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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 1934FOR THE QUARTERLY PERIOD ENDED JULY 31, 2003o
    
    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 September 1, 2003, the registrant had 27,159,852 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 2-3. None                                                                              
|                                               | Item 4. Submission of matters to a vote of security holders                                  
|                                               | Item 5. None                                                                                 
|                                               | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES                                    
|EXHIBIT INDEX                                 
|EX-2 Amendment to Purchase Agreement          
|EX-10 Amendment to 1999 Stock Award Plan      
|EX-11 Statement Re: Computation of Net Income 
|Ex-31.1 Certification of CEO - Section 302    
|Ex-31.2 Certification of CFO - Section 302    
|EX-32 Certification of CEO & CFO - Section 906



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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 and six months ended July 31, 2003 and 2002
    
    
    3Consolidated Balance Sheets as of July 31, 2003
and January 31, 2003
Consolidated Statements of Cash Flows for the
six months ended July 31, 2003 and 2002
    
    
    4
5Notes to Consolidated Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of FinancialItem 3.
    
    Condition and Results of Operations
Market Risk
    
    
    1219Item 4.
    
    Controls and Procedures
    
    
    19PART II
    
    OTHER INFORMATION
    
    
    21Item 1.
    
    Legal Proceedings
    
    
    21Items 2-3.
    
    NoneItems 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    22Items 5.
    
    NoneItem 6.
    
    Exhibits and Reports on Form 8-K
    
    
    23SIGNATURES
    
    
    
    
    24CERTIFICATIONSEXHIBIT INDEX


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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
    
    Six months endedJuly 31,
    
    July 31,2003
    
    2002
    
    2003
    
    2002Revenue:Product sales
    
    $
    63,489
    
    
    $
    33,128
    
    
    $
    97,893
    
    
    $
    62,882Service fees
    
    
    33,224
    
    
    
    15,738
    
    
    
    51,150
    
    
    
    31,196Total revenue
    
    
    96,713
    
    
    
    48,866
    
    
    
    149,043
    
    
    
    94,078Cost of revenue:Cost of product sales
    
    
    39,244
    
    
    
    19,612
    
    
    
    60,878
    
    
    
    36,980Cost of service fees
    
    
    20,420
    
    
    
    9,308
    
    
    
    30,506
    
    
    
    19,068Total cost of revenue
    
    
    59,664
    
    
    
    28,920
    
    
    
    91,384
    
    
    
    56,048Gross profit
    
    
    37,049
    
    
    
    19,946
    
    
    
    57,659
    
    
    
    38,030Operating expenses:Sales and marketing
    
    
    24,867
    
    
    
    14,208
    
    
    
    39,073
    
    
    
    29,785Engineering and development
    
    
    12,025
    
    
    
    6,591
    
    
    
    17,945
    
    
    
    13,259General and administrative
    
    
    5,266
    
    
    
    2,694
    
    
    
    7,822
    
    
    
    5,207In-process research and development charge
    
    
    19,706
    
    
    
    
    
    
    
    19,706
    
    
    
    Total operating expenses
    
    
    61,864
    
    
    
    23,493
    
    
    
    84,546
    
    
    
    48,251Loss from operations
    
    
    (24,815
    )
    
    
    (3,547
    )
    
    
    (26,887
    )
    
    
    (10,221
    )Other income (expense):Net gain on sale of marketable securities
    
    
    
    
    
    
    
    
    
    
    747
    
    
    
    Interest expense
    
    
    (1,094
    )
    
    
    (1,150
    )
    
    
    (2,220
    )
    
    
    (2,044
    )Interest income and other, net
    
    
    375
    
    
    
    1,523
    
    
    
    1,454
    
    
    
    3,473Other income (expense), net
    
    
    (719
    )
    
    
    373
    
    
    
    (19
    )
    
    
    1,429Loss before income taxes
    
    
    (25,534
    )
    
    
    (3,174
    )
    
    
    (26,906
    )
    
    
    (8,792
    )Provision (benefit) for income taxes
    
    
    288
    
    
    
    (1,068
    )
    
    
    998
    
    
    
    (2,989
    )Net loss before cumulative effect of
change in accounting principle
    
    
    (25,822
    )
    
    
    (2,106
    )
    
    
    (27,904
    )
    
    
    (5,803
    )Cumulative effect of change in accounting
principle
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,068
    )Net loss
    
    $
    (25,822
    )
    
    $
    (2,106
    )
    
    $
    (27,904
    )
    
