##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  FORM 10-Q (Mark One) x
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED APRIL 30, 2004o
    
    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: 0-13994 COMPUTER NETWORK TECHNOLOGY CORPORATION 
 Minnesota
    
    41-1356476(State of Incorporation)
    
    (I.R.S. Employer Identification No.)
 6000 Nathan Lane North, Minneapolis, Minnesota 55442   Telephone Number: (763) 268-6000   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 the
filing requirements for at least the past 90 days. Yes x No o Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes x No o As of April 30, 2004, the registrant had 27,729,549 shares of $.01 par value
common stock issued and outstanding.




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##### Table of Contents



COMPUTER NETWORK TECHNOLOGY CORPORATION INDEX PagePART I. FINANCIAL INFORMATIONItem 1. Financial Statements (unaudited)Consolidated Statements of Operations for the three months
ended April 30, 2004 and 2003
    
    
    3Consolidated Balance Sheets as of April 30, 2004
and January 31, 2004
    
    
    4Consolidated Statements of Cash Flows for the three months
ended April 30, 2004 and 2003
    
    
    5Notes to Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    14Item 3. Market Risks
    
    
    20Item 4. Controls and Procedures
    
    
    21PART II OTHER INFORMATION
    
    
    23Item 1. Legal Proceedings
    
    
    23Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities
    
    
    23Items 3-5. None
    
    
    23Item 6. Exhibits and Reports on Form 8-K
    
    
    23SIGNATURES
    
    
    25EXHIBIT INDEX
    
    
    26Interest Rate Swap AgreementForm of Restricted Stock Unit Agreement-1992Form of Deferred Stock Award Election-1992Form of Restricted Stock Unit Agreement-1999Form of Restricted Stock Unit Agreement-2002Form of Deferred Stock Award Election-2002Amendment to 2000 Stock Compensation PlanForm of Non-Qualified Stock Option Agreement-2000Computation of Net IncomeCEO CertificationsCFO CertificationsCertification Pursuant to Section 906
 2




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##### Table of Contents



PART I. FINANCIAL INFORMATION 
 Item 1. COMPUTER NETWORK TECHNOLOGY CORPORATION 
  
 Three months endedApril 30,2004
    
    2003Revenue:Product sales
    
    $
    63,675
    
    
    $
    34,404Service fees
    
    
    32,562
    
    
    
    17,926Total revenue
    
    
    96,237
    
    
    
    52,330Cost of revenue:Cost of product sales
    
    
    38,182
    
    
    
    21,634Cost of service fees
    
    
    20,755
    
    
    
    10,086Total cost of revenue
    
    
    58,937
    
    
    
    31,720Gross profit
    
    
    37,300
    
    
    
    20,610Operating expenses:Sales and marketing
    
    
    23,726
    
    
    
    14,206Engineering and development
    
    
    13,157
    
    
    
    5,920General and administrative
    
    
    3,502
    
    
    
    2,556Total operating expenses
    
    
    40,385
    
    
    
    22,682Loss from operations
    
    
    (3,085
    )
    
    
    (2,072
    )Other income (expense):Net gain on sale of marketable securities
    
    
    
    
    
    
    747Interest expense
    
    
    (1,032
    )
    
    
    (1,126
    )Interest income and other, net
    
    
    210
    
    
    
    1,079Total other income (expense), net
    
    
    (822
    )
    
    
    700Loss from continuing operations before income taxes
    
    
    (3,907
    )
    
    
    (1,372
    )Provision for income taxes
    
    
    275
    
    
    
    710Loss from continuing operations
    
    
    (4,182
    )
    
    
    (2,082
    )Discontinued operations
    
    
    (344
    )
    
    
    Net loss
    
    $
    (4,526
    )
    
    $
    (2,082
    )Basic & diluted loss per share:Net loss before discontinued operations
    
    $
    (.15
    )
    
    $
    (.08
    )Discontinued operations
    
    $
    (.01
    )
    
    $
    Net loss
    
    $
    (.16
    )
    
    $
    (.08
    )Shares
    
    
    27,598
    
    
    
    26,960
 See accompanying notes to Consolidated Financial Statements 3




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COMPUTER NETWORK TECHNOLOGY CORPORATION 
   April 30,2004(unaudited)
    
    January 31,2004AssetsCurrent assets:Cash and cash equivalents
    
    $
    73,491
    
    
    $
    75,267Marketable securities
    
    
    6,911
    
    
    
    2,219Receivables, net
    
    
    73,736
    
    
    
    99,815Inventories
    
    
    30,689
    
    
    
    29,976Other current assets
    
    
    5,827
    
    
    
    4,400Total current assets
    
    
    190,654
    
    
    
    211,677Property and equipment, net
    
    
    43,067
    
    
    
    40,313Field support spares, net
    
    
    12,482
    
    
    
    11,951Goodwill
    
    
    105,086
    
    
    
    105,203Other intangibles, net
    
    
    31,549
    
    
    
    33,225Deferred tax asset
    
    
    872
    
    
    
    872Other assets
    
    
    13,228
    
    
    
    9,140$
    396,938
    
    
    $
    412,381Liabilities and Shareholders EquityCurrent liabilities:Accounts payable
    
    $
    37,343
    
    
    $
    47,696Accrued liabilities
    
    
    40,514
    
    
    
    43,733Deferred revenue
    
    
    47,417
    
    
    
    47,058Current installments of obligations under capital lease
    
    
    2,525
    
    
    
    1,619Total current liabilities
    
    
    127,799
    
    
    
    140,106Obligations under capital lease, less current installments
    
    
    6,326
    
    
    
    4,468Convertible subordinated debt
    
    
    125,000
    
    
    
    125,000Total liabilities
    
    
    259,125
    
    
    
    269,574Shareholders equity:Preferred stock
    
    
    
    
    
    
    Common stock, $.01 par value; authorized
100,000 shares, issued and outstanding
27,730 at April 30, 2004 and
27,501 at January 31, 2004
    
    
    277
    
    
    
    275Additional paid-in capital
    
    
    189,541
    
    
    
    187,652Unearned compensation
    
    
    (1,833
    )
    
    
    (319
    )Accumulated deficit
    
    
    (51,525
    )
    
    
    (46,999
    )Accumulated other comprehensive income
    
    
    1,353
    
    
    
    2,198Total shareholders equity
    
    
    137,813
    
    
    
    142,807$
    396,938
    
    
    $
    412,381
 See accompanying notes to Consolidated Financial Statements 4




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COMPUTER NETWORK TECHNOLOGY CORPORATION 
  
 Three months endedApril 30,2004
    
    2003Operating Activities:Net loss
    
    $
    (4,526
    )
    
    $
    (2,082
    )Adjustments to reconcile net loss to net cash provided by
operating activities:Discontinued operations
    
    
    344
    
    
    
    Depreciation and amortization
    
    
    7,251
    
    
    
    3,712Non-cash compensation expense
    
    
    149
    
    
    
    132Net gain on sale of marketable securities
    
    
    
    
    
    
    (747
    )Changes in deferred taxes
    
    
    
    
    
    
    (51
    )Changes in operating assets and liabilities:Receivables
    
    
    25,484
    
    
    
    10,322Inventories
    
    
    (288
    )
    
    
    6,235Other current assets
    
    
    (1,132
    )
    
    
    (498
    )Accounts payable
    
    
    (10,353
    )
    
    
    (1,981
    )Accrued liabilities
    
    
    (3,561
    )
    
    
    (2,697
    )Deferred revenue
    
    
    359
    
    
    
    1,557Net cash provided by continuing operations
    
    
    13,727
    
    
    
    13,902Net cash used in discontinued operations
    
    
    (344
    )
    
    
    Cash provided by operating activities
    
    
    13,383
    
    
    
    13,902Investing Activities:Additions to property and equipment
    
    
    (4,811
    )
    
    
    (1,020
    )Additions to field support spares
    
    
    (2,094
    )
    
    
    (688
    )Purchase of
marketable securities
    
    
    (4,928
    )
    
    
    (19,909
    )Proceeds
from redemption of marketable securities
    
    
    236
    
    
    
    129,775Other assets
    
    
    (2,347
    )
    
    
    72Cash provided by (used in) investing activities
    
    
    (13,944
    )
    
    
    108,230Financing Activities:Proceeds from issuance of common stock
    
    
    228
    
    
    
    112Repayments of obligations under capital leases
    
    
    (777
    )
    
