<PAGE>   1

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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549


                                    FORM 10-Q
(MARK ONE)
   [X]         QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

                  FOR THE QUARTERLY PERIOD ENDED MARCH 28, 1998

                                       OR

   [ ]        TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

               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 other 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
              (Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (l) 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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.

    221,885,858 shares of Common Stock, $.01 par value, as of April 25, 1998

                  This report on Form 10-Q includes exhibits.
             The exhibit index is located on page 21 of this report.



================================================================================

<PAGE>   2



                               BAY NETWORKS, INC.
                          QUARTERLY REPORT ON FORM 10-Q
                       FOR THE PERIOD ENDED MARCH 28, 1998


                                      INDEX

<TABLE>
<CAPTION>
                                                                              PAGE
                                                                              ----
<S>      <C>                                                                  <C> 
PART I   FINANCIAL INFORMATION

Item 1.  Financial Statements:

             Condensed Consolidated Balance Sheets - March 28, 1998
               and June 30, 1997                                                 3

             Condensed Consolidated Statements of Operations - Three Months
               and Nine Months Ended March 28, 1998 and March 31, 1997           4

             Condensed Consolidated Statements of Cash Flows - Nine Months
               Ended March 28, 1998 and March 31, 1997                           5

             Notes to Condensed Consolidated Financial Statements              6-10

Item 2.  Management's Discussion and Analysis of Financial
           Condition and Results of Operations                                11-18

Item 3.  Quantitative and Qualitative Disclosures About Market Risk             18


PART II  OTHER INFORMATION

Item 2.  Changes in Securities                                                  19

Item 6.  Exhibits and Reports on Form 8-K                                       19

         Signature                                                              20

         Exhibit Index                                                          21
</TABLE>





                                       2
<PAGE>   3



                         PART I -- FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

                               BAY NETWORKS, INC.
                      CONDENSED CONSOLIDATED BALANCE SHEETS
                                 (in thousands)


<TABLE>
<CAPTION>
                                                            MARCH 28,      JUNE 30,
                                                              1998           1997
                                                           ----------     ----------
                                                           (unaudited)
<S>                                                        <C>            <C>       
ASSETS

Current assets:
    Cash and cash equivalents                              $  358,389     $  529,962
    Short-term investments                                    348,458        105,180
    Accounts receivable, net of allowance for doubtful
       accounts of $5,803 at March 28, 1998 and
       $8,477 at June 30, 1997                                328,673        277,860
    Inventories                                               164,612        144,468
    Deferred income taxes                                     124,996        121,596
    Other current assets                                       49,845         69,351
                                                           ----------     ----------
        Total current assets                                1,374,973      1,248,417
Investments                                                   228,142        146,367
Property and equipment, net                                   232,321        241,069
Goodwill                                                      117,477        113,811
Other assets                                                   75,430         16,382
                                                           ----------     ----------
                                                           $2,028,343     $1,766,046
                                                           ==========     ==========


LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
    Accounts payable                                       $  125,685     $  117,596
    Accrued expenses                                          223,892        201,266
    Accrued income taxes                                           --         39,269
    Deferred revenue                                           68,270         62,678
                                                           ----------     ----------
        Total current liabilities                             417,847        420,809
Long-term debt                                                 98,744        109,995
Stockholders' equity                                        1,511,752      1,235,242
                                                           ----------     ----------
                                                           $2,028,343     $1,766,046
                                                           ==========     ==========
</TABLE>












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


                                       3
<PAGE>   4



                               BAY NETWORKS, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                    (in thousands, except per share amounts)


<TABLE>
<CAPTION>
                                                              THREE MONTHS ENDED              NINE MONTHS ENDED
                                                           ------------------------      ----------------------------
                                                           MARCH 28,      MARCH 31,       MARCH 28,        MARCH 31,
                                                             1998           1997            1998              1997
                                                           ---------      ---------      -----------      -----------
                                                                 (unaudited)                (unaudited)
<S>                                                        <C>            <C>            <C>              <C>        
Revenue                                                    $ 547,182      $ 512,893      $ 1,793,376      $ 1,550,084
Cost of sales                                                290,909        260,231          898,894          795,022
                                                           ---------      ---------      -----------      -----------
  Gross profit                                               256,273        252,662          894,482          755,062
                                                           ---------      ---------      -----------      -----------
Operating expenses:
  Research and development                                    90,477         73,290          260,747          196,813
  Sales and marketing                                        135,973        129,518          408,335          409,248
  General and administrative                                  25,773         20,110           75,124           66,115
  In-process research and development                        154,040             --          161,432          208,186
  Restructuring/severance charges                                 --         32,188               --           32,188
                                                           ---------      ---------      -----------      -----------
    Total operating expenses                                 406,263        255,106          905,638          912,550
                                                           ---------      ---------      -----------      -----------
Income (loss) from operations                               (149,990)        (2,444)         (11,156)        (157,488)
Net interest income and other                                 10,908          2,845           28,615           14,154
                                                           ---------      ---------      -----------      -----------
Income (loss) from continuing operations
  before income taxes and cumulative effect
  of a change in accounting principle                       (139,082)           401           17,459         (143,334)
Provision for income taxes                                     5,084            146           60,824           23,670
                                                           ---------      ---------      -----------      -----------
Income (loss) from continuing operations
  before cumulative effect of a change in
  accounting principle                                      (144,166)           255          (43,365)        (167,004)
Cumulative effect of a change in accounting
  principle, net of tax                                           --             --           12,018               --
                                                           ---------      ---------      -----------      -----------
Net income (loss)                                          $(144,166)     $     255      $   (55,383)     $  (167,004)
                                                           =========      =========      ===========      ===========
Earnings (loss) per share amounts:
Income (loss) from continuing operations
  before cumulative effect of a change in
  accounting principle:
  Basic earnings (loss) per share                          $   (0.66)     $      --      $     (0.20)     $     (0.87)
                                                           =========      =========      ===========      ===========
  Diluted earnings (loss) per share                        $   (0.66)     $      --      $     (0.20)     $     (0.87)
                                                           =========      =========      ===========      ===========
Cumulative effect of a change in accounting principle:
  Basic earnings per share                                 $      --      $      --      $      0.06      $        --
                                                           =========      =========      ===========      ===========
  Diluted earnings per share                               $      --      $      --      $      0.06      $        --
                                                           =========      =========      ===========      ===========
Net income (loss):
  Basic earnings (loss) per share                          $   (0.66)     $      --      $     (0.26)     $     (0.87)
                                                           =========      =========      ===========      ===========
  Diluted earnings (loss) per share                        $   (0.66)     $      --      $     (0.26)     $     (0.87)
                                                           =========      =========      ===========      ===========
</TABLE>






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


                                       4
<PAGE>   5



                               BAY NETWORKS, INC.
                 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
        (Increase (decrease) in cash and cash equivalents, in thousands)


