments were not material. Foreign exchange transaction gains and losses
were not material and are included in the results of operations.

Bay Networks' international business is an important contributor to the
Company's revenue and net profits. However, the majority of Bay Networks'
international sales are denominated in the U.S. dollar, and an increase in the
value of the U.S. dollar relative to foreign currencies could make products sold
internationally less competitive. The operating expenses of Bay Networks'
overseas offices are paid in local currencies and are subject to the effect of
fluctuations in foreign currency exchange rates. The effect of foreign exchange
rate fluctuations did not significantly impact the Company's operating results.
Financial exposure may nonetheless result, primarily from the timing of
transactions and the movement of exchange rates.

24
26

BAY NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Inventories

Inventories, stated at the lower of cost (first-in, first-out) or market,
consist of:

JUNE 30,
--------------------
(In thousands) 1996 1995
- - ------------------------------------------------------------------------ -------- -------

Raw materials........................................................... $ 98,342 $30,988
Work-in-process......................................................... 54,468 38,158
Finished goods.......................................................... 86,915 25,454
-------- -------
Total inventories..................................................... $239,725 $94,600
======== =======

Property and Equipment

Property and equipment are stated at cost. Depreciation is provided for on
the straight-line method over the estimated useful lives of the assets ranging
from two to five years. Leasehold improvements are recorded at cost and are
amortized using the straight-line method over the remaining lease term or the
economic useful life, whichever is shorter.

JUNE 30,
-----------------------
(In thousands) 1996 1995
- - --------------------------------------------------------------------- --------- ---------

Machinery and equipment.............................................. $ 309,473 $ 214,942
Furniture and fixtures............................................... 36,685 22,769
Leasehold improvements............................................... 55,327 26,086
-------- --------
Total property and equipment....................................... 401,485 263,797
Accumulated depreciation and amortization............................ (189,811) (141,618)
-------- --------
Total property and equipment, net.................................. $ 211,674 $ 122,179
======== ========

Warranty

Upon shipment to its customers, the Company provides for the estimated cost
to repair or replace products to be returned under warranty. The Company's
warranty period is up to 12 months from the date of shipment for domestic sales
and up to 15 months from the date of shipment for international export sales.

Revenue Recognition

The Company recognizes revenue from product sales and accrues for estimated
returns at the time of shipment. Service revenue is recognized at the time
service is provided or ratably over the contractual service period.

Advertising Costs

Advertising costs are charged to operations as incurred. Advertising
expense was $18.2 million, $7.6 million and $8.4 million in 1996, 1995 and 1994,
respectively.

Net Income per Share

Net income per share is calculated using the weighted average number of
common shares and dilutive common share equivalents outstanding during the
period. Dilutive common share equivalents consist of stock options using the
treasury stock method.

25
27

BAY NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Stock Distribution

On November 24, 1995, the Company effected a stock distribution in the form
of a three-for-two stock split to stockholders of record as of October 30, 1995.
All share and per share amounts applicable to prior periods have been
retroactively restated to reflect the effect of this split.

Effect of New Accounting Standards

In 1995, the Financial Accounting Standards Board (FASB) issued Statement
No. 121 (SFAS 121), Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of. The Company will adopt SFAS 121 in the
first quarter of fiscal year 1997 and, based on current circumstances, does not
believe the effect of adoption will be material.

The Company accounts for its stock options and its employee stock purchase
plan in accordance with the provisions of the Accounting Principles Board
Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees. In 1995, the
FASB issued Statement No. 123 (SFAS 123), Accounting for Stock-Based
Compensation. The Company intends to adopt the pro forma disclosure alternative
of SFAS 123 for the Company's fiscal year 1997. The adoption of SFAS 123 is not
expected to have a material effect on consolidated financial position, results
of operations, or cash flows.

Reclassifications

Certain reclassifications have been made to the 1995 and 1994 consolidated
financial statements to conform to the 1996 presentation.

2. BUSINESS COMBINATIONS

On October 21, 1994, SynOptics Communications, Inc. (SynOptics) and
Wellfleet Communications, Inc. (Wellfleet) effected a strategic combination of
the two companies through the merger of a wholly-owned subsidiary of Wellfleet
with and into SynOptics (the Combination). In connection with the Combination,
Wellfleet changed its name to Bay Networks, Inc. and issued 70,612,759 shares of
common stock for all the outstanding stock of SynOptics in a transaction
accounted for as a pooling of interests. The accompanying consolidated financial
statements are presented on a combined basis for all periods presented.

In May 1995, Bay Networks acquired Centillion Networks, Inc. (Centillion)
and issued 5,353,275 shares of common stock for all the outstanding stock of
Centillion in a transaction accounted for as a pooling of interests. As the
results of operations and financial position of Centillion were not material to
Bay Networks' 1995 consolidated financial statements, the prior years' amounts
were not restated.

