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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


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 OCTOBER 31, 2003

|  |  |                                                                                                                                      
|- |  | -------------------------------------------------------------------------------------------------------------------------------------
|o |  | 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




(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)


Minnesota
    
    41-1356476(State of Incorporation)
    
    (I.R.S. Employer Identification No.)


6000 Nathan Lane North, Minneapolis, Minnesota 55442




(Address of principal executive offices)(Zip Code)


Telephone Number: (763) 268-6000




(Registrants telephone number, including area code)


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 December 1, 2003, the registrant had 27,230,026 shares of $.01 par value
common stock issued and outstanding.



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TABLE OF CONTENTS



|                                                   |                                                                                               |                                            |  |  |  |  |  | 
|-------------------------------------------------- | --------------------------------------------------------------------------------------------- | ------------------------------------------ |  |  |  |  |  | 
|PART I                                            
|                                                   | Item 1.                                                                                      
|                                                   |                                                                                               | CONSOLIDATED STATEMENTS OF OPERATIONS     
|                                                   |                                                                                               | CONSOLIDATED BALANCE SHEETS               
|                                                   |                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                                                   |                                                                                               | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|                                                   | ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                                                   | ITEM 3. MARKET RISK                                                                          
|                                                   | ITEM 4. CONTROLS AND PROCEDURES                                                              
|PART II. OTHER INFORMATION                        
|                                                   | Item 1. Legal Proceedings                                                                    
|                                                   | Items 2-4. None                                                                              
|                                                   | Item 5. other information                                                                    
|                                                   | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES                                        
|EXHIBIT INDEX                                     
|EX-11 Statement Re: Computation of Net Income/loss
|EX-31.1 Certification of Chief Executive Officer  
|EX-31.2 Certification of Chief Financial Officer  
|EX-32 Certification of CEO & CEO - Section 906    



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COMPUTER NETWORK TECHNOLOGY CORPORATION

INDEX

PagePART I.
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial Statements (unaudited)Consolidated Statements of Operations for the
three and nine months ended October 31, 2003 and 2002
    
    
    3Consolidated Balance Sheets as of October 31, 2003
and January 31, 2003
    
    
    4Consolidated Statements of Cash Flows for the
nine months ended October 31, 2003 and 2002
    
    
    5Notes to Consolidated Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    13Item 3.
    
    Market Risk
    
    
    20Item 4.
    
    Controls and Procedures
    
    
    20PART II
    
    OTHER INFORMATION
    
    
    21Item 1.
    
    Legal Proceedings
    
    
    21Items 2-4.
    
    None
    
    
    22Item 5.
    
    Other Information
    
    
    22Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    23SIGNATURES
    
    
    
    
    24EXHIBIT INDEX
    
    
    
    
    25CERTIFICATIONS


2



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PART I







Item 1.







COMPUTER NETWORK TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)

Three months ended
    
    Nine months endedOctober 31,
    
    October 31,2003
    
    2002
    
    2003
    
    2002Revenue:Product sales
    
    $
    65,871
    
    
    $
    39,009
    
    
    $
    163,764
    
    
    $
    101,891Service fees
    
    
    33,745
    
    
    
    16,894
    
    
    
    84,895
    
    
    
    48,090Total revenue
    
    
    99,616
    
    
    
    55,903
    
    
    
    248,659
    
    
    
    149,981Cost of revenue:Cost of product sales
    
    
    37,023
    
    
    
    24,842
    
    
    
    97,901
    
    
    
    61,822Cost of service fees
    
    
    20,845
    
    
    
    9,511
    
    
    
    51,351
    
    
    
    28,579Total cost of revenue
    
    
    57,868
    
    
    
    34,353
    
    
    
    149,252
    
    
    
    90,401Gross profit
    
    
    41,748
    
    
    
    21,550
    
    
    
    99,407
    
    
    
    59,580Operating expenses:Sales and marketing
    
    
    24,353
    
    
    
    13,614
    
    
    
    63,426
    
    
    
    43,399Engineering and development
    
    
    12,229
    
    
    
    7,063
    
    
    
    30,174
    
    
    
    20,322General and administrative
    
    
    4,182
    
    
    
    2,696
    
    
    
    12,004
    
    
    
    7,903In-process research and development charge
    
    
    
    
    
    
    
    
    
    
    19,706
    
    
    
    Total operating expenses
    
    
    40,764
    
    
    
    23,373
    
    
    
    125,310
    
    
    
    71,624Income (loss) from operations
    
    
    984
    
    
    
    (1,823
    )
    
    
    (25,903
    )
    
    
    (12,044
    )Other income (expense):Net gain on sale of marketable securities
    
    
    
    
    
    
    
    
    
    
    747
    
    
    
    Interest expense
    
    
    (1,116
    )
    
    
    (1,146
    )
    
    
    (3,336
    )
    
    
    (3,190
    )Interest income and other, net
    
    
    272
    
    
    
    1,344
    
    
    
    1,726
    
    
    
    4,817Other income (expense), net
    
    
    (844
    )
    
    
    198
    
    
    
    (863
    )
    
    
    1,627Income (loss) before income taxes
    
    
    140
    
    
    
    (1,625
    )
    
    
    (26,766
    )
    
    
    (10,417
    )Provision (benefit) for income taxes
    
    
    (97
    )
    
    
    (554
    )
    
    
    901
    
    
    
    (3,543
    )Net income (loss) before discontinued operations
and cumulative effect of change in accounting
principle
    
    
    237
    
    
    
    (1,071
    )
    
    
    (27,667
    )
    
    
    (6,874
    )Discontinued operations
    
    
    
    
    
    
    207
    
    
    
    
    
    
    
    207Cumulative effect of change in accounting principle
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,068
    )Net income (loss)
    
    $
    237
    
    
    $
    (864
    )
    
    $
    (27,667
    )
    
    $
    (16,735
    )Basic income (loss) per share:Net income (loss) before discontinued operations and
cumulative effect of change in accounting principle
    
