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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

COMMISSION FILE NUMBER: 0-13994

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         

As of December 4, 2002, the registrant had 26,803,035 shares of $.01 par value common stock issued and outstanding.

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COMPUTER NETWORK TECHNOLOGY CORPORATION

INDEX

PART I. FINANCIAL INFORMATION

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CNT
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
(unaudited)

See accompanying notes to Consolidated Financial Statements

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CNT
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)

See accompanying notes to Consolidated Financial Statements

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

See accompanying notes to Consolidated Financial Statements

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS)

(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, 2002 as filed with the Securities and Exchange Commission. References to fiscal 2002 and 2001, represent the twelve months ended January 31, 2003 and 2002, respectively.

(2)  MARKETABLE SECURITIES

     During the first quarter of fiscal 2001, the Company sold 232,511 shares of webMethods stock received from the sale of IntelliFrame for approximately $6.3 million, resulting in a pre-tax loss of approximately $8.7 million. The Company also wrote-down the carrying value of the remaining 41,031 shares of webMethods stock that it still owns, resulting in a pre-tax loss of approximately $1.5 million.

     The Company’s remaining investments in marketable securities primarily consist of U.S. government and agency securities, corporate debt securities and bank certificates of deposit. Excluding the sale of webMethods stock noted above, the Company did not realize any significant gains or losses from the sale of marketable securities during the first nine months of fiscal 2002 or 2001.

(3)  INVENTORIES

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

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(4)  CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE

     In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 141 requires use of the purchase method of accounting for all business combinations initiated after June 30, 2001. SFAS No. 141 also provides new criteria in the determination of intangible assets, including goodwill acquired in a business combination, and expands financial disclosure concerning business combinations consummated after June 30, 2001. 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. The application of SFAS No. 141 did not affect previously reported amounts included in goodwill and other intangible assets.

     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 Company engaged a third-party appraisal firm to determine the fair value of a reporting unit within its former Storage Solutions segment. This valuation indicated that the goodwill associated with the acquisition of Articulent in April of 2001 was impaired. The performance of this business has 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. Impairment adjustments recognized after adoption, if any, generally are required to be recognized as an operating expense.

(5)  ACQUISITION

     On June 24, 2002, the Company acquired all the outstanding stock of Bi-Tech Solutions, Inc. (Bi-Tech), a leading provider of storage management solutions and services, for $12 million in cash plus the assumption of approximately $3.6 million of liabilities and the acquisition of approximately $8.7 million of tangible assets. The Company has allocated $5.9 million and $1.8 million of the purchase price to goodwill and customer list, respectively. The customer list is currently being amortized over a ten-year period. The final allocation of the purchase price will be subject to adjustment based on an independent third party appraisal. The accompanying financial statements include the results of Bi-Tech since June 24, 2002.

     The purchase agreement requires payment of additional consideration to the former stockholders and the Bi-Tech employees based on achievement of certain earnings levels for each of the next two years starting July 1, 2002. The additional consideration can be paid in cash or stock of the Company at the Company’s option. The portion payable to the former stockholders will be recorded as goodwill. The portion payable to Bi-Tech employees will be recorded as compensation expense. During the third quarter and nine months ended October 31, 2002 and based on Bi-Tech’s operations since July 1, 2002, an additional $2.6 million and $3.1 million respectively, was added to goodwill and $537,000 and $625,000 respectively, was recorded as compensation expense. The additional consideration payable to the employees for the three and nine months ended October 31, 2002 net of tax was $376,000 and $438,000, respectively.

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(6)  GOODWILL AND INTANGIBLE ASSETS

     As described previously, the Company adopted SFAS No. 142 as of February 1, 2002. The following table reflects the consolidated results adjusted as if the adoption of SFAS No. 142 occurred as of the beginning of the nine month period ended October 31, 2001:

     The change in the net carrying amount of goodwill for the nine months ended October 31, 2002 was as follows:

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     The components of other amortizable intangible assets were as follows:

     Amortization expense for intangible assets during the nine months ended October 31, 2002 was $106. Amortization expense for the remainder of fiscal 2002 is estimated to be $62. Amortization expense is estimated to be $248 each year from 2003 through 2007.

(7) COMPREHENSIVE LOSS

     Comprehensive loss consists of the following:

(8)  CONVERTIBLE 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 payment if the closing price of its common stock exceeds 175% of the conversion price for at least 20 consecutive trading days within a period of 30 consecutive trading days ending on the trading day prior to the date the redemption notice is mailed. The make whole payment represents additional interest payments that would have been made if the notes would not have been redeemed prior to its due date. 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.

