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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 June 30, 1999
Commission File Number 1-2982
ANCOR COMMUNICATIONS, INCORPORATED
(Exact name of issuer as specified in its charter)
Minnesota 41-1569659
- ------------------------------- -------------------
(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 [ ]
25,217,405
(Number of shares of common stock of the
registrant outstanding as of July 20, 1999)
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ANCOR COMMUNICATIONS, INCORPORATED
Form 10-Q
For the Quarterly Period Ended
June 30, 1999
Page
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PART I - FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
Balance Sheets as of June 30, 1999 (unaudited)
and December 31, 1998 3
Statements of Operations for the three
and six month periods ended June 30, 1999
and 1998 (unaudited) 4
Statements of Cash Flows for the six
month periods ended June 30, 1999
and 1998 (unaudited) 5
Notes to Financial Statements 6
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF
OPERATIONS 8
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISKS 14
PART II - OTHER INFORMATION 14
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2
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PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
ANCOR COMMUNICATIONS, INCORPORATED
BALANCE SHEETS
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------------ ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 191,662 $ 3,477,236
Short-term investments 7,922,994 3,970,137
Accounts receivable, less allowance of $39,492 1,747,587 442,600
Inventories 2,118,548 1,288,868
Prepaid expenses and other current assets 488,141 110,398
------------ ------------
Total current assets 12,468,932 9,289,239
Equipment, net of accumulated depreciation 3,014,882 3,120,618
Patents, prepaid royalties, and other assets,
net of accumulated amortization 208,363 195,668
Capitalized software development costs,
net of accumulated amortization 31,655 132,568
------------ ------------
TOTAL ASSETS $ 15,723,832 $ 12,738,093
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term debt $ 94,000 $ 139,791
Accounts payable 913,995 448,383
Accrued liabilities 779,748 955,676
Unearned revenue, current 2,798,856 2,146,936
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Total current liabilities 4,586,599 3,690,786
Long-term unearned revenue, less current 6,067,886 3,727,919
Long-term debt, less current maturities 86,183 110,997
Shareholders' Equity
Preferred stock, par value $.01 per share,
authorized 5,000,000 shares; issued and outstanding
Series C, none in 1999 and 229 in 1998 -- 2
Common stock, par value $.01 per share,
authorized 40,000,000 shares; issued and outstanding
24,889,107 shares in 1999 and 23,265,819 shares in 1998 248,891 232,658
Additional paid-in capital 50,133,162 46,566,386
Accumulated deficit (45,398,889) (41,590,655)
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Total shareholders' equity 4,983,164 5,208,391
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TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 15,723,833 $ 12,738,093
============ ============
</TABLE>
See Notes to Financial Statements
3
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ANCOR COMMUNICATIONS, INCORPORATED
STATEMENTS OF OPERATIONS
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net sales $ 3,598,655 $ 137,036 $ 5,118,369 $ 1,179,263
Cost of goods sold 1,549,038 4,506,911 2,213,843 5,206,519
------------ ------------ ------------ ------------
Gross profit (loss) 2,049,617 (4,369,875) 2,904,526 (4,027,256)
Operating expenses
Selling, general and administrative 2,058,695 1,802,684 3,810,528 3,513,801
Research and development 1,692,650 1,219,870 3,019,237 2,669,076
------------ ------------ ------------ ------------
Total operating expenses 3,751,345 3,022,554 6,829,765 6,182,877
------------ ------------ ------------ ------------
Operating loss (1,701,728) (7,392,429) (3,925,239) (10,210,133)
Nonoperating income (expense)
Interest expense (4,640) (7,126) (10,824) (20,182)
Other, primarily interest income 60,394 98,923 127,829 164,662
------------ ------------ ------------ ------------
Net loss (1,645,974) (7,300,632) (3,808,234) (10,065,653)
Accretion on convertible preferred stock (4,330) (273,425) (12,011) (424,712)
------------ ------------ ------------ ------------