<TABLE>
<CAPTION>
                                                                     NINE MONTHS ENDED
                                                                  ------------------------
                                                                  MARCH 28,      MARCH 31,
                                                                    1998           1997
                                                                  ---------      ---------
                                                                        (unaudited)
<S>                                                               <C>            <C>       
Cash flows provided by operating activities:
    Net loss                                                      $ (55,383)     $(167,004)
    Adjustments to reconcile net loss to cash flows
      provided by operating activities:
        Depreciation and amortization                               118,400         88,144
        In-process research and development                         161,432        208,186
        Restructuring/severance charges                                  --          9,833
        Deferred income taxes                                         4,505        (26,443)
        Cumulative effect of a change in accounting principle        12,018             --
        Non-cash compensation                                         2,269             --
        Changes in operating assets and liabilities:
          Accounts receivable                                       (50,813)        30,369
          Inventories                                               (20,144)        99,216
          Other current assets                                       19,531        (26,204)
          Accounts payable                                            7,633        (11,690)
          Accrued expenses                                           20,075         48,495
          Accrued income taxes                                        2,752          6,912
          Deferred revenue                                            5,592         17,276
                                                                  ---------      ---------
        Cash flows provided by operating activities                 227,867        277,090
                                                                  ---------      ---------
Cash flows used in investing activities:
    Expenditures for property and equipment                         (96,153)       (99,310)
    Consulting expenditures on information technology systems       (10,811)       (28,744)
    Purchases of investments                                       (738,980)      (153,250)
    Proceeds from maturities of investments                         385,307        146,719
    Proceeds from sales of investments                               28,620         27,140
    Investment in NetSpeak common stock                             (37,557)            --
    Acquisitions:
       LANcity, net of cash acquired                                     --        (58,821)
       Penril DSP                                                        --         (6,549)
       NetICs, net of cash acquired                                  (8,000)       (37,087)
       New Oak, net of cash acquired                                (16,693)            --
       Netsation                                                     (8,756)            --
    Other assets                                                     (3,767)        13,914
                                                                  ---------      ---------
        Cash flows used in investing activities                    (506,790)      (195,988)
                                                                  ---------      ---------
Cash flows provided by financing activities:
    Payments of short-term borrowings related to the
      acquisition of Penril DSP                                          --         (4,165)
    Payments of long-term debt                                      (12,000)          (152)
    Purchases of treasury common stock                                   --        (11,827)
    Issuances of common stock                                       119,350         30,205
                                                                  ---------      ---------
        Cash flows provided by financing activities                 107,350         14,061
                                                                  ---------      ---------
Net increase (decrease) in cash and cash equivalents               (171,573)        95,163
Cash and cash equivalents, beginning of period                      529,962        315,064
                                                                  ---------      ---------
Cash and cash equivalents, end of period                          $ 358,389      $ 410,227
                                                                  =========      =========
Non-cash investing activities:
    Unrealized gain on minority (cost) investments, net           $  24,578      $      --
                                                                  =========      =========
</TABLE>


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


                                       5
<PAGE>   6



                               BAY NETWORKS, INC.
              NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


1.  BASIS OF PRESENTATION

   Bay Networks, Inc. (the Company or Bay Networks) develops, manufactures,
markets, sells and supports a comprehensive line of data networking products and
services. The Company provides products that meet the connectivity requirements
of corporate enterprises, network service providers and telecommunications
carriers. The Company offers products that operate under open standards such as
switches, routers, shared media hubs, remote and Internet access solutions,
Internet Protocol (IP) services and network management applications. The
Company's products provide adaptive networking solutions to network managers
that allow seamless operation of multi-protocol and multi-vendor networks.

   The unaudited condensed consolidated financial statements have been prepared
by the Company and reflect all adjustments which are, in the opinion of
management, necessary for a fair presentation of the interim periods presented.
Such adjustments are of a normal recurring nature, except for the in-process
research and development charges incurred during the three and nine month
periods ended March 28, 1998, the in-process research and development charges
incurred in the first half of fiscal 1997, and the restructuring/severance
charges incurred during the three month period ended March 31, 1997. The results
of operations for the interim periods presented are not necessarily indicative
of results for any future interim period or for the entire fiscal year. Certain
information and footnote disclosures normally included in annual consolidated
financial statements prepared in accordance with generally accepted accounting
principles have been omitted, although the Company believes that the disclosures
included are adequate to make the information presented not misleading. The
unaudited condensed consolidated financial statements and notes included herein
should be read in conjunction with the consolidated financial statements and
notes for the fiscal year ended June 30, 1997, included in the Company's 1997
Annual Report on Form 10-K.

   Beginning with the first quarter of fiscal year 1998, for purposes of
operational efficiency, the Company's fiscal quarters end on the Saturday
closest to the end of each calendar quarter. Accordingly, for fiscal year 1998,
the fiscal quarters end on September 27, 1997, December 27, 1997 and March 28,
1998, and the fiscal year will end on June 27, 1998.

   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 unaudited condensed consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates.

2.  CONSOLIDATED BALANCE SHEET INFORMATION

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

<TABLE>
<CAPTION>
                                           MARCH 28, 1998       JUNE 30, 1997
                                           --------------       -------------
(in thousands)                               (unaudited)
<S>                                           <C>                 <C>     
Raw materials                                 $ 26,811            $ 21,068
Work-in-process                                 44,318              45,140
Finished goods                                  93,483              78,260
                                              --------            --------
   Total inventories                          $164,612            $144,468
                                              ========            ========
</TABLE>


   Property and Equipment. During the nine months ended March 28, 1998, the
Company purchased property in Massachusetts and Ireland for a total purchase
price of $5.2 million. The total purchase price for each property was allocated
to the assets on the basis of their relative fair market values.

   Property and equipment are stated at cost. Depreciation and amortization are
computed using the straight-line method over the estimated useful lives of the
assets, which are 30 years for buildings, five to ten years for building
improvements, and two to five years for machinery, equipment, furniture and
fixtures. The life of the lease or the useful life, whichever is shorter, is
used for the amortization of leasehold improvements.



                                       6
<PAGE>   7

<TABLE>
<CAPTION>
                                                  MARCH 28, 1998   JUNE 30, 1997
                                                  --------------   -------------
(in thousands)                                     (unaudited)
<S>                                                 <C>              <C>      
Land                                                $   1,373        $      --
Building and improvements                               6,111               --
Machinery and equipment                               466,219          402,192
Furniture and fixtures                                 51,107           45,188
Leasehold improvements                                 71,614           76,679
                                                    ---------        ---------
   Total property and equipment                       596,424          524,059
Accumulated depreciation and amortization            (364,103)        (282,990)
                                                    ---------        ---------
   Total property and equipment, net                $ 232,321        $ 241,069
                                                    =========        =========
</TABLE>

3.  BUSINESS COMBINATIONS

   During the nine months ended March 28, 1998, the Company acquired the two
businesses described below, each of which has been accounted for as a purchase.
Pro forma results of operations have not been presented because the effects of
these acquisitions were not material to the Company's consolidated financial
position, results of operations, and cash flows.