    
    (226
    )Cash used in financing activities
    
    
    (549
    )
    
    
    (114
    )Effects of exchange rate changes
    
    
    (666
    )
    
    
    (481
    )Net increase (decrease) in cash and cash equivalents
    
    
    (1,776
    )
    
    
    121,537Cash and cash equivalents beginning of period
    
    
    75,267
    
    
    
    98,341Cash and cash equivalents end of period
    
    $
    73,491
    
    
    $
    219,878
 See accompanying notes to Consolidated Financial Statements 5




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NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

(IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS) (1) BASIS OF PRESENTATION The accompanying consolidated financial statements have been prepared in
accordance with instructions to Form 10-Q and do not include all of the
information and notes required by accounting principles generally accepted in
the United States of America for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. These
consolidated financial statements should be read in conjunction with the
consolidated financial statements and accompanying notes included in the
Companys Annual Report on Form 10-K for the fiscal year ended January 31, 2004
as filed with the Securities and Exchange Commission. References to fiscal 2004
and 2003, represent the twelve months ended January 31, 2005 and 2004,
respectively. On May 5, 2003, the Company completed the acquisition of Inrange
Technologies (Inrange) for $190 million in cash. The acquisition was
accounted for as a purchase, and the Companys financial statements include the
results of Inrange since May 5, 2003. See footnote 4 Acquisitions for
further information regarding the effect of the Inrange acquisition on the
Companys balance sheet and results of operations. (2) MARKETABLE SECURITIES During the first quarter of fiscal 2003, the Company sold marketable
securities totaling $122 million, resulting in a net pre-tax gain of
approximately $747. No significant gains or losses from the sale of marketable
securities were recorded during the other periods presented. The Companys investments in marketable securities primarily consist of
U.S. government and agency securities, corporate debt securities and bank
certificates of deposit. The Company also holds trading securities consisting
of various mutual funds. The Company intends to use any gain or loss from
these investments to fund the investments gains and losses allocated to
participants under the Companys executive deferred compensation plan. (3) INVENTORIES Inventories, stated at the lower of cost (first-in, first-out method) or
market, consist of: April 30,
    
    January 31,2004
    
    2004Inventories:Components and subassemblies
    
    $
    14,774
    
    
    $
    14,311Work in process
    
    
    4,096
    
    
    
    4,015Finished goods
    
    
    11,819
    
    
    
    11,650$
    30,689
    
    
    $
    29,976
 6




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##### Table of Contents



(4) ACQUISITIONS Inrange On April 6, 2003, the Company entered into an agreement whereby a wholly
owned subsidiary of the Company would acquire all of the shares of Inrange
Technologies Corporation (Inrange) that were owned by SPX Corporation. The
shares acquired constituted approximately 91% of the issued and outstanding
shares of Inrange for a purchase price of approximately $2.31 per share and
$173 million in the aggregate. On May 5, 2003 the Company completed the
acquisition of Inrange and pursuant to the agreement the subsidiary merged into
Inrange, and the remaining capital stock owned by the other Inrange
shareholders was converted into the right to receive approximately $2.31 per
share in cash, resulting in a total payment of $190 million for both the stock
purchase and merger. The Company acquired Inrange to significantly broaden its portfolio of
storage networking products and solutions, particularly in the area of Fibre
Channel and FICON switching, increase its global size and scope, and expand its
customer base. Management believes the acquisition provides the Company with
significant revenue growth and cost reduction synergies. Management believes
the integration of the two companies completed in fiscal 2003, will result in
over $20,000 in annualized cost savings. The acquisition was accounted for as a purchase and the consolidated
financial statements of the Company include the results of Inrange since May 5,
2003. The purchase price was allocated to the fair value of the assets and
liabilities acquired as follows: Purchase Price:Cash paid
    
    $
    190,526Value of stock option grants
    
    
    10,286Transaction costs
    
    
    3,347Total Purchase consideration paid
    
    $
    204,159Fair Value of Assets Acquired and Liabilities Assumed:Cash
    
    $
    41,088Accounts receivable
    
    
    34,542Inventory
    
    
    12,461Property and equipment
    
    
    22,538Field support spares
    
    
    7,757Developed technology
    
    
    20,248Customer list
    
    
    15,294Trademarks
    
    
    1,234In-process research and development charge
    
    
    19,706Goodwill
    
    
    86,899Deferred taxes
    
    
    75Other assets
    
    
    6,677Accounts payable
    
    
    (10,788
    )Accrued expenses
    
    
    (32,628
    )Deferred revenue
    
    
    (20,944
    )Total purchase consideration paid
    
    $
    204,159
 The following table presents the unaudited pro forma consolidated results
of operations of the Company for the three months ended April 30, 2004 and 2003
as if the acquisition of Inrange took place on February 1, 2003: Pro FormaThree months endedApril 30,2004
    
    2003Total revenue
    
    $
    96,237
    
    
    $
    92,492Net loss
    
    $
    (4,526
    )
    
    $
    (12,846
    )Net loss per share
    
    $
    (.16
    )
    
    $
    (.48
    )
 7




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The pro forma results include amortization of the customer list, developed
technology and trademarks presented above. The unaudited pro forma results do
not include the $19.7 million charge for in-process research and development
related to the Inrange acquisition. The unaudited pro forma results are for
comparative purposes only and do not necessarily reflect the results that would
have been recorded had the acquisition occurred at the beginning of the period
presented or the results which might occur in the future. As part of the Inrange acquisition, the Company assumed the 2000 Inrange
stock compensation plan which provides for the issuance of up to 3,782,993
shares of the Companys common stock. The plan provided for the conversion of
pre-existing Inrange stock options into company stock options. The options
granted under the 2000 Inrange stock compensation plan were valued at $10,286
using the Black-Scholes option-pricing model. The amount was deemed to be part
of the Inrange purchase price and was recorded as additional paid-in capital. The intangible assets acquired included developed technology, customer
list and trademarks valued at $20.2 million, $15.3 million and $1.2 million,
respectively. The developed technology, customer list and trademarks are
being amortized on a straight-line basis over periods of approximately five
years, seven years and five years, respectively. Goodwill resulting from the
acquisition of $86.9 million is deductible for income tax purposes. The Company has allocated $19.7 million of the Inrange purchase price to
acquired in-process research and development to reflect the value of new Fibre
Channel switching technology that was approximately 50% complete at the time of
acquisition. At the date of acquisition, the technological feasibility of the
new Fibre Channel switching technology had not been attained and the technology
had no alternative future use. The new Fibre Channel switching technology is
projected to have significantly greater functionality and port density when
compared to other Fibre Channel technology currently available in the
marketplace. The allocation to in-process research and development was based
on an independent third party appraisal that utilized the excess earnings
approach. Significant assumptions used in the third party appraisal include
the cost to complete the project, and the projected revenue and expense
generated over the estimated life cycle of the new Fibre Channel switching
technology. A significant part of our integration strategy related to the Inrange
acquisition, included the termination of duplicative employees across most
functional areas, and the closing of duplicative facilities to obtain cost
synergies. Integration planning was initiated prior to the closing of the
acquisition. Severance costs for terminated Inrange employees were treated as
an acquired liability, effectively increasing the purchase price. Severance
costs for terminated CNT employees were recorded as an expense in the statement
of operations. The integration plan resulted in the termination of 165
employees, including employees of both CNT and Inrange. The duplicative
facilities that were closed were part of the pre-acquisition Inrange business,
and the accrual for future rents associated with these facilities was treated
as an acquired liability, effectively increasing the purchase price. The
integration of product strategies for the new combined entity resulted in a
$1.6 million charge in fiscal 2003 for the write-down of inventory that CNT had
purchased prior to the acquisition. There have been no subsequent sales of
this inventory. A summary of severance and facility accrual activity follows: Obligation
    
    
    
    
    
    ObligationAs of
    
    
    
    
    
    As ofJanuary 31, 2004
    
    Utilization
    
    April 30, 2004Inrange severance
    
    $
    283
    
    
    $
    (62
    )
    
    $
    221CNT severance
    
    $
    50
    
    
    $
    
    
    
    $
    50Duplicative facilities
    
    $
    5,574
    
    
    $
    (1,138
    )
    
