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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarterly Period Ended September 30, 1998
Commission File Number 1-2982
ANCOR COMMUNICATIONS, INCORPORATED
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(Exact name of issuer as specified in its charter)
Minnesota 41-1569659
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
6130 Blue Circle Drive Minnetonka, Minnesota 55343
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(Address of principal executive offices) (Zip code)
Registrant's Telephone number, including area code (612) 932-4000
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 such shorter period that the registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days. Yes [X] No [ ]
19,700,604
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(Number of shares of common stock of the
registrant outstanding as of October 30, 1998)
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ANCOR COMMUNICATIONS, INCORPORATED
Form 10-Q
For the Quarterly Period Ended
September 30, 1998
Page
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PART I - FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
Balance Sheets as of September 30, 1998 (unaudited)
and December 31, 1997 3
Statements of Operations for the three and nine
month periods ended September 30, 1998
and 1997 (unaudited) 4
Statements of Cash Flows for the nine
month periods ended September 30, 1998
and 1997 (unaudited) 5
Notes to Financial Statements 6
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 8
PART II - OTHER INFORMATION 14
2
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
ANCOR COMMUNICATIONS, INCORPORATED
BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
1998 1997
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ASSETS (UNAUDITED)
Current Assets:
Cash and cash equivalents $ 3,908,002 $ 2,001,404
Short-term investments 997,282 --
Accounts receivable, less allowances of $77,558 and $804,000, respectively 254,975 1,499,634
Inventories (Note 2) 2,267,647 2,493,722
Prepaid expenses and other current assets 254,371 154,983
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Total current assets 7,682,277 6,149,743
Equipment, net of accumulated depreciation 3,087,145 3,273,528
Patents, prepaid royalties, and other assets,
net of accumulated amortization 211,824 269,190
Capitalized software development costs
net of accumulated amortization 190,627 471,043
=========== ============
TOTAL ASSETS $ 11,171,873 $ 10,163,504
=========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term debt $ 145,550 $ 65,145
Accounts payable 594,284 963,321
Accrued liabilities 1,590,698 687,990
Unearned revenue, current 1,316,467 1,000
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Total current liabilities 3,646,999 1,717,456
Long-term unearned revenue, less current 1,055,062 --
Long-term debt, less current maturities 142,268 129,702
Shareholders' Equity (Notes 3 and 6)
Preferred stock, par value $.01 per share,
authorized 5,000,000 shares; issued and outstanding
Series A, 0 shares in 1998 and 42 shares in 1997 -- 1
Series B, 70 shares in 1998 and 440 shares in 1997 1 4
Series C, 680 shares in 1998 and none issued in 1997 7
Common stock, par value $.01 per share,
authorized 40,000,000 shares; issued and outstanding
19,194,374 Shares in 1998 and 11,778,006 shares in 1997 191,943 117,780
Additional paid-in capital 46,409,052 35,290,763
Accumulated deficit (40,273,459) (27,092,202)
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Total shareholders' equity 6,327,544 8,316,346
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TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 11,171,873 $ 10,163,504
=========== ============
See notes to Financial Statements
3
ANCOR COMMUNICATIONS, INCORPORATED
STATEMENT OF OPERATIONS
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- ---------------------------
1998 1997 1998 1997
----------- ----------- ------------ -----------
Net sales $ 230,301 $ 3,423,837 $ 1,409,563 $ 7,328,414
Cost of goods sold (Note 2) 200,898 2,587,013 5,407,417 4,923,271
----------- ----------- ------------ -----------
Gross profit 29,403 836,824 (3,997,854) 2,405,143
Operating expenses
Selling, general and administrative 1,813,094 1,968,412 5,326,894 4,992,851
Research and development 1,335,624 1,374,756 4,004,700 3,662,830
----------- ----------- ------------ -----------
Total operating expenses 3,148,718 3,343,168 9,331,594 8,655,681
----------- ----------- ------------ -----------
Operating loss (3,119,315) (2,506,344) (13,329,448) (6,250,538)
Nonoperating income (expense)
Interest expense (7,838) (5,363) (28,020) (10,526)
Other, primarily interest income 11,549 59,070 176,211 176,281
----------- ----------- ------------ -----------
Net loss (3,115,604) (2,452,636) (13,181,257) (6,084,783)
Accretion on convertible preferred stock (239,908) (111,604) (664,621) (275,192)
----------- ----------- ------------ -----------
Net loss attributable to common shareholders $(3,355,512) $(2,564,240) $(13,845,878) $(6,359,975)
=========== =========== ============ ===========
Basic and diluted net loss per common share $ (0.24) $ (0.23) $ (1.11) $ (0.59)
=========== =========== ============ ===========
Weighted average common shares
outstanding 13,731,135 10,984,569 12,528,182 10,721,111
=========== =========== ============ ===========
See notes to Financial Statements
4
ANCOR COMMUNICATIONS, INCORPORATED
STATEMENT OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