    $
    .01
    
    
    $
    (.04
    )
    
    $
    (1.02
    )
    
    $
    (.24
    )Discontinued operations
    
    $
    
    
    
    $
    .01
    
    
    $
    
    
    
    $
    .01Cumulative effect of change in accounting
principle
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (.35
    )Net income (loss)
    
    $
    .01
    
    
    $
    (.03
    )
    
    $
    (1.02
    )
    
    $
    (.59
    )Shares
    
    
    27,193
    
    
    
    26,896
    
    
    
    27,047
    
    
    
    28,574Diluted income (loss) per share:Net income (loss) before discontinued operations and
cumulative effect of change in accounting principle
    
    $
    .01
    
    
    $
    (.04
    )
    
    $
    (1.02
    )
    
    $
    (.24
    )Discontinued operations
    
    $
    
    
    
    $
    .01
    
    
    $
    
    
    
    $
    .01Cumulative effect of change in accounting
principle
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (.35
    )Net income (loss)
    
    $
    .01
    
    
    $
    (.03
    )
    
    $
    (1.02
    )
    
    $
    (.59
    )Shares
    
    
    28,750
    
    
    
    26,896
    
    
    
    27,047
    
    
    
    28,574


See accompanying notes to Consolidated Financial Statements

3



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COMPUTER NETWORK TECHNOLOGY CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)

October 31,
    
    January 31,2003
    
    2003(unaudited)AssetsCurrent assets:Cash and cash equivalents
    
    $
    62,614
    
    
    $
    98,341Marketable securities
    
    
    3,882
    
    
    
    111,143Receivables, net
    
    
    94,799
    
    
    
    56,040Inventories
    
    
    23,374
    
    
    
    24,091Other current assets
    
    
    5,019
    
    
    
    2,118Total current assets
    
    
    189,688
    
    
    
    291,733Property and equipment, net
    
    
    40,458
    
    
    
    22,566Field support spares, net
    
    
    11,269
    
    
    
    6,009Goodwill, net
    
    
    107,612
    
    
    
    14,113Other intangibles, net
    
    
    34,903
    
    
    
    1,669Other assets
    
    
    6,164
    
    
    
    3,079$
    390,094
    
    
    $
    339,169Liabilities and Shareholders EquityCurrent liabilities:Accounts payable
    
    $
    39,850
    
    
    $
    16,889Accrued liabilities
    
    
    48,022
    
    
    
    25,060Deferred revenue
    
    
    39,630
    
    
    
    19,340Current installments of capital lease
    
    
    462
    
    
    
    708Total current liabilities
    
    
    127,964
    
    
    
    61,997Obligations under capital lease, less current installments
    
    
    727
    
    
    
    Convertible subordinated debt
    
    
    125,000
    
    
    
    125,000Deferred tax liability
    
    
    462
    
    
    
    541Total liabilities
    
    
    254,153
    
    
    
    187,538Shareholders equity:Preferred stock
    
    
    
    
    
    
    Common stock, $.01 par value; authorized
100,000 shares, issued and outstanding
27,320 at October 31, 2003 and
26,921 at January 31, 2003
    
    
    272
    
    
    
    269Additional paid-in capital
    
    
    185,819
    
    
    
    173,955Unearned compensation
    
    
    (436
    )
    
    
    (675
    )Accumulated deficit
    
    
    (50,613
    )
    
    
    (22,946
    )Accumulated other comprehensive income (loss)
    
    
    899
    
    
    
    1,028Total shareholders equity
    
    
    135,941
    
    
    
    151,631$
    390,094
    
    
    $
    339,169


See accompanying notes to Consolidated Financial Statements

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COMPUTER NETWORK TECHNOLOGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

Nine months endedOctober 31,2003
    
    2002Operating Activities:Net loss
    
    $
    (27,667
    )
    
    $
    (16,735
    )Adjustments to reconcile net loss to net cash provided by
operating activities:Cumulative effect of change in accounting principle
    
    
    
    
    
    
    10,068Discontinued operations
    
    
    
    
    
    
    (207
    )Depreciation and amortization
    
    
    18,065
    
    
    
    11,889In-process research and development charge
    
    
    19,706
    
    
    
    Non-cash compensation expense
    
    
    331
    
    
    
    436Net gain on sale of marketable securities
    
    
    (747
    )
    
    
    Changes in deferred taxes
    
    
    (4
    )
    
    
    (5,447
    )Changes in operating assets and liabilities, net of acquisition:Receivables
    
    
    (5,431
    )
    
    
    6,774Inventories
    
    
    12,139
    
    
    
    1,157Other current assets
    
    
    2,703
    
    
    
    1,257Accounts payable
    
    
    13,299
    
    
    
    360Accrued liabilities
    
    
    (8,930
    )
    
    
    (2,275
    )Deferred revenue
    
    
    (654
    )
    
    
    2,526Net cash provided by continuing operations
    
    
    22,810
    
    
    
    9,803Net cash provided by discontinued operations
    
    
    
    
    
    
    207Cash provided by operating activities
    
    
    22,810
    
    
    
    10,010Investing Activities:Additions to property and equipment
    
    
    (5,893
    )
    
    
    (4,738
    )Additions to field support spares
    
    
    (1,770
    )
    
    
    (4,448
    )Acquisition of Inrange Technologies, net of cash acquired
    
    
    (152,585
    )
    
    
    Acquisition of BI-Tech, net of cash acquired
    
    
    (3,868
    )
    
    
    (7,723
    )Net redemption (purchase) of marketable securities
    
    
    107,262
    
    
    
    (18,939
    )Other assets
    
    
    (2,466
    )
    
    
    390Cash used in investing activities
    
    
    (59,320
    )
    
    
    (35,458
    )Financing Activities:Net proceeds from issuance of convertible subordinated debt
    
    
    
    
    
    
    121,706Proceeds from issuance of common stock
    
    
    1,352
    
    
    
    2,119Payments for repurchases of common stock
    
    
    
    
    
    
    (31,975
    )Repayments of obligations under capital leases
    
    
    (961
    )
    
    
    (1,179
    )Cash provided by financing activities
    
    
    391
    
    
    
    90,671Effects of exchange rate changes
    
    
    392
    
    
    
    701Net increase (decrease) in cash and cash equivalents
    
    
    (35,727
    )
    
    
    65,924Cash and cash equivalents  beginning of period
    
    
    98,341
    
    
    
    34,402Cash and cash equivalents  end of period
    
    $
    62,614
    
    
    $
    100,326


See accompanying notes to Consolidated Financial Statements

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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, 2003
as filed with the Securities and Exchange Commission. References to fiscal 2003
and 2002, represent the twelve months ended January 31, 2004 and 2003,
respectively.