    $
    4,436
 8




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BI-Tech On June 24, 2002, the Company acquired all the outstanding stock of
BI-Tech, a leading provider of storage management solutions and services, for
$12 million in cash plus the assumption of approximately $3.6 million of
liabilities and the acquisition of approximately $8.7 million of tangible
assets. The Company has allocated $6.5 million, $1.1 million and $250 of the
purchase price to goodwill, customer list and non-compete agreements,
respectively. The customer list and non-compete agreements are currently being
amortized over periods of ten and two years, respectively. The accompanying
financial statements include the results of BI-Tech since June 24, 2002. The original purchase agreement required payments of additional
consideration to the former stockholders and the BI-Tech employees based on
achievement of certain earnings for each of the two years beginning July 1,
2002. A modification to the purchase agreement was made during the second
quarter of fiscal 2003, whereby the first earn out period ended April 30, 2003.
It also guarantees the former stockholders a minimum payment for the second
earn out period, which ends June 30, 2004, of at least $3.9 million. The
portion payable to the former stockholders is recorded as goodwill. The portion
payable to BI-Tech employees is recorded as compensation expense. No additional
goodwill and compensation expense has been recorded under this earn out
agreement since February 1, 2004. (5) GOODWILL AND INTANGIBLE ASSETS The change in the net carrying amount of goodwill for the first three
months of 2004 was as follows: TotalBalance February 1, 2004
    
    $
    105,203Acquisition of Inrange
    
    
    (117
    )Balance as of April 30, 2004
    
    $
    105,086
 The components of other amortizable intangible assets were as follows: April 30, 2004
    
    January 31, 2004Gross Carrying
    
    Accumulated
    
    Gross Carrying
    
    AccumulatedAmount
    
    Amortization
    
    Amount
    
    AmortizationCustomer list
    
    $
    16,924
    
    
    $
    (2,411
    )
    
    $
    16,924
    
    
    $
    (1,883
    )Trademarks
    
    
    1,234
    
    
    
    (246
    )
    
    
    1,234
    
    
    
    (185
    )Developed technology
    
    
    20,248
    
    
    
    (4,220
    )
    
    
    20,248
    
    
    
    (3,165
    )Non-compete agreements
    
    
    250
    
    
    
    (230
    )
    
    
    250
    
    
    
    (198
    )Total
    
    $
    38,656
    
    
    $
    (7,107
    )
    
    $
    38,656
    
    
    $
    (5,431
    )Total other intangible
assets, net
    
    $
    31,549
    
    
    
    
    
    
    $
    33,225
 Amortization expense for intangible assets during the first quarter of
2004 was $1.7 million. Amortization expense for the remainder of 2004 is
estimated to be $5.2 million. Amortization expense is estimated to be $6.8
million in 2005 and 2006, $6.2 million in 2007 and $3.2 million in 2008. 9




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(6) COMPREHENSIVE LOSS Comprehensive loss consists of the following: Three months endedApril 30,2004
    
    2003Net loss
    
    $
    (4,526
    )
    
    $
    (2,082
    )Foreign currency translation adjustment, net of
tax effect of $0
    
    
    845
    
    
    
    (213
    )Total comprehensive loss
    
    $
    (3,681
    )
    
    $
    (2,295
    )
 (7) CONVERTIBLE SUBORDINATED DEBT In February 2002, the Company sold $125 million of 3% convertible
subordinated notes due February 15, 2007, raising net proceeds of $121.6
million. The notes are convertible into the Companys common stock at a price
of $19.17 per share. The Company may redeem the notes upon payment of the
outstanding principal balance, accrued interest and a make whole payment if the
closing price of its common stock exceeds 175% of the conversion price for at
least 20 consecutive trading days within a period of 30 consecutive trading
days ending on the trading day prior to the date the redemption notice is
mailed. The make whole payment represents additional interest payments that
would be made if the notes were not redeemed prior to the due date. In January 2004, the Company entered into an interest-rate swap agreement
with a notional amount of $75 million that has the economic effect of
modifying that dollar portion of the fixed interest obligations associated with
$75 million of its 3% convertible subordinated notes due February 2007 such
that the interest payable effectively becomes variable based on the three month
LIBOR plus 69.5 basis points. The payment dates of the swap are January 31st,
April 30th, July 31st and October 31st of each year, commencing April 30, 2004,
until maturity on February 15, 2007. The initial LIBOR setting for the swap was
1.15%, creating a combined effective rate of approximately 1.845%, which was
effective until April 30, 2004. The combined effective rate for the period from
May 1, 2004 through July 31, 2004 is approximately 1.865%. The swap was
designated as a fair value hedge, and as such, the gain or loss on the swap, as
well as the fully offsetting gain or loss on the notes attributable to the
hedged risk, were recognized in earnings. As part of the agreement, the Company
is also required to post collateral based on changes in the fair value of the
interest rate swap. This collateral, in the form of restricted cash, was $2.5
million at April 30, 2004. The Company could incur charges to terminate the
swap in the future prior to February 15, 2007 if interest rates rise, or upon
certain events such as a change in control or certain redemptions of
convertible subordinated notes. 10




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(8) STOCK-BASED COMPENSATION The estimated per share weighted average fair value of all stock options
granted during the three months ended April 30, 2004 and 2003 was $5.92 and
$5.01, respectively. The fair value of each option grant was estimated using
the Black-Scholes option pricing model with the following weighted average
assumptions: Three months endedApril 30,2004
    
    2003Risk free interest rate
    
    
    3.08
    %
    
    
    3.15
    %Expected life
    
    
    5.73
    
    
    
    6.18Expected volatility
    
    
    94.59
    %
    
    
    87.38
    %
 Had the Company recorded compensation cost for its stock options based on
the estimated fair value on the date of grant, as defined by SFAS 123, the
Companys pro forma net loss would have been as follows: Three months endedApril 30,2004
    
    2003Net loss, as reported
    
    $
    (4,526
    )
    
    $
    (2,082
    )Deduct: Total stock-based employee
compensation expense under fair value
based method of all awards, net of tax
    
    
    (2,810
    )
    
    
    (2,508
    )Pro forma net loss
    
    $
    (7,336
    )
    
    $
    (4,590
    )Basic & diluted net loss per share:As reported
    
    $
    (.16
    )
    
    $
    (.08
    )Pro forma
    
    $
    (.27
    )
    
    $
    (.17
    )
 11




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(9) WARRANTY The Company records a liability for warranty claims at the time of sale.
The amount of the liability is based on contract terms and historical warranty
costs, which is periodically adjusted for recent actual experience. Warranty
terms on the Companys equipment range from 90 days to 13 months. The changes
in warranty reserve balances for the three months ended April 30, 2004 and 2003
were as follows: April 30,2004
    
    2003Beginning balance
    
    $
    2,348
    
    
    $
    1,521Charged to cost of product
    
    
    1,010
    
    
    
    358Cost of warranty
    
    
    (892
    )
    
    
    (711
    )Ending balance
    
    $
    2,466
    
    
    $
    1,168
 (10) NEW ACCOUNTING PRONOUNCEMENTS On December 24, 2003, the Financial Accounting Standards Board (the
FASB) issued Interpretation (FIN) No. 46R Consolidation of Variable
Interest Entities. FIN No. 46R replaces Interpretation No. 46, Consolidation
of Variable Interest Entities FIN 46, which was issued on January 17, 2003.
FIN No. 46R provides guidance on identification of entities for which control
is achieved through means other than through voting rights called variable
interest entities or VIEs and how to determine when and which business
enterprise should consolidate the VIE (the primary beneficiary). This new
model for consolidation applies to an entity in which either (1) the equity
investors (if any) do not have a controlling financial interest or (2) the
equity investment at risk is insufficient to finance that entitys activities
without receiving additional subordinated financial support from other parties.
In addition, FIN 46R requires that both the primary beneficiary and all other
enterprises with a significant variable interest in a VIE to make additional
disclosures. The adoption of FIN No. 46R did not have material effect on our
financial statements. (11) DISCONTINUED OPERATIONS In connection with the acquisition of Inrange, the Company acquired a
non-complementary business focused on enterprise resource planning (ERP)
consulting services. In April 2004, the business and its net assets totaling
approximately $2.0 million were sold for estimated cash proceeds of $1.3
million, subject to adjustment based on the final agreed upon net assets of the
business, and installments payments having a discounted value of approximately
$1.2 million. The business was divested to allow the Company to focus on its
core storage networking solutions business. Revenue and expense for the ERP
business in the first quarter of 2004 totaled approximately $2.5 million and
$2.8 million, respectively. The business has been accounted for as a
discontinued operation in the accompanying financial statements, meaning that
its revenues and expenses are not included in results from continuing
operations, and the net loss of the ERP business for the first quarter of 2004
totaling $344 was included under the discontinued operations caption in the
statement of operations. The pre-tax gain from the sale of $450 has been recorded as reduction in
goodwill from the Inrange Technologies acquisition during the first quarter of
2004. (12) ENTERPRISE-WIDE INFORMATION Summarized information regarding enterprise-wide revenue and gross margins
from external customers are as follows: April 30,2004
    
