<PAGE>
 
================================================================================
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, DC  20549
        
                                  FORM 10-K/A-1           
                    Annual Report Under Section 13 or 15(d)
                     of the Securities Exchange Act of 1934

(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
    of 1934 for the year ended December 31, 1996

[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
    Act of 1934.

Commission File Number 1-2982
                       ------

                       ANCOR COMMUNICATIONS, INCORPORATED
                       ----------------------------------
             (Exact name of registrant as specified in its charter)

               Minnesota                                41-1569659
               ---------                                ----------
    (State or other jurisdiction of          (IRS Employer Identification No.)
     incorporation or organization)

6130 Blue Circle Drive  Minnetonka, Minnesota              55343
---------------------------------------------              -----
  (Address of principal executive offices)              (Zip code)

       Registrant's Telephone number, including area code (612) 932-4000
                                                          --------------


          Securities registered pursuant to Section 12(b) of the Act:


        Title of each class            Name of each exchange on which registered
        -------------------            -----------------------------------------
Common Stock, par value $.01 per share          Pacific Stock Exchange

       Securities registered pursuant to Section 12(g) of the Act:  None

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 [_]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

As of March 11, 1997, the Company had 10,448,653 shares of Common Stock
outstanding.  The aggregate market value of the 9,147,673 shares of Common Stock
held by non-affiliates of the Company was $56,029,497, based on the closing
share price on March 11, 1997 on the Nasdaq SmallCap Market.

Documents incorporated by reference:  Certain responses to Part III are
incorporated herein by reference to information contained in the Company's
definitive proxy statement for its 1997 annual meeting of shareholders to be
filed with the Securities and Exchange Commission on or before April 30, 1997.

===============================================================================
<PAGE>
 
                               TABLE OF CONTENTS

    
                                    Part II      
<TABLE>     
<CAPTION>

<S>        <C>                                                               <C>

Item 7.    Management's Discussion and Analysis of Financial Condition
           and Results of Operations......................................... 10

Item 8.    Financial Statements and Supplementary Data....................... 14

</TABLE>      

                                       2

<PAGE>
 
Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations 

Results of Operations - For the Years ended December 31, 1996, 1995 and 1994.

The following table sets forth selected information derived from the Company's
Statement of Operations as a percentage of net sales:

<TABLE>
<CAPTION>
                                           For the Twelve Months
                                             Ended December 31
                                           ---------------------
                                           1996    1995    1994
                                           -----   -----   -----
<S>                                        <C>     <C>     <C>
Net sales                                  100.0%  100.0%  100.0%
Cost of sales                               57.0    54.2    57.6
                                           -----   -----   -----

    Gross profit                            43.0    45.8    42.4

Operating expenses
    Selling, general and administrative     79.0    59.6    49.9
    Research and development                51.1    54.4    43.2
                                           -----   -----   -----

Total operating expenses                   130.1   114.0    93.1
                                           -----   -----   -----

    Operating loss                         -87.1   -68.2   -50.7

Nonoperating income (expense)
    Interest expense                        -1.0    -3.3    -5.8
    Other, net                               3.6     1.5     2.0
                                           -----   -----   -----

Net loss                                   -84.5%  -70.0%  -54.5%
                                           =====   =====   =====
 
</TABLE>

     Net Sales  Net sales for 1996 increased by $1,584,889 (34%) from 1995 to
$6,257,840. This increase in net sales is due to (i) a significant increase in
net sales to Hucom, Inc., the Company's Japanese distributor, (ii) to increased
market acceptance of the Company's Fibre Channel products, (iii) continued
strength in the data networking market, and (iv) increases in network capacity
requirements. Net sales to Hucom, Inc. increased $1,459,000 (129.6%) to
$2,585,000 in 1996, representing 41% of net sales for the year. The market
acceptance of the Company's products are attributable to the breadth of the
Company's product offering for switches and adapters and the Company's ability
to deliver complete Fibre Channel networking solutions for different
connectivity environments. In 1996, net sales of switches increased by
approximately $2,200,000 (110%) to approximately $4,200,000 and net sales of
adapters increased approximately $200,000 (12.5%) to approximately $1,800,000.

    
                                       3      

<PAGE>
 
The 1996 net sales increase was partially offset by significant unanticipated
product returns, which began during the second and third quarters of the year.
The Company does not generally provide customers with a right of return at the
date of sale. However, in response to significant pressures from the
marketplace, the Company allowed product returns from certain customers as a
marketing concession to stimulate a positive impression of the Company and its
products in the marketplace. Additionally, certain customers had difficulty
integrating the new technology of the Company's products and negotiated product
returns. As a result, the Company issued significant credits for sales returns
in 1996, including (i) a $700,000 credit granted to a customer in the third
quarter of 1996 as a result of the customer significantly modifying its network
design after shipment by the Company, (ii) a fourth quarter sales return of
$660,000 for a contract cancellation, and (iii) the recording of a sales returns
reserve of $300,000 at December 31, 1996 for estimated future product returns.

The $660,000 fourth quarter sales return relates to the January 1997
cancellation of an OEM contract by Sequent Computer Systems, Inc. (Sequent), a
reseller of the Company's Fibre Channel switches. After acceptance of the
Company's shipment, Sequent discovered an interoperability conflict between
Sequent's NUMA-Q technologies and the Fibre Channel technologies. The Company
agreed to accept the product return and to issue a credit for the previous sale.

At December 31, 1996, the Company recorded a net sales return reserve of
$150,000 ($300,000 gross sales less the estimated value of the product to be
returned) as an estimate of future anticipated returns of product. The recording
of this reserve is in recognition of the difficulty in obtaining market
penetration of the Company's new technology and the necessity to make
concessions to customers during the initial introduction of a new technology
product.

Net sales for 1995 decreased $88,050 (1.8%) to $4,672,951. However, there was a
substantial shift in sales to Fibre Channel product. Net sales of switches
increased approximately $1,100,000 (133.6%) to approximately $2,004,000, net
sales of adapters increased approximately $122,000 (8.5%) to approximately
$1,554,000, and the initial introduction of Fibre Link product sales were
approximately $254,000 in 1995. These increases were offset by a reduction of
sales caused by the closure of the Anderson Cornelius division in 1994, because
plant floor data collection systems were not central to its Fibre Channel
direction. Additionally, the Company ceased its defense communications business
in 1995. In 1995, defense sales decreased by approximately $457,000 (54.0%) to
approximately $390,000 and there were no sales of plant floor communication
systems compared to sales of such systems of approximately $1,400,000 in 1994.

