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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTIONS 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarter Ended September 30, 2002 Commission File Number 0-13071
INTERPHASE CORPORATION
(Exact name of registrant as specified in its charter)
TEXAS 75-1549797
(State of incorporation) (IRS Employer Identification No.)
PARKWAY CENTRE I
2901 NORTH DALLAS PARKWAY, SUITE 200
PLANO, TEXAS 75093
(Address of principal executive offices)
(214)-654-5000
(Registrant's telephone number, including area code)
- --------------------------------------------------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for a much 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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at November 11, 2002
----- --------------------------------
Common Stock, $.10 par value 5,514,276
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INTERPHASE CORPORATION
INDEX
PART I -FINANCIAL INFORMATION
Item 1. Consolidated Interim Financial Statements
Consolidated Balance Sheets as of September 30, 2002 (unaudited)
and December 31, 2001 3
Consolidated Statements of Operations for the three months
and nine months ended September 30, 2002 and 2001 (unaudited) 4
Consolidated Statements of Cash Flows for the nine months
ended September 30, 2002 and 2001 (unaudited) 5
Notes to Consolidated Interim Financial Statements 6-12
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 12-19
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19
Item 4. Controls and Procedures 19
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 2. Changes in Securities and Use of Proceeds 20
Item 3. Defaults Upon Senior Securities 20
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 5. Other Information 20
Item 6. Exhibits and Report on Form 8-K 20
Signature 21
Certifications Pursuant to Rule 13a-14(b) 22-23
2
INTERPHASE CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except number of share data)
(unaudited)
Sept. 30, Dec. 31,
ASSETS 2002 2001
------------------------------------
Cash and cash equivalents $ 12,355 $ 10,415
Marketable securities 5,440 5,216
Restricted cash 3,500 3,500
Trade accounts receivable, less allowances for uncollectible
accounts and returns of $260 and $370, respectively 4,420 5,046
Inventories 4,096 6,655
Prepaid expenses and other current assets 486 480
Income taxes receivable -- 2,476
Deferred income taxes 1,604 1,636
------------------------------------
Total current assets 31,901 35,424
Machinery and equipment 6,311 6,117
Leasehold improvements 2,947 2,936
Furniture and fixtures 633 543
------------------------------------
9,891 9,596
Less-accumulated depreciation and amortization (9,231) (8,653)
------------------------------------
Total property and equipment, net 660 943
Capitalized software, net 239 335
Deferred income taxes, net 3,296 2,373
Other assets 270 168
------------------------------------
Total assets $ 36,366 $ 39,243
====================================
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Accounts payable $ 1,369 $ 921
Deferred revenue 346 110
Accrued liabilities 1,553 1,615
Accrued compensation 1,137 1,177
------------------------------------
Total current liabilities 4,405 3,823
Long term debt 3,500 3,500
------------------------------------
Total liabilities 7,905 7,323
COMMITMENTS AND CONTINGENCIES
Common stock redeemable; zero and 121,996 shares, respectively -- 762
SHAREHOLDERS' EQUITY
Common stock, $.10 par value; 100,000,000 shares
authorized; 5,514,276 and 5,518,476 shares issued and
outstanding, respectively 551 552
Additional paid in capital 37,304 37,324
Retained deficit (9,174) (6,394)
Cumulative other comprehensive loss (220) (324)
------------------------------------
Total shareholders' equity 28,461 31,158
------------------------------------
Total liabilities and shareholders' equity $ 36,366 $ 39,243
====================================
The accompanying notes are an integral part of these
consolidated financial statements.