    2003Revenue:Proprietary products
    
    $
    38,511
    
    
    $
    18,294Third party products
    
    
    25,164
    
    
    
    16,110Professional services
    
    
    11,604
    
    
    
    7,088Maintenance
    
    
    20,958
    
    
    
    10,838Total
    
    $
    96,237
    
    
    $
    52,330Gross margins:Proprietary products
    
    $
    21,365
    
    
    $
    9,980Third party products
    
    
    4,128
    
    
    
    2,790Professional services
    
    
    2,336
    
    
    
    2,404Maintenance
    
    
    9,471
    
    
    
    5,436Total
    
    $
    37,300
    
    
    $
    20,610
 12




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(13) LITIGATION Inrange Technologies Corporation, which is now a wholly owned subsidiary
of the Company, has been named as a defendant in the case SBC Technology
Resources, Inc. v. Inrange Technologies Corp., Eclipsys Corp. and Resource
Bancshares Mortgage Group, Inc., No. 303-CV-418-N, pending in the United States
District Court for the Northern District of Texas, Dallas Division. The action
was commenced on February 27, 2003. The complaint claims that Inrange is
infringing one SBC patent by manufacturing and selling storage area networking
equipment, including Fibre Channel directors and switches, for use in storage
networks that allegedly embody certain inventions claimed in a patent owned by
SBC. The complaint asks for judgment that SBCs patent is infringed by the
defendants in the case, an accounting for actual damages, attorneys fees, costs
of suit and other relief. Additionally, Eclipsys has demanded that Inrange
indemnify and defend Eclipsys pursuant to documentation under which it acquired
the product from Inrange. Hitachi Data Systems Corporation has informed Inrange
that it has also received a demand from Eclipsys that Hitachi indemnify and
defend Eclipsys for this action. Hitachi has put Inrange on notice that it will
tender any claim by Eclipsys for indemnification and defense of this action to
Inrange. Inrange has answered, denying SBCs allegations. The case is in its
preliminary stages and management is evaluating the litigation. At this point,
it is too early to form a definitive opinion concerning the ultimate outcome of
this matter. A shareholder class action was filed against Inrange and certain of its
officers on November 30, 2001, in the United States District Court for the
Southern District of New York, seeking recovery of damages caused by Inranges
alleged violation of securities laws, including section 11 of the Securities
Act of 1933 and section 10(b) of the Exchange Act of 1934. The complaint, which
was also filed against the various underwriters that participated in Inranges
initial public offering (IPO), is identical to hundreds of shareholder class
actions pending in this court in connection with other recent IPOs and is
generally referred to as In re Initial Public Offering Securities Litigation.
The complaint alleges, in essence, (a) that the underwriters combined and
conspired to increase their respective compensation in connection with the IPO
by (i) receiving excessive, undisclosed commissions in exchange for lucrative
allocations of IPO shares, and (ii) trading in Inranges stock after creating
artificially high prices for the stock post-IPO through tie-in or laddering
arrangements (whereby recipients of allocations of IPO shares agreed to
purchase shares in the aftermarket for more than the public offering price for
Inrange shares) and dissemination of misleading market analysis on Inranges
prospects; and (b) that Inrange violated federal securities laws by not
disclosing these underwriting arrangements in its prospectus. The defense has
been tendered to the carriers of Inranges director and officer liability
insurance, and a request for indemnification has been made to the various
underwriters in the IPO. At this point the insurers have issued a reservation
of rights letter and the underwriters have refused indemnification. The court
has granted Inranges motion to dismiss claims under section 10(b) of the
Securities Exchange Act of 1934 because of the absence of a pleading of intent
to defraud. The court granted plaintiffs leave to replead these claims, but no
further amended complaint has been filed. The court also denied Inranges
motion to dismiss claims under section 11 of the Securities Act of 1933. The
court has also dismissed Inranges individual officers without prejudice, after
they entered into a tolling agreement with the plaintiffs. On July 25, 2003,
the Companys board of directors conditionally approved a proposed partial
settlement with the plaintiffs in this matter. The settlement would provide,
among other things, a release of Inrange and of the individual defendants for
the conduct alleged in the action to be wrongful in the complaint. Inrange
would agree to undertake other responsibilities under the partial settlement,
including agreeing to assign away, not assert, or release certain potential
claims Inrange may have against its underwriters. Any direct financial impact
of the proposed settlement is expected to be borne by Inranges insurers. The
settlement was approved subject to a number of conditions, including the
participation of a substantial number of other issuer defendants in the
proposed settlement, the consent of Inranges insurers to the settlement, and
the completion of acceptable final settlement documentation. Furthermore, the
settlement is subject to a hearing on fairness and approval by the court
overseeing the IPO litigations. At this point, it is too early to form a
definitive opinion concerning the ultimate outcome of this matter. From time-to-time we are a party to various other legal actions and
receive threats of litigation. At this time, management does not believe any
such litigation or threats will have a material impact on our consolidated
financial position or results of operations. 13




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS This Managements Discussion and Analysis of Financial Condition and Results of
Operations (MD&A) should be read in conjunction with our interim consolidated
financial statements and notes thereto which appear elsewhere in this Quarterly
Report and the MD&A contained in our Annual Report on Form 10-K filed with the
Securities and Exchange Commission on April 14, 2004. Overview We are a leading provider of todays most cost-effective and reliable
storage networking solutions. For over 20 years, businesses around the world
have depended on us to improve business efficiency, increase data availability
and manage their business-critical information. We apply our technology,
products and expertise in open storage networking architecture and business
continuity to help companies build end-to-end storage solutions, including
hardware and software products, analysis, planning and design, multi-vendor
integration, implementation and ongoing remote management. We focus primarily
on helping our customers design, develop, deploy and manage storage and data
networks, including storage area networks, or SANs, a high speed network within
a business existing computer system that allows the business to manage its
data storage needs with greater efficiency and less disruption to its overall
network. We design, manufacture, market and support a wide range of solutions
that provide fast and reliable connections among networks of computers and
related devices, allowing customers to manage and expand large, complex storage
networks efficiently, without geographic limitations, including applications
such as remote data replication, or the real-time backup of data to remotely
located disks, and remote tape vaulting, or the backup of data to remotely
archived tapes. We market our storage networking products and services
directly to customers through our sales force and worldwide distributors. We
also have strategic marketing and supply relationships with leading storage,
telecommunications and fibre switching companies, including Brocade, EMC,
Hewlett-Packard, Hitachi Data Systems, IBM, StorageTek, and Dell Computer
Corporation. On May 5, 2003, we completed the acquisition of Inrange for $190 million
in cash plus transaction costs. Inrange designs, manufactures, markets and
supports switching and networking products for storage and data networks.
Inranges flagship product, the FC/9000®, is the most scalable storage
networking director-class switch available for SANs. With an ability for
customers to upgrade and scale to 256 ports without disrupting existing
systems, the FC/9000® provides a platform from which enterprises can build
storage networks that can be used in systems where reliability and continuous
availability are critical. The acquisition of Inrange makes us one of the
worlds largest providers of complete storage networking products, solutions
and services, with combined 2003 pro forma annual revenues of approximately
$400 million. We believe we have global leadership positions in our combined
markets. The acquisition significantly broadens and strengthens our portfolio
of storage networking products and solutions, increases our global size and
scope, expands our customer base, and provided us with significant
opportunities for both revenue growth and cost reduction synergies. Our
integration of the two companies has resulted in over $20 million in projected
annualized cost savings. The markets in which we operate are characterized by rapidly changing
technology and evolving industry standards, resulting in rapid product
obsolescence and frequent product and feature introductions and improvements.
We compete with several companies that have greater engineering and development
resources, marketing resources, financial resources, manufacturing capability,
customer support resources and name recognition. As a result, our competitors
may have greater credibility with existing and potential customers. They also
may be able to adopt more aggressive pricing policies and devote greater
resources to the development, promotion and sale of their products than we can
to ours, which would allow them to respond more quickly than we can to new or
emerging technologies and changes in customer requirements. Our competitors for our storage networking products, primarily our
UltraNet® family of products, include storage system vendors and others
including Akara, which is owned by Ciena, and Nishan Systems, which is owned by
McData. In addition, Cisco has acquired technology (Andiamo and NuSpeed) with
functionality similar to our product offerings. EMC has a WAN capability for
storage networking that competes with our products. Our UltraNet® product
revenue may be impacted as customers switch to channels such as FICON with
improved distance and price performance capabilities or to less expensive IP
based solutions. There are numerous competitors for our third party product
and solution sales. While the Fibre Channel and FICON switching markets have yet to develop
fully, we believe that the market for our FC/9000® Fibre Channel and FICON
director switching products, and our next generation products, will be highly
competitive, continually evolving and subject to rapid technology change. Our
competitors in Fibre Channel and FICON switching include Brocade Communications
Systems, McData Corporation, Cisco Systems, Inc., and Qlogic Corporation, as
well as storage system vendors who may re-sell the Fibre Channel and FICON
switching products manufactured by our competitors. 14