Net loss attributable to common shareholders $ (1,650,304) $ (7,574,057) $ (3,820,245) $(10,490,365)
============ ============ ============ ============
Basic and diluted net loss per common share $ (0.07) $ (0.63) $ (0.16) $ (0.88)
============ ============ ============ ============
Weighted average common shares
outstanding 24,196,636 11,949,093 24,099,902 11,916,736
============ ============ ============ ============
</TABLE>
See Notes to Financial Statements
4
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ANCOR COMMUNICATIONS, INCORPORATED
STATEMENTS OF CASH FLOWS
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
----------------------------
1999 1998
------------ ------------
<S> <C> <C>
CASH FLOW FROM OPERATING ACTIVITIES:
Net loss $ (3,808,234) $(10,065,653)
Adjustments to reconcile net loss to net
cash used in operating activities:
Writedown of inventory to net realizable value -- 4,262,587
Depreciation and amortization 798,951 629,611
Changes in current assets and liabilities:
Accounts receivable (1,304,987) 621,115
Inventories (829,680) (2,643,510)
Prepaid expenses and other (377,743) (1,329)
Accounts payable 465,612 443,395
Accrued liabilities (175,928) (69,004)
Unearned revenue 2,991,887 169,336
------------ ------------
Net cash used in operating activities (2,240,122) (6,653,452)
------------ ------------
CASH FLOW FROM INVESTING ACTIVITIES:
Purchases of equipment (501,255) (167,850)
Purchase of short-term investments (16,066,786) (9,942,915)
Sale of short-term investments 12,113,929 5,979,579
Investment in other, net (94,377) (11,070)
------------ ------------
Net cash used in investing activities (4,548,489) (4,142,256)
------------ ------------
CASH FLOW FROM FINANCING ACTIVITIES:
Principal payments on long-term debt (79,970) (81,593)
Net proceeds from sale of preferred stock -- 10,254,747
Net proceeds from sale of common stock
and exercise of warrants and options 3,583,007 146,037
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Net cash provided by financing activities 3,503,037 10,319,191
------------ ------------
Net decrease in cash (3,285,574) (476,517)
Cash, beginning of period 3,477,236 2,001,404
------------ ------------
Cash, end of period $ 191,662 $ 1,524,887
============ ============
Supplemental Schedule of Noncash Investing and Financing Activities:
Equipment acquired under capital lease $ 9,365 $ 222,673
============ ============
</TABLE>
See Notes to Financial Statements
5
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ANCOR COMMUNICATIONS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
June 30, 1999
(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 six months
ended June 30, 1999 are not necessarily indicative of the operating results to
be expected for the year ending December 31, 1999.
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 June 30, 1999 and December 31, 1998 consisted of:
1999 1998
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Raw materials $ 4,349,080 $ 4,031,546
Finished goods consigned to customers and others 821,568 779,054
Finished goods 2,116,837 1,289,577
Reserve for obsolescence (5,168,937) (4,811,309)
--------------------------
$ 2,118,548 $ 1,288,868
==========================
NOTE 3 - 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 4 - CONTINGENCY
The Company is a defendant in a lawsuit brought by Hoyt Properties, Inc.
("Hoyt") venued in Hennepin County District Court in the State of Minnesota.
Hoyt claims that the Company breached an agreement which provided that Hoyt
would build and lease to the Company an office building to be located in Eden
Prairie, Minnesota, and asserts damages in excess of $2,500,000. The Company
asserts there was no binding agreement. The Company denies all liability, and
alleges that Hoyt refused to provide improvements desirable and necessary
to the Company's occupancy of the proposed leased space, and multiple
contingencies, conditions, and agreements did not occur. The Company is
vigorously defending the case. There has been limited discovery completed to
date. However, there is no assurance that any judgment, order or decree against
the Company arising out of this action will not have a material adverse effect
on the Company or its business. The Company is unable to determine at this time
if there will be a material adverse outcome. No provision has been made for any
loss that may occur as a result of an adverse outcome of the suit.