3
INTERPHASE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except per share amounts)
(unaudited)
Three Months Ended Sept. 30, Nine Months Ended Sept. 30,
- ---------------------------- ------------------------------
2002 2001 2002 2001
- ---------------------------- ------------------------------
$ 6,022 $ 4,603 Revenues $ 18,338 $ 21,662
3,414 2,833 Cost of sales 11,676 16,127
- ---------------------------- ------------------------------
2,608 1,770 Gross margin 6,662 5,535
1,836 1,818 Research and development 5,198 6,118
1,433 1,320 Sales and marketing 4,414 5,542
846 795 General and administrative 2,415 2,921
Restructuring costs and other
-- -- special charges -- 2,091
- ---------------------------- ------------------------------
4,115 3,933 Total operating expenses 12,027 16,672
- ---------------------------- ------------------------------
(1,507) (2,163) Operating loss (5,365) (11,137)
- ---------------------------- ------------------------------
100 231 Interest, net 427 417
23 (395) Other, net 24 (616)
- ---------------------------- ------------------------------
(1,384) (2,327) Loss before income taxes (4,914) (11,336)
(663) (871) Benefit for income taxes (2,134) (3,686)
- ---------------------------- ------------------------------
$ (721) $ (1,456) Net loss $ (2,780) $ (7,650)
============================ ==============================
Loss per share
$ (0.13) $ (0.26) Basic EPS (0.50) $ (1.34)
- ---------------------------- ------------------------------
$ (0.13) $ (0.26) Diluted EPS $ (0.50) $ (1.34)
- ---------------------------- ------------------------------
5,521 5,689 Weighted average common shares 5,564 5,724
- ---------------------------- ------------------------------
Weighted average common and
5,521 5,689 dilutive shares 5,564 5,724
- ---------------------------- ------------------------------
The accompanying notes are an integral part of these
consolidated financial statements.
4
INTERPHASE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Nine Months ended Sept. 30,
----------------------------------------
2002 2001
----------------------------------------
CASH FLOW FROM OPERATING ACTIVITIES:
Net loss $ (2,780) $ (7,650)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Noncash realized holding period loss on marketable securities -- 334
Provision for uncollectible accounts and returns (76) 30
Provision for excess and obsolete inventory 1,649 4,794
Depreciation and amortization 628 1,503
Deferred income taxes (891) 115
Tax benefit from stock option exercises -- 94
Non-cash restructuring costs and other special charges -- 1,608
Change in assets and liabilities:
Trade accounts receivable 701 11,360
Inventories 910 793
Prepaid expenses and other current assets (2) 351
Income taxes receivable 2,476 (3,785)
Other assets (90) 13
Accounts payable, deferred revenue and accrued liabilities 596 (2,667)
Accrued compensation (102) (993)
Income tax payable -- (78)
----------------------------------------
Net adjustments 5,799 13,472
----------------------------------------
Net cash provided by operating activities 3,019 5,822
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, equipment, capitalized software and
leasehold improvements (233) (469)
Proceeds from sale of marketable securities 1,014 5,929
Purchases of marketable securities (1,187) (3,922)
----------------------------------------
Net cash used by investing activities (406) 1,538
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on debt -- (1,683)
Purchase of redeemable common stock (762) (763)
Purchase of common stock (21) --
Proceeds from the exercise of stock options -- 154
----------------------------------------
Net cash used by financing activities (783) (2,292)
----------------------------------------
Effect of exchange rate changes on cash and cash equivalents 110 (84)
----------------------------------------
Net increase in cash and cash equivalents 1,940 4,984
----------------------------------------
Cash and cash equivalents at beginning of period 10,415 10,587
----------------------------------------
Cash and cash equivalents at end of period $ 12,355 $ 15,571
========================================
The accompanying notes are an integral part of these
consolidated financial statements.
5
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
Interphase Corporation and subsidiaries ("Interphase" or the "Company") enables
rapid platform design and integration for the global voice and data
communications markets through custom and off-the-shelf communications
equipment, embedded software development suites, and systems integration and
consulting services for telecom and enterprise networks. The Company's products
connect computer and telecommunication servers to Wide Area Networks (WANs),
Local Area Networks (LANs) and Storage Area Networks (SANs) using Asynchronous
Transfer Mode (ATM), Ethernet, Signaling System 7 (SS7), IP, Fibre Channel,
HDLC, Frame Relay and Integrated Services Digital Network (ISDN) technologies.
The accompanying consolidated interim financial statements include the accounts
of Interphase Corporation and its wholly owned subsidiaries. Significant
intercompany accounts and transactions have been eliminated.