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We anticipate that the proprietary products acquired in the Inrange
acquisition, including the Inrange Fibre Channel and FICON director products,
will account for a significant and growing portion of our proprietary product
revenue in future periods. IDC estimates that the revenue for Fibre Channel
hubs, switches and directors will grow from $938 million in 2003 to $2.2
billion in 2007, reflecting a compound annual growth rate of 23%. We
anticipate that we will be able to capture a larger share of this growing
market by expanding our established relationships with leaders in the storage
networking market, including the major storage vendors, such as EMC, Hitachi
Data Systems and IBM. We believe our current and future strategic
relationships will facilitate the integration of our products, thereby
increasing our market share and reducing the length of our sales cycle. We
will also expand sales of our proprietary products, including our Fibre Channel
and FICON director products, through our direct sales force. We believe that
our ability to provide the customer with complete professional consulting
services, product maintenance and advanced networking monitoring services gives
us an advantage over our competitors, that will enable us to expand sales and
grow market share. Our revenue can be significantly impacted by general economic trends in
the global economy and capital spending plans for information technology
equipment. Our revenue can also be impacted by the introduction or phase out
of products and services, either by us, or competitors. The introductions of
new technologies by other companies, including the large storage vendors with
whom we do business, can also impact our quarterly revenue. We expect
continued quarter-to-quarter fluctuations in revenue in both domestic and
international markets. The timing of sizable orders, because of their relative
impact on total quarterly sales, may contribute to such fluctuations. The level
of product sales reported by us in any given period will continue to be
affected by the receipt and fulfillment of sizable new orders in both domestic
and international markets. In fiscal 2003, we achieved cost synergies in most functional areas of our
business due to the Inrange acquisition. We consolidated our manufacturing
operations, including the in-house capability to add parts and components to
printed circuit boards. We anticipate that these cost synergies will continue
in fiscal 2004. The mix of products sold by us, (i.e. our proprietary products
or third party products), and the level of services we provide to customers has
a significant impact on our level of profitability in any given quarterly
period. We acquired new Fibre Channel switching technology in connection with the
Inrange acquisition that is in development and is projected to have greater
functionality when compared to other Fibre Channel technology currently
existing in the marketplace. We expect to expend significant research and
development resources in fiscal 2004 to bring this new technology to market.
Significant costs for us include wages, fringe benefits, facilities and
depreciation and amortization. These costs tend to be relatively fixed in the
short term, or may be incurred in advance of anticipated revenue. As a result,
the timing of the receipt of sizable of new orders, and the related recognition
of revenue, has a significant impact on our level of profitability in any given
quarterly period. Acquisition of Inrange On April 6, 2003, we entered into an agreement whereby a wholly owned
subsidiary would acquire all of the shares of Inrange that were owned by SPX
Corporation. The shares acquired constituted approximately 91% of the issued
and outstanding shares of Inrange for a purchase price of approximately $2.31
per share and $173 million in the aggregate. On May 5, 2003 we completed the
acquisition of Inrange and pursuant to the agreement the subsidiary merged into
Inrange, and the remaining capital stock owned by the other Inrange
shareholders was converted into the right to receive approximately $2.31 per
share in cash, resulting in a total payment of $190 million for both the stock
purchase and merger. During fiscal 2003 we incurred integration charges
related to the acquisition of $5.4 million, primarily for wages and severance
for terminated employees, and extra travel costs for integration activities.
We also recorded a $1.6 million charge for the write-down of inventory
resulting from the integration of the product strategies for the new combined
entity, and a $19.7 million charge for in-process research and development
related to the acquisition of Inrange. The integration of Inrange is now
complete and no further integration charges are anticipated in fiscal 2004.
Our consolidated financial statements include the results of Inrange from May
5, 2003. See footnote 4 per the accompanying financial statements for a
summary of the purchase price allocation and pro forma results of operations as
if the acquisition of Inrange took place on February 1, 2003. 15




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Acquisition of BI-Tech Solutions, Inc. In June 2002, we acquired all of the outstanding stock of Business Impact
Technology Solutions Limited (BI-Tech), a leading provider of storage
management solutions and services, for $12 million in cash, plus the assumption
of approximately $3.6 million of liabilities and the acquisition of
approximately $8.7 million of tangible assets. The accompanying financial
statements include the results of BI-Tech since June 24, 2002. The original purchase agreement required payments of additional
consideration to the former stockholders and the BI-Tech employees based on
achievement of certain earnings for each of the two years beginning July 1,
2002. A modification to the purchase agreement was made during the second
quarter of fiscal 2003, whereby the first earn out period ended April 30, 2003.
It also guarantees the former stockholders a minimum payment for the second
earn out period, which ends June 30, 2004, of at least $3.9 million. The
portion payable to the former stockholders is recorded as goodwill. The portion
payable to BI-Tech employees is recorded as compensation expense. No additional
goodwill and compensation expense have been recorded under this earn out
agreement since February 1, 2004. Discontinued Operations In connection with the acquisition of Inrange Technologies in May 2003, we
acquired a non-complementary business focused on enterprise resource planning
(ERP) consulting services. In April 2004, the business and its net assets
totaling approximately $2.0 million were sold for estimated cash proceeds of
$1.3 million, subject to adjustment based on the final agreed upon net assets
of the business, and installments payments having a discounted value of
approximately $1.2 million. The business was divested to allow us to focus on
our core storage networking solutions business. Revenue and expense for the
ERP business in the first quarter of 2004 totaled approximately $2.5 million
and $2.8 million, respectively. The business has been accounted for as a
discontinued operation in the accompanying financial statements, meaning that
its revenues and expenses are not included in results from continuing
operations, and the net loss of the ERP business for the first quarter of 2004
totaling $344,000 was included under the discontinued operations caption in the
statement of operations. The pre-tax gain from the sale of $450,000 during the first quarter of
2004 has been recorded as reduction in goodwill related to the Inrange
acquisition. Convertible Debt Offering In February 2002, we sold $125 million of 3% convertible subordinated
notes due February 2007, raising net proceeds of $121.6 million. The notes are
convertible into our common stock at a price of $19.17 per share. We may redeem
the notes upon payment of the outstanding principal balance, accrued interest
and a make whole premium if the closing price of our common stock exceeds 175%
of the conversion price for at least 20 consecutive trading days within a
period of 30 consecutive trading days ending on the trading day prior to the
date we mail the redemption notice. On August 15, 2002 a registration statement
for the resale of the notes and the 6.5 million shares of common stock issuable
upon conversion of the notes became effective. Valuation Allowance for Deferred Tax Assets In the fourth quarter of fiscal 2002, we recorded a non-cash charge of
$23.6 million to provide a full valuation allowance for our United States
deferred tax assets. As we generate taxable income in future periods, we do not
expect to record significant income tax expense in the United States until it
becomes more likely than not that we will be able to utilize the deferred tax
assets, and we reduce the valuation allowance. The establishment of the
valuation allowance does not impair our ability to use the deferred tax assets
upon achieving profitability. Our federal net operating loss carry-forwards and
credits do not expire until 15 to 20 years from now. 16




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Results of Operations The following table sets forth financial data for our operations for the
periods indicated as a percentage of total revenue except for gross profit,
which is expressed as a percentage of the related revenue. Three months endedApril 30,2004
    