    $
    (15,871
    )Basic and diluted loss per share:Net loss before cumulative effect of changein accounting principle
    
    $
    (.96
    )
    
    $
    (.07
    )
    
    $
    (1.03
    )
    
    $
    (.20
    )Cumulative effect of change in accountingprinciple
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (.34
    )Net loss
    
    $
    (.96
    )
    
    $
    (.07
    )
    
    $
    (1.03
    )
    
    $
    (.54
    )Shares
    
    
    26,979
    
    
    
    28,466
    
    
    
    26,973
    
    
    
    29,437


See accompanying notes to Consolidated Financial Statements

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

July 31,2003
    
    January 31,(unaudited)
    
    2003AssetsCurrent assets:Cash and cash equivalents
    
    $
    51,545
    
    
    $
    98,341Marketable securities
    
    
    8,644
    
    
    
    111,143Receivables, net
    
    
    92,110
    
    
    
    56,040Inventories
    
    
    23,769
    
    
    
    24,091Other current assets
    
    
    4,131
    
    
    
    2,118Total current assets
    
    
    180,199
    
    
    
    291,733Property and equipment, net
    
    
    41,761
    
    
    
    22,566Field support spares, net
    
    
    11,202
    
    
    
    6,009Goodwill
    
    
    108,991
    
    
    
    14,113Other intangibles, net
    
    
    36,638
    
    
    
    1,669Other assets
    
    
    3,306
    
    
    
    3,079$
    382,097
    
    
    $
    339,169Liabilities and Shareholders EquityCurrent liabilities:Accounts payable
    
    $
    27,480
    
    
    $
    16,889Accrued liabilities
    
    
    53,145
    
    
    
    25,060Deferred revenue
    
    
    41,211
    
    
    
    19,340Current installments of capital lease
    
    
    290
    
    
    
    708Total current liabilities
    
    
    122,126
    
    
    
    61,997Convertible subordinated debt
    
    
    125,000
    
    
    
    125,000Deferred tax liability
    
    
    473
    
    
    
    541Total liabilities
    
    
    247,599
    
    
    
    187,538Shareholders equity:Preferred stock
    
    
    
    
    
    
    Common stock, $.01 par value; authorized
100,000 shares, issued and outstanding
27,159 at July 31, 2003 and
26,921 at January 31, 2003
    
    
    272
    
    
    
    269Additional paid-in capital
    
    
    185,499
    
    
    
    173,955Unearned compensation
    
    
    (487
    )
    
    
    (675
    )Accumulated deficit
    
    
    (50,850
    )
    
    
    (22,946
    )Accumulated other comprehensive income (loss)
    
    
    64
    
    
    
    1,028Total shareholders equity
    
    
    134,498
    
    
    
    151,631$
    382,097
    
    
    $
    339,169


See accompanying notes to Consolidated Financial Statements

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

Six months endedJuly 31,2003
    
    2002Operating Activities:Net loss
    
    $
    (27,904
    )
    
    $
    (15,871
    )Adjustments to reconcile net loss to net cash provided by
operating activities:Cumulative effect of change in accounting principle
    
    
    
    
    
    
    10,068Depreciation and amortization
    
    
    11,162
    
    
    
    8,138In-process research and development charge
    
    
    19,706
    
    
    
    Non-cash compensation expense
    
    
    280
    
    
    
    354Net gain on sale of marketable securities
    
    
    (747
    )
    
    
    Changes in deferred taxes
    
    
    7
    
    
    
    Changes in operating assets and liabilities, net of acquisition:Receivables
    
    
    (2,967
    )
    
    
    9,442Inventories
    
    
    10,970
    
    
    
    (1,925
    )Other current assets
    
    
    3,591
    
    
    
    1,448Accounts payable
    
    
    321
    
    
    
    (5,418
    )Accrued liabilities
    
    
    (7,672
    )
    
    
    (4,578
    )Deferred revenue
    
    
    927
    
    
    
    2,359Cash provided by operating activities
    
    
    7,674
    
    
    
    4,017Investing Activities:Additions to property and equipment
    
    
    (4,434
    )
    
    
    (4,052
    )Additions to field support spares
    
    
    (739
    )
    
    
    (2,823
    )Acquisition of Inrange Technologies, net of cash acquired
    
    
    (152,585
    )
    
    
    Acquisition of BI-Tech, net of cash acquired
    
    
    
    
    
    
    (7,723
    )Net redemption (purchase) of marketable securities
    
    
    102,500
    
    
    
    (32,775
    )Other assets
    
    
    392
    
    
    