----------------------------
1998 1997
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CASH FLOW FROM OPERATING ACTIVITIES:
Net loss $(13,181,257) $ (6,084,783)
Adjustments to reconcile net loss to net
cash used in operating activities:
Provisions for receivables allowances -- 248,953
Writedown of inventory to net realizable value 4,257,657 500,000
Depreciation and amortization 1,024,695 767,979
Changes in current assets and liabilities:
Accounts receivable 1,244,659 409,479
Inventories (3,788,582) (202,026)
Prepaid expenses and other (99,388) 82,557
Accounts payable (369,037) (442,679)
Accrued liabilities 659,708 295,550
Unearned revenue 3,138,593 1,000
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Net cash used in operating activities (7,112,952) (4,423,970)
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CASH FLOW FROM INVESTING ACTIVITIES:
Purchases of equipment (244,450) (999,981)
Purchase of short-term investments (997,282) (1,996,470)
Decrease in other, net (33,407) (115,306)
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Net cash used in investing activities (1,275,139) (3,111,757)
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CASH FLOW FROM FINANCING ACTIVITIES:
Principal payments on long-term debt (129,702) (69,856)
Net proceeds from sale of preferred stock 10,239,724 7,948,001
Net proceeds from sale of common stock
and exercise of options 184,667 259,568
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Net cash provided by financing activities 10,294,689 8,137,713
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Net increase in cash 1,906,598 601,986
Cash, beginning of period 2,001,404 507,041
============ ============
Cash, end of period $ 3,908,002 $ 1,109,027
============ ============
Supplemental Schedule of Noncash Investing
and Financing Activities:
Equipment acquired under capital lease $ 222,673 $ 78,623
============ ============
Warrants issued under license agreement $ 768,064 $ --
============ ============
See notes to Financial Statements
5
ANCOR COMMUNICATIONS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information.
In the opinion of management, the interim financial statements include all
adjustments necessary for a fair presentation of the results of operations for
the interim periods presented. Operating results for the three and nine months
ended September 30, 1998 are not necessarily indicative of the operating results
to be expected for the year ending December 31, 1998.
During 1998, the Company changed the internal allocation of reporting
depreciation. This new method of allocation resulted in reclassifying
depreciation expense from selling, general and administrative to research and
development in the amounts of $165,259 and $427,617 for the three and nine
months ended September 30, 1997, respectively.
Certain information and footnote disclosures normally included in financial
statements in accordance with generally accepted accounting principles have been
condensed or omitted.
NOTE 2 - INVENTORIES
INVENTORIES AT SEPTEMBER 30, 1998 AND DECEMBER 31, 1997 CONSISTED OF:
1998 1997
- -----------------------------------------------------------------------------
Raw materials $ 3,949,192 $ 2,398,066
Finished goods consigned to customers and others 1,062,084 527,078
Finished goods 2,385,782 663,500
Reserve for obsolescence (5,129,411) (1,094,922)
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$ 2,267,647 $ 2,493,722
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NOTE 3 - EQUITY FINANCING
On February 19, 1998, the Company sold 1,100 shares of $0.01 par value Series C
Preferred Stock through a private placement at $10,000 per share. Total net
proceeds from this private placement were $10,239,724, after reduction for
commissions and issuance costs of $760,276. In conjunction with the transaction,
the placement agent was granted a five year warrant to purchase 90,644 shares of
common stock at $7.281 per share.
The Series C Preferred Stock is convertible into Common Stock of the Company,
subject to certain restrictions, at a variable conversion rate equal to the
lower of (i) the Maximum Conversion Price (as defined below) or (ii) the average
of the three lowest closing bid prices of the Common Stock during the applicable
Pricing Period (as defined below). The Maximum Conversion Price for the first
year is $11.00. After the first year, the Maximum Conversion Price is equal to
the lesser of $11 per share and the average closing bid price of the five
Wednesdays immediately preceding the first anniversary of the date the Series C
Preferred Stock was issued. The applicable Pricing Period is a number of
consecutive trading days immediately preceding the date of conversion of the
Series C Preferred Stock initially equal to twelve and increased by one
additional consecutive trading day for each full calendar month which has
elapsed since February 19, 1998.
See notes to Financial Statements
6
NOTE 4 - NET LOSS PER SHARE
The Company computes net loss per common share based upon the weighted average
number of common shares outstanding during the year. Potential common shares,
consisting of options, warrants and convertible preferred stock for all periods,
were not included in the computation as their effect was antidilutive. Premiums
earned by preferred shareholders are included in the net loss attributable to
common shareholders computation. Basic and diluted loss per-share amounts are
the same in each period presented.