     Gross Profit  Gross margin percentage was 43.0% in 1996, 45.8% in 1995 and
42.4% in 1994. The decrease in 1996 gross margin percentage is attributable to a
4.9 point reduction in the percentage caused by fourth quarter 1996 inventory
obsolescence, scrap and rework charges, with the offset caused by improved
margins from the switch vs. adapter mix of product sold. The 3.4% increase in
1995 gross margin percentage is attributable to reduced manufacturing overhead
and Fibre Channel start up expenses as a percentage of sales.

    
                                       4      

<PAGE>
 
     Operating Expenses  Operating expenses were $8,142,321 (130.1% of net
sales) in 1996, $5,327,043 (114.0% of net sales) in 1995 and $4,432,869 (93.1%
of net sales) in 1994. The increase in operating expenses in 1996 and 1995 are
attributable to an increase in the number of employees, increased development
costs for the network products, increased promotion costs and increased selling
expenses as sales volume increases.

Selling, general and administrative expenses (SG&A) were approximately
$4,944,000 (79.0% of net sales) in 1996; $2,785,000 (59.6% of net sales) in
1995; and $2,377,000 (49.9% of net sales) in 1994. SG&A increased in 1996 and
1995 due to the addition of sales and management personnel resulting from the
Company's increased focus on the marketing of its Fibre Channel products.
Specifically in 1996, in addition to $1.8 million of salaries, the Company
expended $368,000 in employee recruitment, and $755,000 on outfitting marketing
demonstration facilities, development of advertising and promotion campaigns and
costs to develop the worldwide Company channels of distribution. In 1995, such
expenditures amounted to $1.3 million, $61,000 and $354,000 respectively, and in
1994 were $1.1 million, $0, and $193,000 respectively.

Research and development expenses (R&D) were approximately $3,198,000 (51.1% of
net sales) in 1996; $2,542,000 (54.4% of net sales) in 1995; and $2,056,000
(43.2% of net sales) in 1994. The Company believes the introduction of new
technologies and products to the market in a timely manner is crucial to its
success, and will continue to make strategic program expenditures where
appropriate. The nature of costs for such program development activities is
primarily the employee related cost for design, prototype development and
testing. Salaries and contracted labor incurred were approximately $2,492,000 in
1996, $1,740,000 in 1995, and $1,495,000 in 1994. Engineering expenditures
increased in 1996, as the next generation of Fibre Channel switching products is
being developed. In 1995, as the Company continued to bring new Sbus and PCI
adapters to market, research and development spending increased over 1994. The
Company expects that spending for research and development will increase in
absolute dollars but may continue to vary as a percentage of net sales.

     Nonoperating Income (Expense)  Interest expense totaled $63,986 in 1996,
$153,407 in 1995 and $275,001 in 1994. In June 1996, the Company repaid a $1.5
million note payable with the proceeds of a preferred stock offering and the
conversion of warrants to common stock (see Liquidity and Capital Resources
section below), resulting in lower interest expense for the year. Similarly, in
May 1994, the Company repaid $4 million of debt with a portion of the net
proceeds of the initial public offering.

Interest income totaled $224,086 in 1996, $70,846 in 1995 and $95,026 in 1994.
The increase in 1996 is attributable to the short-term investment of a portion
of the net proceeds of the preferred stock offering and the conversion of
warrants to common stock.

     Net Loss  The Company's net loss increased to approximately $5,290,000, or
$0.60 per share in 1996, compared to a net loss of $3,269,000, or $0.44 per
share in 1995, and a net loss of approximately $2,595,000, or $0.47 per share in
1994. In addition to the increased operating loss, the net loss of $0.60 per
share for 1996 includes an adjustment of 3 cents loss per share for the effect
of the 8% accretion benefit earned by the Series A Preferred shareholders from
the date

    
                                       5      

<PAGE>
 
of issue to the date of conversion or to the end of the reporting period,
whichever is earlier. Such accretion amounted to $331,000 for 1996.


Liquidity and Capital Resources

The Company's principal source of liquidity at December 31, 1996 was cash, cash
equivalents and short term investments of approximately $1,511,000. This
compares to approximately $1,552,000 at year end 1995, and to approximately
$1,328,000 at year end 1994. Net cash used in operating activities increased
from approximately $3,559,000 in 1994 to approximately $3,804,000 in 1995 to
approximately $8,058,000 in 1996. The increase in 1996 was due to the net
loss, as well as increases in both accounts receivable and inventories, which,
in turn, were the result of increased sales and increased stocking in
anticipation of sales growth in 1997. The 120.5% increase in receivables is
primarily attributable to (i) a $1,485,000 sale to Hucom, Inc. in the last week
of December 1996, and (ii) extended terms granted to customers as an inducement
to utilize the Company's technology. Additionally, customers are also encouraged
to install the Company's products through a free evaluation period lasting over
a number of months. This equipment remains the property of the Company, thus
increasing inventory, unless the evaluation is converted into a sale. The
increase in 1995 was due to an increase in receivables of approximately $831,000
and a higher net loss, without the need for significant additional investments
in inventory, prepaid expenses and accounts payable. The increase in receivables
at December 31, 1995 was due primarily to significant sales near year end,
including a couple of large contracts, and a significant increase in receivables
from value added resellers.

Cash flow used in investing activities totaled approximately $2,536,000 in 1996,
as compared with approximately $601,000 in 1995 and approximately $1,978,000 in
1994. Major capital expenditures in 1996 included upgrades and additions to
facilities, development of a new worldwide management information system,
upgrades of desktop systems, development of salable software and internally-
built testing and tooling equipment for the next generation of Fibre Channel
switching products. Investments in 1995 included design and expansion of the
Company's own Fibre Channel research network of engineering tools and software.
Cash invested in 1994 included that for short-term investments and hardware and
software for ASIC design.