In December 1995, Bay Networks acquired Xylogics, Inc. (Xylogics), in a
transaction accounted for as a pooling of interests. The Company issued
8,710,865 shares of common stock for all the outstanding stock of Xylogics and
reserved 1,655,275 shares of its common stock for issuance under Xylogics stock
option plans which the Company assumed in the acquisition. The accompanying
consolidated financial statements for prior periods have, accordingly, been
restated to reflect this transaction.

26
28

BAY NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

2. BUSINESS COMBINATIONS (CONTINUED)
The following information shows revenue and net income (loss) of the
separate companies through the periods preceding the business combinations and
the combined results following the business combinations.

YEARS ENDED JUNE 30,
----------------------------------------
(In thousands) 1996 1995 1994
- - ----------------------------------------------------- ---------- ---------- ----------

Revenue:
Bay Networks....................................... $2,026,038 $1,042,665 --
Wellfleet.......................................... -- 126,572 $ 384,223
SynOptics.......................................... -- 173,056 701,749
Xylogics........................................... 30,596 61,302 50,421
---------- ---------- ----------
$2,056,634 $1,403,595 $1,136,393
========== ========== ==========
Net income (loss):
Bay Networks....................................... $ 214,383 $ 92,633 --
Wellfleet.......................................... -- 21,576 $ 61,106
SynOptics.......................................... -- 16,790 59,825
Xylogics........................................... (8,058)(1) (2,013) 3,447
---------- ---------- ----------
$ 206,325 $ 128,986 $ 124,378
========== ========== ==========

- - ---------------
(1) Xylogics' net loss includes a portion of the merger related expenses.

Merger related expenses for these transactions were as follows:

YEARS ENDED JUNE
30,
-------------------
(In thousands) 1996 1995
--------------------------------------------------------------- ------- -------

Asset write-offs:
Duplicate product line inventory............................. $ 1,000 $ 4,700
Other........................................................ 4,300 4,200
------- -------
5,300 8,900
Accruals (reversals):
Duplicate facilities......................................... (5,900) 15,700
Transaction fees............................................. 7,600 18,800
Severance and related expenses............................... 1,200 8,200
Other........................................................ 2,000 11,800
------- -------
4,900 54,500
------- -------
$10,200 $63,400
======= =======

Of the total amount for the year ended June 30, 1995, $61.1 million relates
to the Wellfleet/SynOptics combination and $2.3 million relates to the
Centillion acquisition. Of the total amount for the year ended June 30, 1996,
$16.1 million relates to the Xylogics acquisition and $5.9 million represents a
reversal of previously recorded merger related expenses in connection with the
prior year's transactions. Such reduction in the previous estimate was due
primarily to the usage of facilities which the Company had previously planned to
vacate. The remaining $5.5 million accrued at June 30, 1996 allows for accrued
rent and severance related expenses to be paid principally over periods of up to
two years.

The Company has acquired several smaller businesses, each of which has been
accounted for as a purchase. Bay Networks purchased Performance Technology, Inc.
for approximately $12.6 million and Armon

27
29

BAY NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

2. BUSINESS COMBINATIONS (CONTINUED)
Networking, Ltd. for approximately $34.2 million in 1996; Scorpion Ltd. for
approximately $9.3 million in 1995; and Coral Network Corporation for
approximately $18.0 million in 1994. The purchase price of each acquired company
was allocated to the acquired assets and liabilities based on their estimated
fair values as of the date of respective acquisition. Amounts allocated to
developed technology, workforce and goodwill are being amortized on a
straight-line basis over a five year period. Amounts allocated to in-process
research and development of approximately $39.7 million, $6.7 million and $17.9
million in 1996, 1995 and 1994, respectively, were expensed upon the closing of
the respective transactions. Pro forma information has not been presented
because the effects of these acquisitions were not material to the Company's
consolidated financial position, results of operations, or cash flows.

On June 16, 1996, Bay Networks signed a definitive agreement to acquire the
Digital Signal Processing (DSP) modem business of Penril DataComm Networks, Inc.
(Penril), a provider of advanced DSP-based modems and remote access products.
Under terms of the agreement, the Company will exchange $10 payable in the
Company's common stock according to an exchange value determined by averaging
the Company's closing stock prices over a specified period prior to closing, for
each share of Penril's common stock. (At June 6, 1996, Penril had 10,543,369
shares of common stock outstanding.) Immediately prior to the closing of this
transaction, the remaining non-DSP modem businesses of Penril will be spun off
to Penril stockholders. This acquisition is subject to regulatory approval and
Penril stockholders' approval. The acquisition will be accounted for as a
purchase. Based on preliminary estimates, the Company expects to allocate
approximately $60 million to $65 million to in-process research and development,
which will be charged to expense upon the closing of the transaction, currently
expected to be in the quarter ending December 31, 1996.