NOTE 5 - CONTINGENCY
In July 1997, the Company, along with Stephen O'Hara, Lee B. Lewis and Dale
Showers, was named as a defendant in a securities action captioned Richard
Radman and Sol Rosenthal v. Ancor Communications, Inc., et. al filed in the
United States District Court for the District of Minnesota. The lawsuit alleges
that the Company violated sections 10(b) of the Securities Exchange Act of 1934
when it allegedly made misleading public disclosures relating to the Company's
contract with Sequent Computer Systems, Inc. and the Company's financial
results. The Company and each of the other defendants have entered into a
settlement agreement with the plaintiffs in the action that was preliminarily
approved by the District Court on November 6, 1998. Under the terms of the
settlement, a fund will be created in the amount of $1,650,000. The Company will
pay $250,000 of the total settlement and the remaining $1,400,000 will be paid
by the Company's insurer. As such, $250,000 has been recorded as an expense in
the third quarter ended September 30, 1998. Notice of the class action
settlement will be sent to the members of the class, who will be given an
opportunity to object to the settlement, and the settlement is subject to final
approval by the court. Although the settlement agreement has received
preliminary approval by the court, there can be no assurance that the court will
ultimately approve the final settlement, or that members of the plaintiff class
will not opt out of the settlement and seek an individual action against the
Company. Therefore, there is no assurance that any future events relating to
this action will not have a material adverse effect on the Company or its
business.
NOTE 6 - INCREASE IN AUTHORIZED NUMBER OF COMMON SHARES
At the Annual Meeting of Shareholders of Ancor Communications, Incorporated held
on May 20, 1998, shareholders approved an amendment to the Company's Second
Amended and Restated Articles of Incorporation to increase the number of
authorized shares of Common Stock, par value $.01, from 20,000,000 to
40,000,000.
NOTE 7 - OPTION REPRICING
In order to retain its employees in a competitive employment market, and given
the current price of the Company's common stock, the Company's Board of
Directors voted and approved to reprice outstanding options to purchase
1,091,333 shares of common stock held by active employees to an exercise price
of $1.78, the closing price of the Company's common stock on October 21, 1998.
These options were originally issued before May 1, 1998 to employees at a
weighted average exercise price of $7.16. The repriced options may not be
exercised until October 21, 1999, at which point the options are exercisable
subject to the vesting schedule of the original option agreements.
NOTE 8 - UNEARNED REVENUE
On September 24, 1998 the Company entered into a technology licensing agreement
with Inrange Technologies Corporation ("Inrange"), a unit of General Signal
Corporation. Under the agreement, Inrange is to pay the Company $9,000,000 in
three equal installments: on September 25, 1998, December 15, 1998, and March
31,
See notes to Financial Statements
7
1999. The $9,000,000 is comprised of (i) approximately $6,200,000 for licensing
fees; (ii) approximately $800,000 in warrants to purchase 750,000 shares of the
Company's common stock at prices prices ranging from $2.50 to $10.00; and (iii)
$2,000,000 of prepaid royalties. The $6,200,000 will be recognized as revenue
evenly over the term of the agreement which is 60 months and the $2,000,000
royalty will be recorded as revenue as Inrange products ship and royalties are
earned. As of September 30, 1998, the Company has received the first $3,000,000
payment. This amount, reduced by the value of the warrants granted, has been
recorded as unearned revenue in the third quarter financial statements.
NOTE 9 - RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities." This statement
establishes standards for derivative instruments and hedging activities. The
Company is required to adopt SFAS 133 in the first quarter of fiscal year 2000.
The Company does not anticipate that SFAS 133 will have a material impact on its
financial statements.
See notes to Financial Statements
8
ITEM 2
MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997.
The following table sets forth, for the periods indicated, certain statements of
operations data as a percentage of net sales.
For the Three Months For the Nine Months
Ended September 30 Ended September 30
--------------------- -------------------
1998 1997 1998 1997
------- ----- ---- ----
Net Sales 100.0% 100.0% 100.0% 100.0%
Cost of Goods Sold 87.2 75.6 383.6 67.2
Gross Profit 12.8 24.4 (283.6) 32.8
Operating Expenses:
Selling, general & admin. 787.3 57.5 377.9 68.1
Research & development 579.9 40.2 284.1 50.0
Total operating expenses 1,367.2 97.6 662.0 118.1
Operating loss (1,354.5) (73.2) (945.6) (85.3)
Other income (expense)
Interest expense (3.4) (0.2) (2.0) (0.1)
Other, net 5.0 1.7 12.5 2.4
------- ----- ------ -----
Net Loss (1,352.8)% (71.6)% (935.1)% (83.0)%
======= ===== ====== =====
Net Sales. Net sales for the third quarter 1998 decreased by
approximately $3,194,000 (93%) from 1997 to $230,301. Net sales for the nine
months ended September 30, 1998, decreased by approximately $5,919,000 (81%)
from the same period in 1997 to $1,409,563. The decrease in net sales is
attributable to: (i) decreased sales to the Company's Japanese distributor,
Hucom, Inc. ("Hucom"); and (ii) the Company's shift in emphasis to opportunities
in the storage area networks market resulting in diminished sales to customers
in the high-performance local area networking market. Net sales to Hucom
decreased 99.7% from approximately $2,854,000 (83% of total sales) in the third
quarter 1997 to $8,350 (4% of total sales) in the same period in 1998. Net sales
to Hucom for the first nine-months decreased 89% from approximately $6,048,000
(83% of total sales) in 1997 to approximately $650,000 (46% of total sales) in
1998. In light of the financial condition of Hucom, the Company reevaluated its
distribution plans in
9
Japan and entered into a distribution agreement dated August 31, 1998 with
Netmarks, Inc. to represent the Company in the Japanese marketplace.