Since its inception, the Company has financed its operations and met its capital
expenditure requirements from private and public sales of capital stock and from
borrowing. In 1996, the Company completed an off-shore private placement of
1,030 shares of convertible preferred stock with a stated value of $10,000 per
share, resulting in net proceeds to the Company of approximately $9,544,000
after deducting selling commissions and offering expenses. Additionally, during
the year, certain warrant holders elected to convert those warrants to 683,728
shares of common stock, resulting in net proceeds to the Company of
approximately $2,518,000, after deducting expenses of issuance, including the
cost of registering the shares pursuant to registration rights held by such
warrant holders. The proceeds of these equity transactions were used to repay
$1,500,000 of indebtedness to IBM due in June 1996, and were used to fund sales
and marketing efforts to accelerate penetration of the Company's products into
OEM, system integrator and reseller accounts, to fund research and development
efforts needed

    
                                       6      

<PAGE>
 
to maintain technological leadership and broaden the Company's product line, and
for working capital. In 1995, the Company completed two private placements
resulting in net proceeds to the Company of approximately $4.7 million. During
the second quarter of 1994, the Company completed its initial public offering of
common stock, raising approximately $8,300,000. Of the total net proceeds, $4
million was used to pay $2 million of its obligation to IBM and $2 million to
retire 10% subordinated notes. In 1992, the Company entered into a term loan
agreement with IBM to borrow $3.5 million dollars at 8.75%. In 1993, the Company
sold $2 million principal amount of 10% subordinated notes.

        
Management believes that the Company must obtain additional capital to fund the
continued growth in net sales and to fund the Company's working capital
requirements, operating activities, and future capital expenditures until
profitability is achieved. On March 24, 1997, the Company completed a private
placement transaction by selling 855 shares of Series B 5% Convertible Preferred
Stock which provided net proceeds of approximately $8,000,000. In conjunction
with the transaction, the placement agent was granted a five year warrant to
purchase 105,556 shares of common stock at $4.86 per share. In addition, the
investors have a right to receive warrants to purchase common stock equal to 20%
of their original investment not converted to common stock as of March 24, 1998
divided by the conversion price then in effect, with an exercise price equal to
115% of the average closing bid price for five days ending on the one year
anniversary date. The Company believes that the capital received from the
private placement will provide adequate liquidity to fund growth, operations,
and capital expenditures for 1997.       

Item 8.  Financial Statements and Supplementary Data
    
The following financial statements are included as a separate section following
the signature page to this Form 10-K/A-1:      

                         INDEX TO FINANCIAL STATEMENTS
<TABLE>     
<CAPTION>
                                                                     Page
                                                                     ---- 
<S>                                                                   <C>
Independent Auditor's Report for the years ended
  December 31, 1996, 1995,  and 1994............................      F-2
 
Balance Sheets as of
  December 31, 1996 and 1995....................................      F-3
 
Statements of Operation's for the years ended
  December 31, 1996, 1995 and 1994..............................      F-5
 
Statements of Shareholders' Equity/Deficit for the years ended
  December  31, 1996, 1995 and 1994.............................      F-6

Statements of Cash Flows for the years ended
  December 31, 1996, 1995 and 1994..............................      F-8

Notes to Financial Statements...................................  F-9 to F-18

</TABLE>      
   
                                       7     
<PAGE>
 

                                  SIGNATURES
    
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.


                                       ANCOR COMMUNICATIONS, INCORPORATED
                             
                             
                                       By /s/ Stephen O'Hara
                                          -------------------------------
                                          Stephen O'Hara
                                          President & CEO


Dated: April 3, 1997 
       ----------------

           

     
    
                                       8      
<PAGE>
 

                         INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
                                                                            Page
                                                                            ----
<S>                                                                    <C>
Independent Auditor's Report for the years ended
  December 31, 1996, 1995,  and 1994................................         F-2
 
Balance Sheets as of
  December 31, 1996 and 1995........................................         F-3
 
Statements of Operation's for the years ended
  December 31, 1996, 1995 and 1994..................................         F-5
 
Statements of Shareholders' Equity/Deficit for the years ended
  December  31, 1996, 1995 and 1994.................................         F-6
 
Statements of Cash Flows for the years ended
  December 31, 1996, 1995 and 1994..................................         F-8
 
Notes to Financial Statements....................................... F-9 to F-18
</TABLE>

                                      F-1
<PAGE>
 
                         INDEPENDENT AUDITOR'S REPORT


To the Board of Directors
Ancor Communications, Incorporated
Minnetonka, Minnesota

We have audited the accompanying balance sheets of Ancor Communications,
Incorporated as of December 31, 1996 and 1995, and the related statements of
operations, shareholders' equity, and cash flows for each of the three years in
the period ended December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Ancor Communications,
Incorporated as of December 31, 1996 and 1995, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1996, in conformity with generally accepted accounting principles.

          

    
Our previous report on the financial statements, dated February 21, 1997, except
for Note 2 dated March 13, 1997, included an explanatory paragraph that
expressed substantial doubt about the Company's ability to continue as a going
concern. As explained in Note 2, the Company raised approximately $8,000,000 in
a private placement of Series B, 5 percent Convertible Preferred Stock. Due to
this event, substantial doubt does not remain about the Company's ability to
continue as a going concern.     
    
Minneapolis, Minnesota                          
February 21, 1997, except for Note 2, as        /s/ MCGLADREY & PULLEN, LLP.
  to which the date is March 21, 1997               McGLADREY & PULLEN, LLP.
     

                                      F-2
<PAGE>
 
<TABLE>
<CAPTION>

ANCOR COMMUNICATIONS, INCORPORATED

BALANCE SHEETS
December 31, 1996 and 1995

ASSETS                                                                         1996             1995
--------------------------------------------------------------------------------------------------------
<S>                                                                       <C>              <C> 
Current Assets
  Cash and cash equivalents                                                 $   507,041      $   251,475
  Short-term investments                                                      1,003,530        1,300,178
  Accounts receivable, less allowances of $214,000 and $50,000,
    respectively (Notes 5 and 9)                                              4,019,000        1,822,883
  Inventories (Note 3)                                                        2,695,961          819,760
  Prepaid expenses and other current assets                                     336,734          180,848
                                                                            -----------      -----------
          Total current assets                                                8,562,266        4,375,144
                                                                            -----------      -----------


Equipment, at cost (Note 4)                                                   4,681,585        2,392,046
  Less accumulated depreciation                                               1,843,469        1,359,831
                                                                            -----------      -----------
                                                                              2,838,116        1,032,215
                                                                            -----------      -----------


Other Assets
  Patents, prepaid royalties, and other assets, net of
    accumulated amortization (Note 8)                                           247,754          256,982
  Capitalized software development costs, less accumulated
    amortization of $74,720 in 1996 and $2,736 in 1995                          614,188          108,684
                                                                            -----------      -----------
                                                                                861,942          365,666
                                                                            -----------      -----------
                                                                            $12,262,324      $ 5,773,025
                                                                            ===========      ===========
</TABLE> 
See Notes to Financial Statements.