On May 5, 2003, the Company completed the acquisition of Inrange
Technologies 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.

(3) INVENTORIES

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

October 31,
    
    January 31,2003
    
    2003Inventories:Components and subassemblies
    
    $
    12,130
    
    
    $
    16,918Work in process
    
    
    1,726
    
    
    
    306Finished goods
    
    
    9,518
    
    
    
    6,867$
    23,374
    
    
    $
    24,091


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(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 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
    
    
    33,087Inventory
    
    
    11,422Property and equipment
    
    
    21,614Field support spares
    
    
    6,826Developed technology
    
    
    20,248Customer list
    
    
    15,294Trademarks
    
    
    1,234In-process research and development charge
    
    
    19,706Goodwill
    
    
    89,297Deferred taxes
    
    
    75Other assets
    
    
    6,227Accounts payable
    
    
    (9,687
    )Accrued expenses
    
    
    (31,328
    )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 and nine months ended October 31,
2003 and 2002 as if the acquisition of Inrange took place on February 1, 2003
and 2002, respectively:

Pro Forma
    
    Pro FormaThree months ended
    
    Nine months endedOctober 31,
    
    October 31,2003
    
    2002
    
    2003
    
    2002Total revenue
    
    $
    99,616
    
    
    $
    108,816
    
    
    $
    288,821
    
    
    $
    317,617Net income (loss)
    
    $
    237
    
    
    $
    (2,033
    )
    
    $
    (17,091
    )
    
    $
    (29,163
    )Net income (loss) per share
    
    $
    .01
    
    
    $
    (.08
    )
    
    $
    (.63
    )
    
    $
    (1.02
    )


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. The Inrange
purchase price allocation is preliminary and subject to change pending
completion of the purchase price allocation analysis.

7



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BI-Tech

On June 24, 2002, the Company acquired all 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 Company 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 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 the BI-Tech employees is recorded as compensation expense. During
the third quarter and first nine months of 2003, $0 and $4.2 million,
respectively, was added to goodwill compared to $2.6 million and $3.1 million,
respectively, for the same periods of 2002. The Company also recorded
compensation expense under the earn out arrangement of $0 and $1.1 million
during the third quarter and first nine months of 2003, respectively, compared
to $537,000 and $626,000, respectively, for the same periods of 2002.

(5) GOODWILL AND INTANGIBLE ASSETS

The change in the net carrying amount of goodwill for the first nine
months of 2003 was as follows:

TotalBalance February 1, 2003
    
    $
    14,113Additional purchase price consideration for BI-Tech
    
    
    4,228Acquisition of Inrange
    
    
    89,297Translation adjustment
    
    
    (26
    )Balance as of October 31, 2003
    
    $
    107,612


The components of other amortizable intangible assets were as follows:

October 31, 2003
    
    January 31, 2003Gross Carrying
    
    Accumulated
    
    Gross Carrying
    
    AccumulatedAmount
    
    Amortization
    
    Amount
    
    AmortizationCustomer list
    
    $
    16,924
    
    
    $
    (1,376
    )
    
    $
    1,630
    
    
    $
    (161
    )Trademarks
    
    
    1,234
    
    
    
    (124
    )
    
    
    
    
    
    
    Developed technology
    
    
    20,248
    
    
    
    (2,110
    )
    
    
    
    
    
    
    Non-compete agreements
    
    
    250
    
    
    
    (143
    )
    
    
    250
    
    
    
    (50
    )Total
    
    $
    38,656
    
    
    $
    (3,753
    )
    
    $
    1,880
    
    
    $
    (211
    )Total other intangible
assets, net
    
    $
    34,903
    
    
    
    
    
    
    $
    1,669


Amortization expense for intangible assets during the third quarter and
first nine months of 2003 was $1.7 million and $3.5 million, respectively.
Amortization expense for the remainder of 2003 is estimated to be $1.7 million.
Amortization expense is estimated to be $6.8 million in 2004 through 2006, $6.2
million in 2007 and $3.2 million in 2008.

8



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(6) COMPREHENSIVE LOSS

Comprehensive loss consists of the following:

Nine months endedOctober 31,2003
    
    2002Net loss
    
    $
    (27,667
    )
    
    $
    (16,735
    )Unrealized loss on marketable securities, net of
tax effect of $0 and $60
    
    
    
    
    
    
    (116
    )Foreign currency translation adjustment, net of
tax effect of $0
    
    
    (129
    )
    
    
    546Total comprehensive loss
    
    $
    (27,796
    )
    
    $
    (16,305
    )


(7) CONVERTIBLE SUBORDINATED DEBT

In February 2002, the Company sold $125 million of 3% convertible
subordinated notes due February 2007, raising net proceeds of $121 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 premium 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.