The Company's shift in marketing focus to opportunities in the storage area
network market has resulted in diminished revenues from customers in the
high-performance local area network market. Although the Company intends to
continue to offer its Fibre Channel products to select customers in the
high-performance network market, the Company plans to focus its resources on the
storage area network market. The slower-than-anticipated market development in
the storage area network market combined with the lack of orders from Hucom and
diminished revenues from the local area network market, will likely result in
continued weak revenues until the storage area network market develops.
Net sales for the third quarter of 1997 include the effect of an allowance
against sales of $300,000 for product returns and customer stock rotation. Net
sales for the first nine months 1997 include the effect of an allowance against
sales of $1,000,000 for product returns and customer stock rotation. There was
no addition to the allowance recorded in the first nine months of 1998. The
Company does not generally provide customers with a right of return at the date
of sale; however, in response to significant pressure from the marketplace, the
Company has allowed product returns in the past from certain customers as a
marketing concession to stimulate a positive impression of the Company and its
products in the marketplace. In addition, resellers have incorrectly anticipated
the configuration needed by end user equipment purchasers and have requested
that purchased but unused product be exchanged for the product needed to meet
the end user requirements. Further, certain end users have requested that they
purchase their initial products from the Company, instead of the reseller, which
resulted in credits issued to the resellers. Additionally, in the fourth quarter
of 1997, the Company recorded additional reserves for sales returns and
allowances which may occur as a result of the Company's shift in marketing focus
to OEMs and resellers who are more experienced in and are focused on specific
vertical markets that the Company believes are most appropriate for its
products. During 1998, the expected returns were realized, thereby reducing the
reserve included in the Company's net assets to its current balance. The reserve
at September 30, 1998, was approximately $42,000 ($65,000 gross sales less the
estimated value of product to be returned). No additional returns beyond this
reserve are expected.
Gross Profit. Gross profit in the third quarter of 1998 decreased to
$29,403, or 12.8% of sales, from a profit of $836,824, or 24.4% of sales, in the
third quarter of 1997. Gross profit in the first nine months of 1998 decreased
to a loss of $3,997,854, or a negative 283.6% of sales, from a profit of
$2,405,143, or 32.8% of sales, for the same period of 1997. The decrease in
gross profit for the 1998 reported periods from the prior year was due in part
to the decreased sales volume and is also affected by indirect costs, such as
normal scrap and overhead allocations, the impact of which is decreased as sales
increase. Gross profit percentage is impacted by the mix of product sold within
a period. In general, adapter cards have lower margins than switch and service
revenue and different switch types have different margins. For the reported
periods of 1998, the gross margin percentage was positively impacted because the
mix of product sold during these periods carried greater margins than that sold
in the comparable periods in 1997; however, due to the significantly lower sales
volume, the indirect costs caused the overall gross profit percentage to
decrease over the comparable periods of 1997.
10
More significantly for the first nine months of 1998, however, are special
charges of approximately $4,428,000 recorded in the cost of sales for the second
quarter. These charges included: (i) $4,015,000 provision for excess or obsolete
inventory, (ii) $243,000 provision for future commitments to purchase excess or
obsolete inventory, and (iii) $170,000 fee for canceling an order for excess or
obsolete inventory. The Company made these provisions because its shift in focus
from local area networks to storage area networks and lack of demand in Japan
have caused it to believe its inventory of certain product exceeds current and
future market demands. Gross profit for the first nine months excluding the
effects of the special charges was $430,146 (30.5%). A similar lesser provision
was recorded in the third quarter of 1997. Included in the cost of sales for the
third quarter 1997 was a $500,000 provision for excess and obsolete inventory
which had the effect of decreasing gross profit as a percentage of sales by
14.6%. The Company made this provision in 1997 because it believed its inventory
of certain host bus adapter cards exceeded current and future market demands as
customers transition to newer server and workstation platforms.