3. FINANCIAL INSTRUMENTS

Cash, Cash Equivalents and Investments

All of Bay Networks' cash, cash equivalents and investments were classified
as available-for-sale and consist of the following:

JUNE 30,
-----------------------------
(In thousands) 1996 1995
- - --------------------------------------------------------------------- ------------- -------------

Estimated Fair Value:
U.S. Treasuries and obligations of U.S. Government agencies.......... $ 158,000 $ 119,331
Obligations of states and political subdivisions..................... 122,338 163,519
Commercial paper..................................................... 101,568 177,084
Short-term money market funds........................................ 132,740 90,817
Bankers' acceptances................................................. -- 16,143
Demand deposits...................................................... 56,150 22,381
Other debt securities................................................ 17,425 62,374
-------- --------
$ 588,221 $ 651,649
======== ========

28
30

BAY NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

3. FINANCIAL INSTRUMENTS (CONTINUED)
The estimated fair value of available-for-sale securities by contractual
maturity is as follows:

JUNE 30,
-----------------------------
(In thousands) 1996 1995
- - --------------------------------------------------------------------- ------------- -------------

Due in three months or less.......................................... $ 315,064 $ 283,913
Due through one year................................................. 119,093 314,872
Due after one year through three years............................... 132,547 52,864
Due after three years through five years............................. 21,517 --
-------- --------
$ 588,221 $ 651,649
======== ========

Both gross unrealized gains and losses as of June 30, 1996 and 1995, and
realized gains and losses on sales of each type of security for the years ended
June 30, 1996 and 1995, were immaterial. At June 30, 1996 and 1995, the fair
market value of available-for-sale investments and cash equivalents approximates
cost. For the purpose of determining gross realized gains and losses, the cost
of securities sold is based upon specific identification.

Long-Term Debt

A subsidiary of the Company has outstanding $110,000,000 of convertible
subordinated debentures which bear interest of 5 1/4% per annum, payable
semi-annually, and mature in May 2003. The debentures are convertible at the
option of the holder into the Company's common stock at a conversion price of
$42.61 per share. Beginning May 1996, the debentures are redeemable at the
option of the Company, initially at approximately 103.7% and at decreasing
prices thereafter to 100% at maturity. The fair value of these debentures is
estimated based on quoted market prices obtained from a third party for similar
debt and is approximately $99.7 million and $101.3 million as of June 30, 1996
and 1995, respectively. The Company has reserved 2,581,725 shares of common
stock for the conversion of these debentures. Interest expense, primarily
related to these debentures, was approximately $5.9 million, $6.0 million and
$5.9 million in 1996, 1995 and 1994, respectively.

4. COMMITMENTS AND CONTINGENCIES

Leases

The Company leases its domestic and international facilities under
cancelable, non-cancelable and month-to-month operating leases. Rent expense was
approximately $27.5 million, $22.7 million and $18.4 million in 1996, 1995 and
1994, respectively.

A subsidiary of the Company has a fifty percent interest in a limited
partnership which owns one of the Company's manufacturing facilities. The
Company leases this facility from the limited partnership. Included in the
operating lease commitments table below are $13.7 million related to this
facility.

29
31

BAY NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

4. COMMITMENTS AND CONTINGENCIES (CONTINUED)
Future minimum lease payments as of June 30, 1996, of which $2.1 million
has been accrued as merger related expenses, are as follows:

(In thousands)
-------------------------------------------------------------------------- OPERATING
YEARS ENDING LEASES
-------------------------------------------------------------------------- ----------

1997.................................................................... $ 34,442
1998.................................................................... 33,983
1999.................................................................... 29,630
2000.................................................................... 24,016
2001.................................................................... 18,850
Thereafter................................................................ 30,759
--------
Total minimum payments required........................................... $171,680
========

Legal

5. EQUITY

Employee Stock Option Plans. Bay Networks established a Stock Option Plan
in 1994 under which it authorized 30,000,000 shares of common stock for granting
of either incentive or non-qualified stock options and increased the authorized
shares to 41,700,000 in 1996. Exercisability, option price and other terms are
determined by the Board of Directors, but the option price shall not be less
than the fair market value of the stock at the date of grant. Shares of options
generally vest at the rate of 25% after one year from the date of grant, and
then ratably over the following 36 months. At June 30, 1996, 13,339,025 shares
of common stock were reserved for future grants.

Pursuant to business combinations in 1995, the Company assumed stock option
plans under which options were generally exercisable upon grant and vested at
the rate of 25% after one year from the date of grant, and then ratably over the
following 36 months; however, those shares received upon exercise prior to
vesting were subject to repurchase by the Company. As of June 30, 1996, 60,222
shares were subject to repurchase.