                                      F-3
<PAGE>
 
<TABLE>
<CAPTION>

LIABILITIES AND SHAREHOLDERS' EQUITY                                                   1996         1995
------------------------------------------------------------------------------------------------------------
<S>                                                                           <C>              <C> 
Current Liabilities
  Current maturities of long-term debt                                            $      61,923 $  1,540,000
  Accounts payable                                                                    1,752,258      838,689
  Accrued compensation and benefits                                                     259,800      200,901
  Other accrued expenses                                                                104,264      234,363
                                                                                  --------------------------
          Total current liabilities                                                   2,178,245    2,813,953
                                                                                  --------------------------

Long-Term Debt, less current maturities (Note 4)                                        177,382      199,653
                                                                                  --------------------------

Commitments and Contingencies (Note 8)

Shareholders' Equity (Note 7)
  Preferred stock, $0.01 par value, liquidation value of $1,854,000,
    authorized 5,000,000 shares; issued and outstanding 174 shares
    in 1996                                                                                   2           -
  Common stock, par value $0.01; authorized 20,000,000
    shares; issued and outstanding 10,407,687 shares in
    1996 and 8,273,426 shares in 1995                                                   104,077       82,734
  Additional paid-in capital                                                         27,071,820   14,656,203
  Accumulated deficit                                                               (17,269,202) (11,979,518)
                                                                                  --------------------------
                                                                                      9,906,697    2,759,419
                                                                                  --------------------------
                                                                                  $  12,262,324 $  5,773,025
                                                                                  ==========================
</TABLE> 
                                      F-4
<PAGE>
 

<TABLE>
<CAPTION>

ANCOR COMMUNICATIONS, INCORPORATED

STATEMENTS OF OPERATIONS
Years Ended December 31, 1996, 1995, and 1994

                                           1996           1995         1994
-------------------------------------------------------------------------------
<S>                                    <C>           <C>           <C>
Net sales (Note 5)                      $ 6,257,840   $ 4,672,951   $ 4,761,001
Cost of goods sold                        3,565,393     2,532,622     2,743,284
                                        ---------------------------------------
          Gross profit                    2,692,447     2,140,329     2,017,717
          Percent to sales                     43.0%         45.8%         42.4%
                                        ---------------------------------------

Operating expenses:
  Selling, general and administrative     4,944,166     2,784,636     2,376,849
  Research and development                3,198,155     2,542,407     2,056,020
                                        ---------------------------------------
          Total operating expenses        8,142,321     5,327,043     4,432,869
                                        ---------------------------------------

          Operating loss                 (5,449,874)   (3,186,714)   (2,415,152)

Nonoperating income (expense):
  Interest expense                          (63,896)     (153,047)     (275,001)
  Other, primarily interest income          224,086        70,846        95,024
                                        ---------------------------------------
          Net loss                      $(5,289,684) $ (3,268,915)  $(2,595,129)
                                        =======================================

Net loss per common share               $     (0.60) $      (0.44)  $     (0.47)
Weighted average common 
  shares outstanding                      9,351,060     7,449,182     5,516,399
</TABLE>


See Notes to Financial Statements.

                                      F-5
<PAGE>
 
ANCOR COMMUNICATIONS, INCORPORATED

STATEMENTS OF SHAREHOLDERS' EQUITY
Years Ended December 31, 1996, 1995, and 1994

<TABLE> 
<CAPTION> 
                                                              Preferred Stock              Common Stock
                                                          ----------------------- -------------------------
                                                            Shares       Amount          Shares      Amount
----------------------------------------------------------------------------------------------------------- 
<S>                                                      <C>         <C>            <C>         <C>
Balance, December 31, 1993                                        -     $     -       3,327,000   $  33,270
   Issuance of common stock                                       -           -       1,200,000      12,000
   Sale of common stock (net of issuance costs of
      $1,137,098)                                                 -           -       2,216,000      22,160
   Transfer of notes receivable to current assets                 -           -               -           -
   Exercise of stock options                                      -           -             499           5
   Net loss                                                       -           -               -           -
                                                            --------    --------    -----------   ---------
Balance, December 31, 1994                                        -           -       6,743,499      67,435
   Exercise of stock options                                      -           -          19,035         190
   Employee stock purchases                                       -           -             892           9
   Sale of common stock through private 
      placement (net of issuance costs of $203,247)               -           -         845,000       8,450
   Sale of common stock through private placement
      (net of issuance costs of $194,669)                         -           -         665,000       6,650
   Net loss                                                       -           -               -           -
                                                            --------    --------    -----------   ---------
Balance, December 31, 1995                                        -           -       8,273,426      82,734
   Sale of preferred stock (net of issuance costs
      of $756,466)                                            1,030          10               -           -
   Preferred stock conversions                                 (856)         (8)      1,352,494      13,525
   Exercise of stock options and warrants (net of
      issuance costs of $33,915)                                  -           -         773,519       7,735
   Employee stock purchases                                       -           -           8,248          83
   Net loss                                                       -           -               -           -
                                                            --------    --------    -----------   ---------
Balance, December 31, 1996                                      174     $     2      10,407,687   $ 104,077
                                                            ========    ========     ==========   ========= 
</TABLE> 

See Notes to Financial Statements.

                                      F-6
<PAGE>
 
<TABLE> 
<CAPTION> 
                                                                                                 Notes
                                                              Additional                       Receivable
                                                                Paid-In       Accumulated    From Issuance of
                                                                Capital         Deficit        Common Stock          Total
------------------------------------------------------------------------------------------------------------------------------
<S>                                                        <C>              <C>              <C>               <C>
Balance, December 31, 1993                                  $  1,694,551     $ (6,115,474)     $  (240,000)      $  (4,627,653)
   Issuance of common stock                                      (12,000)              -                -                   -
   Sale of common stock (net of issuance costs of
      $1,137,098)                                              8,258,742               -                -            8,280,902
   Transfer of notes receivable to current assets                     -                -           240,000             240,000
   Exercise of stock options                                         744               -                -                  749
   Net loss                                                           -        (2,595,129)              -           (2,595,129)
                                                            ------------------------------------------------------------------
Balance, December 31, 1994                                     9,942,037       (8,710,603)              -            1,298,869
   Exercise of stock options                                      29,734               -                -               29,924
   Employee stock purchases                                        8,073               -                -                8,082
   Sale of common stock through private 
      placement (net of issuance costs of $203,247)            2,217,678               -                -            2,226,128
   Sale of common stock through private placement
      (net of issuance costs of $194,669)                      2,458,681               -                -            2,465,331
   Net loss                                                           -        (3,268,915)              -           (3,268,915)
                                                            ------------------------------------------------------------------
Balance, December 31, 1995                                    14,656,203      (11,979,518)              -            2,759,419 
   Sale of preferred stock (net of issuance costs
      of $756,466)                                             9,543,524               -                -            9,543,534
   Preferred stock conversions                                   (13,517)              -                -                   -
   Exercise of stock options and warrants (net of
      issuance costs of $33,915)                               2,832,061               -                -            2,839,796
   Employee stock purchases                                       53,549               -                -               53,632
   Net loss                                                           -        (5,289,684)              -           (5,289,684)
                                                            ------------------------------------------------------------------
Balance, December 31, 1996                                  $ 27,071,820     $(17,269,202)              -        $   9,906,697
                                                            ==================================================================
</TABLE>
                                      F-7
<PAGE>
 