    2003Revenue:Product sales
    
    
    66.2
    %
    
    
    65.7
    %Service fees
    
    
    33.8
    
    
    
    34.3Total revenue
    
    
    100.0
    
    
    
    100.0Gross profit:Product sales
    
    
    40.0
    
    
    
    37.1Service fees
    
    
    36.3
    
    
    
    43.7Total gross profit
    
    
    38.8
    
    
    
    39.4Operating expenses:Sales and marketing
    
    
    24.7
    
    
    
    27.1Engineering and development
    
    
    13.7
    
    
    
    11.3General and administrative
    
    
    3.6
    
    
    
    4.9Total operating expenses
    
    
    42.0
    
    
    
    43.3Loss from operations
    
    
    (3.2
    )%
    
    
    (3.9
    )%
 Cost of product for the first three months of 2004 includes $1.1 million
of amortization of developed technology related to the Inrange acquisition.
Sales and marketing expense includes $608,000 of amortization for trademarks
and customer lists which are also related to the Inrange acquisition. Revenue Product revenue Sales of our proprietary products generated revenues of $38.5 million in
the first quarter of 2004, up $20.2 million or 111% from the first quarter of
2003. The vast majority of the increase in proprietary product sales relates to
the acquisition of Inrange. Throughout fiscal 2003, we worked to fully
integrate the Inrange products into our existing proprietary product offerings,
and now offer our customers one complete and fully integrated line of
proprietary storage networking products. Sales of our third party storage solutions products generated revenues of
$25.2 million in the first quarter of 2004, up $9.1 million or 56% from the
first quarter of 2003. During the first three months of 2004, we received a
large customer order which accounted for the majority of this increase. Our
sales representatives that we employed prior to our acquisition of Inrange also
have become more proficient at selling third party storage solutions. We also
anticipate that third party storage solutions products revenue will increase in
the future periods once the sales representatives we acquired with the Inrange
acquisition become more experienced and proficient at selling third party
products. Service revenue Maintenance
revenues from our proprietary products for the first quarter
of 2004 totaled $21.0 million, up $10.1 or 93% from the first quarter of 2003.
The increase is primarily attributable to our acquisition of Inrange, as
maintenance related to the proprietary products acquired from Inrange provide
us with a recurring annual revenue stream of approximately $40 million. 17




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Our consulting fee revenues increased 64% in the first quarter of 2004 to
$11.6 million from $7.1 million in the first quarter of 2003. We have started
to offer professional consulting services with sales of the proprietary
products we acquired from Inrange, and have trained the Inrange sales force to
sell these services, along with our proprietary and third party products. Our
sales force has also become more experienced and proficient at selling our
consulting services. A significant component of our strategy includes having a
direct sales force and professional consulting organization capable of
providing customers with complete end-to-end storage networking solutions,
thereby capturing more of the customers IT spending and increasing our overall
consulting fee and product revenue. General Revenue generated from the sale of products and services outside the
United States for the first quarter of 2004 totaled $31.4 million, up 104% from
$15.3 million in the first quarter of 2003. We derived 33% and 29% of our
revenue outside the United States for the first quarter of fiscal 2004 and
2003, respectively. The increase in revenue generated outside the United
States and the increase in revenue generated outside the United States as a
percentage of our total revenue is primarily attributable to the acquisition of
Inrange in May 2003. The acquisition of Inrange expanded our presence outside
the United States, primarily in Europe. During calendar year 2002,
international sales accounted for approximately 40% of Inranges total revenue.
We expect to continue to expand our presence outside the United States,
thereby increasing both our sales outside the United States, and our overall
percentage of revenue coming from international markets. Two
customers accounted for 17% and 20%,
respectively, of our revenue during the first quarter of 2004. No customer
accounted for more than 10% of our revenue during the first quarter of 2003.
Price discounting had a small impact on our product revenue during these
periods. Gross Profit Margins Product margins Gross margins from the sale of our proprietary products for the first
quarter of 2004 were 55%, compared to 55% in the first quarter of 2003.
Excluding the $1.1 million of amortization expense for developed technology
related to the Inrange acquisition, gross margins for the first quarter of 2004
would have been 58%. The improvement in gross margin percentage, excluding the
amortization of developed technology, was due to the cost synergies resulting
from the Inrange acquisition. We obtained significant cost synergies by
consolidating our manufacturing operations following the acquisition of
Inrange, resulting in lower labor and overhead costs. A significant part of
our product cost includes the addition of parts and components to printed
circuit boards. Following the acquisition of Inrange, we were able to reduce
our material costs by bringing this activity in-house. We previously outsourced
this activity to various third party suppliers. Gross margins from the sale of third party storage solutions products for
the first quarter of 2004 were 16% compared to 17% in the first quarter of
2003. The slight decrease in gross margin percentage was primarily due to
product mix. We anticipate that product margins for third party products will
remain in the high teens in future periods. Service margins Gross service margins from maintenance of our proprietary products in the
first quarter of 2004 were 45%, compared to 50% in the first quarter of 2003.
The decrease in gross margin percentage was primarily due to the cost
associated with our continued efforts to enhance the level of service provided
to the Inrange customer install base. Gross profit margins from our consulting fees in the first quarter of 2004
were 20%, compared to 34% in the first quarter of 2003. The decrease in gross
margin percentage was due to our acquisition of Inrange, and a planned
expansion of our consulting workforce. The consulting business we acquired
with our May 2003 acquisition of Inrange generated lower gross margin
percentages than our pre-acquisition consulting business due to lower
utilization of employee consultants. We also expanded our workforce of
consulting employees in the first quarter of 2004 in anticipation of additional
future revenue. We anticipate that our gross profit margin percentages from
consulting fees will increase in future periods as revenue and utilization of
the Inrange consulting force and our newly hired consulting employees increase. 18




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Operating Expenses Sales and marketing Sales and marketing expense for the first quarter of 2004 totaled $23.7
million, up 67% from $14.2 million in the first quarter of 2003. Excluding
amortization for customer list and trademarks related to our acquisition of
Inrange for the first quarter 2004 of $608,000, our sales and marketing expense
would have been $23.1 million. Substantially all of the increase was due to
our acquisition of Inrange in May 2003. Engineering Engineering and development expense for the first quarter of 2004 totaled
$13.2 million, up 122% from $5.9 million in the first quarter of 2003. The
increase was primarily due to our acquisition of Inrange in May of 2003. We
are committed to the future development of our Fibre Channel director products,
and our UltraNet® family of products. In future periods, we expect to continue
to invest a significant portion of our resources in the engineering and
development of new products, and new features for existing products. General and administrative General and administrative expenses for the first quarter of 2004 totaled
$3.5 million, up 37% from $2.6 million in the first quarter of 2003. The
increase in expense was primarily due to our acquisition of Inrange in May
2003. Other Other expense for the first quarter of 2004 totaled $822,000, compared to
other income of $700,000 for the first quarter of 2003. In February 2002, we
sold $125 million of 3% convertible subordinated notes due February 2007,
raising net proceeds of $121.6 million. Coupon interest on the notes, plus
amortization of debt issuance costs, and interest expense from our capital
lease obligations resulted in interest expense for the first quarter of 2004 of
$1.0 million, compared to interest expense of $1.1 million in the first quarter
of 2003. In January 2004, we entered into an interest-rate swap agreement with
a notional amount of $75 million that has the economic effect of modifying that
dollar portion of the fixed interest obligations associated with $75 million of
our 3% convertible subordinated notes due February 2007 such that the interest
payable effectively becomes variable based on the three month LIBOR plus 69.5
basis points. The initial LIBOR setting for the swap was 1.15%, creating a
combined effective rate of approximately 1.845%, which was effective until
April 30, 2004. The combined effective rate for the period from May 1, 2004
through July 31, 2004 is approximately 1.865%. Interest and other income
totaled $210,000 in the first quarter of 2004, compared to $1.1 million in the
first quarter of 2003. During the first quarter of 2003, we sold substantially
all of our investments in marketable securities to finance our acquisition of
Inrange on May 5, 2003 for $190 million in cash. The sale resulted in a net
realized gain totaling $747,000, and was the primary reason for the reduction
in interest income when comparing the first quarter of 2004 and 2003. Liquidity and Capital Resources We have historically financed our operations through the public and
private sale of debt and equity securities, bank borrowings under lines of
credit, capital and operating leases and cash generated by operations. Cash, cash equivalents and marketable securities at April 30, 2004 totaled
$80.4 million, an increase of $2.9 million since January 31, 2004. The increase
is primarily due to a reduction in our accounts receivable during the first
three months of 2004 of $25.5 million which was offset by a reduction in
accounts payable and accrued expenses of $13.9 million. Other uses of cash
during the first three months of 2004 included capital equipment and field
support spares totaling $6.9 million. Expenditures for capital equipment and
field support spares have been, and will likely continue to be, a significant
capital requirement. 19