    175Cash used in investing activities
    
    
    (54,866
    )
    
    
    (47,198
    )Financing Activities:Net proceeds from issuance of convertible subordinated debt
    
    
    
    
    
    
    121,706Proceeds from issuance of common stock
    
    
    1,032
    
    
    
    1,531Payments for repurchases of common stock
    
    
    
    
    
    
    (29,941
    )Repayments of obligations under capital leases
    
    
    (418
    )
    
    
    (719
    )Cash provided by financing activities
    
    
    614
    
    
    
    92,577Effects of exchange rate changes
    
    
    (218
    )
    
    
    687Net increase (decrease) in cash and cash equivalents
    
    
    (46,796
    )
    
    
    50,083Cash and cash equivalents  beginning of period
    
    
    98,341
    
    
    
    34,402Cash and cash equivalents  end of period
    
    $
    51,545
    
    
    $
    84,485


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 (Inrange) for $190 million in cash. The acquisition was accounted for as a
purchase, and the Companys financial statements include the results of
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 second quarter of fiscal 2003 or the first
half of fiscal 2002.

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:

July 31,
    
    January 31,2003
    
    2003Inventories:Components and subassemblies
    
    $
    13,467
    
    
    $
    16,918Work in process
    
    
    1,622
    
    
    
    306Finished goods
    
    
    8,680
    
    
    
    6,867$
    23,769
    
    
    $
    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 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
    
    
    33,102Inventory
    
    
    10,648Property and equipment
    
    
    21,614Field support spares
    
    
    6,826Developed technology
    
    
    20,248Customer list
    
    
    15,294Trademarks
    
    
    1,234In-process research and development
    
    
    19,706Goodwill
    
    
    90,643Deferred taxes
    
    
    75Other assets
    
    
    6,223Accounts payable
    
    
    (10,270
    )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 six months ended July 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
    
    Six months endedJuly 31,
    
    July 31,2003
    
    2002
    
    2003
    
    2002Total revenue
    
    $
    96,713
    
    
    $
    101,687
    
    
    $
    189,205
    
    
    $
    208,801Net loss
    
    $
    (6,116
    )
    
    $
    (12,609
    )
    
    $
    (17,328
    )
    
    $
    (27,130
    )Net loss per share
    
    $
    (.23
    )
    
    $
    (.44
    )
    
    $
    (.64
    )
    
    $
    (.92
    )


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.

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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 second quarter and first six months of 2003, $3.5 million and $7.7 million,
respectively, was added to goodwill and $0 and $1.1 million, respectively, was
recorded as compensation expense under the earn out arrangement.

(5) GOODWILL AND INTANGIBLE ASSETS

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

TotalBalance February 1, 2003
    
    $
    14,113Addition purchase price of BI-Tech
    
    
    4,228Acquisition of Inrange
    
    
    90,643Translation adjustment
    
    
    7Balance as of July 31, 2003
    
    $
    108,991


The components of other amortizable intangible assets were as follows:

July 31, 2003
    
    January 31, 2003Gross Carrying
    
    Accumulated
    
    Gross Carrying
    
    AccumulatedAmount
    
    Amortization
    
    Amount
    
    AmortizationCustomer list
    
    $
    16,924
    
    
    $
    (789
    )
    
    
    
    
    
    $
    1,630
    
    
    $
    (161
    )Trademarks
    
    
    1,234
    
    
    
    (62
    )
    
    
    
    
    
    
    
    
    
    
    Developed technology
    
    
    20,248
    
    
    
    (1,055
    )
    
    
    
    
    
    
    
    
    
    
    Non-compete agreements
    
    
    250
    
    
    
    (112
    )
    
    
    
    
    
    
    250
    
    
    
    (50
    )Total
    
    $
    38,656
    
    
    $
    (2,018
    )
    
    
    
    
    
    $
    1,880
    
    
    $
    (211
    )Total other intangible
assets, net
    
    $
    36,638
    
    
    
    
    
    
    
    
    
    
    $
    1,669


Amortization expense for intangible assets during the second quarter and
first six months of 2003 was $1.7 million and $1.8 million, respectively.
Amortization expense for the remainder of 2003 is estimated to be $3.5 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.