Additionally, on December 15, 1995, pursuant to the acquisition of
Xylogics, Bay Networks assumed 1,655,275 outstanding options originally issued
under various Xylogics stock option plans. The options generally vest at the
rate of 25% per year beginning one year from the date of grant.

Outside Directors Stock Option Plans. Bay Networks established an Outside
Directors Stock Option Plan in 1994 under which it authorized 750,000 shares of
the common stock pursuant to a fixed formula for granting of non-qualified stock
options to directors of the Company who are not employees of the Company
(Outside Directors) at exercise prices not less than the fair market value on
the date of grant. Upon initial election or appointment, an Outside Director
shall automatically receive an option to purchase 52,500 shares of common stock.
An Outside Director is granted an additional 15,000 shares of common stock
automatically on each of the second through seventh anniversary dates of his or
her initial grant. The options granted under the Directors Stock Option Plan
generally vest at a rate of 33 1/3% on the one year anniversary of the date of

30
32

BAY NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

5. EQUITY (CONTINUED)
grant and then ratably over the following 36 months. As of June 30, 1996,
495,000 shares of common stock were reserved for future grants.

Additional information concerning stock option activity under the various
plans is as follows:

NUMBER OF EXERCISE PRICE
SHARES PER SHARE
---------- ----------------

Outstanding at June 30, 1994.............................. 27,816,565 $ .02 - $35.06
Granted and assumed....................................... 12,907,410 .18 - 26.42
Exercised................................................. (4,468,013) .02 - 22.99
Canceled.................................................. (2,779,672) .10 - 35.06
---------- --------- ------
Outstanding at June 30, 1995.............................. 33,476,290 .02 - 35.06
Granted................................................... 6,134,745 19.69 - 43.96
Exercised................................................. (8,625,632) .02 - 35.06
Canceled.................................................. (1,902,955) .10 - 43.81
---------- --------- ------
Outstanding at June 30, 1996.............................. 29,082,448 $ .03 - $43.96
========== ========= ======
Exercisable at June 30, 1996.............................. 26,279,561 $ .03 - $43.96
========== ========= ======

Employee Stock Purchase Plans. Bay Networks has an Employee Stock Purchase
Plan (the Purchase Plan) under which 2,695,812 shares of common stock remain
available for future purchases. Each eligible employee may purchase shares of
common stock through the accumulation of payroll deductions of up to 10% of each
participating employee's gross wages not to exceed a maximum of $5,040 per
purchase period. The Purchase Plan authorizes the purchase of shares of common
stock at the end of semi-annual purchase periods beginning May 1 and November 1
of each year. The purchase price is an amount equal to 85% of its fair market
value determined as of the beginning of an offering period and the end of a
purchase period. In 1996 and 1995, employees purchased 696,712 shares and
613,070 shares and approximately $13.9 million and $8.2 million of proceeds were
recorded to stockholders' equity, respectively. The Purchase Plan will expire
upon either issuance of all shares reserved for issuance or at the discretion of
the Board of Directors. There are no plans to terminate the Purchase Plan at
this time.

Both Wellfleet and SynOptics maintained employee stock purchase plans under
which eligible employees purchased common stock at a price equal to 85% of the
lower of the fair market values as of the beginning of an offering period and
the end of a purchase period. During 1994, 543,658 shares were issued under
these plans and approximately $7.7 million of proceeds were recorded to
stockholders' equity. Pursuant to the Combination, these plans were terminated.

Stock Purchase Rights Plan. Under a preferred stock purchase rights plan,
adopted by the Company's Board of Directors on February 7, 1995, stockholders of
the Company received rights to purchase stock in the Company, or in an acquirer
of the Company, at a discounted price, under certain circumstances and in the
event of particular hostile efforts to acquire control of the Company. The
rights may be redeemed pursuant to the plan by the Board of Directors. The
rights expire on February 7, 2005.

6. EMPLOYEE BENEFIT PLAN

The Company maintains the Bay Networks, Inc. 401(k) Plan (the Plan) to
provide retirement benefits for its employees. As allowed under Section 401(k)
of the Internal Revenue Code, the Plan provides tax deferred salary deductions
for eligible employees. Eligible employees may contribute from 1% to 15% of
their annual compensation to the Plan, limited to a maximum amount as set by the
Internal Revenue Service. The Company will make matching contributions unless
business conditions dictate otherwise, pursuant to a fixed

31
33

BAY NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

6. EMPLOYEE BENEFIT PLAN (CONTINUED)
formula and up to a maximum of $1,500 per year. Bay Networks' matching
contributions to the Plan totaled $3.4 million in 1996 and immaterial in 1995
and 1994.