Operating Expense. The Company's operating expenses for the third
quarter of 1998 were $3,148,718, or 1,367.2% of net sales, compared to
$3,343,168, or 97.6% of net sales, in the third quarter of 1997. Operating
expenses for the first nine months of 1998 were $9,331,594, or 662.0% of net
sales, compared to $8,655,681, or 118.1% of net sales, in the same period of
1998. The Company believes that the level of expense incurred is appropriate to
address the opportunities available to it in the Original Equipment Manufacturer
("OEM") storage and high-performance networking marketplaces. The increase in
operating expenses is primarily due to increases in the cost for personnel,
product development expenses and out-of-pocket settlement costs for the
shareholder litigation. Reorganization and a 10% growth in personnel,
particularly in sales and marketing senior management positions, resulted in
personnel and related expenses increasing approximately $453,000 in the first
nine months of 1998 as compared with the same period of 1997. Additionally, the
Company's ongoing commitment to product development and enhancements resulted in
research and development expenses increasing $342,000 in the first nine months
of 1998 as compared with the same period 1997. Further, the shareholder
litigation against the Company is pending settlement subject to final approval
by the District Court. The Company has recorded a charge in the operating
expenses for $250,000 in connection with this settlement (see Shareholder
Litigation section below).
Other Income (Expense) Interest expense increased to $28,020 in the
first nine months of 1998 from $10,526 in the first nine months of 1997 as a
result of the Company's payments on an increased level of capitalized lease
obligations. Interest income of approximately $176,000 in each of the first nine
month periods of 1998 and 1997 was earned from the investment of the net
proceeds of preferred stock offerings occurring in February and March of each
year, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash, cash equivalents and short-term investments were $4,905,284
as of September 30, 1998, compared to $2,001,404 as of December 31, 1997. For
the nine months ended September 30, 1998, cash flows used in operating
activities totaled $7,112,952, due to the operating loss and excess and obsolete
inventory purchase commitments incurred. This was offset by approximately
$3,000,000 the Company received as part of the technology license
11
agreement the Company signed with Inrange Technologies, Inc., which will be
performed over the next five years (see below). For the nine months ended
September 30, 1998, cash flows used in investing activities totaled $1,275,139
primarily as a result of the purchase of short-term investments using a portion
of the Company's private placement proceeds.
On September 24, 1998, the Company entered into a technology licensing agreement
with Inrange Technologies Corporation ("Inrange"), a unit of General Signal
Corporation. Inrange will develop a series of Fibre Channel enhancements to
their successful CD/9000 Channel Director. Under the agreement, Inrange, a
worldwide provider of data center networking connectivity technologies, is to
pay the Company $9,000,000 in three equal installments: on September 25, 1998,
December 15, 1998, and March 31, 1999. The $9,000,000 is comprised of (i)
approximately $6,200,000 for licensing fees; (ii) approximately $800,000 (as
valued using the Black Sholes methodology) in warrants to purchase 750,000
shares of the Company's common stock at prices ranging from $2.50 to $10.00; and
(iii) $2,000,000 prepaid royalties. The $6,200,000 will be recognized as revenue
evenly over 60 months, which is the term over which the Company has agreed to
support and keep current the technology which Inrange has licensed. The
$2,000,000 royalty will be recorded as revenue as Inrange products ship and
royalties are earned. Any additional royalties after this first $2,000,000 will
result in both additional royalty revenue and cash payments to the Company.
On February 19, 1998, the Company completed a private placement of $11,000,000
(1,100 shares) of Series C Preferred Stock which resulted in net proceeds of
approximately $10,239,724. The Securities were privately sold to accredited
investors by Dunwoody Brokerage Services, Inc. ("Dunwoody"). As consideration
for its services, Dunwoody received a fee equal to 6% of the gross proceeds,
plus a five-year warrant to purchase 90,644 shares of Common Stock at a price
per share equal to $7.281. The securities were sold pursuant to Rule 506 under
Regulation D.
The Series C Preferred Stock is convertible into Common Stock of the Company,
subject to certain restrictions, at a variable conversion rate equal to the
lower of (i) the Maximum Conversion Price (as defined below) or (ii) the average
of the three lowest closing bid prices of the Common Stock during the applicable
pricing Period (as defined below). The Maximum Conversion Price for the first
year is $11.00. After the first year, the Maximum Conversion Price is equal to
the lesser of $11 and the average closing bid price of the five Wednesdays
immediately preceding the first anniversary of the date the Series C Preferred
Stock was issued. The applicable Pricing Period is a number of consecutive
trading days immediately preceding the date of conversion of the Series C
Preferred Stock initially equal to twelve and increased by one additional
consecutive trading day for each full calendar month which has elapsed since
February 19, 1998.