6
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NOTE 5 - 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 paid 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 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 is being 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 March 31, 1999, the Company has received all three $3,000,000
payments, totalling $9,000,000. This amount, reduced by the value of the
warrants granted, and further reduced by nine months of revenue recognized, has
been recorded as unearned revenue in the June 30, 1999 balance sheet.
NOTE 6 - SUN MICROSYSTEMS AGREEMENT
On June 2, 1999, the Company entered into a product purchase agreement with Sun
Microsystems, Inc. (Sun). This agreement provides Sun the ability to distribute
the Company's product for a period of two years with automatic extensions for
one-year periods unless there is written notice of termination within 180 days
of an anniversary date.
In addition, Sun received a warrant to purchase an aggregate 1,500,000 shares of
common stock of the Company at an exercise price of $7.30 per share. Upon Sun
purchasing $10,000,000 of the Company's product, the warrant will vest with
respect to 149,253 shares of common stock. Subsequent purchases of the Company's
product will vest quarterly at a rate of one warrant for each $67 of purchases
through September 30, 2002. This warrant expires five years from the date of the
agreement.
7
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ITEM 2
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Results of Operations
- ---------------------
For the three and six months ended June 30, 1999 and 1998.
The following table sets forth, for the periods indicated, certain statements of
operations data as a percentage of net sales.
<TABLE>
<CAPTION>
For the Three Months For the Six Months
Ended June 30 Ended June 30
------------------- ------------------
1999 1998 1999 1998
------ -------- ------ -------
<S> <C> <C> <C> <C>
Net Sales 100.0% 100.0% 100.0% 100.0%
Cost of Goods Sold 43.0 3,288.9 43.3 441.5
Gross Profit 57.0 (3,188.9) 56.7 (341.5)
Operating Expenses:
Selling, general & admin 57.2 1,315.5 74.4 298.0
Research & development 47.1 890.1 59.0 226.3
Total operating expenses 104.3 2,205.6 133.4 524.3
Operating loss (47.3) (5,394.5) (76.7) (865.8)
Other income (expense)
Interest expense (0.1) (5.2) (0.2) (1.8)
Other, net 1.7 72.2 2.5 14.0
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Net Loss (45.7)% (5,327.5)% (74.4)% (853.6)%
====== ======= ====== ======
</TABLE>
Net Sales. Net sales for the second quarter of 1999 increased by
approximately $3,462,000 (2,527%) from 1998 to approximately $3,599,000. Net
sales for the six months ended June 30, 1999 increased by approximately
$3,939,000 (334%) to approximately $5,118,000. The increases in net sales are
attributable to (i) a large shipment of the Company's Fibre Channel switches to
Boeing for a LAN application; (ii) an increase in the shipments of the Company's
MKII Fibre Channel switches to Original Equipment Manufacturer ("OEM") customers
as a result of the Company's shift in marketing focus to opportunities in the
storage area network market; and (iii) license fee revenue of approximately
$312,000 and $623,000 in the three and six month periods ended June 30, 1999,
respectively, from INRANGE Technologies Corporation ("INRANGE"). These increases
in revenue were offset by decreases in sales to the Company's Japanese
distributor. Future sales to the Company's current Japanese distributor,
Netmarks, Inc., are uncertain.
8
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In June 1999, the Company entered into an original equipment manufacturing
agreement with Sun Microsystems, Inc. ("Sun"). Under this agreement, the
Company expects to sell its Fibre Channel switches to Sun for incorporation into
Sun's SAN products. Together with Sun, the Company is in the final stages of
testing its new switch for use with Sun products and expects to begin
recognizing limited amounts of revenue from Sun beginning in the fourth quarter
of 1999. However, the Company cannot be certain that Sun will complete the
integration of the Company's switch with Sun's final SAN products and, like
other original equipment manufacturer agreements, the Company's agreement with
Sun does not guarantee that it will ultimately sell its products to Sun.