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(6) COMPREHENSIVE LOSS

Comprehensive loss consists of the following:

Six Months endedJuly 31,2003
    
    2002Net loss
    
    $
    (27,904
    )
    
    $
    (15,871
    )Unrealized loss on marketable securities, net
of tax effect of $277 and $267
    
    
    (444
    )
    
    
    (519
    )Realized gains on marketable securities
included in net loss, net of tax effect $288
and $0
    
    
    (459
    )
    
    
    Foreign currency translation adjustment, net of
tax effect of $0
    
    
    (61
    )
    
    
    448Total comprehensive loss
    
    $
    (28,868
    )
    
    $
    (15,942
    )


(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.

(8) STOCK-BASED COMPENSATION

The estimated per share weighted average fair value of all stock options
granted during the six months ended July 31, 2003 and 2002 was $5.02 and $7.13
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
    
    Six months endedJuly 31,
    
    July 31,2003
    
    2002
    
    2003
    
    2002Risk free interest rate
    
    
    2.55
    %
    
    
    4.16
    %
    
    
    2.71
    %
    
    
    4.36
    %Expected life
    
    
    6.68
    
    
    
    5.91
    
    
    
    6.68
    
    
    
    5.91Expected volatility
    
    
    86.60
    %
    
    
    87.50
    %
    
    
    86.60
    %
    
    
    87.50
    %


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
    
    Six months endedJuly 31,
    
    July 31,2003
    
    2002
    
    2003
    
    2002Net loss, as reported
    
    $
    (25,822
    )
    
    $
    (2,106
    )
    
    $
    (27,904
    )
    
    $
    (15,871
    )Stock-based employee
compensation expense
determined under fair
value based method for all
awards
    
    
    (2,783
    )
    
    
    (1,933
    )
    
    
    (5,292
    )
    
    
    (3,683
    )Pro forma net loss
    
    $
    (28,605
    )
    
    $
    (4,039
    )
    
    $
    (33,196
    )
    
    $
    (19,554
    )Basic and diluted net loss per share:As reported
    
    $
    (.96
    )
    
    $
    (.07
    )
    
    $
    (1.03
    )
    
    $
    (.54
    )Pro forma
    
    $
    (1.06
    )
    
    $
    (.14
    )
    
    $
    (1.23
    )
    
    $
    (.66
    )


9



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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 six months ended July 31, 2003 and
2002 were as follows:

July 31,2003
    
    2002Beginning balance
    
    $
    1,521
    
    
    $
    1,935Inrange acquisition
    
    
    1,709
    
    
    
    Charged to cost of product
    
    
    636
    
    
    
    1,183Revisions to estimates
    
    
    
    
    
    
    Cost of warranty
    
    
    (1,299
    )
    
    
    (1,390
    )Ending balance
    
    $
    2,567
    
    
    $
    1,728


(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 is effective for
revenue arrangements entered into in fiscal periods beginning after June 15,
2003. We do not expect the adoption of EITF 00-21 will 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 our 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. We will adopt the provisions of the
Statement on August 1, 2003. We did not enter into any financial instruments
within the scope of the Statement during June or July of 2003. We do not expect
that the adoption of SFAS 150 will have an effect on our 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 alleges Inrange is infringing
the SBC patent by manufacturing and selling storage area networking equipment,
including Fibre Channel directors and switches, for use in storage networks
that 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. The case is in its preliminary stages and management is evaluating the
litigation.

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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. 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.

(13) SEVERANCE

The consolidated
statement of operations for the three and six months ended July 31, 2003 includes severance
costs related to our integration of Inrange Technologies Corporation as follows:

Cost of product
    
    $
    504,000Sales and marketing
    
    $
    238,000Engineering and development
    
    $
    52,000General and administrative
    
    $
    28,000


At July 31, 2003 the Company
had a remaining accrual for severance in the amount of $345,000.

11



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##### 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
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.

12



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##### 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 provides us
with significant scale and cost reduction opportunities.

Impact of Inrange Integration

During the second quarter of 2003, we incurred integration charges related
to the Inrange acquisition of $3.4 million for wages and severance related to
terminated employees, and travel costs for integration activities. Employees were terminated in most functional areas
to obtain cost synergies. 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 charges on our
Statements of Operations for
the three and six months ended July 31, 2003:

Three months
    
    
    
    
    
    
    
    
    
    Six monthsImpact of
    
    ended
    
    
    
    Impact of
    
    endedAs reported
    
    integration
    
    July 31, 2003
    
    As reported
    
    integration
    
    July 31, 2003Cost of product
    
    $
    39,244
    
    
    $
    (2,223
    )
    
    $
    37,021
    
    
    $
    60,878
    
    
    $
    (2,223
    )
    
    $
    58,655Cost of service
    
    
    20,420
    
    
    