The Company believes that the proceeds received from the private placement and
the Inrange agreement, together with interest earned thereon, and anticipated
revenues from operations will provide adequate liquidity to fund growth,
operations, and capital expenditures for 1999. However, the Company aniticipates
the need to secure additional financing in order to fund operating and working
capital requirements thereafter. There can be no assurance that additional
financing can be obtained with terms acceptable to the Company. Any additional
equity financings may be dilutive to existing shareholders, and any debt
financing may contain
12
restrictive covenants. The Company's inability to obtain additional financing if
and when needed could adversely affect the Company and its operations.
Shareholder Litigation. In July 1997, the Company, along with Stephen
O'Hara, Lee B. Lewis and Dale Showers, was named as a defendant in a securities
action captioned Richard Radman and Sol Rosenthal v. Ancor Communications, Inc.,
et. al filed in the United States District Court for the District of Minnesota.
The lawsuit alleges that the Company violated sections 10(b) of the Securities
Exchange Act of 1934 when it allegedly made misleading public disclosures
relating to the Company's contract with Sequent Computer Systems, Inc. and the
Company's financial results. The Company and each of the other defendants have
entered into a settlement agreement with the plaintiffs in the action that was
preliminarily approved by the District Court on November 6, 1998. Under the
terms of the settlement, a fund will be created in the amount of $1,650,000. The
Company will pay $250,000 of the total settlement and the remaining $1,400,000
will be paid by the Company's insurer. As such, $250,000 has been recorded as an
expense in the third quarter ended September 30, 1998. Notice of the class
action settlement will be sent to the members of the class, who will be given an
opportunity to object to the settlement, and the settlement is subject to final
approval by the court. Although the settlement agreement has received
preliminary approval by the court, there can be no assurance that the court will
ultimately approve the final settlement, or that members of the plaintiff class
will not opt out of the settlement and seek an individual action against the
Company. Therefore, there is no assurance that any future events relating to
this action will not have a material adverse effect on the Company or its
business.
Option Repricing. In order to retain its employees in a competitive
employment market, and given the current price of the Company's common stock,
the Company's Board of Directors voted and approved to reprice outstanding
options to purchase 1,091,333 shares of common stock held by active employees to
an exercise price of $1.78, the closing price of the Company's common stock on
October 21, 1998. These options were originally issued before May 1, 1998 to
employees at a weighted average exercise price of $7.16. The repriced options
may not be exercised until October 21, 1999, at which point the options are
exercisable subject to the vesting schedule of the original option agreements.
Year 2000 Issue. The Company has completed an assessment of Year 2000
compliance for its critical operating and application systems, specifically its
enterprise-wide information systems, analysis tools, computer-aided design
systems and supporting operating system infrastructure. As a result of this
assessment, it has been determined that through normal recurring system
upgrades, the vast majority of the Company's systems are currently, or will be
by early 1999, Year 2000 compliant. During fiscal 1996 the Company purchased
from a world-wide supplier and developer of information systems an
enterprise-wide information system. The developer of this information system has
provided its clients written assurance that the system will correctly function
across the year 2000, as verified by previous system tests and Year 2000
certification by the International Technology Association of America.
Additionally, the Company's products, including software, are not date sensitive
as to functionality. Since Year 2000 compliance with regard to the Company's
internal systems has been, or will be, significantly achieved through normal
system upgrades and not through accelerated or dedicated efforts, the costs of
becoming Year 2000 compliant has not had and is not expected to have a material
effect on the Company's financial position, operations or cash flow.
13
Ultimately, the potential impact of the Year 2000 issue will depend not only on
the Company's internal Year 2000 compliance, but also on the way in which the
Year 2000 is addressed by customers, vendors, service utilities, government and
other external entities. The Company is communicating with such external parties
to determine how they are addressing the Year 2000 issue and to evaluate any
likely impact on the Company. The Company has requested commitment dates from
these parties as to their Year 2000 readiness. This process will likely continue
into fiscal 1999. The efforts of third parties are not within the Company's
control, however, and their failure to remedy Year 2000 issues successfully
could result in business disruption, loss of revenue and increased operating
cost. At the present time, it is not possible to determine whether any such
events are likely to occur, or to quantify any potential negative impact they
may have on the Company's future results of operations and financial condition.
The Company has not currently established contingency plans, but expects to
assess its need for contingency plans during 1999.
The foregoing discussion regarding Year 2000 contains forward-looking statements
which are based on management's best estimates derived using various
assumptions. These forward-looking statements involve inherent risks and
uncertainties, and actual results could differ materially from those
contemplated by such statements. Factors that might cause material differences
include, but are not limited to, (i) the Company's ability to obtain alternative
manufacturing sources should its current sources' operations be disrupted due to
Year 2000 complications, and (ii) the Company's ability to respond to unforeseen
Year 2000 complications. Such material differences could result in, among other
things, business disruption, operational problems, financial loss, legal
liability and similar risks.