As part of the Company's agreement with Sun, it granted Sun a warrant to
purchase 1.5 million shares of the Company's common stock at an exercise price
of $7.30 per share. The warrant shares are earned at a rate of one share for
every $67.00 of product sales to Sun through September 30, 2002. In each period
in which the warrant shares are earned, a non-cash sales discount will be
recorded. The amount of the non-cash sales discount will be the fair value of
the warrant shares which are earned in the period. Fair value of the warrant
shares will be calculated by using the Black-Scholes option pricing model. The
primary component in the Black-Scholes calculation is the value of the Company's
common stock at that time. The value of the warrant shares, and the
corresponding sales discount, increases as the Company's stock price increases.
Conversely, the value of the warrant shares, and the corresponding sales
discount, decreases as the Company's stock price decreases. Since the price of
the Company's stock cannot be estimated, it is not possible to estimate the
amount of the non-cash sales discount that could be recorded, but it could be
significant. Consequently, gross margins could be impacted significantly by the
vesting of the Sun warrant shares. For example, if the Company's share price is
$30.75, the value of a warrant share would be $29.08 based on the Black-Scholes
model. This means that for each $67.00 in gross revenue to Sun, the Company
would record a non-cash sales discount of $29.08. Depending on the Company's
stock price, this sales discount could cause the Company to report a negative
gross margin on sales to Sun. Although these sales discounts will be recorded
beginning with initial sales to Sun, no warrant shares will vest until Sun
purchases an aggregate of $10 million of products from the Company.
None of the warrant shares will vest until the Company has received a total of
$10,000,000 in revenue from Sun. During this period, any warrant shares earned
in one quarter will be revalued in subsequent quarters using the then-current
Black-Scholes option pricing model, and an additional non-cash sales discount
will be recorded if the value of the warrant shares increases or a non-cash
sales credit will be recorded if the value of the warrant shares decreases. In
the quarter in which we achieve an aggregate of $10,000,000 in revenues from
Sun, the Company will perform a final Black-Scholes calculation for the warrant
shares earned through the end of that quarter, which will result in a final
adjustment to the non-cash sales discount. Thereafter, warrant shares will vest
as they are earned, and the Company will record a non-cash discount quarterly
based on the Black-Scholes calculation, as described above. No subsequent
revaluation will be recorded.
Gross Profit. Gross profit in the second quarter of 1999 increased to
approximately $2,050,000, or 57.0% of sales, from a loss of approximately
$4,370,000 in the second quarter of 1998. Gross profit in the first six months
of 1999 increased to approximately $2,905,000, or 56.7% of sales, from a loss of
approximately $4,027,000 in the first six months of 1998. The significant
increase in gross profit shows the effect on the previous year of the special
charges of approximately $4,432,000 which were recorded in second quarter of
1998. Gross profit
9
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excluding the effects of the special charges was approximately $62,000 (45.3% of
sales) and $405,000 (34.3% of sales) for the second quarter and first six months
of 1998, respectively.
Gross profit is affected by sales volume and its direct cost and also by
indirect costs, such as normal scrap and overhead allocations, the percentage
impact of which is decreased as sales increase. Gross profit percentage is also
impacted by the mix of product sold within a period. Adapter cards generally
have lower margins than switch and service revenue and various switch types have
different margins. Excluding the effects of the previous year's special
charges, the increase in gross profit for 1999 was due primarily to increased
sales volume. The gross profit percentage was positively impacted because (i)
indirect costs remained relatively constant; and (ii) the mix of product sold
during the period carried greater margins than that sold in the comparable
periods in 1998, particularly the revenue from INRANGE. The INRANGE license fee
revenue positively impacts margins as substantially all the costs to develop the
licensed technology were expended in prior years.
Selling, General and Administrative Expenses. The Company's selling,
general and administrative expenses for the second quarter of 1999 were
approximately $2,059,000, or 57.2% of net sales, compared to approximately
$1,803,000, or 1,315.5% of net sales, in the second quarter of 1998. Selling,
general and administrative expenses for the first six months of 1999 were
approximately $3,811,000, or 74.4% of net sales, compared to approximately
$3,514,000, or 298.0% of net sales in the same period of 1998. The increase was
primarily attributable to additions to staff, particularly sales and customer
account management positions, which increased personnel related expenses by
approximately $297,000 and $350,000 in the second quarter and first six months
of 1999, respectively, as compared with the same periods of 1998.