   In January 1998, the Company acquired New Oak Communications, Inc. (New Oak),
a developer of Extranet Access technology, which provides scalable, secure,
private networks managed over the Internet, based in Acton, Massachusetts. The
Company exchanged 5,093,551 million shares of the Company's common stock and
$23.0 million in cash for all of the outstanding capital stock of New Oak as of
the date of the acquisition. In addition, the Company has reserved 115,619
shares of its common stock for issuance under New Oak's outstanding stock
options, which the Company assumed in the acquisition. The total purchase price
of $166.9 million was allocated to the acquired assets and liabilities based on
their estimated fair values as of the date of the acquisition. This includes an
allocation of $15.6 million to goodwill and $0.9 million to other intangible
assets, which are being amortized on a straight-line basis over a five year
period. Approximately, $146.1 million was allocated to in-process research and
development and charged to operations.

   In February 1998, the Company acquired Netsation Corporation (Netsation), a
developer of multi-vendor network management tools, based near Research Triangle
Park, North Carolina, for $11.8 million in cash, of which $2.9 million was paid
to an escrow account for contingent consideration to the founders of Netsation
and will be charged to operations over the next two years. The remaining $8.9
million was accounted for as purchase price consideration and was allocated to
the acquired assets and liabilities based on their estimated fair values as of
the date of acquisition. This includes an allocation of $0.9 million to goodwill
and $0.1 million to other intangible assets, which are being amortized on a
straight-line basis over a five year period. Approximately, $7.9 million was
allocated to in-process research and development and charged to operations.

4.  INVESTMENT IN NETSPEAK CORPORATION

   In February 1998, the Company and NetSpeak Corporation (NetSpeak), a
developer and marketer of IP telephony technology, entered into a stock purchase
agreement whereby the Company purchased 1,334,171 shares of NetSpeak's common
stock for approximately $37.6 million, representing a 9% ownership in NetSpeak,
on a fully diluted basis.

5. FOREIGN EXCHANGE HEDGING

   The Company had $21.2 million of short-term foreign exchange forward
contracts outstanding, which approximated the fair value of such contracts and
their underlying transactions at March 28, 1998. These contracts are denominated
in Australian, British, Canadian, French, Indian, Indonesian, Italian, Japanese,
Mexican, South Korean, Spanish and Singapore currencies. The outstanding
contracts have original maturities that do not exceed three months. The gains
and losses on these contracts are included in earnings when the underlying
foreign currency denominated transaction is recognized. Gains and losses related
to these instruments at March 28, 1998, were not material. In addition, the
Company has not terminated or extinguished any foreign exchange forward
contracts. The Company does not anticipate any material adverse effect on its
consolidated financial position, results of operations, or cash flows resulting
from the use of these instruments.


                                       7
<PAGE>   8



6. LONG-TERM DEBT

   During the nine months ended March 28, 1998, the Company redeemed and retired
$12.0 million of its outstanding convertible subordinated debentures due in May
2003 for cash. The cash used to purchase the debentures was from the Company's
operating funds.

7. INCOME TAXES

   The Company's provision for income taxes for the three and nine month periods
ended March 28, 1998, is based upon the Company's estimate of the effective tax
rate for fiscal year 1998. The Company's effective tax rate for the three and
nine month periods ended March 28, 1998, was 34% excluding the effect of the
in-process research and development charge which was not deductible for income
tax purposes. The Company's accrued income taxes was reduced by a tax benefit
from employee stock option transactions of $8.7 million and $42.0 million for
the three and nine month periods ended March 28, 1998, respectively, which was
credited directly to stockholders' equity.

8. CHANGE IN ACCOUNTING PRINCIPLE

   During the nine months ended March 28, 1998, the Emerging Issues Task Force
issued a consensus, Accounting for Costs Incurred in Connection with a
Consulting Contract that Combines Business Process Reengineering and Information
Technology Transformation (EITF 97-13), effective upon issuance. Under EITF
97-13, substantially all of the costs of business process reengineering
activities should be expensed as incurred. Prior to this consensus, the Company
capitalized such costs. As a result of this accounting change, the Company
recognized a non-cash charge as a cumulative effect of a change in accounting
principle of $12.0 million ($18.2 million pre-tax) for the nine month period
ended March 28, 1998. This charge represents the expense for such costs covered
under this EITF consensus incurred through the date of the consensus. In
accordance with EITF 97-13, prior years have not been restated to reflect the
change in accounting method.

9. EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS

   During the nine months ended March 28, 1998, the Emerging Issues Task Force
issued a consensus, Accounting for Increased Share Authorizations in an IRS
Section 423 Employee Stock Purchase Plan under APB Opinion No. 25, Accounting
for Stock Issued to Employees (EITF 97-12), effective upon issuance. As a result
of this new accounting interpretation, the Company incurred a non-cash charge of
$2.3 million in the third quarter of fiscal 1998 and the impact on basic and
diluted earnings per share is expected to be a charge of approximately $0.01 per
share for each fiscal quarter through the fourth quarter of fiscal 1999.

   In addition, there may be changes in accounting interpretations affecting
revenue recognition for software that may impact the Company's business. During
fiscal 1998, the American Institute of Certified Public Accountants issued
Statements of Position (SOPs) 97-2 and 98-4 regarding Software Revenue
Recognition. The Company is in the process of evaluating the applicability of
the SOPs to its financial statements. If applicable, the SOPs may impact the
Company's current revenue accounting practices, and such changes may impact the
Company's consolidated financial position, results of operations, or cash flows.

10. EARNINGS PER SHARE

   In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128 (SFAS 128), Earnings per Share. SFAS 128
replaced the previously reported primary and fully diluted earnings per share
with basic and diluted earnings per share. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of options, warrants and
convertible securities. Diluted earnings per share is similar to the previously
reported fully diluted earnings per share. All earnings per share amounts for
all periods have been presented, and where necessary, restated to conform to
SFAS 128 requirements.

   Basic earnings per share is computed using the weighted average number of
common shares outstanding during the period. Diluted earnings per share is
computed using the weighted average number of common shares and dilutive
potential common shares outstanding during the period. Dilutive potential common
shares consist of employee stock options using the treasury stock method and
dilutive convertible securities using the if-converted method.