SAFE HARBOR CAUTIONARY STATEMENT
Statements made in this Management's Discussion and Analysis that are not
historical in nature, including statements regarding the level of future
revenues and expenses, are "forward-looking statements" as defined in the
Private Securities Litigation Reform Act of 1995 and are subject to risks and
uncertainties. Factors that may affect the Company's future performance and
results are set forth in the Company's filings with the Securities and Exchange
Commission and include the level of market acceptance of Fibre Channel
technology and the Company's products and the timing of such acceptance, the
ability of the Company to successfully market and sell its products to OEMs and
others, the Company's ability to compete with others providing Fibre Channel
technology, the success of the products incorporating the Company's technology
marketed by INRANGE, the ability of the Company to develop enhancements to its
products and technology and keep pace with technological developments, the
Company's ability to manage growth, the Company's ability to attract and retain
qualified personnel and the ability of the Company's products to interoperate
with products manufactured by others. Retention of $2.0 million of prepaid
royalties from INRANGE is contingent upon Ancor's completion of certain
deliverables defined in the Company's technology license agreement with INRANGE.
14
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
In July 1997, the Company, along with Stephen O'Hara, Lee B. Lewis and
Dale Showers, was named as a defendant in a securities action captioned
Richard Radman and Sol Rosenthal v. Ancor Communications, Inc., et. al
filed in the United States District Court for the District of
Minnesota. The lawsuit alleges that the Company violated sections 10(b)
of the Securities Exchange Act of 1934 when it allegedly made
misleading public disclosures relating to the Company's contract with
Sequent Computer Systems, Inc. and the Company's financial results. The
Company and each of the other defendants have entered into a settlement
agreement with the plaintiffs in the action that was preliminarily
approved by the District Court on November 6, 1998. Under the terms of
the settlement, a fund will be created in the amount of $1,650,000. The
Company will pay $250,000 of the total settlement and the remaining
$1,400,000 will be paid by the Company's insurer. Notice of the class
action settlement will be sent to the members of the class, who will be
given an opportunity to object to the settlement, and the settlement is
subject to final approval by the court. Although the settlement
agreement has received preliminary approval by the court, there can be
no assurance that the court will ultimately approve the final
settlement, or that members of the plaintiff class will not opt out of
the settlement and seek an individual action against the Company.
Therefore, there is no assurance that any future events relating to
this action will not have a material adverse effect on the Company or
its business.
Item 2. Changes in Securities.
(a.) None.
(b.) None.
(c.) Recent Sales of Unregistered Securities.
On September 24, 1998, the Company issued a warrant to
purchase 750,000 shares of Common Stock (the "Warrant") to
INRANGE Technologies Corporation ("INRANGE") in connection
with a Technology License Agreement entered into between the
Company and INRANGE on such date. The Warrant is exercisable
for a period of five years. Of the 750,000 shares subject to
the Warrant, 250,000 may be purchased at an exercise price of
$2.50 per share, 250,000 may be purchased at an exercise price
of $5.00 per share and 250,000 may be purchased at an exercise
price of $10.00 per share. The Warrant was issued pursuant to
Section 4(2) of the Securities Act of 1933, as amended.
Item 3 Defaults Upon Senior Securities.
None.
15
Item 4. Submission of Matters to a Vote of Securities Holders.
None.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a.) Exhibits
3.1a Second Amended and Restated Articles of Incorporation
of the Company.
3.2a Amended Bylaws of the Company.
3.3k Amendment to Second Amended and Restated Articles of
Incorporation of the Company relating to an increase
of the number of authorized shares.
4.1a Loan and Warrant Purchase Agreement, dated as of June
24, 1992, between Ancor Communications, Incorporated
and International Business Machines Incorporated.
4.2a Agreement and Amendment to Loan and Warrant Purchase
Agreement, dated March 10, 1994, by and among Ancor
Communications, Incorporated, International Business
Machines Corporation and IBM Credit Corporation.
4.3b Second Amendment to Loan and Warrant Purchase
Agreement dated April 25, 1994, by and among Ancor
Communications, Incorporated, International Business
Machines Corporation and IBM Credit Corporation.
4.4a Shareholders Agreement, dated as of June 24, 1992,
among Ancor Communications, Incorporated,
International Business Machines Incorporated and the
shareholders of the Company named on the signature
page thereto.
4.5c Representative's Warrant.
4.6 [Reserved.]
4.7d Form of Warrant issued April 28, 1995.
16
4.8 [Reserved.]
4.9e Form of Warrant issued to John G. Kinnard & Company
on October 23, 1995.
4.10f Certificate of Designation of Series A Preferred
Stock.
4.11f Form of Warrant issued to Swartz Investments, Inc. on
March 7, 1996.
4.12g Form of Warrant issued to Dunwoody Brokerage
Services, Inc. on March 24, 1997.
4.13g Form of Warrant issued to Purchasers of the Company's
Series B Preferred Stock.
4.14g Certificate of Designation of Series B Preferred
Stock.