ANCOR COMMUNICATIONS, INCORPORATED

STATEMENTS OF CASH FLOWS
Years Ended December 31, 1996, 1995, and 1994
<TABLE> 
<CAPTION> 
                                                                                    1996              1995             1994
-------------------------------------------------------------------------------------------------------------------------------     
<S>                                                                             <C>               <C>               <C> 
Cash Flows From Operating Activities
 Net loss                                                                       $(5,289,684)      $(3,268,915)      $(2,595,129)
 Adjustments to reconcile net loss to net cash used in operating activities:
  Depreciation and amortization                                                     617,419           234,333           196,876
  Changes in assets and liabilities:
   Accounts receivable                                                           (2,196,117)         (830,778)           92,919
   Inventories                                                                   (1,876,201)            9,709          (635,994)
   Prepaid expenses and other                                                      (155,886)          (73,519)         (234,481)
   Accounts payable and accrued expenses                                            842,369           125,191          (383,643)
                                                                                -----------------------------------------------
     Net cash used in operating activities                                       (8,058,100)       (3,803,979)       (3,559,452)
                                                                                -----------------------------------------------
Cash Flows From Investing Activities
 Purchases of equipment                                                          (2,202,259)         (403,324)         (737,034)
 Purchase of short-term investments                                              (1,003,530)       (3,063,206)       (4,467,527)
 Sale of short-term investments                                                   1,300,178         2,998,301         3,232,254
 Capitalized software development costs                                            (577,488)         (111,420)                -
 Other, net                                                                         (52,569)          (21,028)           (5,562)
                                                                                -----------------------------------------------
     Net cash used in investing activities                                       (2,535,668)         (600,677)       (1,977,869)
                                                                                -----------------------------------------------
Cash Flows From Financing Activities
 Net proceeds from sales of common and preferred stock                            9,597,166         4,699,541         8,280,902
 Proceeds from exercise of options and warrants                                   2,839,796            29,924               749
 Principal payments on long-term debt                                            (1,587,628)         (356,482)       (4,059,898)
 Collection of notes receivable from the issuance of common stock                         -           240,000                 -
 Payment of debt financing and deferred offering fees                                     -           (50,000)                -
 Long-term borrowings                                                                     -                 -           385,000
                                                                                -----------------------------------------------
     Net cash provided by financing activities                                   10,849,334         4,562,983         4,606,753
                                                                                -----------------------------------------------
     Increase (decrease) in cash                                                    255,566           158,327          (930,568)

Cash
 Beginning                                                                          251,475            93,148         1,023,716
                                                                                -----------------------------------------------
 Ending                                                                         $   507,041       $   251,475       $    93,148
                                                                                ===============================================
Supplemental Cash Flow Disclosures
 Cash payments for interest                                                     $    63,896       $   119,755       $   361,697
                                                                                ===============================================
Supplemental Schedule of Noncash Investing and Financing Activities
 Equipment acquired under capital lease                                         $    87,280       $   100,235       $         -
 Reduction of note payable through shipments of inventory                                 -                 -            66,764
                                                                                ===============================================
</TABLE> 
See Notes to Financial Statements.

                                      F-8
<PAGE>
 
ANCOR COMMUNICATIONS, INCORPORATED

NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

Note 1.  Nature of Business and Significant Accounting Policies

Nature of business: Ancor Communications, Incorporated (the Company) operates in
one business segment, the development and marketing of various products for the
communications market. The Company's main product is fiber-optic communications
networks. The Company also previously designed, produced, and marketed system
components used in United States military communications systems. During 1995,
the Company ceased its defense communications systems business and sold the
related technology. Sales of defense communication systems totaled approximately
$390,000 and $847,000 in 1995 and 1994, respectively. During 1994, the Company
ceased the majority of its plant floor communications systems business. Sales of
plant floor communications systems totaled approximately $1,200,000 in 1994.
Sales are made to customers throughout the United States, in Japan, and in
certain other foreign countries. Credit, including foreign credit, is determined
on an individual customer basis.

Accounting estimates: The preparation of the financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.

Revenue recognition: Revenue is generally recognized at the time product is
shipped or services are provided. In certain circumstances, revenue is
recognized upon completion of production under specific contractual arrangements
for billing and delivery. At December 31, 1996, the Company recorded a reserve
for estimated future product returns (see Note 9).

Cash and cash equivalents: For purposes of reporting cash flows, the Company
considers all unrestricted cash and any U.S. Treasury bills, commercial paper,
and money market funds with an original maturity of three months or less to be
cash equivalents. The Company maintains its cash in bank deposit and money
market accounts, which, at times, exceed federally insured limits. The Company
has not experienced any losses in such accounts.

Short-term investments: Short-term investments consist primarily of investments
in money market funds and in U.S. government obligations (primarily U.S.
Treasury bills). Short-term investments are recorded at cost (which approximates
market) and mature in 1997.

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

Depreciation and amortization: Equipment purchases are stated at cost.
Depreciation is computed by the straight-line method over estimated useful lives
of five and seven years. Intangible assets consist principally of patents,
prepaid royalties, and cost in excess of net assets acquired. Amortization is
computed by the straight-line method over estimated useful lives ranging from 5
to 15 years.