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(9)  DISCONTINUED OPERATIONS

     Propelis Software, Inc., formerly known as the Enterprise Integration Solutions Division, including IntelliFrame, developed and sold EAI software that automates the integration of computer software applications, and business workflow processes. In August 2000, the Company determined to divest Propelis Software, Inc. and focus on its core storage networking business. As a result, Propelis Software, Inc. has been accounted for as a discontinued operation in the accompanying financial statements. During 2001 the Company sold substantially all of the assets of its discontinued operations in a series of transactions. These included the sale of its IntelliFrame subsidiary to webMethods and the sale of other assets to Jacada Ltd. All outstanding options to purchase stock of Propelis Software were cancelled or have lapsed.

     On February 2, 2001 the Company sold all of the outstanding stock of IntelliFrame Corporation, including the technology underlying the Propelis BPm™ product, to webMethods, Inc. for $8.8 million in cash and 273,542 shares of webMethods common stock. The stock received from webMethods, Inc. was valued at $17.1 million which reflects a discount from its publicly reported trading price due to the initial restrictions placed on the Company’s ability to freely sell the stock. In connection with this transaction, the Company paid $3.0 million to two employees, who were former shareholders of IntelliFrame, to satisfy all obligations to make further bonus payments under their employment agreements. The sale resulted in an after tax gain of $12.6 million in the first quarter of fiscal 2001.

     In the first quarter of fiscal 2001, the Company accrued $9.3 million for the estimated future operating losses of Propelis Software, Inc. through the potential date of divestiture, resulting in an after tax loss of $6.2 million.

     On August 23, 2001 the Company sold substantially all of the remaining assets and liabilities of Propelis Software, Inc. to Jacada Ltd. for $6.0 million in cash, plus a warrant to purchase 350,000 ordinary shares of Jacada Ltd. stock at a price of $3.26 per share. The transaction resulted in an after tax gain of $1.8 million in the third quarter of fiscal 2001.

     In the third quarter of fiscal 2002, the Company received $207,000 of royalty income, net of tax, related to the sale of discontinued operations in 2001.

(10)  NEW ACCOUNTING PRONOUNCEMENTS

     In July 2002, the Financial Accounting Standards Board issued SFAS No. 146 “Accounting for Costs Associated with Exit or Disposal Activities.” The standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at a date of a commitment to an exit or disposal plan. Management believes the adoption of SFAS No. 146 will not have a material effect on the Company’s financial statements. SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002 with early application encouraged.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 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. We design, manufacture, market and support a wide range of solutions for critical storage networking applications such as remote data replication, or the real-time backup of data to remotely located disks, and remote tape vaulting, or the backup of data to remotely archived tapes. We also supply storage systems, Fibre Channel switches, telecommunications capacity and storage application software.

     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 our storage networking products and services directly to customers through our sales force and worldwide distributors. We also have strategic marketing and supply relationships with leading storage, telecommunications and fibre switching companies, including Brocade, Dynergy Global Communications, EMC, Hewlett-Packard, Hitachi Data Systems, IBM, McDATA, StorageTek and Veritas.

     During the third quarter of fiscal 2002, we consolidated our Storage Solutions and Networking sales force into a single unit. Our business has evolved to the point where many of our traditional Networking sales personnel are now selling complete storage solutions, in addition to our proprietary UltraNet and Channelink products. It is no longer possible to allocate costs and prepare separate meaningful statements for what had been our Networking and Storage Solutions segments. As a result, our management now reviews and makes decisions utilizing financial information for the consolidated business.

     Economic conditions in early 2001 caused our customers to reevaluate their capital spending plans, and to defer previously planned projects for information technology infrastructure. However, we believe the need for storage networking solutions is significant and will continue to increase. The reduction in demand for our products and services resulted in the following charges in the first quarter of fiscal 2001:

	•		$2.0 million to write-down slow moving inventory
	•		$325,000 for the write-off of a product; and
	•		$996,000 for restructuring, principally severance.

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

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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.

Sale and Write-down of webMethods Stock

     During the first quarter of fiscal 2001, we sold 232,511 shares of webMethods stock received from the sale of IntelliFrame for approximately $6.2 million, resulting in a pre-tax loss of approximately $8.7 million. We also wrote-down the carrying value of the remaining 41,031 shares of webMethods stock that we still own, resulting in a pre-tax loss of approximately $1.5 million.