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At April 30, 2004, our available cash and marketable securities totaled
$80.4 million. We believe that our available balances of cash, cash
equivalents and marketable securities, when combined with anticipated cash
flows from operations, will be adequate to fund our operating plans and meet
our current anticipated aggregate capital requirements, at least for the next
twelve months. This belief is based upon a number of assumptions and
estimates, including obtaining certain revenue levels from Inrange products and
services and payments of expenses in line with estimates by management. If
these estimates and assumptions do not turn out to be correct, or if we
encounter unanticipated difficulties or economic conditions, our liquidity
could be impaired. We believe that inflation has not had a material impact on our operations
or liquidity to date. Our future minimum contractual cash obligations at April 30, 2004,
including open purchase orders incurred in the ordinary course of business, are
as follows (in millions): Less Than
    
    One to
    
    Four to Five
    
    AfterCash Obligation
    
    Total
    
    One year
    
    Three Years
    
    Years
    
    Five YearsCapital leases
    
    $
    10.0
    
    
    $
    3.0
    
    
    $
    6.7
    
    
    $
    .3
    
    
    NoneOperating leases
    
    $
    46.4
    
    
    $
    10.0
    
    
    $
    22.0
    
    
    $
    13.1
    
    
    $
    1.3Purchase orders
    
    $
    28.7
    
    
    $
    28.7
    
    
    None
    

None
    
    NoneBI-Tech earn out
    
    $
    3.9
    
    
    $
    3.9
    
    
    None
    

None
    
    NoneConvertible notes, plus interest
    
    $
    136.2
    
    
    $
    3.8
    
    
    $
    132.4
    
    
None
    
    None
 Our acquisition of BI-Tech originally required us to pay the former
stockholders and BI-Tech employees additional consideration based on
achievement of certain earnings for each of the two years beginning July 1,
2002. A modification to the purchase agreement was made during the second
quarter of fiscal 2003, whereby the first earn out period ended April 30, 2003.
It also guarantees the former stockholders a minimum payment for the second
earn out period, which ends June 30, 2004, of at least $3.9 million. 
 ITEM 3. MARKET RISK Our exposure to market risk due to changes in the general level of U.S.
interest rates relates primarily to our cash, cash equivalents, and marketable
securities. The primary objective of our investment activities is the
preservation of principal while maximizing investment income and minimizing
risk. We mainly invest our cash, cash equivalents and marketable securities in
investment grade, highly liquid investments, consisting of U.S. government and
agency securities, corporate debt securities and bank certificates of deposits. At April 30, 2004, our marketable securities include $1.4 million of
various mutual funds. These investments were purchased to directly offset any
investment gains or losses owed to participants under our executive deferred
compensation plan, which has been established for selected key employees. We are exposed to market risks related to fluctuations in foreign exchange
rates because some sales transactions, and the assets and liabilities of our
foreign subsidiaries, are denominated in foreign currencies, primarily the euro
and British pounds sterling. As of April 30, 2004, we had no open forward
exchange contracts. In January 2004, we entered into an interest-rate swap agreement with a
notional amount of $75 million that has the economic effect of modifying that
dollar portion of the fixed interest obligations associated with $75 million of
our 3% convertible subordinated notes due February 2007, such that the interest
payable effectively becomes variable based on the three month LIBOR plus 69.5
basis points. The payment dates of the swap are January 31st, April 30th, July
31st and October 31st of each year, commencing April 30, 2004, until maturity
on February 15, 2007. The initial LIBOR setting for the swap was 1.15%,
creating a combined effective rate of approximately 1.845%, which was effective
until April 30, 2004. The combined effective rate for the period from May 1,
2004 through July 31, 2004 is approximately 1.865%. The swap was designated as
a fair value hedge, and as such, the gain or loss on the swap, as well as the
fully offsetting gain or loss on the notes attributable to the hedged risk,
were recognized in earnings. As part of the agreement, we are also required to
post collateral based on changes in the fair value of the interest rate swap.
This collateral, in the form of restricted cash, was $2.5 million at April 30,
2004. We could incur charges to terminate the swap in the future prior to
February 15, 2007 if interest rates rise, or upon certain events such as a
change in control or certain redemptions of convertible subordinated notes. A
25 basis point increase in the LIBOR rate would increase our annual interest
expense by $187,500. 20




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##### Table of Contents



On April 30, 2004, the reported trading price of our convertible
subordinated notes due 2007 was $86 per $100 in face amount of principal
indebtedness, resulting in an aggregate fair value of approximately $107.7
million. Our common stock is quoted on the Nasdaq National Market under the
symbol CMNT. On April 30, 2004, the last reported sale price of our common
stock on the Nasdaq Market was $6.55 per share. 
 ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures The Company reviewed and evaluated the effectiveness of our disclosure
controls and procedures (as defined in the Securities Exchange Act of 1934
Rules 13a-14(c) and 15d-14(c)) as of the end of the period covered by this
report (the Evaluation Date). This review and evaluation was done under the
supervision and with the participation of management, including our Chief
Executive Officer (CEO) and Chief Financial Officer (CFO). Based on their
review and evaluation, the Chief Executive Officer and Chief Financial Officer
have concluded that, as of the Evaluation Date, our disclosure controls and
procedures were adequate and effective to ensure that information required to
be disclosed by us in reports we file or submit under the Securities Exchange
Act of 1934 is recorded, processed, summarized and reported within the time
periods specified in Securities and Exchange Commission rules and forms. It
should be noted that the design of any system of controls is based upon certain
assumptions about the likelihood of future events, and there can be assurance
that design will succeed in achieving its stated objective under all potential
future conditions, regardless of how remote. However, the CEO and CFO believe
the Companys disclosure controls and procedures provide reasonable assurance
that the disclosure controls and procedures are effective at the reasonable
assurance level. (b) Change in Internal Controls There have been no changes in our internal controls over financial
reporting that occurred during the period covered by this report that has
materially affected, or is reasonably likely to materially affect, our internal
controls over financial reporting. Forward Looking Statements This Form 10-Q and other documents we have filed with the Securities and
Exchange Commission contain forward-looking statements, which may include
statements about our:  
    
    anticipated receipt of orders and their impact on quarterly sales;
    
    business strategy;
    
    expectations regarding future liquidity revenue levels, gross margins, expenses, operating margins and earnings per share;
    
    timing of and plans for the introduction or phase-out of products or services;
    
    enhancements of existing products or services;
    
    plans for hiring or reducing personnel;
    
    entering into strategic partnerships;
    
    other plans, objectives, expectations and intentions contained in this Form 10-Q that are not historical facts. 21




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##### Table of Contents



When used in this Form 10-Q, the words may, should, expect, plan,
anticipate, believe, estimate, predict, intend, potential or
continue and similar expressions are generally intended to identify
forward-looking statements, although not all forward-looking statements contain
these identifying words. These forward-looking statements involve risks and
uncertainties. Actual results could differ materially from those expressed or
implied by these forward-looking statements as a result of certain risk
factors, including but not limited to (i) competitive factors, including
pricing pressures, (ii) variability in quarterly and annual sales, (iii)
economic trends in various geographic markets, including changes in IT spending
levels; (iv) relationships with our strategic partners; (v) unanticipated risks
associated with introducing new products and features; (vi) technological
change affecting our products; (vii) adverse judgments in present and future
litigation; (viii) our ability to obtain market acceptance of our new products;
(ix) our ability to anticipate end user needs; (x) dependence on sole source
and limited source suppliers; (xi) our ability to retain and attract key
personnel; (xii) the existence of undetected errors in our products; (xiii) our
ability to protect our intellectual property and defend against infringement
claims; (xiv) variability in gross profit caused by sales mix and other
factors; (xv) receipt of anticipated orders; and (xvi) other events and other
important factors disclosed previously and from time to time in our filings
with the U.S. Securities and Exchange Commission, including our Form 10-K. We
assume no obligation to update any forward-looking statements. These statements
are only predictions. Although we believe that the expectations reflected in
the forward-looking statements are reasonable, we cannot guarantee future
results, levels of activity, performance or achievements. 22