                                      F-9
<PAGE>
 
ANCOR COMMUNICATIONS, INCORPORATED

NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

Note 1.  Nature of Business and Significant Accounting Policies (Continued)

The Company reviews its long-lived assets periodically to determine potential
impairment by comparing the carrying value of the long-lived assets with the
estimated future net undiscounted cash flows expected to result from the use of
the assets, including cash flows from disposition. Should the sum of the
expected future net cash flows be less than the carrying value, the Company
would recognize an impairment loss at that date. An impairment loss would be
measured by comparing the amount by which the carrying value exceeds the fair
value (estimated discounted future cash flows) of the long-lived assets. To
date, management has determined that no impairment of long-lived assets exists.

Fair value of financial instruments: The financial statements include the
following financial instruments: cash and cash equivalents, short-term
investments, and long-term debt. No separate comparison of fair values versus
carrying values is presented for the aforementioned financial instruments since
their fair values are not significantly different than their balance sheet
carrying amounts.

Income taxes: Deferred taxes are provided on an asset and liability method
whereby deferred tax assets are recognized for deductible temporary differences
and operating loss or tax credit carryforwards and deferred tax liabilities are
recognized for taxable temporary differences. Temporary differences are the
differences between the amounts of assets and liabilities recorded for income
tax and financial reporting purposes. Deferred tax assets are reduced by a
valuation allowance when management determines that it is more likely than not
that some portion or all of the deferred tax assets and liabilities will not be
realized. Deferred tax assets and liabilities are adjusted for the effects of
changes in tax laws and rates on the date of enactment. Income tax expense or
benefit would be the tax payable or refundable for the year plus or minus the
change in deferred tax assets and liabilities during the year.

Capitalized software development costs: The Company capitalizes software
development costs incurred after the establishment of technological feasibility.
These costs are amortized to cost of goods sold at the greater of (i) the amount
computed using the ratio of current gross revenues for the product to the total
of current and anticipated future gross revenues, or (ii) the straight-line
method over the remaining estimated economic life of the product. An original
estimated economic life ranging from one to five years is assigned to
capitalized software development costs. It is reasonably possible that those
estimates of anticipated future gross revenues, the remaining estimated economic
life of the product, or both, will be reduced significantly in the near term due
to the rapid technological change of the Company's products. Software
development costs capitalized were approximately $578,000 and $111,000 for 1996
and 1995, respectively. Software development cost amortization was approximately
$72,000 and $3,000 for 1996 and 1995, respectively.

Research and development: Research and development costs applicable to both
present and future products are charged to operations as incurred.

Net loss per common share: Net loss per common share is computed based upon the
weighted average number of common shares outstanding during the year. Common
equivalent shares, consisting of options and warrants for all periods and
convertible preferred stock in 1996, were not included in the computation as
their effect was antidilutive. However, the 8 percent premium earned by the
preferred shareholders in 1996 was added to the net loss for computation
purposes.

                                     F-10
<PAGE>
 
ANCOR COMMUNICATIONS, INCORPORATED

NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

Note 2.  Corporate Liquidity

The financial statements have been prepared on a going-concern basis that
contemplates the recoverability of assets and the satisfaction of liabilities in
the ordinary course of business. In 1996, the Company incurred a net loss of
$5,289,684 and used cash in operating activities of $8,058,100. At December 31
1996, the Company has cash, cash equivalents, and short-term investments
totaling $1,510,571 and an accumulated deficit of $17,269,202.

        
Management believes that the Company must obtain additional capital to fund the
continued growth in net sales and to fund the Company's working capital
requirements, operating activities, and future capital expenditures until
profitability is achieved. On March 24, 1997, the Company completed a private
placement transaction by selling 855 shares of Series B 5% Convertible Preferred
Stock which provided net proceeds of approximately $8,000,000. In conjunction
with the transaction, the placement agent was granted a five year warrant to
purchase 105,556 shares of common stock at $4.86 per share. In addition, the
investors have a right to receive warrants to purchase common stock equal to 20%
of their original investment not converted to common stock as of March 24, 1998
divided by the conversion price then in effect, with an exercise price equal to
115% of the average closing bid price for five days ending on the one year
anniversary date. The Company believes that the capital received from the
private placement will provide adequate liquidity to fund growth, operations,
and capital expenditures for 1997.        

Note 3.  Inventories

Inventories at December 31, 1996 and 1995, consisted of:

<TABLE>
<CAPTION>
                                                            1996          1995
-------------------------------------------------------------------------------
<S>                                                   <C>           <C>
Raw materials                                           $   753,147  $  218,830
Work in process                                             437,023     195,342
Finished goods consigned to customers                       
 and others                                                 625,222     235,016
Finished goods                                              880,569     170,572
                                                        -----------------------
                                                        $ 2,695,961  $  819,760
                                                        =======================
 </TABLE>


                                     F-11
<PAGE>
 
 
ANCOR COMMUNICATIONS, INCORPORATED

NOTES TO FINANCIAL STATEMENTS
--------------------------------------------------------------------------------

Note 4.  Notes Payable and Long-Term Debt

Long-term debt consists of the following at December 31, 1996 and 1995:

<TABLE>
<CAPTION>
                                                       1996               1995
--------------------------------------------------------------------------------
<S>                                                 <C>               <C>
IBM term-loan paid in 1996                          $       -         $1,500,000
Note payable to shareholder (1)                       143,752            165,778
Capital lease obligations (2)                          95,553             73,875
                                                    ----------------------------
                                                      239,305          1,739,653
                                                          
Less current maturities                                61,923          1,540,000
                                                    ----------------------------
                                                    $ 177,382         $  199,653
                                                    ============================
</TABLE>

(1)  Payments are made to the note holder in an amount equal to 0.94 percent of
     Company sales in excess of $4,000,000 in any calendar year.

(2)  The Company has capitalized certain equipment held under capital leases
     with a capitalized cost of $186,496 and accumulated depreciation of $45,902
     at December 31, 1996. The related obligations are recorded in the
     accompanying financial statements based on the present value of the future
     minimum lease payments based on an implicit interest rate of 13 percent.

Aggregate annual maturities of long-term debt, including capital lease
obligations, at December 31, 1996, are as follows:

<TABLE>
<CAPTION>
Years ending December 31:
<S>                                                                   <C>
  1997                                                                $   61,923
  1998                                                                    30,274
  1999                                                                     3,356
Note with no specified maturity                                          143,752
                                                                      ----------
                                                                      $  239,305
                                                                      ==========
</TABLE>

Note 5.  Major Customers and Concentration of Credit Risk

Major customers:  A summary of major customers follows:

<TABLE>
<CAPTION>
                            1996                 1995                1994
                     -------------------  -------------------  -----------------
                                Percent              Percent            Percent
Customer               Sales    to Total    Sales    to Total   Sales   to Total
--------------------------------------------------------------------------------
<S>                  <C>        <C>       <C>        <C>       <C>      <C>
Hucom, Inc.          $2,585,000       41  $1,126,000       24  $      -        -
Falcon Systems          757,000       12     142,000        3         -        -
U.S. government               -        -     307,000        7    83,300       17
Hewlett Packard               -        -     265,000        6   687,000       14
Ford Motor Company            -        -           -        -   560,000       12
</TABLE>
 
Accounts receivable from major customers totaled approximately $2,115,000 at
December 31, 1996.