7. INCOME TAXES

The components of the provision for income taxes are as follows:

YEARS ENDED JUNE 30,
---------------------------------
(In thousands) 1996 1995 1994
---------------------------------------------------- -------- -------- -------

Current:
Federal........................................... $131,676 $103,206 $77,200
State............................................. 21,262 19,821 15,592
Foreign........................................... 6,453 6,256 2,243
-------- -------- -------
159,391 129,283 95,035
Deferred:
Federal........................................... (8,346) (31,927) (9,362)
State............................................. (1,171) (5,669) (1,830)
Foreign........................................... (4,383) -- --
-------- -------- -------
(13,900) (37,596) (11,192)
-------- -------- -------
Total provision for income taxes.................... $145,491 $ 91,687 $83,843
======== ======== =======

The components of the Company's total income (loss) before provision for
income taxes are as follows:

YEARS ENDED JUNE 30,
---------------------
(In thousands) 1996 1995
--------------------------------------------------------------- -------- --------

Domestic....................................................... $363,282 $205,273
Foreign........................................................ (11,466) 15,400
-------- --------
Total.......................................................... $351,816 $220,673
======== ========

For the year ended June 30, 1994, the foreign component of the Company's
income before provision for income taxes was not material.

The Company's effective tax rate was different from the U.S. statutory
income tax rate due to the following:

YEARS ENDED JUNE 30,
----------------------
1996 1995 1994
---- ---- ----

U.S. federal statutory tax rate........................................ 35.0% 35.0% 35.0%
State taxes, net of federal income tax benefit......................... 3.3 3.5 4.0
Tax benefit from Foreign Sales Corporation............................. (1.8) (2.6) (1.6)
Research and development (R&D) tax credits............................. -- -- (0.9)
In-process R&D costs relating to an acquisition........................ -- -- 2.7
Merger related expenses................................................ 1.9 3.5 --
Foreign losses not benefitted.......................................... 1.9 -- --
Other.................................................................. 1.1 2.1 1.1
---- ---- ----
41.4% 41.5% 40.3%
==== ==== ====

32
34

BAY NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

7. INCOME TAXES (CONTINUED)
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The Company's net
deferred tax assets (net of deferred tax liabilities) are comprised primarily of
the following:

YEARS ENDED JUNE
30,
-------------------
(In millions) 1996 1995
- - ------------------------------------------------------------------------- ----- -----

Reserves not currently deductible for tax purposes....................... $67.8 $59.7
Accrued expenses not currently deductible for tax purposes............... 6.1 3.6
Net operating losses and credit carryforwards acquired from Coral Network
Corporation............................................................ 3.9 4.1
Less valuation reserve against above carryforwards....................... (3.9) (4.1)
Net operating losses and credit carryforwards acquired from Centillion
Networks, Inc.......................................................... 2.6 4.4
Less valuation reserve against above carryforwards....................... (2.4) (2.4)
Net operating losses and credit carryforwards acquired from Performance
Technology, Inc........................................................ 0.5 --
Less valuation reserve against above carryforwards....................... (0.5) --
State income taxes....................................................... 2.5 3.0
Other individually immaterial items...................................... 5.6 --
----- -----
Total.................................................................... $82.2 $68.3
===== =====

The valuation allowance at June 30, 1994 was $4.3 million related to Coral
Network Corporation. At June 30, 1996, the Company has available the following
acquired tax carryforwards. Utilization of these carryforwards may be subject to
substantial limitations due to the ownership change limitations provided by the
Internal Revenue Code of 1986.

FEDERAL YEARS OF
TYPE OF TAX CARRYFORWARD: COMPANY FROM WHICH ACQUIRED: AMOUNTS EXPIRATION
- - ------------------------------------ ----------------------------- -------------- ----------

Net operating losses Coral Network Corporation $ 10.6 million 2003-2007
Centillion Networks, Inc. 5.7 million 2007-2009
Performance Technology, Inc. 1.0 million 2004-2009
General Business Tax Credits Coral Network Corporation $ 0.2 million 2003-2007
Centillion Networks, Inc. 0.2 million 2007-2009
Performance Technology, Inc. 0.2 million 2004-2009

8. GEOGRAPHIC AREA AND SIGNIFICANT CUSTOMER INFORMATION

Bay Networks operates in one industry segment and develops, manufactures,
markets and supports a comprehensive line of data networking products and
services, including high-speed routers, switches, intelligent hubs, remote and
Internet access solutions and sophisticated management software providing
network design and configuration solutions. These products enable end users to
build or enhance their data network systems, including all levels from small
local area networks to large enterprise-wide information infrastructures.

