Updated from 8:35 a.m. EDT

McData

(MCDT)

is paying the penalty for issuing disappointing third-quarter guidance on Monday. In recent trading, shares of the network storage switch maker were off $2.31, or 18.6%, to $10.13 on heavy volume.

Before the opening bell, the company announced revenue of $107 million for the second quarter ended July 31, up 39% from $77.3 million last year. McData earned $9.1 million, or 8 cents a share, reversing a loss of $3.9 million, or 3 cents a share, a year ago. Excluding items, the company earned $11.5 million, or 10 cents a share, for the second quarter of 2003.

McData also announced the acquisition of two privately held storage networking companies. It will acquire

Nishan Systems

for $83 million in cash and will also assume about $2 million in debt. The company will also buy

Sanera Systems

for around $102 million in cash.

Analyst Daniel Renourad of Baird said "McData continues to execute well in a tough environment and these acquisitions make long-term sense." However, he called McData's third-quarter guidance "modestly disappointing" and said that with the stock trading at "high earnings multiples, investors should remain on the sidelines pending better visibility on the competitive/pricing landscape." Baird has an investment banking relationship with McData.

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McData forecast revenue of $105 million to $110 million and earnings of 5 cents to 7 cents a share, before items, for the third quarter ending Oct. 31.

Analysts polled by Thomson First Call expected a profit of 7 cents a share on revenue of $108.8 million in the second quarter. For the third quarter, analysts are looking for earnings of 7 cents and a top line of $112.9 million.

Like other enterprise storage companies, McData ran up sharply during the first half of the year, appreciating 74%. And like rival

Brocade

(BRCD)

, it is facing increasing pricing pressure and a competitive threat from networking giant

Cisco

(CSCO) - Get Report

, which recently entered the storage market.

Second-quarter gross margins were improved, increasing to 59%, up from 44% a year ago, and from 56% in the first quarter. However, much of the improvement was due to a one-time vendor benefit. Going forward, management expects margins to be in the mid 50s percentage range.

The two acquisitions are expected to add about $6 million in operating expenses and dilute third-quarter earnings by 3 cents, management said. (The company's guidance did not include the effects of the acquisition.) Management said that assuming a 6-cent dilution in the fourth-quarter would be "conservative" and will give more exact guidance during the next earnings call.

Additionally, McData will provide 1.5 million to 1.7 million Class B common shares and roughly $8 million in cash to fund employee retention programs over the next two years for workers added through the acquisitions. McData expects to close the transactions within one to two months.