UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

COMMISSION FILE NUMBER: 0-13994

COMPUTER NETWORK TECHNOLOGY CORPORATION

6000 Nathan Lane North, Minneapolis, Minnesota 55442

Telephone Number: (763) 268-6000

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for at least the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ No o

As of October 31, 2004, the registrant had 28,701,785 shares of $.01 par value common stock issued and outstanding.

COMPUTER NETWORK TECHNOLOGY CORPORATION

INDEX

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PART I. FINANCIAL INFORMATION

Item 1.

COMPUTER NETWORK TECHNOLOGY CORPORATION

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See accompanying notes to Consolidated Financial Statements

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COMPUTER NETWORK TECHNOLOGY CORPORATION

See accompanying notes to Consolidated Financial Statements

5

COMPUTER NETWORK TECHNOLOGY CORPORATION

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, 2004 as filed with the Securities and Exchange Commission. References to fiscal 2004 and 2003 represent the twelve months ended January 31, 2005 and 2004, respectively.

     On May 5, 2003, the Company completed the acquisition of Inrange Technologies (Inrange) for $190 million in cash. The acquisition was accounted for as a purchase, and the Company’s financial statements include the results of Inrange since May 5, 2003. See footnote 4 “Acquisition of Inrange” for further information regarding the effect of the Inrange acquisition on the Company’s balance sheet and results of operations.

(2) MARKETABLE SECURITIES

     During the first quarter of fiscal 2003, the Company sold marketable securities totaling $122 million, resulting in a net pre-tax gain of approximately $747. No significant gains or losses from the sale of marketable securities were recorded during the other periods presented. During the third quarter of fiscal 2004, the Company recorded a $181 charge for permanent impairment of marketable securities.

     The Company’s investments in marketable securities primarily consist of U.S. government and agency securities, corporate debt securities and bank certificates of deposit. The Company also holds trading securities consisting of various mutual funds. The Company intends to use any gain or loss from these investments to fund the investments gains and losses allocated to participants under the Company’s executive deferred compensation plan.

(3) INVENTORIES

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

(4) ACQUISITION OF INRANGE

Inrange

     On April 6, 2003, the Company entered into an agreement whereby a wholly owned subsidiary of the Company would acquire all of the shares of Inrange Technologies Corporation (Inrange) that were owned by SPX Corporation. The shares acquired constituted approximately 91% of the issued and outstanding shares of Inrange for a purchase price of approximately $2.31 per share and $173 million in the aggregate. On May 5, 2003 the Company completed the acquisition of Inrange and pursuant to the agreement the subsidiary merged into Inrange, and the remaining capital stock owned by the other Inrange shareholders was converted into the right to receive approximately $2.31 per share in cash, resulting in a total payment of $190 million for both the stock purchase and merger.

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     The Company acquired Inrange to significantly broaden its portfolio of storage networking products and solutions, particularly in the area of Fibre Channel and FICON switching, increase its global size and scope, and expand its customer base.

     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:

     As part of the Inrange acquisition, the Company assumed the 2000 Inrange stock compensation plan which provides for the issuance of up to 3,782,993 shares of the Company’s common stock. The plan provided for the conversion of pre-existing Inrange stock options into company stock options. The options granted under the 2000 Inrange stock compensation plan were valued at $10.3 million using the Black-Scholes option-pricing model. The amount was deemed to be part of the Inrange purchase price and was recorded as additional paid-in capital.

     The intangible assets acquired included developed technology, customer list and trademarks valued at $20.2 million, $15.3 million and $1.2 million, respectively. The developed technology, customer list and trademarks were initially being amortized on a straight-line basis over periods of approximately five years, seven years and five years, respectively. These lives were subsequently revised in the third quarter of fiscal 2004 in connection with the Company’s impairment analysis of long lived assets and goodwill (see footnote 5). Goodwill resulting from the acquisition of $86.9 million is deductible for income tax purposes.

     The Company has allocated $19.7 million of the Inrange purchase price to acquired in-process research and development to reflect the value of new Fibre Channel switching technology that was approximately 50% complete at the time of acquisition. At the date of acquisition, the technological feasibility of the new Fibre Channel switching technology had not been attained and the technology had no alternative future use. The allocation to in-process research and development was based on an independent third party appraisal that utilized the excess earnings approach. Significant assumptions used in the third party appraisal include the cost to complete the project, and the projected revenue and expense generated over the estimated life cycle of the new Fibre Channel switching technology.