9



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##### Table of Contents



(8) STOCK-BASED COMPENSATION

The estimated per share weighted average fair value of all stock options
granted during the nine months ended October 31, 2003 and 2002 was $4.74 and
$6.21 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 ended
    
    Nine months endedOctober 31,
    
    October 31,2003
    
    2002
    
    2003
    
    2002Risk free interest rate
    
    
    3.25
    %
    
    
    3.06
    %
    
    
    2.89
    %
    
    
    3.93
    %Expected life
    
    
    5.82
    
    
    
    5.40
    
    
    
    5.82
    
    
    
    5.40Expected volatility
    
    
    86.2
    %
    
    
    87.8
    %
    
    
    86.2
    %
    
    
    87.8
    %


Had the Company recorded compensation cost 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 ended
    
    Nine months endedOctober 31,
    
    October 31,2003
    
    2002
    
    2003
    
    2002Net income (loss), as reported
    
    $
    237
    
    
    $
    (864
    )
    
    $
    (27,667
    )
    
    $
    (16,735
    )Stock-based employee
compensation expense
determined under fair
value based method for all
awards
    
    
    (3,008
    )
    
    
    (2,100
    )
    
    
    (8,300
    )
    
    
    (5,783
    )Pro forma net loss
    
    $
    (2,771
    )
    
    $
    (2,964
    )
    
    $
    (35,967
    )
    
    $
    (22,518
    )Basic net income (loss) per share:As reported
    
    $
    .01
    
    
    $
    (.03
    )
    
    $
    (1.02
    )
    
    $
    (.59
    )Pro forma
    
    $
    (.10
    )
    
    $
    (.11
    )
    
    $
    (1.33
    )
    
    $
    (.79
    )Diluted net income (loss) per
share:As reported
    
    $
    .01
    
    
    $
    (.03
    )
    
    $
    (1.02
    )
    
    $
    (.59
    )Pro forma
    
    $
    (.10
    )
    
    $
    (.11
    )
    
    $
    (1.33
    )
    
    $
    (.79
    )


10



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##### Table of Contents



(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
loss expenses, 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 nine months ended October 31, 2003
and 2002 were as follows:

October 31,2003
    
    2002Beginning balance
    
    $
    1,521
    
    
    $
    1,935Inrange acquisition
    
    
    1,709
    
    
    
    Charged to cost of product
    
    
    1,649
    
    
    
    1,664Revisions to estimates
    
    
    
    
    
    
    Cost of warranty
    
    
    (2,492
    )
    
    
    (2,160
    )Ending balance
    
    $
    2,387
    
    
    $
    1,439


(10) NEW ACCOUNTING PRONOUNCEMENTS

In December 2002, the EITF reached a consensus on EITF 00-21, Revenue
Arrangements with Multiple Deliverables. This Issue addresses certain aspects
of the accounting by a vendor for arrangements under which it will perform
multiple revenue-generating activities. In some arrangements, the different
revenue-generating activities (deliverables) are sufficiently separable and
there exists sufficient evidence of their fair values to separately account for
some or all of the deliverables (that is, there are separate units of
accounting). In other arrangements, some or all of the deliverables are not
independently functional, or there is not sufficient evidence of their fair
values to account for them separately. This Issue addresses when and, if so,
how an arrangement involving multiple deliverables should be divided into
separate units of accounting. This Issue does not change otherwise applicable
revenue recognition criteria. The guidance in this Issue was effective for
revenue arrangements entered into by the Company after July 31, 2003. The
adoption of EITF 00-21 did not have a material effect on our financial
statements.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging, which amends and clarifies financial
accounting and reporting for derivative instruments. The adoption of SFAS 149
in June of 2003 did not have an effect on the Companys consolidated financial
statements.

On May 15, 2003, the Financial Accounting Standards Board issued SFAS No.
150, Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity. The Statement requires issuers to classify as
liabilities (or assets in some circumstance) three classes of freestanding
financial instruments that embody obligations for the issuer. Generally, the
Statement is effective for financial instruments entered into or modified after
May 31, 2003 and is otherwise effective at the beginning of the first interim
period beginning after June 15, 2003. The adoption of SFAS No. 150 effective
August 1, 2003 did not have an effect on the Companys consolidated financial
statements.

(11) 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 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.

11



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##### Table of Contents



Inrange has also been named as a defendant in the case Onex, Inc., Joseph
P. Huffine, and Sally Huffine Breen v. Inrange Technologies Corporation, No.
CV-0593LJM-WTL, pending in the United States District Court, Southern District
of Indiana.The action was commenced on April 23, 2003. The complaint alleges
breach of the contract pursuant to which Inrange acquired certain assets of
Onex, Inc. The contract includes a provision for additional payments of
purchase price based on the performance of the business acquired over a two
year period. The contract requires the payments be made at the end of each year
in such two year period. Specifically, the complaint alleges, among other
things, that Inrange did not conduct the business in a commercially reasonable
manner and the pay out for the first year should have been $6 million and that
the payment for the second year will be substantially smaller. The complaint
also alleges the plaintiffs were harmed by the failure to provide accurate data
with respect to the business acquired and Inranges failure to pay certain
liabilities harmed the plaintiffs. The case is in its preliminary stages and
management is evaluating the litigation.

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 our
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.

(12) CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE

In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (SFAS) No. 142, Goodwill and Other
Intangible Assets. SFAS No. 142 requires that goodwill and intangible assets
with indefinite useful lives no longer be amortized but instead be tested for
impairment at least annually using a two-step impairment test.

Effective February 1, 2002, the Company adopted SFAS No. 142. SFAS No. 142
provides a six-month transitional period from the effective date of adoption
for the Company to perform an assessment of whether there is an indication of
goodwill impairment. The Company tested its reporting units for impairment by
comparing fair value to carrying value. Fair value was determined using a
discounted cash flow and cost methodology. The valuation of the Companys
former Storage Solutions segment indicated that the goodwill associated with
the acquisition of Articulent in April of 2001 was impaired. The performance of
this business had not met managements original expectations, primarily due to
the unexpected global slow down in capital spending for information technology
equipment. Accordingly, a non-cash impairment charge of $10.1 million from the
adoption of SFAS No. 142 was recognized as a cumulative effect of change in
accounting principle in the first quarter ended April 30, 2002.