Research and Development Expenses. The Company's research and development
expenses for the second quarter of 1999 were approximately $1,693,000, or 47.1%
of net sales, compared to approximately $1,220,000, or 890.1% of net sales, in
the second quarter of 1998. Research and development expenses for the first six
months of 1999 were approximately $3,019,000, or 59.0% of net sales, compared to
approximately $2,669,000, or 226.3% of net sales in the same period of 1998.
Increase in employee and contractor headcount caused labor costs to increase by
approximately $160,000 and $250,000 in the second quarter and first six months
of 1999, respectively. Additionally, due to the timing of non-recurring
engineering charges between periods, expenses related to product development and
enhancement increased by approximately $310,000 during the second quarter 1999,
but increased by only approximately $140,000 for the first six months of 1999 as
compared to similar periods of 1998.
Other Income (Expense) Interest expense decreased to approximately $5,000
in the second quarter of 1999 from approximately $7,000 in the second quarter of
1998 as the Company completed its obligations on certain capitalized leases.
Similarly, interest expense decreased to approximately $11,000 in the first six
months of 1999 from approximately $20,000 in the first six months of 1998.
Interest income of approximately $60,000 and approximately $99,000 in the second
quarters of 1999 and 1998, respectively, and approximately $128,000 and
approximately $165,000 in the first six month periods of 1999 and 1998,
respectively, was earned from the investment of available cash balances. The
interest income in the second quarter and first six months of 1998 was earned
from the investment of the net proceeds of the preferred stock offering which
occurred in February 1998.
10
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Liquidity and Capital Resources
- -------------------------------
The Company's cash, cash equivalents and short-term investments were
approximately $8,115,000 as of June 30, 1999, compared to approximately
$7,447,000 as of December 31, 1998. For the six months ended June 30, 1999,
cash flows used in operating activities totaled approximately $2,240,000, due
primarily to the operating loss and increase in end-of-period receivables,
offset by the third and final $3,000,000 installment received under the
technology licensing agreement with INRANGE. For the six months ended June 30,
1999, cash flows used in investing activities totaled approximately $4,548,000
primarily as a result of the purchase of short-term investments with available
cash balances. For the six months ended June 30, 1999, cash flows provided by
financing activities totaled approximately $3,503,000, primarily as a result of
the exercise of warrants and options to purchase the Company's common stock.
On July 15, 1999, the Company filed a registration statement with the Securities
and Exchange Commission for the offering of 2,500,000 shares of its common
stock. All of the shares are being offered by the Company. The registration
statement also includes an underwriters' over-allotment option for an additional
375,000 shares. The Company believes that the proceeds it receives from this
offering, together with interest earned, and anticipated revenues from
operations, will provide adequate liquidity to fund its growth, operations, and
capital expenditures at least through the next 12 months. However, the Company
may need to secure additional financing in order to fund operating and working
capital requirements after that. 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 restrictive covenants. The Company's inability to obtain
additional financing if and when needed could adversely affect the Company and
its operations.
Litigation. The Company is a defendant in a lawsuit brought by Hoyt Properties,
Inc. ("Hoyt") venued in Hennepin County District Court in the State of
Minnesota. Hoyt claims that the Company breached an agreement which provided
that Hoyt would build and lease to the Company an office building to be located
in Eden Prairie, Minnesota, and asserts damages in excess of $2,500,000. The
Company asserts there was no binding agreement. The Company denies all
liability, and alleges that Hoyt refused to provide improvements desirable and
necessary to the Company's occupancy of the proposed leased space, and multiple
contingencies, conditions, and agreements did not occur. The Company is
vigorously defending the case. There has been limited discovery completed to
date. However, there is no assurance that any judgment, order or decree against
the Company arising out of this action will not have a material adverse effect
on the Company or its business. The Company is unable to determine at this time
if there will be a material adverse outcome. No provision has been made for any
loss that may occur as a result of an adverse outcome of the suit.