    (124
    )
    
    
    20,296
    
    
    
    30,506
    
    
    
    (124
    )
    
    
    30,382Sales and marketing
    
    
    24,867
    
    
    
    (1,201
    )
    
    
    23,666
    
    
    
    39,073
    
    
    
    (1,201
    )
    
    
    37,872Engineering and
development
    
    
    12,025
    
    
    
    (343
    )
    
    
    11,682
    
    
    
    17,945
    
    
    
    (343
    )
    
    
    17,602General and administrative
    
    
    5,266
    
    
    
    (1,145
    )
    
    
    4,121
    
    
    
    7,822
    
    
    
    (1,145
    )
    
    
    6,677


In addition to the above impact of integration,
cost of product for the three and six months ended July 31, 2003 includes
$1.1 million of amortization for developed technology related to the Inrange
acquisition. Sales and marketing expense includes $607,000 of amortization for
trademarks and customer lists which are also related to the Inrange acquisition. We may incur additional integration expenses of $1.0 million in our third quarter ending October 31, 2003
for wages and severance.

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
second quarter and first half of 2003, an additional $3.5 million and $7.7
million, respectively, was added to goodwill and $0 and $1.1 million,
respectively, was recorded as compensation expense under this earn out
arrangement.

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.

13



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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 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 for the next 15-20 years.

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 $3.4 million of Inrange
integration expenses and the $1.6 million inventory write-down on the Companys
financial statements.

Three months ended
    
    Six months endedJuly 31,
    
    July 31,Impact of
    
    
    
    
    
    
    
    
    
    
    
    Impact ofAs reported
    
    integration
    
    2003
    
    2002
    
    As reported
    
    integration
    
    2003
    
    2002Revenue:Product sales
    
    
    65.6
    %
    
    
    
    %
    
    
    65.6
    %
    
    
    67.8
    %
    
    
    65.7
    %
    
    
    
    %
    
    
    65.7
    %
    
    
    66.8
    %Service fees
    
    
    34.4
    
    
    
    
    
    
    
    34.4
    
    
    
    32.2
    
    
    
    34.3
    
    
    
    
    
    
    
    34.3
    
    
    
    33.2Total revenue
    
    
    100.0
    
    
    
    
    
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0
    
    
    
    
    
    
    
    100.0
    
    
    
    100.0Gross profit:Product sales
    
    
    38.2
    
    
    
    (3.5
    )
    
    
    41.7
    
    
    
    40.8
    
    
    
    37.8
    
    
    
    (2.3
    )
    
    
    40.1
    
    
    
    41.2Service fees
    
    
    38.5
    
    
    
    (.4
    )
    
    
    38.9
    
    
    
    40.9
    
    
    
    40.4
    
    
    
    (.2
    )
    
    
    40.6
    
    
    
    38.9Total gross profit
    
    
    38.3
    
    
    
    (2.4
    )
    
    
    40.7
    
    
    
    40.8
    
    
    
    38.7
    
    
    
    (1.6
    )
    
    
    40.3
    
    
    
    40.4Operating expenses:Sales and marketing
    
    
    25.7
    
    
    
    (1.3
    )
    
    
    24.4
    
    
    
    29.1
    
    
    
    26.2
    
    
    
    (.8
    )
    
    
    25.4
    
    
    
    31.7Engineering and development
    
    
    12.4
    
    
    
    (.3
    )
    
    
    12.1
    
    
    
    13.5
    
    
    
    12.1
    
    
    
    (.3
    )
    
    
    11.8
    
    
    
    14.1General and administrative
    
    
    5.4
    
    
    
    (1.1
    )
    
    
    4.3
    
    
    
    5.5
    
    
    
    5.2
    
    
    
    (.8
    )
    
    
    4.4
    
    
    
    5.5In process research and
development charge
    
    
    20.4
    
    
    
    
    
    
    
    20.4
    
    
    
    
    
    
    
    13.2
    
    
    
    
    
    
    
    13.2
    
    
    
    Total operating
expenses
    
    
    63.9
    
    
    
    (2.7
    )
    
    
    61.2
    
    
    
    48.1
    
    
    
    56.7
    
    
    
    (1.9
    )
    
    
    54.8
    
    
    
    51.3Loss from operations
    
    
    (25.6
    )%
    
    
    (5.1
    )%
    
    
    (20.5
    )%
    
    
    (7.3
    )%
    
    
    (18.0
    )%
    
    
    (3.5
    )%
    
    
    (14.5
    )%
    
    
    (10.9
    )%


Cost of product as reported of $39.2 million includes $1.1
million of amortization for developed technology related to the Inrange
acquisition and $2.2 million of integration expenses related to the integration of Inrange. Sales and marketing expense as reported of $24.9 million includes $607,000 of amortization for trademarks and
customer list related to the Inrange acquisition and $1.2 million of integration expenses related to the integration of Inrange. We also incurred a $19.7
million charge related to the Inrange acquisition for purchased in-process
research and development.