4.15i Certificate of Designation of Series C Preferred
Stock.
4.16j Form of Warrant issued to Dunwoody Brokerage
Services, Inc. on February 19, 1998.
4.17l Form of Warrant issued to Inrange Technologies, Inc.
on September 24, 1998.
10.1 [Reserved.]
*10.2a Ancor Communications, Incorporated 1990 Stock Option
Plan.
*10.3a Ancor Communications, Incorporated 1994 Long-Term
Incentive and Stock Option Plan.
10.4 [Reserved.]
*10.5a Employment Agreement, dated January 1, 1994, between
Ancor Communications, Incorporated and Stephen C.
O'Hara.
10.6 [Reserved.]
10.7 [Reserved.]
10.8a Sublease, dated March 29, 1988, by and between
Anderson Cornelius and Unisys Corporation, formerly
known as Burroughs Corporation.
17
10.9a Sublease, Amendment Agreement, dated March 8, 1989,
by and between Anderson Cornelius and Unisys
Corporation, formerly known as Burroughs Corporation.
10.10a Sublease, Amendment Agreement, dated August 31, 1992,
by and between the Company and Unisys Corporation,
formerly known as Burroughs Corporation.
10.11 [Reserved.]
10.12 [Reserved.]
10.13 [Reserved.]
10.14 [Reserved.]
10.15 [Reserved.]
10.16 [Reserved.]
*10.17e Ancor Communications, Inc. 1995 Employee Stock
Purchase Plan.
*10.18e Ancor Communications, Inc. Non-Employee Director
Stock Option Plan.
10.19 [Reserved.]
10.20 [Reserved.]
10.21 [Reserved.]
10.22 [Reserved.]
10.23g Form of Subscription Agreement between the Company
and Purchasers of the Company's Series B Preferred
Stock (March 1997).
10.24g Registration Rights Agreement dated March 24, 1997
between the Company, Swartz Investments, Inc. and
Purchasers of the Company's Series B Preferred Stock.
*10.25h Letter Employment Agreement with Kenneth E.
Hendrickson dated July 25, 1997.
*10.26h Letter Employment Agreement with Steven E. Snyder
dated September 23, 1997.
18
10.27i Form of Subscription Agreement, dated as of February
19, 1998, between Ancor Communications, Incorporated
and each purchaser of Series C Preferred Stock.
10.28i Registration Rights Agreement, dated as of February
19, 1998, by and between Ancor Communications,
Incorporated, the placement agent and each purchaser
of Series C Preferred Stock.
*10.29j Termination of Employment Agreement dated August 29,
1997, between the Company and Dale C. Showers.
10.30j Sublease, Amendment Agreement, dated February 11,
1998, by and between the Company and Unisys
Corporation, formerly known as Burroughs Corporation.
*10.31j Separation and General Release Agreement between the
Company and Lee B. Lewis.
*10.32j Amendments to Ancor Communications, Inc. Non-Employee
Director Stock Option Plan filed as exhibit 10.18.
27.1l Financial Data Schedule.
- ----------
* Indicates management contract or compensatory plan or agreement.
a Incorporated by reference to the Company's Registration Statement on
form SB-2 filed March 11, 1994.
b Incorporated by reference to Amendment No. 2 to the Company's
Registration Statement on form SB-2 Filed April 28, 1994.
c Incorporation by reference to the Company's Form 10-QSB filed for the
quarterly period ended March 31, 1994.
d Incorporated by reference to the Company's form 10-QSB filed for the
quarterly period ended March 31, 1995.
e Incorporated by reference to the Company's form 10-QSB filed for the
quarterly period ended September 30, 1995.
19
f Incorporated by reference to the Company's Form 10-KSB filed for the
fiscal year ended December 31, 1995.
g Incorporated by reference to the Company's form 10-Q filed for the
quarterly period ended March 31, 1997.
h Incorporated by reference to the Company's form 10-Q filed for the
quarterly period ended September 30, 1997.
i Incorporated by reference to the Company's form 8-K filed February 19,
1998.
j Incorporated by reference to the Company's Form 10-K filed for the
fiscal year ended December 31, 1997.
k Incorporated by reference to the Company's form 10-Q filed for the
quarterly period ended June 30, 1998.
l Included herewith.
(b.) Reports on Form 8-K
The Company filed a report on Form 8-K, Item 4, Changes in
Registrant's Certifying Accountants, on September 25, 1998.
20
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
ANCOR COMMUNICATIONS, INCORPORATED
Dated: November 13, 1998 By /S/ Kenneth E. Hendrickson
------------------------------
Kenneth E. Hendrickson
Chairman of the Board &
Chief Executive Officer
Dated: November 13, 1998 By /S/ Steven E. Snyder
------------------------------
Steven E. Snyder
Vice President,
Chief Financial Officer &
Secretary
21