One customer accounted for approximately 13% ($263.0 million), 14% ($198.0
million) and 14% ($162.0 million) of the Company's revenue in 1996, 1995 and
1994, respectively.

33
35

BAY NETWORKS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

8. GEOGRAPHIC AREA AND SIGNIFICANT CUSTOMER INFORMATION (CONTINUED)
The Company's foreign operations consist of sales, marketing, and support
activities in subsidiaries throughout the world. The Company's international
export sales represented 34.8%, 32.7% and 30.4% in 1996, 1995 and 1994,
respectively. Substantially all of the export sales each year were denominated
in U.S. dollars.

Operating income generated by the foreign operations of the Company and
their corresponding identifiable assets were not material to the Company in 1995
and 1994, respectively. Revenue classified by major geographic area is as
follows:

YEARS ENDED JUNE 30,
------------------------------------
(In thousands) 1996 1995 1994
- - ----------------------------------------------------------- ---------- ---------- ----------

Revenues from unaffiliated customers in the United
States................................................... $1,340,136 $ 945,221 $ 790,716
Export sales from the United States:
Europe................................................... 469,762 300,896 211,780
Other.................................................... 246,736 157,478 133,897
---------- ---------- ----------
$2,056,634 $1,403,595 $1,136,393
========== ========== ==========
Operating income (loss):
United States............................................ $ 341,765
Europe................................................... (18,181)
Other.................................................... 5,905
Eliminations............................................. (6,162)
----------
$ 323,327
----------
----------
Identifiable assets:
United States............................................ $1,452,935
Europe................................................... 50,241
Other.................................................... 11,052
Eliminations............................................. (7,693)
----------
$1,506,535
----------
----------

9. SELECTED QUARTERLY DATA (UNAUDITED)

THREE MONTHS ENDED
-----------------------------------------
(In thousands, except per share amounts) SEPT. 30 DEC. 31 MAR. 31 JAN. 30
- - ------------------------------------------------------ -------- -------- -------- --------

1996:
Revenue............................................... $457,773 $541,601 $521,715 $535,545
Gross profit.......................................... 251,563 293,388 279,428 286,937
Net income before provision for income taxes.......... 100,770 99,270 63,542 88,234
Net income............................................ 63,168 58,826 29,187 55,144
Net income per share.................................. 0.32 0.29 0.15 0.28
1995:
Revenue............................................... $313,661 $328,711 $353,299 $407,924
Gross profit.......................................... 173,382 181,325 193,877 224,028
Income before provision for income taxes.............. 61,589 1,042 66,658 91,384
Net income............................................ 38,151 (4,101) 38,985 55,951
Net income per share.................................. 0.21 (0.02) 0.20 0.29

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS IN ACCOUNTING AND
FINANCIAL DISCLOSURE.

None.

34
36

PART III

Certain information required by Part III is omitted from this Report in
that the Company will have filed its definitive proxy statement pursuant to
Regulation 14A not later than 120 days after the end of the fiscal year covered
by this report, and certain information included therein is incorporated herein
by reference.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

Information relating to the directors of the Company is set forth under the
caption "Information about Bay Networks -- Management" in the Company's
definitive Proxy Statement (the "Proxy Statement") in connection with the Annual
Meeting of Stockholders to be held October 17, 1996. Such information is
incorporated herein by reference. Information relating to the executive officers
of the Company is set forth in Part I of this report under the caption
"Management." Information relating to compliance with Section 16(a) of the
Securities Exchange Act of 1934 is set forth under the caption "Executive
Compensation and Other Matters -- Section 16(a) of the Securities Exchange Act
of 1934 -- Beneficial Ownership Reporting Compliance" in the Proxy Statement and
incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION.

Information relating to executive compensation is set forth under the
caption "Executive Compensation and Other Matters -- Stock Options Granted in
Fiscal 1996," "-- Option Exercises and Fiscal 1996 Year-End Values," "-- Change
of Control Arrangements," "-- Compensation of Directors," and "-- Compensation
Committee Interlocks and Insider Participation" in the Proxy Statement. Such
Information is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

Information relating to ownership of equity securities of the Company by
certain beneficial owners and management is set forth under the caption
"Information about Bay Networks -- Stock Ownership of Certain Beneficial Owners
and Management" in the Proxy Statement. Such information is incorporated herein
by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

Information is set forth under the caption "Executive Compensation and
Other Matters -- Certain Transactions" in the Proxy Statement. Such information
is incorporated herein by reference.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) 1. Financial Statements

The financial statements listed in Item 14(a) are filed as part of this
Form 10-K.

2. Financial Statement Schedule

The financial statement schedule listed in Item 14(a) is filed as part of
this Form 10-K.

3. Exhibits

The exhibits listed in the accompanying Index to Exhibits are filed or
incorporated by reference as part of this Form 10-K.