14



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##### Table of Contents



Revenue

Product revenue

Sales of our proprietary CNT products generated revenues of $51.0 million
and $69.3 million in the second quarter and first half of 2003, respectively,
increases of 116% and 51%, respectively, from $23.7 million and $45.9 million
for the second quarter and first half of 2002. A substantial amount of the
increase in our proprietary CNT product sales during the second quarter and
first half of 2003 relates to the acquisition of Inrange, including the Inrange
Fibre Channel director products. Revenue from the sale of the Fibre Channel
director products totaled $12 million in the second quarter and first half of
2003. We anticipate that the Fibre Channel director products acquired from
Inrange will account for a significant portion of our proprietary CNT product
revenue in future periods.

Sales of our third party storage solutions products generated revenues of
$12.5 million and $28.6 million in the second quarter and first half of 2003,
respectively, increases of 32% and 68%, respectively, from $9.5 million and
$17.0 million for the second quarter and first half of 2002. Our acquisition
of Articulent in April 2001 and BI-Tech in June 2002 significantly expanded our
third party solution offerings. The BI-Tech acquisition accounted for $5.0
million and $8.9 million of third party product revenue in the second quarter
and first half of 2003.

Service revenue

Service revenues from our proprietary CNT products for the second quarter
and first half of 2003 totaled $22.0 million and $32.9 million, respectively,
increases of 102% and 50%, respectively, from $10.9 million and $21.9 million
for the second quarter and first half 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 an expected $44 million
recurring annual revenue stream.

Our consulting fee revenues increased 132% and 96% in the second quarter
and first half of 2003 to $11.2 million and $18.3 million, respectively, up
from $4.8 million and $9.3 million for the second quarter and first half of
2002. A large portion of the growth in consulting fee revenue relates to our
acquisition of Inrange. We also continue to experience an increase in customer
acceptance of our consulting offerings, and our sales team has become more
experienced and proficient at selling solutions that include our consulting
offerings.

General

Revenue generated from the sale of products and services outside the
United States for the second quarter and first half of 2003 totaled $35.3
million and $50.6 million, respectively, increases of 179% and 128%,
respectively, from $12.7 million and $22.2 million for the second quarter and
first half 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 15% of our revenue during first half of fiscal
2003. No customer accounted for more than 10% of our revenue during the first
half 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.

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.

15



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##### Table of Contents



Gross Profit Margins

Product margins

Gross margins from the sale of proprietary CNT products for the second
quarter and first half of 2003 were 43% and 46%, respectively, compared to 48%
and 49%, respectively, in the second quarter and first half of 2002. Excluding
the $1.6 million write-down of inventory resulting from the integration of
product strategies related to the Inrange acquisition, $600,000 of integration
expenses, and $1.1 million of amortization expense for developed technology
acquired through the Inrange acquisition, gross product margins from the sale
of proprietary CNT products for the second quarter and first half of 2003 would
have been 50% and 51%, respectively. 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 to reduce the manufactured cost of our
UltraNet® Director products. A large portion of our newly
acquired Fibre Channel director products are sold through indirect channels.
Sales through indirect channels carry a lower gross margin, but approximately
the same operating margin as a direct sale to the end user.

Gross margins from the sale of third party storage solutions products for
the second quarter and first half of 2003 were 18% and 17%, respectively,
compared to 23% and 20%, respectively, in the second quarter and first half 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 second
quarter and first half of 2003 were 48% and 49%, respectively, compared to 50%
and 48%, respectively, in the second quarter and first half of 2002. We
anticipate that gross service margins for our proprietary CNT products,
excluding any potential integration expenses in the third quarter of 2003, will
continue to be in the 50% range for the foreseeable future.

Gross profit margins from our consulting fees were 20% and 26%,
respectively, for the second quarter and first half of fiscal 2003, compared to
20% and 18%, respectively, for the second quarter and first half of 2002.
Gross profit margins for the second quarter of 2003, were consistent with the
second quarter of 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. The improvement in the gross
profit margin percentage in the first half of 2003 compared to 2002 was
primarily due to higher utilization of employee consultants.