                                       8
<PAGE>   9




   The following table sets forth the computation of basic and diluted earnings
per share:

<TABLE>
<CAPTION>
                                                     THREE MONTHS ENDED              NINE MONTHS ENDED
                                                 ---------         --------     ---------         ---------
                                                 MARCH 28,         MARCH 31,    MARCH 28,         MARCH 31,
(in thousands, except per share amounts)           1998              1997         1998              1997
                                                 ---------         --------     ---------         ---------
                                                         (unaudited)                    (unaudited)
<S>                                              <C>               <C>          <C>               <C>       
NUMERATOR:
Income (loss) from continuing operations
  before cumulative effect of a change in
  accounting principle                           $(144,166)        $    255     $ (43,365)        $(167,004)
                                                 =========         ========     =========         =========
Numerator for basic and diluted earnings
  per share - income (loss) available to
  common stockholders                            $(144,166)        $    255     $ (43,365)        $(167,004)
                                                 =========         ========     =========         =========

DENOMINATOR:

Denominator for basic earnings per share -
  weighted average shares                          219,106          198,292       213,882           192,893
Effect of dilutive securities:
   Employee stock options                               --            4,787            --                --
                                                 ---------         --------     ---------         ---------
Dilutive potential common shares                        --            4,787            --                --

Denominator for diluted earnings per share -
  adjusted weighted average shares and
  assumed conversions                              219,106          203,079       213,882           192,893
                                                 =========         ========     =========         =========

Basic earnings (loss) per share                  $   (0.66)        $     --     $   (0.20)        $   (0.87)
                                                 =========         ========     =========         =========

Diluted earnings (loss) per share                $   (0.66)(1)     $     --     $   (0.20)(1)     $   (0.87)(1)
                                                 =========         ========     =========         =========
</TABLE>

(1)  Diluted earnings per share does not reflect any potential shares relating
     to employee stock options or convertible debentures since a loss was
     reported for the period, in accordance with SFAS 128. The assumed issuance
     of any additional shares would be anti-dilutive.

   For additional disclosure regarding employee stock options, see Note 6 in the
Company's 1997 Annual Report on Form 10K.

   Diluted earnings per share for the three and six month periods ended December
27, 1997, as reported in the Company's fiscal 1998 second quarter Form 10Q,
incorrectly assumed conversion of the outstanding convertible debentures.
Although not material to the Company, this represents a decrease of $0.01 per
share from the previously reported diluted earnings per share from continuing
operations before cumulative effect of a change in accounting principle and the
previously reported diluted earnings per share from net income. The restated
diluted earnings per share amounts are as follows: income from continuing
operations before cumulative effect of a change in accounting principle -
diluted earnings per share is $0.27 and $0.45 for the three and six month
periods ended December 27, 1997, respectively; and net income - diluted earnings
per share is $0.21 and $0.40 for the three and six month periods ended December
27, 1997, respectively.

11. SIGNIFICANT CUSTOMERS

   One reseller customer accounted for 13.2% and another reseller customer
accounted for 10.0% of the Company's revenue in the three month period ended
March 28, 1998, and the same two resellers combined accounted for 21.0% (10.5%
each) of the Company's revenue for the nine month period ended March 28, 1998.
No one reseller customer accounted for more that 10% of the Company's revenue in
the three or nine month periods ended March 31, 1997.



                                       9
<PAGE>   10

12. SUBSEQUENT EVENT

    In April 1998, the Company held a special meeting of the stockholders and
approved the following employee benefit plans and other matters: an increase in
the maximum number of shares that may be issued under the Company's 1994
Employee Stock Purchase Plan by 2,000,000 shares; adoption of the Company's 1998
Employee Stock Purchase Plan; and an amendment to the Company's Restated
Certificate of Incorporation to increase the number of shares of the Company's
Common Stock authorized for issuance by 100,000,000 shares.








                                       10
<PAGE>   11



ITEM 2. 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 condensed
consolidated financial statements and related notes included elsewhere herein as
well as the section entitled "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.
These statements may differ materially from actual future events or results. 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, may
affect the Company's actual results and cause actual results to differ
materially from those in any forward-looking statements.

RESULTS OF OPERATIONS

   Revenue. Revenue was $547.2 million for the third quarter of fiscal 1998 as
compared to $512.9 million for the third quarter of fiscal 1997, an increase of
6.7%. For the first nine months of fiscal 1998 and fiscal 1997, revenue was
$1,793.4 million and $1,550.1 million, respectively, an increase of 15.7%. The
growth in both periods resulted primarily from increased sales of the Company's
switching products, service offerings, and remote access products. The Company
experienced a significant growth in sales of its switching products, due to the
positive customer response to several new switching products introduced over the
past year, and market acceptance of the Company's product offerings as a single
source of open, standards-based technology. Revenue from switching products
accounted for 31% of the Company's total revenue in the third quarter of fiscal
1998, more than any other single product category. However, revenue for the
third quarter of fiscal 1998 decreased by $97.7 million or 15.2%, compared to
revenue of $644.9 million in the second quarter of fiscal 1998. Sales decreased
from the second quarter of fiscal 1998 in all principal product categories. This
decline is primarily a result of weaker demand in the industry segments that the
Company serves, combined with a seasonally slow quarter, competitive pricing
actions taken by the Company on workgroup switches, and longer customer purchase
decision cycles.

   International revenue increased 13.0% to $204.8 million for the third quarter
of fiscal 1998, as compared to $181.3 million for the comparable period of the
prior year. International revenue represented approximately 37.4% and 35.3% of
total revenue for the third quarter of fiscal 1998 and fiscal 1997,
respectively. For the first nine months of fiscal 1998, international revenue
increased 25.1% to $678.0 million, as compared to $541.8 million for the
comparable period of the prior year. International revenue represented
approximately 37.8% and 35.0% of total revenue for the first nine months of
fiscal 1998 and 1997, respectively. The current year to date growth in
international revenue primarily occurred in Europe due to improved international
standards-based switching and routing products along with the strengthening of
distribution channels. However, this growth was partially offset by the effects
of the economic turmoil in the Asia/Pacific markets, resulting in a reduction of
capital expenditures by businesses located in these regions. The Company's
international revenue is 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 the periods presented. The effects of foreign
exchange rate fluctuations may adversely affect the Company's operating results
in future periods. For a description of additional risks related to foreign
markets, see the section entitled "Risk Factors that May Affect Future Results."
Revenue in past periods may not be indicative of future revenue, which may be
affected by other factors discussed elsewhere herein, as well as other business
environment and risk factors.

   Gross Profit. Gross profit increased by $3.6 million or 1.4% to $256.3
million or 46.8% of revenue for the third quarter of fiscal 1998, from $252.7
million or 49.3% of revenue for the comparable period of the prior year. For the
first nine months of fiscal 1998, gross profit increased by $139.4 million or
18.5% to $894.5 million or 49.9% of revenue from $755.1 million or 48.7% of
revenue for the comparable period of the prior year. The gross profit increase
in absolute dollars for both periods is attributable to increased unit sales of
the Company's products, driven by the introduction of new products and
enhancements to existing products. The gross profit percentage increase for the
first nine months of fiscal 1998 was a result of the introduction of products
designed with lower



                                       11
<PAGE>   12

manufacturing costs and management's initiation of cost reduction programs on
existing products. However, gross profit decreased by $75.5 million or 22.8%
during the third quarter from the second quarter of fiscal 1998 which was
primarily attributable to competitive price reductions, additional price
protection granted to the distribution channels, lower sales volume, and a less
favorable product mix shift towards lower margin products. Despite the focus on
lower manufacturing costs and cost reduction programs, there can be no assurance
that changes in material, labor costs and distribution channels will not have an
adverse effect on gross profit percentages in the future. For a description of
additional risks which may impact gross profit, see the section entitled "Risk
Factors that May Affect Future Results."