11
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Year 2000 Compliance
- --------------------
Year 2000 issues exist when computer systems and applications fail to recognize
date information correctly when the year changes to 2000. If those computer
programs are not corrected, many computer systems could fail or create erroneous
results. To date, the Company has experienced no year 2000 issues with any of
its internal systems or our products, and it does not expect to experience any.
State of Readiness. 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. The Company considers a
product to be year 2000 compliant if the product's performance and functionality
are unaffected by the processing of dates before, during and after the year
2000. As a result of its assessment, the Company has determined that through
normal recurring system upgrades, the vast majority of its systems are
currently, or will be by the end of third quarter 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.
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 its key customers and
vendors to determine how they are addressing the year 2000 issue and to evaluate
any likely impact on its business. The Company has requested commitment dates
from these parties as to their year 2000 readiness and will continue to monitor
vendor compliance. 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.
Costs Associated with Year 2000 Compliance. 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.
Risks Associated with Year 2000 Issues. While it is impossible to evaluate
every aspect of year 2000 compliance, the Company believes that either of two
events would be its most likely year 2000 worst case scenario. The first would
be from one or more of the Company's sole or limited source suppliers to fail to
be year 2000 compliant or to have its business negatively impacted by year 2000
issues of others. The second would be delays in receiving orders or payments
from customers due to year 2000 problems they experience. Similarly, the
Company's revenues could be reduced if the market for advanced electronic
products declines due to general concerns with year 2000 compliance. At the
present time, it is not possible to determine whether any of these events is
likely to occur, or to quantify any potential negative impact they may have on
the Company's future results of operations and financial condition.
12
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Contingency Plans. The Company is preparing contingency plans specifying what
it will do if failures occur in its internal systems, or if important third
parties are not Year 2000 compliant. The Company anticipates the process to be
complete by early fourth quarter of 1999.
Additional Risks. Any failure by the Company to make its products year 2000
compliant could result in a decrease in sales of its products, an increase in
allocation of resources to address year 2000 problems of its customers without
additional revenue corresponding to its dedication of resources, or an increase
in litigation costs relating to losses suffered by its customers due to year
2000 problems. Failure of its internal systems could temporarily prevent the
Company from processing orders, issuing invoices, and developing products, and
could require it to devote significant resources to correcting these problems.
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 timing of customer orders, including whether customers will
purchase products from the Company at the rates and times projected by those
customers; 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 the Company's completion of certain
deliverables defined in the Company's technology license agreement with INRANGE.
13
<PAGE>
ITEM 3
------
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
The Company has no history of, and does not anticipate in the future, investing
in derivative financial instruments, derivative commodity instruments or other
such financial instruments. Contracts with international customers are entered
into in US dollars, precluding the need for foreign currency hedges.
Additionally, the Company invests in money market funds and in U.S. government
obligations (primarily U.S. Treasury bills) which experience minimal volatility.
Thus, the exposure to market risk is immaterial.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
The Company is a defendant in a lawsuit brought by Hoyt Properties, Inc.
("Hoyt") venued in Hennepin County District Court in the State of
Minnesota. Hoyt claims that the Company breached a agreement which
provided that Hoyt would build and lease to the Company an office building
to be located in Eden Prairie, Minnesota, and asserts damages in excess of
$2,500,000. The Company asserts there was no binding agreement. The
Company denies all liability, and alleges that Hoyt refused to provide
improvements desirable and necessary to the Company's occupancy of the
proposed leased space, and multiple contingencies, conditions, and
agreements did not occur. The Company is vigorously defending the case.
There has been limited discovery completed to date. However, there is no
assurance that any judgment, order or decree against the Company arising
out of this action will not have a material adverse effect on the Company
or its business. The Company is unable to determine at this time if there
will be a material adverse outcome. No provision has been made for any
loss that may occur as a result of an adverse outcome of the suit.
Item 2. Changes in Securities.
(a.) None.