While the accompanying interim financial statements are unaudited, they have
been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission. In the opinion of the Company, all material
adjustments and disclosures necessary to fairly present the results of such
periods have been made. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with accounting
principles generally accepted in the United States have been condensed or
omitted pursuant to the rules and regulations of the Securities and Exchange
Commission. These financial statements should be read in conjunction with the
consolidated financial statements and notes thereto for the year ended December
31, 2001.
Certain prior period amounts within the Statements of Cash Flows have been
reclassified to conform with the 2002 presentation.
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States, requires Company 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.
Areas involving significant estimates are the allowance for bad debts, warranty
reserves, allowance for returns and inventory valuation.
6
2. RESTRUCTURING COSTS AND OTHER SPECIAL CHARGES
In the second quarter 2001, the Company announced a restructuring program
designed to allow the Company to continue aggressive funding of its development
organizations, while preserving cash levels and securing new design-ins. As a
result of the restructuring program, continued decline in predicted revenue and
customers' cautious expectations regarding market recovery, the Company recorded
restructuring costs and other special charges of $2.1 million, classified as
operating expenses, and an additional excess and obsolete inventory charge of
$4.4 million, classified as cost of sales.
The restructuring program resulted in the reduction of approximately 22% of the
Company's workforce, impacting all business functions in North America. As a
result, the Company recorded a workforce reduction charge of $483,000 relating
to severance and fringe benefits. In addition, the Company wrote off $123,000 of
nonutilized fixed assets.
Due to the decline in business conditions, decline in legacy product revenues
and the diminished expected future benefits from the purchased intangibles
related to the acquisition of Synaptel, S.A. in 1996, the Company recorded a
charge of $1.5 million related to the impairment of developed technology and
assembled workforce during the second quarter 2001. These intangible assets,
purchased in the acquisition of Synaptel, S.A., relate to the Company's legacy
product lines. In the second quarter 2000, the Company developed a strategy to
end-of-life many of its legacy products in an effort to focus its resources on
its new product lines. This strategy resulted in increased sales of legacy
products in 2000; however, legacy product revenues declined in the first quarter
of 2001, and continued to decline through the second quarter of 2001. Management
did not expect significant revenues from its legacy product lines in future
periods.
The Company wrote off $5.9 million of excess and obsolete inventory during the
second quarter of 2001, resulting in an additional charge to cost of sales of
$4.4 million. Approximately 74% of the write-off relates to the Company's legacy
product lines. The remaining $1.5 million of excess and obsolete inventory
written off was charged against the already established reserve. This additional
excess and obsolete inventory charge was due to a sudden and significant
decrease in predicted revenue and was calculated in accordance with the
Company's established policy.
7
Only the severance and fringe benefit payments relating to the workforce
reduction impacted cash flow. A summary of the restructuring costs and other
special charges is outlined as follows (in thousands):
Second Quarter
Cash Payments Third Fourth Accrual
Total and Noncash Quarter Cash Quarter Cash Balance at
Charge Charges Payments Payments Dec. 31, 2001
----------------------------------------------------------------------------
Workforce reduction $ 483 $ 17 $ 384 $ 82 $ --
Fixed asset write-off 123 123 -- -- --
Impairment of purchased
intangibles 1,485 1,485 -- -- --
Excess and obsolete
inventory charge 4,394 4,394 -- -- --
----------------------------------------------------------------------------
$6,485 $6,019 $ 384 $ 82 $ --
============================================================================
3. INVENTORIES
Inventories are valued as the lower of cost or market and include material,
labor and manufacturing overhead. Cost is determined on a first-in, first-out
basis (in thousands):
Sept. 30, 2002 Dec. 31, 2001
-----------------------------------
Raw Materials $ 2,896 $ 4,740
Work-in-Process 837 1,397
Finished Goods 363 518
-----------------------------------
Total $ 4,096 $ 6,655
===================================
Valuing inventory at the lower of cost or market involves an inherent level of
risk and uncertainty due to technology trends in the industry and customer
demand for our products. Future events may cause significant fluctuations in our
operating results.