(b) Reports on Form 8-K

No reports on Form 8-K were filed during the fourth quarter of fiscal 1996.

(d) See Index to Consolidated Financial Statements and Financial Statement
Schedule of this Form 10-K

35
37

SIGNATURE

Pursuant to the requirements of Section 13 or 15(d) of the Securities Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized in the City of Santa Clara, State
of California, on the 5th day of September, 1996.

BAY NETWORKS, INC.

By: /s/ ANDREW K. LUDWICK

------------------------------------
Andrew K. Ludwick
President and Chief
Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.

SIGNATURE TITLE DATE
- - ------------------------------------------ ------------------------------- ------------------

/s/ ANDREW K. LUDWICK President, Chief Executive September 5, 1996
- - ------------------------------------------ Officer and Director
Andrew K. Ludwick (Principal Executive Officer)
/s/ WILLIAM J. RUEHLE Executive Vice President and September 5, 1996
- - ------------------------------------------ Chief Financial Officer
William J. Ruehle (Principal Financial Officer)
/s/ VITO E. PALERMO Vice President and Controller September 5, 1996
- - ------------------------------------------ (Principal Accounting Officer)
Vito E. Palermo
/s/ PAUL J. SEVERINO Chairman of the Board September 5, 1996
- - ------------------------------------------
Paul J. Severino
Director , 1996
- - ------------------------------------------
Arthur Carr
/s/ SHELBY H. CARTER, JR. Director September 5, 1996
- - ------------------------------------------
Shelby H. Carter, Jr.
Director , 1996
- - ------------------------------------------
Kathleen A. Cote
/s/ JOHN S. LEWIS Director September 5, 1996
- - ------------------------------------------
John S. Lewis
/s/ BENJAMIN F. ROBELEN Director September 5, 1996
- - ------------------------------------------
Benjamin F. Robelen
/s/ RONALD V. SCHMIDT Director September 5, 1996
- - ------------------------------------------
Ronald V. Schmidt

36
38

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE

ITEM 14(A)

Report of Independent Auditors
Report of Independent Accountants
Consolidated balance sheets at June 30, 1996 and June 30, 1995
Consolidated statements of income for the three years ended June 30, 1996, 1995
and 1994
Consolidated statements of stockholders' equity for the three years ended June
30, 1996, 1995 and 1994
Consolidated statements of cash flows for the three years ended June 30, 1996,
1995 and 1994
Notes to consolidated financial statements
Selected quarterly data (unaudited):
Three months ended fiscal years 1996 and 1995

SCHEDULE:

II Valuation Accounts for the years ended June 30, 1996, 1995, and 1994

All other schedules have been omitted since the required information is not
present in amounts sufficient to require submission of the schedules, or because
the information required is included in the consolidated financial statements or
notes thereto.
39

SCHEDULE II

BAY NETWORKS, INC.

VALUATION ACCOUNTS
(In thousands)

BALANCE AT BALANCE
BEGINNING CHARGE TO AT END
ALLOWANCE FOR DOUBTFUL ACCOUNTS: OF PERIOD EXPENSE WRITE-OFFS OTHER OF PERIOD
- - ------------------------------------ ---------- --------- ---------- -------- ---------

June 30, 1996....................... $ 10,441 $ 1,364 $ (2,122) $ -- $ 9,683
=========== ========== ========== ========== ==========
June 30, 1995....................... $ 10,935 $ 1,482 $ (2,077) $ 101(2) $10,441
=========== ========== ========== ========== ==========
June 30, 1994....................... $ 8,626 $ 3,425 $ (798) $ (318)(1) $10,935
=========== ========== ========== ========== ==========

- - ---------------

(1) Due to the differing fiscal years of SynOptics and Wellfleet amount
represents the elimination of SynOptics' net allowance for doubtful accounts
activity for the six months ended December 31, 1993.

(2) Due to the differing fiscal years of the Company and Xylogics amount
represents the elimination of Xylogics' net allowance for doubtful accounts
activity for the three months ended October 31, 1994.
40