(b.) None.
(c.) Recent Sales of Unregistered Securities.
On June 2, 1999, the Company issued a warrant to purchase up
to 1,500,000 shares of Common Stock at a price of $7.30 per
share (the "Sun Warrant") to Sun Microsystems, Inc. ("Sun") in
connection with a Product Purchase Agreement entered into
between the Company and Sun. The Sun Warrant has a term of
five years and becomes exercisable as Sun purchases products
from the Company. The Sun Warrant was issued pursuant to
Section 4(2) of the Securities Act of 1933, as amended.
14
<PAGE>
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Securities Holders.
The Annual Meeting of Shareholders of Ancor Communications,
Incorporated was held on May 12, 1999. Shareholders holding 23,043,738
shares, or approximately 95.8% of the outstanding shares, were
represented at the meeting in person or by proxy. Matters submitted at
the meeting for vote by the shareholders were as follows:
a. Election of Directors.
Amyl Ahola was elected to serve as a director of the Company
for a term of three years by a vote of 22,681,107 shares for
and 362,631 shares withholding. Thomas F. Hunt, Jr. was
elected to serve as a director of the Company for a term of
three years by a vote of 22,703,827 shares for and 339,911
shares withholding. The terms of Gerald M. Bestler, John F.
Carlson, Kenneth E. Hendrickson, Paul F. Lidsky and Michael L.
Huntley continued following the meeting.
b. Amend the Company's 1995 Employee Stock Purchase Plan.
Shareholders approved an amendment to the Company's 1995
Employee Stock Purchase Plan to increase the number of shares
of Common Stock authorized to be available for issuance
thereunder, from an overall limitation of 75,000 shares of
Common Stock of the Company, to an overall limitation equal to
375,000 shares of Common Stock of the Company, with a vote of
21,887,776 shares for, 839,737 shares against, 316,225 shares
abstaining and no shares representing broker non-votes.
c. Ratify KPMG LLP as independent auditors of the Company for
fiscal year 1999.
Shareholders approved the ratification of KPMG LLP as
independent auditors of the Company for fiscal year 1999, with
a vote of 22,887,776 shares for, 104,590 shares against,
113,990 shares abstaining and no shares representing broker
non-votes.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a.) Exhibits
3.1(a) Second Amended and Restated Articles of
Incorporation of the Company.
15
<PAGE>
3.2(a) Amended Bylaws of the Company.
3.3(k) Amendment to Second Amended and Restated Articles
of Incorporation of the Company relating to an
increase of the number of authorized shares.
3.4(m) Amendment to Bylaws adopted October 21, 1998.
4.1(a) Loan and Warrant Purchase Agreement, dated as of
June 24, 1992, between Ancor Communications,
Incorporated and International Business Machines
Incorporated.
4.2(a) 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.
4.3(b) 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.
4.4(a) 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.
4.5(c) Representative's Warrant.
4.6 [Reserved.]
4.7(d) Form of Warrant issued April 28, 1995.
4.8 [Reserved.]
4.9(d) Form of Warrant issued to John G. Kinnard & Company
on October 23, 1995.
4.10(f) Certificate of Designation of Series A Preferred
Stock.
4.11(f) Form of Warrant issued to Swartz Investments, Inc.
on March 7, 1996.
4.12(g) Form of Warrant issued to Dunwoody Brokerage
Services, Inc. on March 24, 1997.
16
<PAGE>
4.13(g) Form of Warrant issued to Purchasers of the
Company's Series B Preferred Stock.
4.14(g) Certificate of Designation of Series B Preferred
Stock.
4.15(i) Certificate of Designation of Series C Preferred
Stock.
4.16(j) Form of Warrant issued to Dunwoody Brokerage
Services, Inc. on February 19, 1998.
4.17(l) Form of Warrant issued to Inrange Technologies,
Inc. on September 24, 1998.
4.18(n) Warrant issued to Sun Microsystems, Inc. on June 2,
1999.
10.1 [Reserved.]
*10.2(a) Ancor Communications, Incorporated 1990 Stock
Option Plan.