12



---



##### Table of Contents









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 30, 2003.

Overview

We are a leading provider of end-to-end storage solutions, including
hardware and software products, related consulting and integration services,
and managed services in the growing storage networking market. We focus
primarily on helping our customers design, develop, deploy and manage a wide
range of solutions for critical storage 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.

Our storage networking solutions enable businesses to cost-effectively
design, implement, monitor and manage their storage requirements, connect
geographically dispersed storage networks, provide continuous availability to
greater amounts of data and protect increasing amounts of data more
efficiently. We market out 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 and
telecommunications companies, including EMC, Hewlett-Packard, Hitachi Data
Systems, IBM, StorageTek, Dell Computer Corporation and Veritas.

Our wholly owned subsidiary, Inrange Technologies Corporation (Inrange),
which we acquired on May 5, 2003, also designs, manufactures, markets and
services networking and switching products for storage and data networks. These
products 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.

The flagship product of Inrange, the FC/9000, is the storage area networks
most scalable storage networking director-class Fibre Channel 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
an enterprise can build storage networks that can be used in systems where
reliability and continuous availability are critical. These products are
designed to be compatible with various vendors products and multiple
communication standards and protocols. Inrange distributes and supports these
products through a combination of direct sales and service operations and
indirect channels.

We also supply storage systems, telecommunications capacity, storage
application software and other products and services manufactured or provided
by others.

Acquisition of Inrange

On April 6, 2003, we entered into an agreement whereby our 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 the third quarter and first nine months of 2003
we incurred integration charges related to the acquisition of Inrange of $1.3
million and $4.7 million, respectively, primarily for wages and severance for
terminated employees, and extra travel costs for integration activities.
During the first nine months of 2003, 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
acquisition will also increase our quarterly amortization charges for developed
technology, and other intangible assets by $1.7 million. During the fourth
quarter we expect to record an additional integration charge of approximately
$500,000 primarily for wages and severance. See caption Impact of Inrange
Integration on page 13 for further discussion regarding the impact of the
integration on quarterly results.

13



---



##### Table of Contents



Completion of this acquisition makes us one of the worlds largest providers of
complete storage networking products, solutions and services, with combined
2002 pro forma annual revenues of approximately $435 million. We have global
leadership positions in our markets. The acquisition significantly broadens and
strengthens our portfolio of storage and networking products and solutions,
increases our global size and scope, expands our customer base, and provide us
with significant scale and cost reduction opportunities.

Impact of Inrange Integration

During the third quarter and first nine months of 2003, we incurred
integration charges related to the Inrange acquisition of
$1.3 million and $4.7
million, respectively, for wages and severance related to terminated employees,
and extra travel costs for integration activities. We also incurred a $1.6
million charge to write-down inventory related to the integration of product
strategies for the new combined entity. The following table sets forth the
impact of the integration charge on our expense data for the three and nine
months ended October 31, 2003:

As
reported
    
    Impact of
    
    Three months ended
    
    As reported
    
    Impact of
    
    Nine months endedunder GAAP
    
    Integration
    
    October 31, 2003
    
    under GAAP
    
    Integration
    
    October 31, 2003Cost of product
    
    $
    37,023
    
    
    $
    
    
    
    $
    37,023
    
    
    $
    97,901
    
    
    $
    (2,223
    )
    
    $
    95,678Cost of service
    
    
    20,845
    
    
    
    (266
    )
    
    
    20,579
    
    
    
    51,351
    
    
    
    (390
    )
    
    
    50,961Sales and marketing
    
    
    24,353
    
    
    
    (558
    )
    
    
    23,795
    
    
    
    63,426
    
    
    
    (1,759
    )
    
    
    61,667Engineering and
development
    
    
    12,229
    
    
    
    (92
    )
    
    
    12,137
    
    
    
    30,174
    
    
    
    (435
    )
    
    
    29,739General and administrative
    
    
    4,182
    
    
    
    (336
    )
    
    
    3,846
    
    
    
    12,004
    
    
    
    (1,481
    )
    
    
    10,523


Cost of product for the three and nine months ended October 31, 2003
includes $1.1 million and $2.1 million, respectively, of amortization for
developed technology related to the Inrange acquisition. Sales and marketing
expense includes $607,000 and $1.2 million, respectively, of amortization for
trademarks and customer list also related to the Inrange acquisition.

Acquisition of BI-Tech

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. During the
third quarter and first nine months of 2003, $0 and $4.2 million, respectively,
was added to goodwill compared to $2.6 million and $3.1 million, respectively,
for the same periods of 2002. We also recorded compensation expense under the
earn out arrangement of $0 and $1.1 million during the third quarter and first
nine months of 2003, respectively, compared to $537,000 and $626,000,
respectively, for the same periods of 2002.

Convertible Debt Offering

In February 2002, we sold $125 million of 3% convertible subordinated
notes due February 2007, raising net proceeds of $121 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.

14



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##### Table of Contents



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 15-20 years from now.

Cumulative Effect of Change in Accounting Principle

Effective February 1, 2002, we adopted SFAS No. 142 Goodwill and Other
Intangible Assets. In connection with the adoption of SFAS No. 142, we engaged
a third party appraisal firm to determine the fair value of one of the
reporting units within our former storage solutions segment. This valuation
indicated that the goodwill associated with our acquisition of Articulent in
April of 2001 was impaired, resulting in a $10.1 million non-cash charge. This
non-cash charge was recognized as a cumulative effect of change in accounting
principle in our first quarter ended April 30, 2002.

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. The financial data
has also been presented to show the impact of the $1.3 million and $4.7 million
of Inrange integration expenses recognized during the three and nine months of
2003. Also, the $1.6 million inventory write-down on the Companys financial
statements recognized during the nine months of 2003.