   Research and Development. Research and development expenses for the third
quarter of fiscal 1998 increased 23.5% to $90.5 million from $73.3 million for
the comparable period of the prior year. As a percentage of revenue, expenses
were 16.5% in the third quarter of fiscal 1998 and 14.3% in the comparable
period of the prior year. Research and development expenses for the first nine
months of fiscal 1998 increased 32.5% to $260.7 million from $196.8 million for
the comparable period of the prior year. As a percentage of revenue, expenses
were 14.5% for the current fiscal year to date compared to 12.7% in the
comparable period in the prior year. The increase in both absolute dollars and
as a percentage of revenue relates to the costs associated with the addition of
research and development personnel through hiring and business acquisitions,
costs associated with acquisitions of businesses in the process of developing
technologies, costs of prototypes and depreciation of equipment used in the
development of new products and product enhancements, partially offset by a
decline in outside service fees. The Company believes that continued investment
in research and development is vital to the Company's future success. The
Company plans to maintain research and development spending as a percentage of
revenue in order to pursue a broad range of new products needed for timely
product introductions to the market. As a result of the Company's research and
development efforts and acquisitions of development-stage businesses, new
product sales accounted for 55.2% and 53.6% of revenue for the three and nine
month periods ended March 28, 1998, respectively, compared to 40.5% and 46.2% of
revenue for the comparable periods in the prior year.

   The Company plans to continue its commitment to research and development
through internal development and, given that the industry's technology
environment is rapidly changing, through acquisitions of technology in an effort
to bring products to the market more quickly and provide end-to-end network
solutions. There can be no assurance that research and development efforts or
acquisitions of technology will result in commercially successful new technology
and products in the future, or that such technology and products will be
introduced in time to meet market requirements. The Company's research and
development efforts may be adversely affected by other factors noted elsewhere
herein. Research and development expenses may vary in absolute dollars and as a
percentage of revenue in future periods.

   Sales and Marketing. Sales and marketing expenses for the third quarter of
fiscal 1998 increased 5.0% to $136.0 million, from $129.5 million in the
comparable period of the prior year. As a percentage of revenue, expenses
decreased to 24.8% for the third quarter of fiscal 1998, from 25.3% in the
comparable period of the prior year. For the first nine months of fiscal 1998,
sales and marketing expenses decreased 0.2% to $408.3 million, from $409.2
million in the comparable period of the prior year. As a percentage of revenue,
expenses decreased to 22.8% for the current fiscal year to date compared to
26.4% for the comparable period of the prior year. The decreases as a percentage
of revenue for both periods are primarily attributable to improved sales force
productivity and utilization of facilities. The increase in absolute dollars in
the third quarter of fiscal 1998 compared to the third quarter of fiscal 1997 is
due primarily to an increase in headcount, travel related expenses and costs
associated with product branding and other marketing programs, partially offset
by a decline in outside service fees. While it is management's intent to control
discretionary spending, in the future, sales, marketing and customer support
expenses may vary in absolute dollars or as a percentage of revenue to
effectively market Bay Networks and its products to the public.

   General and Administrative. General and administrative expenses for the third
quarter of fiscal 1998 increased 28.2% to $25.8 million from $20.1 million in
the comparable period of the prior year. As a percentage of revenue, expenses
increased to 4.7% for the third quarter of fiscal 1998, from 3.9% in the
comparable period of the prior year. The increase in absolute dollars and as a
percentage of revenue is primarily due to expenditures associated with personnel
costs, including new hires and college recruiting programs, travel related
expenses and outside service fees. General and administrative expenses for the
first nine months of fiscal 1998 increased 13.6% to $75.1 million, from $66.1
million in the comparable period of the prior year. As a percentage of revenue,
expenses decreased slightly to 4.2% for the current fiscal year to date compared
to 4.3% for the comparable period of the prior year. The increase in absolute
dollars for the first nine months of fiscal 1998 is a result of expenditures


                                       12
<PAGE>   13



associated with personnel costs to support the infrastructure of the Company's
global business strategy. The slight decline in expenses as a percentage of
revenue for the first nine months of fiscal 1998 is due to improved utilization
of facilities.

   In-Process Research and Development. During the nine month period ended March
28, 1998, the Company acquired two businesses for an aggregate total of $175.8
million. Of the aggregate purchase price, $154.0 million was allocated to
in-process research and development related to internetworking technologies and
charged to operations.

   Also, during the nine month period ended March 28, 1998, under the terms of
the NetICs fiscal 1997 acquisition agreement, the Company would pay an
additional purchase price consideration of $8 million for certain commitment
targets associated with revenue milestones achieved by NetICs prior to December
1997. The revenue milestones were achieved during the first half of fiscal 1998
and as a result, $7.4 million of the additional consideration was allocated to
in-process research and development and charged to operations. The remaining
$0.6 million was allocated to intangible assets, which are being amortized on a
straight-line basis over a five year period. This treatment is consistent with
the Company's previous purchase price allocation related to the acquisition of
NetICs. During the third quarter of fiscal 1998, the Company paid the additional
consideration of $8 million.

   Net Interest Income and Other. Net interest income and other increased 283.4%
to $10.9 million for the third quarter of fiscal 1998, compared to $2.8 million
for the comparable period of the prior year and increased as a percentage of
revenue to 2.0% in the third quarter of fiscal 1998 from 0.6% in the comparable
period in the prior year. Current fiscal year to date, net interest income and
other increased 102.2%, to $28.6 million compared to $14.2 million for the
comparable period of the prior year and increased as a percentage of revenue to
1.6% in the first nine months of fiscal 1998 from 0.9% in the first nine months
of fiscal 1997. The increase in interest income was primarily due to higher
average invested cash and investment balances which yielded more interest income
in the third quarter and the first nine months of fiscal 1998, compared to the
comparable periods in the prior year. The increase in the invested cash and
investment balances during the third quarter and the first nine months of fiscal
1998 resulted primarily from increased profitability from the Company's
operations and increased stock option exercise activity during the respective
periods. The overall net interest income and other increase was partially offset
by the continued strengthening of the U.S. dollar which impacted foreign
exchange losses resulting from the translation of the parent company's accounts
receivable from international subsidiaries from the local currency to the U.S.
dollar. However, the impact from foreign exchange losses was mitigated by the
Company's foreign exchange hedging activities.