                                     F-12
<PAGE>
 

ANCOR COMMUNICATIONS, INCORPORATED

NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

Note 5.  Major Customers and Concentration of Credit Risk (Continued)

Export net sales totaled approximately $3,277,000, $1,300,000, and $119,000 in
1996, 1995, and 1994, respectively. Hucom, Inc. comprised 79 and 87 percent of
export net sales in 1996 and 1995, respectively.

Note 6.  Income Taxes

Deferred tax assets consist of the following components as of December 31, 1996
and 1995:

<TABLE>
<CAPTION>
                                                1996                    1995
-------------------------------------------------------------------------------
<S>                                         <C>                     <C>
Loss carryforwards                          $ 7,269,000             $ 5,794,000
Tax credit carryforwards                        578,000                 588,000
Accrued expenses                                 51,000                  64,000
Other items                                      66,000                  35,000
                                            -----------------------------------
                                              7,964,000               6,481,000
                                                            
Less valuation allowance                     (7,964,000)             (6,481,000)
                                            -----------------------------------
                                            $         -             $         -
                                            ===================================
</TABLE>

The income tax benefit differed from the statutory federal rate as follows:

<TABLE>
<CAPTION>
                                                      1996            1995          1994
------------------------------------------------------------------------------------------
<S>                                              <C>             <C>             <C>     
Statutory rate applied to loss before taxes      $(1,851,000)    $(1,144,000)    $(882,000)
Current period tax benefits not utilized           1,851,000       1,144,000       882,000
                                                 -----------------------------------------
                                                 $         -     $         -     $       -
                                                 =========================================
</TABLE>

At December 31, 1996, the Company has net operating loss, research and
development credit, and investment tax credit carryforwards (under existing tax
laws) as follows:

<TABLE>
<CAPTION>
Carryforward                                      Net Operating     
 Expiration                                           Loss           Tax Credits
--------------------------------------------------------------------------------
<S>                                               <C>                <C>
    1997                                          $     700,000      $     6,000
    1998                                                400,000           22,000
    1999                                                      -           15,000
    2000                                                900,000                -
    2006                                              1,100,000           82,000
    2007                                              3,100,000          124,000
    2008                                              2,100,000          126,000
    2009                                              3,000,000          138,000
    2010                                              3,500,000           60,000
    2011                                              5,100,000            5,000
                                                  ------------------------------
                                                  $  19,900,000      $   578,000
                                                  ==============================
</TABLE>

                                     F-13
<PAGE>
 
ANCOR COMMUNICATIONS, INCORPORATED

NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

Note 6.  Income Taxes (Continued)

Under existing federal tax laws, due to changes in stock ownership resulting
from the Company's initial public offering (IPO), the availability of its net
operating loss and tax credit carryforwards incurred through May 1994 will be
limited to approximately $800,000 on an annual basis.  Sales of equity
securities subsequent to the Company's IPO could further limit the availability
of these carryforwards.

Note 7.  Shareholders' Equity

Preferred stock: In 1996, the Board of Directors designated 1,100 shares of the
authorized preferred stock as Series A Preferred Stock. In March 1996, the
Company sold 1,030 shares of Series A Preferred Stock in a private placement
transaction which provided proceeds of $9,543,534, net of issuance costs of
$756,466. In addition, the placement agent was granted warrants to purchase
111,094 shares of common stock at $6.49 per share.

The Series A Preferred Stock has a stated value and liquidation preference of
$10,000, plus an 8 percent per annum premium. The holders of the Series A
Preferred Stock are not entitled to vote or to receive dividends. Each share of
Series A Preferred Stock is convertible into common stock at the option of the
holder based on its stated value at the conversion date divided by a conversion
price. The conversion price is defined as the lesser of $6.49 per share or 85
percent of the average closing bid price of the Company's common stock for the
five days preceding the conversion date. During 1996, a total of 856 shares of
Series A Preferred Stock were converted into 1,352,494 shares of common stock.

The Series A Preferred Stock also includes provisions for (i) adjustment of the
conversion rate and price in the event of stock splits, stock dividends, and
mergers, (ii) restrictions on the Company's ability to issue capital stock with
distribution or liquidation preferences senior to the Series A Preferred Stock,
(iii) registration rights, and (iv) redemption by the Company in certain
circumstances. The Series A Preferred Stock outstanding on February 23, 1999,
automatically converts into common stock at the applicable conversion rate.

Options and warrants: The Company's 1994 Long-Term Incentive and Stock Option
Plan provides for the granting of stock options, stock appreciation rights,
restricted stock awards, and performance awards to officers, directors,
employees, and independent contractors of the Company. The options may be
granted at an exercise price of not less than the fair market value of common
stock at the date of grant (110 percent for more than 10 percent shareholders).

During 1995, in connection with the private placement of common stock, the
Company granted the underwriters warrants to purchase 75,500 shares of common
stock at $5.13 per share.

During 1994, the Company issued 1,200,000 shares of common stock to IBM in
exchange for a warrant to purchase 2,736,164 shares of Company common stock. No
proceeds were received from this transaction.

                                     F-14
<PAGE>
 
ANCOR COMMUNICATIONS, INCORPORATED

NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

Note 7.  Shareholders' Equity (Continued)

The Company has adopted the disclosure-only provisions of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation.
Accordingly, no compensation cost has been recognized for the stock option plan.
Had compensation cost for the Company's stock option plan been determined based
on the fair value at the grant date for awards in 1996 and 1995 consistent with
the provisions of SFAS No. 123, the Company's net loss and net loss per share
would have been increased to the pro forma amounts indicated below:


<TABLE>
<CAPTION>
                                        1996             1995
------------------------------------------------------------------
<S>                                <C>              <C>    
Net loss, as reported              $  (5,289,684)     $ (3,268,915)  
Net loss, pro forma                   (5,781,684)       (3,324,915)   
Net loss per share, as reported            (0.60)            (0.44)
Net loss per share, pro forma              (0.65)            (0.45)
</TABLE>

The above pro forma effects on net loss and net loss per share are not likely to
be representative of the effects on reported net income (loss) for future years
because options vest over several years and additional awards generally are made
each year.