Three months ended
    
    Nine months endedOctober 31,
    
    October 31,As
    
    
    
    
    
    
    
    
    
    
    
    Asreported
    
    Impact of
    
    
    
    
    
    
    
    
    
    reported
    
    Impact ofunder GAAP
    
    integration
    
    2003
    
    2002
    
    under GAAP
    
    Integration
    
    2003
    
    2002Revenue:Product sales
    
    
    65.6
    %
    
    
    
    %
    
    
    65.6
    %
    
    
    69.8
    %
    
    
    65.7
    %
    
    
    
    %
    
    
    65.7
    %
    
    
    68.0
    %Service fees
    
    
    34.4
    
    
    
    
    
    
    
    34.4
    
    
    
    30.2
    
    
    
    34.3
    
    
    
    
    
    
    
    34.3
    
    
    
    32.0Total revenue
    
    
    100.0
    
    
    
    
    
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0
    
    
    
    
    
    
    
    100.0
    
    
    
    100.0Gross profit:Product sales
    
    
    43.8
    
    
    
    
    
    
    
    43.8
    
    
    
    36.3
    
    
    
    40.2
    
    
    
    (1.4
    )
    
    
    41.6
    
    
    
    39.3Service fees
    
    
    38.2
    
    
    
    (.8
    )
    
    
    39.0
    
    
    
    43.7
    
    
    
    39.5
    
    
    
    (.5
    )
    
    
    40.0
    
    
    
    40.6Total gross profit
    
    
    41.9
    
    
    
    (.3
    )
    
    
    42.2
    
    
    
    38.6
    
    
    
    40.0
    
    
    
    (1.0
    )
    
    
    41.0
    
    
    
    39.7Operating expenses:Sales and marketing
    
    
    24.4
    
    
    
    (.5
    )
    
    
    23.9
    
    
    
    24.4
    
    
    
    25.5
    
    
    
    (.7
    )
    
    
    24.8
    
    
    
    28.9Engineering and development
    
    
    12.3
    
    
    
    (.1
    )
    
    
    12.2
    
    
    
    12.6
    
    
    
    12.1
    
    
    
    (.1
    )
    
    
    12.0
    
    
    
    13.6General and administrative
    
    
    4.2
    
    
    
    (.3
    )
    
    
    3.9
    
    
    
    4.8
    
    
    
    4.8
    
    
    
    (.6
    )
    
    
    4.2
    
    
    
    5.3In process research and
development charge
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7.9
    
    
    
    
    
    
    
    7.9
    
    
    
    Total operating
expenses
    
    
    40.9
    
    
    
    (.9
    )
    
    
    40.0
    
    
    
    41.8
    
    
    
    50.3
    
    
    
    (1.4
    )
    
    
    48.9
    
    
    
    47.8Income (loss) from operations
    
    
    1.0
    %
    
    
    (1.2
    )%
    
    
    2.2
    %
    
    
    (3.2
    )%
    
    
    (10.3
    )%
    
    
    (2.4
    )%
    
    
    (7.9
    )%
    
    
    (8.1
    )%


Cost of product as reported and excluding the impact of the Inrange
integration for the three and nine months ended October 31, 2003 includes $1.1
million and $2.1 million, respectively, of amortization for developed
technology related to the Inrange acquisition. Sales and marketing expense as
reported and excluding the impact of the Inrange integration includes $607,000
and $1.2 million, respectively, of amortization for trademarks and customer
list related to the Inrange acquisition. We also incurred a $19.7 million
charge related to the Inrange acquisition for purchased in-process research and
development.

15



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##### Table of Contents



Revenue

Product revenue

Sales of our proprietary CNT products generated revenues of $52.7 million
and $122.0 million in the third quarter and first nine months of 2003,
respectively, increases of 147% and 81%, respectively, from $21.4 million and
$67.3 million for the third quarter and first nine months of 2002. A
substantial amount of the increase in our proprietary CNT product sales during
the third quarter and first nine months of 2003 relates to the acquisition of
Inrange. We anticipate that the proprietary products acquired in the Inrange
acquisition, including the Inrange Fibre Channel director products, will
account for a significant portion of our proprietary CNT product revenue in
future periods. During the six months since the acquisition of Inrange, we
have 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
$13.2 million and $41.7 million in the third quarter and first nine months of
2003, respectively, a decrease of 25% and an increase 21%, respectively, from
$17.6 million and $34.6 million for the third quarter and first nine months of
2002. The decrease in third party storage solutions products revenue during
the third quarter of 2003 compared to the third quarter of 2002 was due to the
deferral of several large third party product orders to future periods, and our
focus on the integration of Inrange. We anticipate that third party storage
solutions products revenue will increase in future periods once the sales
representatives we acquired with the Inrange acquisition become more
experienced and proficient at selling third party products. Our acquisition of
BI-Tech in June 2002 significantly expanded our ability to deliver third party
solution offerings in Europe, and accounted for the majority of the increase in
third party storage solutions products revenue when comparing the first nine
months of 2003 to 2002.

Service revenue

Service revenues from our proprietary CNT products for the third quarter
and first nine months of 2003 totaled $20.5 million and $53.4 million,
respectively, increases of 91% and 63%, respectively, from $10.8 million and
$32.7 million for the third quarter and first nine months of 2002. 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 in excess of $40 million.

Our consulting fee revenues increased 116% and 104% in the third quarter
and first nine months of 2003 to $13.2 million and $31.5 million, respectively,
up from $6.1 million and $15.4 million for the third quarter and first nine
months of 2002. A large portion of the growth in consulting fee revenue relates
to our acquisition of Inrange. In addition, our sales force has become more
experienced and proficient at selling our consulting services.

General

Revenue generated from the sale of products and services outside the
United States for the third quarter and first nine months of 2003 totaled $34.5
million and $85.0 million, respectively, increases of 80% and 106%,
respectively, from $19.1 million and $41.3 million for the third quarter and
first nine months of 2002. The increase in revenue generated outside the
United States is primarily attributable to the acquisition of Inrange in May of
2003 and the BI-Tech acquisition in June of 2002. During calendar year 2002,
international sales accounted for 40% or $89.3 million of Inranges total
revenue. We continue to expect our volume of international sales to increase
significantly in future periods, when compared to the same period last year,
due to the acquisition of Inrange.