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(A) EXHIBITS

2.1 Plan and Agreement of Merger dated as of June 16, 1996 and amended on August 5,
1996 by and among the Registrant, Penril DataComm Networks, Inc. and Beta
Acquisition Corp.
3.1 Restated Certificate of Incorporation of the Registrant, which is incorporated
herein by reference to Exhibit 4.1 to the Registrant's Registration Statement on
Form S-8 (Registration No. 33-92736) filed on May 26, 1995.
3.2 Bylaws of the Registrant, as amended and restated, which is incorporated herein by
reference to Exhibit 3.3 to the Registrant's Registration Statement on Form S-4
(File No. 33-83946) filed with the Securities and Exchange Commission on September
14, 1994.
4.1 Rights Agreement dated as of February 7, 1995 between the Registrant and The First
National Bank of Boston, which is incorporated herein by reference to Exhibit 1 to
the Registrant's Report on Form 8-K dated February 7, 1995.
10.1 Lease Agreement for real property dated May 31, 1995, between Technology Park VII
Limited Partnership and the Registrant, which is incorporated by reference to
Exhibit 10.1 to the Registrant's Annual Report on Form 10-K dated September 22,
1995.
10.2 Lease Agreement for real property dated November 29, 1994, between SNC LAB SUD and
the Registrant, which is incorporated by reference to Exhibit 10.2 to the
Registrant's Annual Report on Form 10-K dated September 22, 1995.
10.3* Amended and Restated 1994 Stock Option Plan, amended on April 2, 1996.
10.4* Amended and Restated 1994 Outside Directors Stock Option Plan, amended on November
27, 1995.
10.5* 1994 Employee Stock Purchase Plan, which is incorporated herein by reference to
Exhibit 10.5 to the Registrant's Registration Statement on Form S-4 (File No.
33-83946) filed with the Securities and Exchange Commission on September 14, 1994.
10.6* 1991 Director Stock Option Plan, which is incorporated herein by reference to the
Registrant's Registration Statement on Form S-1 (File No. 33-41349) filed with the
Securities and Exchange Commission June 21, 1991.
10.7* Form of Stock Option agreements under the SynOptics Communications Inc. Amended and
Restated 1986 Stock Option Plan assumed by the Registrant which is incorporated
herein by reference to Exhibit 10.21 to the 1990 Form 10-K of SynOptics
Communications, Inc.
10.8 Agreement and Plan of Merger dated as of May 9, 1995 among the Registrant, Cent
Merger Co., Inc. and Centillion Networks, Inc., which is incorporated herein by
reference to Exhibit 1 to the Registrant's Report on Form 8-K dated May 11, 1995.
10.9 Agreement and Plan of Merger dated as of September 5, 1995 among the Registrant,
Branch Merger Co., Inc. and Xylogics, Inc. which is incorporated herein by
reference to Exhibit 2.1 to the Registrant's Report on Form 8-K dated December 15,
1995.
10.10 Indenture, dated as of April 23, 1993, between SynOptics Communications, Inc. and
The First National Bank of Boston for 5.25% Convertible Subordinated Debentures due
2003, which is incorporated herein by reference to Exhibit 10.2 to the Form 10-Q
for the quarter ended July 2, 1993 of SynOptics Communications, Inc.
10.11 First Supplemental Indenture dated as of October 20, 1994 among SynOptics
Communications, Inc., Wellfleet Communications, Inc., and The First National Bank
of Boston, which is incorporated by reference to Exhibit 10.10 to the Registrant's
Annual Report on Form 10-K dated September 22, 1995.
10.12 Guaranty dated as of October 20, 1994 between Wellfleet Communications, Inc. and
The First National Bank of Boston, which is incorporated by reference to Exhibit
10.11 to the Registrant's Annual Report on Form 10-K dated September 22, 1995.
10.13 Lease Agreement dated June 1, 1990 between the Registrant and Sobrato Interests for
the Company's principal executive offices, which is incorporated by reference to
Exhibit 10.43 of the 1990 Form 10-K of SynOptics Communications, Inc.

10.14 Amendment, dated March 2, 1992, to the lease agreement dated June 1, 1990 between
the Registrant and Sobrato Interests for the Registrant's principal executive
offices, which is incorporated by reference to Exhibit 10.12 of the 1991 Form 10-K
of SynOptics Communications, Inc.
10.15 Limited Partnership Agreement dated March 2, 1992 between SynOptics Real Estate,
Inc. and Sobrato Interests to form Astra Real Estate, Inc., which is incorporated
by reference to Exhibit 10.16 of the 1991 Form 10-K of SynOptics Communications,
Inc.
10.16 Guaranty of SynOptics Communications, Inc. of real estate obligations of SynOptics
Real Estate, Inc., which is incorporated by reference to Exhibit 10.17 of the 1991
Form 10-K of SynOptics Communications, Inc.
10.17 Lease Agreement dated March 2, 1992 between the Registrant and Astra Real Estate,
Inc., which is incorporated by reference to Exhibit 10.18 of the 1991 Form 10-K of
SynOptics Communications, Inc.
11.1 Statement Regarding Computation of Per Share Earnings.
21 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
23.2 Consent of Independent Accountants, Price Waterhouse LLP.
23.3 Report of Independent Accountants on Financial Statement Schedule.
27 Financial Data Schedule.

- - ---------------
(b) The following financial statement schedule is filed herewith.

II Valuation Account

* Indicates compensatory plan or arrangement.