   Investment Portfolio. The Company does not use derivative financial
instruments in its investment portfolio. The Company places its investments in
instruments that meet high credit quality standards, as specified in the
Company's investment policy guidelines; the policy also limits the amount of
credit exposure to any one issue, issuer, and type of instrument. The Company
does not expect any material loss with respect to its investment portfolio.

   The following table provides information about the Company's investment
portfolio. For investment securities, the table presents principal cash flows
and related weighted average interest rates by expected maturity dates. The
Company's investment policy requires that all investments mature in five years
or less.

Principal (Notional) Amounts by Expected Maturity in U.S. Dollars:
(in thousands, except interest rates)

<TABLE>
<CAPTION>
                                                                        FY 2002 &                FAIR VALUE AT
                          FY 1998     FY 1999     FY 2000    FY 2001    THEREAFTER     TOTAL     MARCH 28,1998
                         ---------   ---------   ---------   --------    --------    ---------     ---------
<S>                      <C>         <C>         <C>         <C>         <C>         <C>           <C>      
Cash Equivalents         $ 313,435   $     --    $      --   $     --    $     --    $ 313,435     $ 314,212
 Average Interest Rate        5.52%        --           --         --          --         5.52%
Investments              $ 113,078   $ 248,319   $ 144,603   $ 45,245    $ 26,793    $ 578,038     $ 576,600
 Average Interest Rate        5.36%       5.54%       5.42%      4.89%       5.79%        5.45%
Total Portfolio          $ 426,513   $ 248,319   $ 144,603   $ 45,245    $ 26,793    $ 891,473     $ 890,812
 Average Interest Rate        5.46%       5.54%       5.42%      4.89%       5.79%        5.47%
</TABLE>



                                       13
<PAGE>   14

   Impact of Foreign Currency Rate Changes. During the first nine months of
fiscal 1998, most currencies in Europe and Asia/Pacific continued to be weak
against the U.S. dollar. Consequently, the translation of the parent company's
intercompany receivables had a negative impact, although not material, on the
consolidated results of the Company. Foreign exchange forward contracts are
purchased to hedge certain intercompany foreign currency denominated balance
sheet positions. These financial instruments may minimize the risks that would
otherwise result from changes in foreign currency exchange rates. Exchange gains
and losses did not have a significant effect on the Company's results for the
third quarter of fiscal 1998 or the first nine months of fiscal 1998.

   Foreign Exchange Hedging. The Company enters into foreign exchange forward
contracts to reduce its exposure to currency fluctuations on intercompany
foreign currency denominated balance sheet positions. The objective of these
contracts is to neutralize the impact of foreign currency exchange rate
movements on the Company's operating results. The Company's accounting policy
for these instruments is based on the Company's designation of such instruments
as hedging transactions. The Company does not use derivative financial
instruments for speculative or trading purposes. The Company had $21.2 million
of short-term foreign exchange forward contracts denominated in Australian,
British, Canadian, French, Indian, Indonesian, Italian, Japanese, Mexican, South
Korean, Spanish and Singapore currencies which approximated the fair value of
such contracts and their underlying transactions at the end of the third quarter
of fiscal 1998. The gains and losses on these contracts are included in earnings
when the underlying foreign currency denominated transaction is recognized.
Gains and losses related to these instruments for the third quarter and the
first nine months of fiscal 1998 were not material to the Company. Looking
forward, the Company does not anticipate any material adverse effect on its
consolidated financial position, results of operations, or cash flows resulting
from the use of these instruments. However, there can be no assurance that these
strategies will be effective or that transaction losses can be minimized or
forecasted accurately.

   The following table provides information about the Company's foreign exchange
forward contracts at the end of the third quarter of fiscal 1998. The table
presents the value of the contracts in U.S. dollars at the contract exchange
rate as of the contract maturity date. Due to the short-term nature of these
contracts, the contract rate approximates the weighted average contractual
foreign currency exchange rate and the forward position in U.S. dollars
approximates the fair value of the contract at the end of the third quarter of
fiscal 1998.

Short-Term Forward Contracts to Sell Foreign Currencies for U.S. Dollars Related
to Intercompany Receivables:

<TABLE>
<CAPTION>
                                                                                    FORWARD
                                         CONTRACT        MATURITY      CONTRACT    POSITION IN
(in thousands, except contract rates)  DATE IN 1998    DATE IN 1998      RATE      U.S.DOLLARS
                                       ------------    ------------      ----      -----------
<S>                                    <C>               <C>           <C>           <C>    
Australian Dollar                      February 12       April 17       1.4843       $ 4,379
Australian Dollar                         March 18         May 20       1.5066       $ 1,328
British Pound Sterling                    March 18       April 20        1.667       $ 1,250
Canadian Dollar                        February 12       April 17        1.436       $ 1,740
French Francs                          February 17       April 20        6.103       $ 4,096
Indian Rupee                              March 12        June 17        41.25       $ 1,818
Indonesian Rupiah                         March 12       April 16     10,570.0       $   331
Italian Lira                           February 12       April 17      1,787.7       $   305
Japanese Yen                           February 17       April 20        125.8       $ 2,782
Mexican Peso                              March 18         May 20        8.820       $   907
Singapore Dollar                           March 4        April 9       1.6610       $   722
South Korean Won                       February 13       April 20      1,659.0       $   915
Spanish Peseta                            March 18         May 20       154.72       $   646
</TABLE>

   Income Taxes. The Company's effective income tax rate for the three and nine
month periods ended March 28, 1998, was 34.0% compared to 36.5% for the
comparable periods in the prior year, respectively, excluding the effect of the
in-process research and development charge which was not deductible for income
tax purposes. The decrease in the effective income tax rate was primarily due to
the reinstatement of the federal research and development tax credits. The
Company does not anticipate any material change to the effective tax rate for
the remainder of fiscal 1998.




                                       14
<PAGE>   15



   Change in Accounting Principle. During the nine months ended March 28,1998,
the Emerging Issues Task Force issued a consensus, Accounting for Costs Incurred
in Connection with a Consulting Contract that Combines Business Process
Reengineering and Information Technology Transformation (EITF 97-13), effective
upon issuance. Under EITF 97-13, substantially all of the costs of business
process reengineering activities should be expensed as incurred. Prior to this
consensus, the Company capitalized such costs. As a result of this accounting
change, the Company recognized a non-cash charge as a cumulative effect of a
change in accounting principle of $12.0 million ($18.2 million pre-tax) for the
nine month period ended March 28, 1998. This charge represents the expense for
such costs covered under this EITF consensus incurred through the date of the
consensus. In accordance with EITF 97-13, prior years have not been restated to
reflect the change in accounting method.

   Effect of New Accounting Pronouncements. During the nine months ended March
28, 1998, the Emerging Issues Task Force issued a consensus, Accounting for
Increased Share Authorizations in an IRS Section 423 Employee Stock Purchase
Plan under APB Opinion No. 25, Accounting for Stock Issued to Employees (EITF
97-12), effective upon issuance. As a result of this new accounting
interpretation, the Company incurred a non-cash charge of $2.3 million in the
third quarter of fiscal 1998 and the impact on basic and diluted earnings per
share is expected to be a charge of approximately $0.01 per share for each
fiscal quarter through the fourth quarter of fiscal 1999.