Discontinued Operations — Divestiture of Propelis Software, Inc.

     Propelis Software, Inc., formerly known as our Enterprise Integration Solutions Division, including IntelliFrame, developed and sold our Enterprise Access Integration software that automates the integration of computer software applications, and business workflow processes. In August 2000, we determined to divest Propelis Software, Inc. and focus on our core storage networking business. As a result, Propelis Software, Inc. has been accounted for as a discontinued operation in the accompanying financial statements. During fiscal 2001 we sold substantially all of the assets of our discontinued operations in a series of transactions. These included the sale of our IntelliFrame subsidiary to webMethods and the sale of other assets to Jacada Ltd. All outstanding options to purchase stock of Propelis Software have been cancelled or have lapsed.

     On February 2, 2001 we sold all of the outstanding stock of IntelliFrame Corporation, including the technology underlying the Propelis BPm™ product, to webMethods, Inc. for $8.8 million in cash and 273,542 shares of webMethods common stock. The stock received from webMethods, Inc. was valued at $17.1 million, which reflects a discount from its publicly reported trading price due to the initial restrictions placed on our ability to freely sell the stock. In connection with this transaction, we paid $3.0 million to two employees, who were former shareholders of IntelliFrame, to satisfy all obligations to make further bonus payments under their employment agreements. The sale resulted in an after tax gain of $12.6 million in the first quarter of fiscal 2001.

     In the first quarter of fiscal 2001, we accrued $9.3 million for the estimated future operating losses of Propelis Software, Inc. through the potential date of divestiture, resulting in an after tax loss of $6.2 million.

     On August 23, 2001 we sold substantially all of the remaining assets and liabilities of Propelis Software, Inc. to Jacada Ltd. for $6.0 million in cash, plus a warrant to purchase 350,000 ordinary shares of Jacada Ltd. stock at a price of $3.26 per share. The transaction resulted in an after tax gain of $1.8 million in the third quarter of fiscal 2001.

     In the third quarter of fiscal 2002, the Company received $207,000 of royalty income, net of tax, related to the sale of discontinued operations in 2001.

Acquisition of Articulent

     On April 3, 2001 we acquired all of the outstanding stock of Articulent Inc., a leading provider of storage solutions and services for $12.4 million

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in cash, plus the assumption of approximately $24.4 million of liabilities and the acquisition of approximately $19.3 million of tangible assets. The accompanying financial statements include the results of Articulent since April 3, 2001.

Acquisition of Bi-Tech Solutions, Inc.

     On June 24, 2002, we acquired all the outstanding stock of Bi-Tech Solutions, Inc. (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 purchase agreement requires that we pay at our option in cash or in our stock to the former stockholders and the Bi-Tech employees additional consideration based on certain earnings levels for each of the next two years starting July 1, 2002. The portion payable to the former stockholders will be recorded as goodwill. The portion payable to Bi-Tech employees will be recorded as compensation expense. During the three and nine months ended October 31, 2002 and based on Bi-Tech’s earnings since July 1, 2002, additional consideration of $2.6 million and $3.1 million, respectively, was added to goodwill and $537,000 and $625,000, respectively, was recorded as compensation expense.

Convertible Debt Offering

     The additional consideration payable to the employees for the three and nine months ended October 31, 2002 net of tax was $376,000 and $438,000, respectively.

     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 payment 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. The make whole payment represents additional interest payments that would have been made if the notes would not have been redeemed prior to its due date. 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.

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Results of Continuing Operations

     The following table sets forth financial data for our continuing 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 operating information for the three and nine months ended October 31, 2002 and 2001 is for illustrative purposes only and has been adjusted to eliminate the effects of special items and other charges recognized during the first quarter of fiscal 2001, including a $2.0 million write-down of inventory, a $325,000 write-off of a product and a $996,000 restructuring charge. Results for the three and nine months ended October 31, 2001 exclude goodwill amortization expense of $163,000 and $414,000, respectively. Goodwill amortization stopped effective February 1, 2002 when we adopted SFAS No. 142 “Goodwill and Other Intangibles Assets”. It also eliminates the effects of an earn-out payable to the employees of Bi-Tech of $537,000 and $625,000, respectively, for the three and nine months ended October 31, 2002.