The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 1996 and 1995:

<TABLE>
<CAPTION>
                                      1996      1995
--------------------------------------------------------
<S>                                 <C>        <C>                              
Expected dividend yield             $    --    $   --
Expected stock price volatility          82%       58%
Risk-free interest rate                6.05%     5.70%
Expected life of options (years)          2       2.5
</TABLE>

                                     F-15
<PAGE>
 
ANCOR COMMUNICATIONS, INCORPORATED

NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

Note 7.  Shareholders' Equity (Continued)

Transactions involving stock options and warrants during the three years ended
December 31, 1996, are summarized as follows:

<TABLE>
<CAPTION>



                                                                    Weighted
                                                                    Average
                                                                 Exercise Price
                                     Warrants     Stock Options    Per Share
-------------------------------------------------------------------------------
<S>                                  <C>           <C>             <C>
Balance, December 31, 1993           3,136,164       245,600       $  1.91
  Granted                              200,000        81,000          4.58
  Exercised                                 --          (499)         1.50
  Expired                                   --          (834)         1.50
  Exchanged                         (2,736,164)           --          1.50
                            ---------------------------------------------------
Balance, December 31, 1994             600,000       325,267          3.35
  Granted                               85,500       201,500          5.08
  Exercised                                 --       (19,035)         1.57
  Expired                                   --       (35,566)         3.49
                            ---------------------------------------------------
Balance, December 31, 1995             685,500       472,166          4.26
  Granted                              135,094       471,000          9.39
  Exercised                           (705,762)      (89,791)         3.72
  Expired                                   --       (12,942)         5.00
                            ---------------------------------------------------
Balance, December 31, 1996             114,832       840,433       $  7.31
                            ===================================================
</TABLE>

The weighted average fair value of options and warrants granted during 1996 and
1995 was $4.70 and $2.00, respectively.

The following tables summarize information about stock options and warrants
outstanding as of December 31, 1996:


                        OPTIONS AND WARRANTS OUTSTANDING

<TABLE>
<CAPTION>
                                                  


                                         Weighted
                                          Average    Weighted
                             Number      Remaining   Average
                            of Units    Contractual  Exercise
Range of Exercise Price    Outstanding     Life       Price
-----------------------------------------------------------------
<S>                       <C>          <C>          <C>
$1.50                           19,642      0.5      $  1.50
3.20 - 4.87                    253,958      4.5         3.85
5.13 - 7.50                    390,665      6.5         5.70
9.13 - 13.25                   291,000      7.5        12.88
                           -----------              ---------
                               955,265               $  7.31
                           ===========              =========
</TABLE>

                                      F-16
<PAGE>
 
ANCOR COMMUNICATIONS, INCORPORATED

NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

Note 7.  Shareholders' Equity (Continued)

                        OPTIONS AND WARRANTS EXERCISABLE

<TABLE>
<CAPTION>


                                        Weighted
                             Number     Average
                            of Units    Exercise
Range of Exercise Price    Exercisable   Price
------------------------------------------------
<S>                        <C> <C>    <C>
1.50                          19,642   $  1.50
3.20 - 4.87                  145,227      3.70
5.13 - 7.50                  137,832      5.48
9.13 - 13.25                      --        --
                         -----------------------
                             302,701   $  4.37
                         =======================
</TABLE>

Note 8.  Commitments

Operating leases:  The Company leases its office and manufacturing facility and
certain equipment under operating leases.  The minimum annual future rentals
under these noncancelable operating leases are as follows:

<TABLE>
<CAPTION>

Years ending December 31:
<S>                                       <C>
1997                                    $  206,055
1998                                        69,345
1999                                         2,918
                                        -----------
                                        $  278,318
                                        ===========
</TABLE>

The office and manufacturing facility lease requires the Company to pay real
estate taxes, insurance, and maintenance costs. Total rent expense under the
operating lease arrangements for 1996, 1995, and 1994, was approximately
$439,000, $312,000, and $320,000, respectively.

Potential contingent consideration: In connection with its 1986 acquisition of
Anderson Cornelius Company (subsequently merged into Ancor), the Company agreed
to pay additional contingent consideration. This additional consideration (up to
a remaining maximum of approximately $259,000) is payable annually at 4 percent
of Company sales in excess of $4,000,000 in any calendar year and is recorded as
cost in excess of assets acquired. Amounts payable under this arrangement were
not material in any year presented.

Profit sharing plan: The Company has a profit sharing/401(k) plan which provides
that an annual contribution, up to the maximum amount allowed as a deduction by
the Internal Revenue Code, may be contributed by the Company to the plan.
Company contributions to the plan are discretionary as determined by the Board
of Directors. No contributions were made by the Company during 1996, 1995, and
1994.

                                      F-17

<PAGE>
 
ANCOR COMMUNICATIONS, INCORPORATED

NOTES TO FINANCIAL STATEMENTS
-------------------------------------------------------------------------------

Note 8.  Commitments (Continued)

Major supplier: The Company outsources the manufacturing of its products with a
contract manufacturer. Purchases from this manufacturer were approximately
$5,086,000 and $870,000 in 1996 and 1995, respectively. The manufacturer has the
right to require that the Company purchase any excess or obsolete inventory, as
defined by the agreement, from the manufacturer. At December 31, 1996, the
Company has accrued approximately $50,000 as an estimate of the potential
commitments under this contract. Management believes that alternative contract
manufacturers are available.

Note 9.  Product Returns and Significant Fourth-Quarter Adjustments

The Company began to experience significant product returns in the second and
third quarters of 1996 as a result of rapidly changing market conditions,
changes in the Company's marketing strategies, and the difficulty of certain
customers with integrating the technology of the Company's products. At December
31, 1996, the Company has recorded a net reserve for product returns of 
$150,000 ($300,000 gross reserve, net of $150,000 estimated value of returned 
product) for estimated future product returns related to 1996 sales.

In the fourth quarter of 1996, the Company made significant adjustments relating
to customer cancellations of sales made in prior 1996 quarters, the recording of
a product returns reserve (discussed above), inventory reserves and write-offs,
and other asset write-offs. These adjustments had the effect of increasing the
fourth-quarter net loss and net loss per common share by approximately $944,000
and $0.09 per share, respectively.

                                     F-18