   In addition, there may be changes in accounting interpretations affecting
revenue recognition for software that may impact the Company's business. During
fiscal 1998, the American Institute of Certified Public Accountants issued
Statements of Position (SOPs) 97-2 and 98-4 regarding Software Revenue
Recognition. The Company is in the process of evaluating the applicability of
the SOPs to its financial statements. If applicable, the SOPs may impact the
Company's current revenue accounting practices, and such changes may impact the
Company's consolidated financial position, results of operations, or cash flows.

   The Year 2000. As the millennium "Year 2000" approaches, all companies that
develop, sell or use software are addressing the issues associated with the
date-programming code in older computer systems. The Year 2000 software issue
arises from older computer programs using two digits rather than four to define
the applicable year; as a result, some of these programs may interpret the year
as the calendar year 1900 rather than the calendar year 2000. Systems that do
not properly recognize such information could generate erroneous data or cause a
system to fail.

   The Company has initiated a Year 2000 product compliance policy to ensure its
products are Year 2000 compliant. The Company provides up-to-date information on
product compliance to its customers in the market place through its external web
site. Products available for sale since January 1997 are warranted to comply
with Year 2000 requirements as defined under the Company's "Year 2000 Compliance
Definitions" listed on its external web site.

   Most of the Company's internally used management information systems were
installed within the last 18 months and are warranted to comply with the Year
2000 requirements. The Company is in the process of conducting a comprehensive
review of its other internal computer systems to identify the systems that could
be affected by the Year 2000 issue and is developing an enterprise-wide
implementation plan to resolve the issue. The Company presently believes that,
with modifications to existing software, the Year 2000 issue will not pose
significant operational problems for the Company's computer systems as so
modified and converted. The Company does expect to incur internal staff costs as
well as consulting and other expenses related to enhancements necessary to
prepare the systems for the Year 2000. The Company has no reasonable estimate of
the amount associated with the transitions of the Company's remaining systems.
If modifications and conversions are not completed timely, the Year 2000 issue
may have a material impact on the Company's operations.

   The Company has not fully determined the extent to which the Company's
interface systems may be impacted by third parties' systems, which may not be
Year 2000 compliant. There can be no assurance that the systems of other
companies which the Company deals with or on which the Company's systems rely
will be timely converted, or that any such failure to convert by another company
could not have an adverse effect on the Company's systems, consolidated
financial position, results of operations, or cash flows.




                                       15
<PAGE>   16



   European Monetary Unit. The Company's sales to European customers are
primarily U.S. dollar based. However, the Company does recognize the emergence
of a new monetary unit and the potential importance of such a new monetary unit
to its customers residing in the European union. The Company's information
systems are capable of functioning in multiple currencies. The Company has
embarked on system changes to make all infrastructures capable of operations in
the European Monetary Unit. Although not material, the Company does expect to
incur additional expenses for these system changes. The Company does not expect
any disruption in operations due to the European Monetary Unit implementation.

LIQUIDITY AND CAPITAL RESOURCES

   Cash generated from operating activities was $227.9 million for the first
nine months of fiscal 1998, compared to $277.1 million for the comparable period
of the prior year. Cash provided by operations decreased from the prior period
primarily due to increases in accounts receivable and inventory, partially
offset by an increase in accrued expenses. Accounts receivable increased to
$328.7 million at March 28, 1998, from $277.9 million at June 30, 1997. This
increase is primarily a result of a non-linear shipment pattern during the third
quarter of fiscal 1998. Days sales outstanding in receivables increased to 55
days at the end of the third quarter of fiscal 1998, from 47 days as of the end
of fiscal 1997. Days sales outstanding may continue to vary, due to, among other
things, linearity of product shipments and collections, and increased
international sales. The increase in inventory from June 30, 1997 is due to
lower than planned shipments at the end of the third quarter of fiscal 1998 and
an increase in service and evaluation units.

   During the current fiscal year to date, the Company invested $107.0 million
in capital expenditures. Major capital expenditures included investments in
property and equipment and improvements to the Company's information technology
systems required to support the Company's operations. During the first nine
months of fiscal 1998, the Company purchased property in Massachusetts and
Ireland for a total purchase price of $5.2 million and the total purchase price
for each property was allocated to the assets on the basis of their relative
fair market values. In addition, the Company acquired two businesses with cash
portions of the purchase consideration, aggregating approximately $25.4 million,
the Company purchased stock in NetSpeak for approximately $37.6 million, and the
Company paid additional purchase price consideration of $8 million related to
the acquisition of NetICs. During the first nine months of fiscal 1997, the
Company invested $128.1 million in capital expenditures and acquired three
businesses with cash portions of the purchase consideration, aggregating
approximately $102.5 million.

   Cash provided by financing activities was $107.4 million in the first nine
months of fiscal 1998, compared to $14.1 million in the first nine months of
fiscal 1997. The cash provided by financing activities during the first nine
months of fiscal 1998 consisted primarily of cash received in connection with
the issuance of stock under the Company's stock option plan, partially offset by
the retirement of debt. In November 1997, the Company repurchased and retired
$12.0 million of its outstanding convertible subordinated debentures for cash.
The cash used to purchase the debentures was from the Company's operating funds.
Cash provided by financing activities during the first nine months of fiscal
1997 consisted primarily of cash received in connection with the issuance of
stock under the Company's stock option plan, offset by the Company's purchase of
treasury stock on the open market and the payment of short-term borrowings
related to the acquisition of Penril DSP.

   As of March 28, 1998, the Company had $98.0 million of convertible
subordinated debentures outstanding, which mature in May 2003. The debentures
are convertible at the option of the holder into the Company's common stock. The
debentures are redeemable at the option of the Company, initially at
approximately 103.7% and at decreasing prices thereafter to 100% at maturity.
Looking forward, the Company's management may decide to repurchase a portion or
all of the debentures in the open market. The Company does not anticipate any
material adverse effect on its consolidated financial position, results of
operations, or cash flows resulting from the repurchase of the debt.

   As of March 28, 1998, cash and short- and long-term investments totaled
$935.0 million, compared to $781.5 million at June 30, 1997. The Company
believes that it has the financial resources needed to meet business
requirements, including capital expenditures, working capital requirements, debt
obligations outstanding and operating lease commitments for facilities at least
through the next twelve months.




                                       16
<PAGE>   17



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 that may affect the Company's actual
results and cause actual results to differ materially from those in the
forward-looking statements.

   Risks Related to New Markets. The markets for data networking products are
rapidly changing and highly competitive. If these markets do not continue to
grow, or if the Company's strategies for the data networking markets are
unsuccessful, the Company's consolidated financial position, results of
operations, or cash flows, may be adversely affected.