Operating Expenses

Sales and marketing

Sales and marketing expense for the second quarter and first half of 2003
totaled $24.9 million and $39.1 million, respectively, up 75% and 31%,
respectively, from $14.2 million and $29.8 million in the second quarter and
first half of 2002. Excluding integration expenses of $1.2 million, and
amortization for customer list and trademarks of $607,000 relating to the
Inrange acquisition, our sales and marketing expense would have been $23.1
million and $37.3 million, respectively, for the second quarter and first half
of 2003. Substantially all of the increase was due to our acquisition of
Inrange in May 2003 and BI-Tech in June 2002.

16



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##### Table of Contents



Engineering

Engineering and development expense for the second quarter and first half
of 2003 totaled $12.0 million and $17.9 million, respectively, up 82% and 35%,
respectively, from $6.6 million and $13.3 million in the second quarter and
first half of 2002. Excluding integration expenses of $343,000 related to the
Inrange acquisition, our engineering and development expenses would have been
$11.7 million and $17.6 million, respectively, for the second quarter and first
half 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 acquired from Inrange, and our UltraNet® family of products, particularly the
UltraNet® Edge product, which has generated $23.2 million of revenue since its
introduction in the third quarter of 2001. 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 second quarter and first half
of 2003 totaled $5.2 million and $7.8 million, respectively, up 95% and 50%,
respectively, from $2.7 million and $5.2 million in the second quarter and
first half of 2002. Excluding integration expenses of $1.1 million related to
the Inrange acquisition, our general and administrative expense, would have
been $4.1 million and $6.7 million, respectively, for the second quarter and
first half of 2003. The increase in expense was primarily due to our
acquisition of Inrange in May 2003 and BI-Tech in June 2002.

In process research and development

In
connection with the acquisition of Inrange, we acquired certain fibre
channel related technology
that was deemed to be in process (approximately 50% complete), that
had not yet reached technological feasibility, and that had no
alternative future use. The in process research
and development was valued at $19.7 million, as determined by an independent appraisal. We expect to incur
additional expenses of $10 to $15 million to achieve technological
feasibility with respect to this technology. As with any new
technology, there are risks and uncertainties associated with
completion of the project. We currently believe revenue related to this
technology will commence during 2004.

Other

Other expense for the second quarter and first half of 2003 totaled
$719,000 and $19,000, respectively, compared to other income of $373,000 and
$1.4 million for the second quarter and first half 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 second
quarter and first half of 2003 of $1.1 million and $2.2 million, respectively,
compared to $1.1 million and $1.9 million, respectively, in the second quarter
and first half of 2002. Interest income totaled $187,000 and $1.3 million for
the second quarter and first half of 2003, compared to $1.5 million and $3.4
million in the second quarter and first half 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.

17



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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 July 31, 2003 totaled
$60.2 million, a decrease of $149.2 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 half of fiscal 2003 totaled
$7.7 million, including a reduction in inventory of $11.0 million due to better inventory management and payments for accrued liabilities of $7.7 million
for severance and other items. Proceeds
related to the issuance of common stock totaled $1.0 million. Uses of cash for
the first half of fiscal 2003, included $5.2 million for capital equipment and
field support spares. Expenditures for capital equipment and field support
spares have been, and will likely continue to be, a significant capital
requirement.

At July 31, 2003, our available cash and marketable securities totaled
$60.2 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 through 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 July 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
    
    $
    .3
    
    
    $
    .3
    
    
    $
    None
    
    
    $
    None
    
    
    $
    NoneOperating leases
    
    $
    40.1
    
    
    $
    8.6
    
    
    $
    16.5
    
    
    $
    
    8.7
    
    
    $
    6.3Purchase orders
    
    $
    19.3
    
    
    $
    18.9
    
    
    $
    .4
    
    
    $
    None
    
    
    $
    NoneBI-Tech earn out
    
    $
    8.8
    
    
    $
    8.8
    
    
    $
    None
    
    
    $
    None
    
    
    $
    NoneConvertible notes, plus interest
    
    $
    138.1
    
    
    $
    3.8
    
    
    $
    11.3
    
    
    $
    
    123.0
    
    
    $
    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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##### Table of Contents









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. On July 31, 2003, the average bid and ask price of our convertible
subordinated notes due 2007 was 81.88 resulting in an aggregate fair value of
approximately $102.4 million. Our common stock is quoted on the Nasdaq National
Market under the symbol CMNT. On July 31, 2003, the last reported sale price
of our common stock on the Nasdaq Market was $6.71 per share.