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     The following table presents the unaudited pro forma consolidated results of operations of the Company for the three and nine months ended October 31, 2004 and 2003 as if the acquisition of Inrange took place on February 1, 2003:

     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.

(5) GOODWILL AND INTANGIBLE ASSETS

     In August 2004, the Company’s market capitalization fell substantially below recorded net book value, indicating that goodwill and other long-lived assets may be impaired, including developed technology, trademarks and customer lists. As part of management’s evaluation and analysis, the Company engaged an independent third party to appraise these assets. The Company’s evaluation and analysis indicated that impairment charges for developed technology, trademarks and goodwill of $11.2 million, $911 and $73.3 million, respectively, should be reflected in results of operations for the fiscal third quarter ended October 31, 2004. Developed technology and trademarks intangibles resulted entirely from the Company’s Inrange acquisition, while most of the Company’s goodwill resulted from the Inrange acquisition. See footnote 4 to the consolidated financial statements for a summary of the Inrange purchase price allocation. Developed technology was analyzed using the excess earnings method, and was impaired due to more rapid market acceptance of the Company’s new generation UMD product following its introduction this year. Trademarks were analyzed using the relief from royalty approach and were impaired due to use of the UltraNet name for the new generation UMD product, and the subsequent rapid market acceptance of this product. The more rapid market acceptance of the Company’s new UMD product resulted in lower estimated revenue and excess earnings, primarily for developed technology, compared to the Company’s original estimate when Inrange was acquired. The Company determined that its customer lists intangible was not impaired. The Company’s fair value was based on a combination of the income and market valuation approaches. The analysis indicated that the Company’s net book value exceeded its implied fair value, resulting in the $73.3 million charge for goodwill impairment. The goodwill impairment charge resulted from the Company’s later than planned launch of the UMD, coupled with slower than planned development of the direct sales channel for these products, and more rapid acceptance of the CNT wide area extension products by the Inrange customer set. The remaining useful lives for developed technology and trademarks were revised to 3 and one years, respectively. The impairment charges will not result in future cash expenditures.

     The change in the net carrying amount of goodwill for the first nine months of 2004 was as follows:

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     The components of other amortizable intangible assets were as follows:

     Amortization expense for intangible assets during the third quarter and first nine months of 2004 was $1.0 million and $4.5 million, respectively. Amortization expense for the remainder of 2004 is estimated to be $0.9 million. Amortization expense is estimated to be $3.6 million in 2005, $3.5 million in 2006, $3.0 million in 2007 and $2.3 million in 2008.

(6) COMPREHENSIVE LOSS

     Comprehensive loss consists of the following:

(7) CONVERTIBLE SUBORDINATED DEBT

     In February 2002, the Company sold $125 million of 3% convertible subordinated notes due February 15, 2007, raising net proceeds of $121.6 million. The notes are convertible into the Company’s common stock at a price of $19.17 per share. The Company may redeem the notes upon payment of the outstanding principal balance, accrued interest and a make whole payment if the closing price of its common stock exceeds 175% of the conversion price for at least 20 consecutive trading days within a period of 30 consecutive trading days ending on the trading day prior to the date the redemption notice is mailed. The make whole payment represents additional interest payments that would be made if the notes were not redeemed prior to the due date.

     In January 2004, the Company entered into an interest-rate swap agreement with a notional amount of $75 million that has the economic effect of modifying that dollar portion of the fixed interest obligations associated with $75 million of its 3% convertible subordinated notes due February 2007, such that the interest payable effectively becomes variable based on the three month LIBOR plus 69.5 basis points. The payment dates of the swap are January 31st, April 30th, July 31st and October 31st of each year, commencing April 30, 2004, until maturity on February 15, 2007. The combined effective rate for the period from August 1, 2004 through October 31, 2004 was approximately 2.375%. The combined effective rate for the period November 1, 2004 to January 31, 2005 will be 2.825%. The swap was designated as a fair value hedge, and as such, the gain or loss on the swap, as well as the fully offsetting gain or loss on the

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notes attributable to the hedged risk, were recognized in earnings. As part of the agreement, the Company is also required to post collateral based on changes in the fair value of the interest rate swap. This collateral, in the form of restricted cash, was $3.2 million at October 31, 2004. The Company could incur charges to terminate the swap in the future prior to February 15, 2007 if interest r