*10.3(a) Ancor Communications, Incorporated 1994 Long-Term
Incentive and Stock Option Plan.
10.4 [Reserved.]
*10.5(a) Employment Agreement, dated January 1, 1994,
between Ancor Communications, Incorporated and
Stephen C. O'Hara.
10.6 [Reserved.]
10.7 [Reserved.]
10.8(a) Sublease, dated March 29, 1988, by and between
Anderson Cornelius and Unisys Corporation, formerly
known as Burroughs Corporation.
10.9(a) Sublease, Amendment Agreement, dated March 8, 1989,
by and between Anderson Cornelius and Unisys
Corporation, formerly known as Burroughs Corporation.
10.10(a) Sublease, Amendment Agreement, dated August 31,
1992, by and between the Company and Unisys
Corporation, formerly known as Burroughs Corporation.
10.11 [Reserved.]
17
<PAGE>
10.12 [Reserved.]
10.13 [Reserved.]
10.14 [Reserved.]
10.15 [Reserved.]
10.16 [Reserved.]
*10.17(e) Ancor Communications, Inc. 1995 Employee Stock
Purchase Plan.
*10.18(m) Amendment to Ancor Communications, Inc., 1995
Employee Stock Purchase Plan, effective September 1,
1998.
*10.19(e) Ancor Communications, Inc. Non-Employee Director
Stock Option Plan.
10.20 [Reserved.]
10.21 [Reserved.]
10.22 [Reserved.]
10.23(g) Form of Subscription Agreement between the Company
and Purchasers of the Company's Series B Preferred
Stock (March 1997).
10.24(g) Registration Rights Agreement dated March 24, 1997
between the Company, Swartz Investments, Inc. and
Purchasers of the Company's Series B Preferred Stock.
*10.25(h) Letter Employment Agreement with Kenneth E.
Hendrickson dated July 25, 1997.
*10.26(h) Letter Employment Agreement with Steven E. Snyder
dated September 23, 1997.
10.27(i) Form of Subscription Agreement, dated as of
February 19, 1998, between Ancor Communications,
Incorporated and each purchaser of Series C Preferred
Stock.
10.28(i) 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.
18
<PAGE>
*10.29(j) Termination of Employment Agreement dated August
29, 1997, between the Company and Dale C. Showers.
10.30(j) Sublease, Amendment Agreement, dated February 11,
1998, by and between the Company and Unisys
Corporation, formerly known as Burroughs Corporation.
*10.31(j) Separation and General Release Agreement between
the Company and Lee B. Lewis.
*10.32(j) Amendments to Ancor Communications, Inc.
Non-Employee Director Stock Option Plan filed as
exhibit 10.18.
27.1(o) 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.
(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 23,
1998.
19
<PAGE>
(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) Incorporated by reference to the Company's Form 10-Q filed for the
quarterly period ended September 30, 1998.
(m) Incorporated by reference to the Company's Form 10-K filed for the
fiscal year ended December 31, 1998.
(n) Incorporated by reference to the Company's Form 8-K filed June 11,
1999.
(o) Included herewith.
(b.) Reports on Form 8-K.
Current Report on Form 8-K filed June 11, 1999
Current Report on Form 8-K filed July 16, 1999
Current Report on Form 8-K filed July 22, 1999
20
<PAGE>
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: July 26, 1999 By /s/ Kenneth E. Hendrickson
------------------------------
Kenneth E. Hendrickson
Chairman of the
Board & Chief Executive Officer
Dated: July 26, 1999 By /s/ Steven E. Snyder
------------------------------
Steven E. Snyder
Vice President,
Chief Financial Officer & Secretary
21
<PAGE>
Exhibit Index To
Form 10-Q
ANCOR COMMUNICATIONS, INC.
For the Quarter Ended
June 30, 1999
Exhibit
Number Description
------ -----------
27.1 Financial Data Schedule.
22
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<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
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<SECURITIES> 7,922,994
<RECEIVABLES> 1,787,079
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248,891
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