At July 31, 2003, our marketable securities included a $210,000 investment
in a Standard & Poors 500 stock price index fund and a $335,000 investment in a
NASDAQ 100 index tracking stock. 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 pound sterling. As of July 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 under all
potential future conditions, regardless of how remote.

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##### Table of Contents



(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.
| | - |  | ---------------------------------------------------------------------------------------------------------------

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; (ix) risks associated with the
unfavorable developments in litigation, and, (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.

20



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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 2-3. None







Item 4. Submission of matters to a vote of security holders

(a) The annual meeting of shareholders was held on June 25, 2003(b) Election of directors of the company:Thomas G. Hudson
      Patrick W. Gross
      Erwin A. Kelen
      John A. Rollwagen
      Lawrence A. McLernon
      Katherine B. Earley
      Bruce J. Ryan(c) Matters voted upon


Affirmative
    
    Negative
    
    Abstain
    
    BrokerVotes
    
    Votes
    
    Votes
    
    Non-Votes1. Election of Directors
    Thomas G. Hudson
    Patrick W. Gross
    Erwin A. Kelen
    John A. Rollwagen
    Lawrence A. McLernon
    Katherine B. Earley
    Bruce J. Ryan
    
    24,107,558
24,410,272
24,715,695
24,393,289
24,401,241
24,789,202
24,785,665
    
    
    879,710
567,996
262,573
584,979
577,027
189,066
192,603
    
    
    
    






    
    
    





2. Proposal to amend the
    1992 employee Stock
    purchase plan to
    increase the number of
    shares authorized for
    issuance thereunder by
    1,300,000 to 2,800,000;
    and to increase to $7,500
    the amount that may be
    withheld by any participant
    to purchase shares of
    common stock under the
    plan during any purchase
    period
    
    23,566,687
    
    
    1,239,650
    
    
    
    171,930
    
    
    3. Proposal to ratify
    and approve the
    appointment of KPMG LLP
    as independent auditors
    for the fiscal year ending
    January 31, 2004.
    
    24,586,745
    
    
    349,731
    
    
    
    41,792
    
    
    








Item 5. None

22



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##### Table of Contents









Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits filed (or where indicated, furnished) herewith.

2
    
    Amendment dated June 9, 2003 to purchase Agreement dated June 24, 2002 between
Computer Network Technology Corporation, Greg Scorziello, Paul John Foskett
and Owen George Smith.(2)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.)10
    
    Amendment to amended and Restated 1999 Non-Qualified Stock Award
Plan.(1)(2)11.
    
    Statement Re: Computation of Net income (loss) per Basic and Diluted
Share.(2)31.1
    
    CEO Certification Required by Rule 13a-14(a)/15d-14(a) under the
Securities Exchange Act of 1934.(2)31.2
    
    CFO Certification Required by Rule 13a-14(a)/15d-14(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 (except Exhibit 32 is furnished herewith).                   
|   
|    |  | (b)   Reports on Form 8-K                                                   

The company filed a current report on Form 8-K on May 16, 2003 and Form
8-K/A on July 18, 2003 relating to the acquisition of Inrange
Technologies Corporation. A current report on Form 8-K was dated and
furnished May 12, 2003, pursuant to Item 9 (Regulation FD Disclosure) to
report the press release announcing the Companys financial results for
the first 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: September 12, 2003

By:
    
    /s/ Gregory T. BarnumGregory T. Barnum
Chief Financial Officer
(Principal financial officer)By:
    
    /s/ Jeffrey A. BertelsenJeffrey A. Bertelsen
Corporate Controller
and Treasurer
(Principal accounting officer)


24



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##### Table of Contents









EXHIBIT INDEX

Item
    
    Description2
    
    Amendment dated June 9, 2003 to purchase Agreement dated June 24, 2002 between
Computer Network Technology Corporation, Greg Scorziello, Paul John Foskett
and Owen George Smith.(2)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.)10
    
    Amendment to amended and Restated 1999 Non-Qualified Stock Award
Plan.(1)(2)11.
    
    Statement Re: Computation of Net income (loss) per Basic and Diluted
Share.(2)31.1
    
    CEO Certification Required by Rule 13a-14(a)/15d-14(a) under the
Securities Exchange Act of 1934.(2)31.2
    
    CFO Certification Required by Rule 13a-14(a)/15d-14(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 (except Exhibit 32 is furnished herewith).