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##### Table of Contents



PART II. OTHER INFORMATION 
 Item 1. Legal Proceedings The information set forth in
Note 13 (Litigation) to the consolidated financial
statements included in Part I of this form 10-Q is hereby incorporated by
reference. 
 Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity
Securities (a) Not applicable. (b) Not applicable. (c) Not applicable. (d) Not applicable. (e) Repurchases of securities in current quarter. In April 2001, our board of directors authorized the repurchase of up to $50.0
million of our common stock. Subsequent to April 2001, our board changed the
authorization so that the remaining balance of the initial $50 million
authorization can be used for the repurchase of either debt or stock. As of
January 31, 2004, we had repurchased 4.1 million shares of our common stock for
$33.0 million under this authorization. No common stock or debt was repurchased
during the three months ended April 31, 2004. 
 Items 3-5. None 23




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##### Table of Contents



Item 6. Exhibits and Reports on Form 8-K (a) Exhibits filed herewith. 3.1
    
    Second Restated Articles of incorporation of the Company. (Incorporated by reference
to Exhibits 3(i)-1 and 3(i)-2 to current report on Form 8-K dated May 25, 1999).3.2
    
    Articles of Amendment of the Second Restated Articles of the Company.
(Incorporated by reference to Exhibit 3(i)-1 to current report on Form 8-K dated May 25, 1999.)3.3
    
    By-laws of the Company (Incorporated by reference to Exhibit 3 (ii)-1 to current report on
Form 8-K dated May 25, 1999.)4.1
    
    Rights Agreement between the Company and Chase Mellon Shareholder Services, L.L.C., as Rights Agent
including the form of Rights Certificate and the Summary of Rights to Purchase Preferred Shares.
(Incorporated by reference to Exhibit 1 to Form 8-A dated July 29, 1998 and
Exhibit 1 to Form 8-A/A dated November 27, 2000.)4.2
    
    First Amendment of Rights Agreement dated November 21, 2000. (Incorporated by reference to Exhibit 1
to Form 8-A/A dated November 27, 2000.)4.3
    
    First Amendment of Certificate of Designations, Preferences and Right of Series A Junior Participating
Preferred Stock. ($.01 Par Value Per Share) of Computer Network Technology Corporation
(Incorporated by reference to Exhibit 2 to Form 8-A/A dated November 27, 2000.)4.4
    
    Interest Rate Swap agreement
between the Company and Credit Suisse First Boston International
dated January 6, 2004. (2)10.1E
    
    Form of Restricted Stock Unit Agreement to be used in conjunction with the Amended and
Restated 1992 Stock Award Plan. (1)(2)10.1F
    
    Form of Deferred Stock Award Election to be used in conjunction with the Amended and
Restated 1992 Stock Award Plan. (1)(2)10.2D
    
    Form of Restricted Stock Unit Agreement to be used in conjunction with the Amended and
Restated 1999 Non-Qualified Stock Award Plan. (1)(2)10.2E
    
    Form of Deferred Stock Award Election to be used in conjunction with the Amended and
Restated 1999 Non-Qualified Stock Award Plan. (1)(2)10.5F
    
    Form of Restricted Stock Unit Agreement to be used in conjunction with the Amended and
Restated 2002 Stock Award Plan. (1)(2)10.5G
    
    Form of Deferred Stock Award Election to be used in conjunction with the Amended and
Restated 2002 Stock Award Plan. (1)(2)10.14A
    
    Amendment to Inrange Technologies Corporation 2000 Stock Compensation Plan. (1)(2)10.14B
    
    Form of Non-Qualified Stock Option Agreement to be used in conjunction with the Amended
Inrange Technologies Corporation 2000 Stock Compensation Plan. (1)(2)11.
    
    Statement Re: Computation of Net income (loss) per Basic and Diluted Share. (2)31.1
    
    CEO Certifications Required by Rule 13a14(a)/15d14(a) under the Securities Exchange Act of 1934. (2)31.2
    
    CFO Certifications Required by Rule 13a14(a)/15d14(a) under the Securities Exchange Act of 1934. (2)32.
    
    Computer Network Technology Corporation Certification of Chief Executive Officer and Chief
Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350). (2)
of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350). (2)
   (1)
    
    Management contracts or compensatory plans or arrangements with the
Company.(2)
    
    Filed herewith. (b) Reports on Form 8-K A current report on Form 8-K was dated and furnished March 1, 2004,
pursuant to Item 12 (Results of Operations and Financial Condition) to report
the press release announcing the Companys financial results for the fourth
quarter of 2003 and certain other information. 24




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##### Table of Contents



SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned duly authorized officers. COMPUTER NETWORK TECHNOLOGY CORPORATION
(Registrant) Date: May 28, 2004 By:
    /s/ Gregory T. BarnumGregory T. BarnumChief Financial Officer
(Principal financial officer) By:
    /s/ Jeffrey A. BertelsenJeffrey A. BertelsenCorporate Controller
and Treasurer
(Principal accounting officer) 25




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##### Table of Contents



EXHIBIT INDEX 3.1
    
    Second Restated Articles of incorporation of the Company. (Incorporated by reference
to Exhibits 3(i)-1 and 3(i)-2 to current report on Form 8-K dated May 25, 1999).3.2
    
    Articles of Amendment of the Second Restated Articles of the Company.
(Incorporated by reference to Exhibit 3(i)-1 to current report on Form 8-K dated May 25, 1999.)3.3
    
    By-laws of the Company (Incorporated by reference to Exhibit 3 (ii)-1 to current report on
Form 8-K dated May 25, 1999.)4.1
    
    Rights Agreement between the Company and Chase Mellon Shareholder Services, L.L.C., as Rights Agent
including the form of Rights Certificate and the Summary of Rights to Purchase Preferred Shares.
(Incorporated by reference to Exhibit 1 to Form 8-A dated July 29, 1998 and
Exhibit 1 to Form 8-A/A dated November 27, 2000.)4.2
    
    First Amendment of Rights Agreement dated November 21, 2000. (Incorporated by reference to Exhibit 1
to Form 8-A/A dated November 27, 2000.)4.3
    
    First Amendment of Certificate of Designations, Preferences and Right of Series A Junior Participating
Preferred Stock. ($.01 Par Value Per Share) of Computer Network Technology Corporation
(Incorporated by reference to Exhibit 2 to Form 8-A/A dated November 27, 2000.)4.4
    
    Interest Rate Swap agreement
between the Company and Credit Suisse First Boston International
dated January 6, 2004. (2)10.1E
    
    Form of Restricted Stock Unit Agreement to be used in conjunction with the Amended and
Restated 1992 Stock Award Plan. (1)(2)10.1F
    
    Form of Deferred Stock Award Election to be used in conjunction with the Amended and
Restated 1992 Stock Award Plan. (1)(2)10.2D
    
    Form of Restricted Stock Unit Agreement to be used in conjunction with the Amended and
Restated 1999 Non-Qualified Stock Award Plan. (1)(2)10.2E
    
    Form of Deferred Stock Award Election to be used in conjunction with the Amended and
Restated 1999 Non-Qualified Stock Award Plan. (1)(2)10.5F
    
    Form of Restricted Stock Unit Agreement to be used in conjunction with the Amended and
Restated 2002 Stock Award Plan. (1)(2)10.5G
    
    Form of Deferred Stock Award Election to be used in conjunction with the Amended and
Restated 2002 Stock Award Plan. (1)(2)10.14A
    
    Amendment to Inrange Technologies Corporation 2000 Stock Compensation Plan. (1)(2)10.14B
    
    Form of Non-Qualified Stock Option Agreement to be used in conjunction with the Amended
Inrange Technologies Corporation 2000 Stock Compensation Plan. (1)(2)11.
    
    Statement Re: Computation of Net income (loss) per Basic and Diluted Share. (2)31.1
    
    CEO Certifications Required by Rule 13a14(a)/15d14(a) under the Securities Exchange Act of 1934. (2)31.2
    
    CFO Certifications Required by Rule 13a14(a)/15d14(a) under the Securities Exchange Act of 1934. (2)32.
    
    Computer Network Technology Corporation Certification of Chief Executive Officer and Chief
Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350). (2)
of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350). (2)
   (1)
    
    Management contracts or compensatory plans or arrangements with the
Company.(2)
    
    Filed herewith. 26