   Risks Related to New Products. The Company's future revenue is dependent on
its ability to successfully develop, acquire, manufacture and market products
for customers in rapidly evolving markets worldwide. To successfully distribute
new products, the Company must establish and maintain new distribution channels.
There can be no assurance that the Company's product development and acquisition
efforts will result in timely and commercially successful new product offerings
in the future.

   Risks Related to Sales. Value added reseller (VAR) and distributor networks
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 may have a material adverse effect on the Company's
revenue and results of operations.

   Risks Related to Gross Profit. The Company's gross profit percentage is a
function of the product mix sold in any period. Therefore, gross profit
percentage may fluctuate, affecting the Company's operating results. Factors
such as unit volumes, obsolescence/surplus of inventory, heightened price
competition, changes in channels of distribution, shortages and cost increases
in supplies of parts from vendors, and the availability of skilled labor, also
may cause fluctuations in gross profit percentages.

   Risks Relating to Manufacturing Operations. The Company operates
manufacturing facilities and relies upon a number of manufacturing arrangements
worldwide. The Company's manufacturing capability may be affected by factors
impacting the operations of its suppliers. In addition, the Company's ability to
meet customer demand may also be dependent on its ability to adjust
manufacturing levels on short notice based on anticipated orders.

   Risks Related to Intellectual Property Rights. The Company relies upon a
combination of patents, copyrights, trademarks and trade secrets to establish
and protect intellectual property rights in its products and technology. There
can be no assurance that the steps taken by the Company will be adequate to
prevent misappropriation of its technology, or that the Company's competitors
will not develop superior technologies. From time to time, it may be necessary
or desirable for the Company to enter into technology licenses, strategic
alliances and cooperative marketing efforts with others. There can be no
assurance that the Company will be able to consistently secure third-party
rights necessary to offer competitive products.

    Risks Related to Competition. The data networking industry is highly
competitive. There can be no assurance that the Company will be able to compete
successfully in the future with existing or new competitors. Among the
competitive factors that may adversely affect the Company's future results are:
conformity to existing and emerging industry standards; interoperability with
other networking products; network management capabilities; price; performance;
product features; technical support; and distribution.

    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
operations. The Company's results of operations, consolidated financial
position, or cash flows, may be adversely affected if it is unable to
successfully acquire and integrate into its operations such new companies.

   Risks Related to Foreign Markets. Economic and political instability in
foreign markets may adversely affect the Company's operations and its resellers
in those markets. Due to the recent currency devaluation in the Asian markets,
the Company's exposure to foreign currency fluctuations may increase if the
global economic environment fails to improve. Weaker foreign currency values
relative to the U.S. dollar may render the Company's products relatively more
expensive to customers in a particular country and may lead to a reduction in



                                       17
<PAGE>   18

sales or profitability in that country, or result in foreign exchange losses on
the conversion to U.S. dollars of foreign currency accounts receivable resulting
from international operations. In addition, the weakening of certain non-U.S.
currencies may impair customers' ability to repay existing obligations. These
risks may have a material adverse effect on the Company's future consolidated
financial position, results of operations, or cash flows.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

   Information relating to quantitative and qualitative disclosure about market
risk is set forth under the captions "Investment Portfolio" and "Foreign
Exchange Hedging" in Item 2, Management's Discussion and Analysis of Financial
Condition and Results of Operations, and "Foreign Exchange Hedging" in Note 5 of
the Notes to Condensed Consolidated Financial Statements. Such information is
incorporated herein.








                                       18
<PAGE>   19



                          PART II -- OTHER INFORMATION

ITEM 2.  CHANGES IN SECURITIES

        (c)  RECENT SALES OF UNREGISTERED SECURITIES

        In January 1998, the Company acquired all of the outstanding shares of
New Oak Communications, Inc. (New Oak), pursuant to a merger of a newly formed,
wholly-owned subsidiary of the Company with and into New Oak in exchange for
5,093,551 shares of the Company's common stock and $23.0 million in cash. Such
shares were not registered under the Securities Act of 1933 as amended (the 1933
Act) in reliance upon the exemptions provided by Section 4(2) of the 1993 Act
and/or Regulation D promulgated thereunder as a transaction by an issuer not
involving a public offering.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

        (a)  Exhibits.

             The Exhibits listed in the accompanying Exhibit Index are filed as
             part of this report.

        (b) Reports on Form 8-K.

             None










                                       19
<PAGE>   20


                                    SIGNATURE


Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.


                                        BAY NETWORKS, INC.




                                        By   /s/ Rob G. Seim
                                             --------------------------------
                                             Rob G. Seim
                                             Vice President and
                                             Corporate Controller
                                             (Authorized Officer and
                                             Principal Accounting Officer)



Date:  May 8, 1998









                                       20
<PAGE>   21



                                  EXHIBIT INDEX

<TABLE>
<CAPTION>
    EXHIBIT NO.                          DESCRIPTION
    -----------                          -----------
       <S>       <C>
        3.1      Restated Certificate of Incorporation of the Registrant.

        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.

        3.3      Certificate of Amendment of the Restated Certificate of
                 Incorporation, dated April 24, 1998.

        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.

       10.5*     Amended and Restated 1994 Employee Stock Purchase Plan, as
                 amended on April 24, 1998.

       10.32*    1998 Employee Stock Purchase Plan, effective April 24, 1998.

       10.33*    Sign-On Stock Option Agreement with David L. House, Chairman of
                 the Board, President and Chief Executive Officer, effective
                 October 29, 1996.

       10.34*    Employee Agreement with Ralph R. Russo, Executive Vice
                 President of Operations, dated October 3, 1997.

       10.35*    Executive Retention and Severance Plan, effective January 27,
                 1998.
     
       10.36*    Executive Retention and Severance Agreement with David L.
                 House, Chairman of the Board, President, and Chief Executive
                 Officer, effective January 27, 1998.

       10.37*    Executive Retention and Severance Agreement with David J.
                 Rynne, Executive Vice President and Chief Financial Officer,
                 effective January 27, 1998.

       10.38*    Form of the Executive Retention and Severance Agreement.

       10.39*    Form of the Officer Retention and Severance Agreement.

       11        Statement Regarding Computation of Per Share Earnings

       27.1      Financial Data Schedule - Nine Months Ended March 28, 1998.

       27.2      Financial Data Schedule - Six Months Ended December 27, 1997.

       27.3      Financial Data Schedule - Three Months Ended September 27,
                 1997.

       27.4      Financial Data Schedule - Fiscal Year Ended June 30, 1997.

       27.5      Financial Data Schedule - Nine Months Ended March 31, 1997.

       27.6      Financial Data Schedule - Six Months Ended December 31, 1996.

       27.7      Financial Data Schedule - Three Months Ended September 30,
                 1996.

       27.8      Financial Data Schedule - Fiscal Year Ended June 30, 1996.
</TABLE>

* Indicates compensatory plan or arrangement.


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