One customer accounted for 17% of our revenue during first nine months of
fiscal 2003. No customer accounted for more than 10% of our revenue during the
first nine months of 2002. Price discounting had a small impact on our
product revenue during these periods.

We primarily sell our proprietary CNT products directly to end-user
customers in connection with joint marketing activities with our business
partners. For a new customer, the initial sales and design cycle, from first
contact through shipment, can vary from 90 days to 12 months or more. We expect
this cycle will continue.

16



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##### Table of Contents



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.

Gross Profit Margins

Product margins

Gross margins from the sale of proprietary CNT products for the third
quarter and first nine months of 2003 were 50% and 48%, respectively, compared
to 49%, in both the third quarter and first nine months of 2002. Excluding the $1.6
million write-down of inventory resulting from the integration of product
strategies related to the Inrange acquisition, $616,000 of integration
expenses, and amortization expense for developed technology related to the
Inrange acquisition for the third quarter and first nine months of 2003 of $1.1
million and $2.1 million, respectively, gross product margins from the sale of
proprietary CNT products for the third quarter and first nine months of 2003
would have been 52%. The increase in gross margin percentage, excluding the
inventory write-down, integration expenses and amortization of developed
technology, was due to a change in mix of products sold, as the acquisition of
Inrange substantially increased our portfolio of proprietary products. We
also have taken actions that have resulted in the reduction of the manufactured
cost of our UltraNet® Director products.

Gross margins from the sale of third party storage solutions products for
the third quarter and first nine months of 2003 were 19% and 18%, respectively,
compared to 21% and 20%, respectively, in the third quarter and first nine
months of 2002. 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 for our proprietary CNT products in the third
quarter and first nine months of 2003 were 48%, compared to 50% and 48%,
respectively, for the third quarter and first nine months of 2002. Excluding
integration costs of $266,000 and $390,000 in the third quarter and
first nine months of 2003, respectively, gross service margins for our
proprietary CNT products in the third quarter and first nine months of 2003
were 49%. We anticipate that gross service margins for our proprietary CNT
products, excluding any potential integration expenses in the fourth quarter of
2003, will continue to be in the 45%-50% range for the foreseeable future.

Gross profit margins from our consulting fees were 26%, respectively, for
the third quarter and first nine months of 2003, compared to 37% and 26%,
respectively, for the third quarter and first nine months of 2002. Excluding
costs related to the BI-Tech earn-out of $0 and $131,000 for the third quarter
and first nine months of 2003, respectively, gross profit margins for our
consulting fees in the third quarter and first nine months of 2003 would have
been 26%. Excluding the impact of the BI-Tech earn-out in 2002, gross profit
margins for our consulting fees in the third quarter and first nine months of
2002 would have been 39% and 27%, respectively. Gross profit margins for the
third quarter and first nine months of 2003, excluding the impact of the
BI-Tech earn-out, were down compared to 2002. Improvements in employee
utilization prior to the acquisition of Inrange were offset by lower
utilization of employees in the newly acquired Inrange consulting business.

Operating Expenses

Sales and marketing

Sales and marketing expense for the third quarter and first nine months of
2003 totaled $24.4 million and $63.4 million, respectively, up 79% and 46%,
respectively, from $13.6 million and $43.4 million in the third quarter and
first nine months of 2002. Excluding integration expenses and amortization for
customer list and trademarks relating to our acquisition of Inrange for the
third quarter and first nine months of 2003 of $1.2 million and $3.0 million,
respectively, our sales and marketing expense would have been $23.2 million and
$60.5 million, respectively, for the third quarter and first nine months of
2003. Substantially all of the increase was due to our acquisition of Inrange
in May 2003 and BI-Tech in June 2002.

17



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##### Table of Contents



Engineering

Engineering and development expense for the third quarter and first nine
months of 2003 totaled $12.2 million and $30.2 million, respectively, up 73%
and 48%, respectively, from $7.1 million and $20.3 million in the third quarter
and first nine months of 2002. Excluding integration expenses of $92,000 and
$435,000 related to the Inrange acquisition, our engineering and development
expenses would have been $12.1 million and $29.7 million, respectively, for the
third quarter and first nine months 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 third quarter and first nine
months of 2003 totaled $4.2 million and $12.0 million, respectively, up 55% and
52%, respectively, from $2.7 million and $7.9 million in the third quarter and
first nine months of 2002. Excluding integration expenses of $336,000 and $1.5
million related to the Inrange acquisition, our general and administrative
expense, would have been $3.8 million and $10.5 million, respectively, for the
third quarter and first nine months of 2003. The increase in expense was
primarily due to our acquisition of Inrange in May 2003 and BI-Tech in June
2002.

Other

Other expense for the third quarter and first nine months of 2003 totaled
$844,000 and $863,000, respectively, compared to other income of $198,000 and
$1.6 million for the third quarter and first nine months of 2002. In February
2002, we sold $125 million of 3% convertible subordinated notes due February
2007, raising net proceeds of $121 million. Coupon interest on the notes, plus
amortization of debt issuance costs, resulted in interest expense in the third
quarter and first nine months of 2003 and 2002 of $1.1 million and $3.2 million,
respectively. Interest and other income totaled
$272,000 and $1.7 million for the third quarter and first nine months of 2003,
compared to $1.3 million and $4.8 million in the third quarter and first nine
months of 2002. 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 in 2003 compared to 2002.

Given our losses in fiscal 2002 and 2001, and our cautious outlook for
information technology spending, we concluded that it was necessary to provide
a full valuation allowance for our United States deferred tax assets, in our
fourth quarter ended January 31, 2003. 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 likely 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 15-20 years from now.

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##### Table of Contents



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 October 31, 2003
totaled $66.5 million, a decrease of $143.0 million since January 31, 2003. The
decrease is primarily due to our acquisition of Inrange in May of 2003. Net
cash used to complete this transaction was $152.6 million. Cash flow from
operations for the first nine months of fiscal 2003 totaled $22.8 million and
proceeds related to the issuance of common stock totaled $1.4 million. Uses of
cash for the first nine months of fiscal 2003 included $7.7 million for capital
equipment and field support spares, and $3.9 million for the BI-Tech earn-out.
Expenditures for capital equipment and field support spares have been, and will
likely continue to be, a significant capital requirement.

At October 31, 2003, our available cash and marketable securities totaled
$66.5 million. We believe our anticipated cash flows from operations,
including cash flow improvements resulting from increased scale and cost
synergies from the acquisition of Inrange, 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, completion of certain restructuring
activities and payments of integration and restructuring charges 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 October 31, 2003,
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
    
    $
    1.3
    
    $
    .5
    
    $
    .8
    
    $
    None
    
    $
    NoneOperating leases
    
    $
    40.4
    
    $
    9.2
    
    $
    17.2
    
    $
    8.2
    
    $
    5.8Purchase orders
    
    $
    20.1
    
    $
    19.8
    
    $
    .3
    
    $
    None
    
    $
    NoneBI-Tech earn out
    
    $
    3.9
    
    $
    3.9
    
    $
    None
    
    $
    None
    
    $
    NoneConvertible notes, plus interest
    
    $
    136.3
    
    $
    3.8
    
    $
    11.3
    
    $
    121.2
    
    $
    None


On December 3, 2002 we entered into a product development agreement that
requires us to purchase $10.0 million of product prior to March 15, 2005. The
commitment expires if the product is not generally available by March 31, 2004.
This purchase commitment has also been reflected in the above table under the
Purchase Order caption.

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. Payment
of the second period earn out may be in the form of a note payable or stock at
our option, or in the case of the employees, cash.

Note Regarding Non-GAAP Financial Measures

This Form 10-Q includes non-GAAP information regarding results from operations,
which includes adjustments to amounts calculated under generally accepted
accounting principles. The non-GAAP information is not in accordance with, or
an alternative for GAAP and may be different from non-GAAP information used by
other companies. Non-GAAP information is provided as a complement to results
provided in accordance with generally accepted accounting principles. The
non-GAAP information is provided to give investors a more complete
understanding of the underlying operational results and trends in our
performance. Management believes that the non-GAAP information is used by some
investors and equity analysts to make informed decisions because the
information may be more useful when analyzing historical results or predicting
future results from operations. In addition, management uses the pro-forma
information as a basis for planning and forecasting future periods

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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.
We believe that market risk due to changes in interest rates is not material.

Our convertible subordinated debt is subject to a fixed interest rate and
the notes are based on a fixed conversion ratio into common stock. Therefore,
we are not exposed to changes in interest rates related to our long-term debt
instruments. However, we are currently considering entering into an
interest rate swap agreement for all or a portion of our convertible
debt.

On October 31, 2003, the average bid and ask price of our
convertible subordinated notes due 2007 was 89.13 resulting in an aggregate
fair value of approximately $111.4 million. Our common stock is quoted on the
Nasdaq National Market under the symbol CMNT. On October 31, 2003, the last
reported sale price of our common stock on the Nasdaq Market was $9.89 per
share.

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 pound sterling. As of October 31, 2003, we had no open forward
exchange contracts.







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
over Financial Reporting

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.

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##### Table of Contents









PART II. OTHER INFORMATION







Item 1. Legal Proceedings

The
information set forth in Note 11 (Litigation) to the
consolidated financial statements included in Part I of this
Form 10-Q is hereby incorporated by reference.

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##### Table of Contents









Items 2-4. None







ITEM 5. OTHER INFORMATION

During
the quarter ended October 31, 2003, Messrs. Edward Walsh, William
Collette, both officers of the Company and Mr. John Rollwagon, a
Director, have all entered into effective 10(b) 5-1 trading plans
which allow for the sale of our stock. The terms of these plans are
as follows:

Employee/Director
    

    Shares
    
    Sale PriceWilliam
Collette
    

    
    26,997
    
    $15.00 - $20.00Edward
Walsh
    
    
    61,562
    

    $18.00John
Rollwagon
    
    
    210,000
    
    $15.00 - $20.00


Mr.
Erwin Kelen, a Director, also has adopted a 10(b)5-1 plan as
disclosed in the Proxy Statement filed on May 8, 2003 and
Form 8-K filed on February 11, 2002.

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.
| | - |  | ---------------------------------------------------------------------------------------------------------------

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 sales; (iii) economic trends
generally and in various geographic markets; (iv) relationships with our
strategic partners; (v) technological change affecting our products; (vi)
whether any delayed orders will be received; (vii) unanticipated difficulties
in integration of Inrange; (viii) unanticipated risks associated with
introducing new products and features, and, (ix) risks associated with the
unfavorable developments in litigation, (x) other events and other important
factors, including those discussed under cautionary statements in Exhibit 99 to
our Form 10-K filing with the Securities and Exchange Commission for the year
ended January 31, 2003. 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. The forward looking statements speak as of the date hereof.
Unless otherwise required by applicable securities laws, we disclaim any
intention or obligation to update or revise any forward looking statements,
whether as a result of new information, future events or otherwise.

22



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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.)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)




---

|(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 August 26, 2003,
pursuant to Item 12 (Results of Operations and Financial
Condition) to report the press release
announcing the Companys financial results for the second quarter of 2003
and certain other information.

23



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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: December 12, 2003

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)


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##### Table of Contents









EXHIBIT INDEX

Item
    
    Description3.1
    
    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.)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)




---

|(1) |  | Management contracts or compensatory plans or arrangements with the
Company.
|--- |  | ----------------------------------------------------------------------------
|   
|(2) |  | Filed herewith.                                                             

25