4. DEFERRED TAXES
As of September 30, 2002, the Company had net deferred tax assets of $4.9
million, reflecting net operating loss carryforwards and temporary differences
which will reduce taxable income in future years. Management is required to
assess the realization of the deferred tax assets. Significant changes in
circumstances may require adjustments during interim periods. The future tax
benefits related to the domestic deferred tax assets are not reserved as it has
been more likely than not that they will be realized due to their relatively
long carryforward periods. Although realization is not assured, management has
concluded at this point that it is more likely than not that the net deferred
tax assets will be realized. However, the Company has incurred significant
losses from operations over recent quarters and due to uncertain market
conditions and the difficulty in determining reliable forecasts, management's
long and short-term forecasts will require
8
frequent reassessment. As a result, the Company may need to establish valuation
allowances for all or a portion of the net deferred tax assets.
5. CREDIT FACILITY
The Company has a $5 million revolving credit facility with a bank. The
revolving credit facility was extended during the quarter and now matures on
June 30, 2004 and is secured throughout the term of the credit facility by a
ninety-day certificate of deposit issued by the bank in the principal amount
equal to the stated principal amount of the promissory note. The certificate of
deposit is reflected as restricted cash on the accompanying balance sheet. The
credit facility bears interest at the rate of approximately 1% per annum above
the certificate of deposit rate, which was 1.39% at September 30, 2002, and
includes certain restrictive covenants including, among others, a tangible net
worth restriction. As of September 30, 2002, the Company was in compliance with
all restrictive covenants included in the revolving credit facility. At
September 30, 2002, the Company had borrowings of $3.5 million and availability
under the revolving credit facility was $1.5 million.
6. COMPREHENSIVE INCOME
The following table shows the Company's comprehensive income (in thousands):
Three months ended Sept. 30, Nine months ended Sept. 30,
2002 2001 2002 2001
-------------------------------------------------------------
Net loss $ (721) $ (1,456) $ (2,780) $ (7,650)
Other comprehensive income:
Unrealized holding (loss) gain
arising during period, net of tax 66 161 51 212
Foreign currency translation adjustment (17) 154 53 (52)
-------------------------------------------------------------
Comprehensive loss $ (672) $ (1,141) $ (2,676) $ (7,490)
=============================================================
7. NET INCOME PER COMMON AND COMMON DILUTIVE SHARE
Diluted earnings per share consist only of the dilutive impact of stock options,
using the treasury stock method. Due to the Company's net losses for the periods
presented, the effect of dilutive securities would have been antidilutive.
Options that would have otherwise been included in the calculation of diluted
earnings per common share were 123 and 3,893 stock options for the three-month
periods ended September 30, 2002 and 2001 and 13,889 and 66,181 stock options
for the nine-month periods ended September 30, 2002 and 2001, respectively.
9
8. SEGMENT INFORMATION
The Company is principally engaged in the business of enabling rapid platform
design and integration for the global voice and data communications markets
through custom and off-the-shelf communications equipment, embedded software
development suites, and systems integration and consulting services for telecom
and enterprise networks. Except for revenue performance, which is monitored by
product line, the chief operating decision-makers review financial information
presented on a consolidated basis, for purposes of making operating decisions
and assessing financial performance. Accordingly, the Company considers itself
to be in a single industry segment.
Geographic revenue and long-lived assets related to North America and other
foreign countries as of and for the three-month periods and nine-month periods
ended September 30, 2002 and 2001 are as follows: (in thousands)
Three months ended Sept. 30: Nine months ended Sept. 30:
Revenue 2002 2001 2002 2001
- -------------------------------------------------------------------------------------------------------------
North America $ 4,842 $3,303 $ 13,501 $17,307
Europe 582 1,300 3,122 3,865
Pac Rim 598 -- 1,715 490
--------------------------------------------------------------------------
Total $ 6,022 $ 4,603 $ 18,338 $ 21,662
=========================================================================
Geographic long-lived assets consist of property and equipment and capitalized
software, net of the related accumulated depreciation and amortization. (in
thousands)
Long-lived assets Sept. 30, 2002 Dec. 31, 2001
- -----------------------------------------------------------------------
North America $ 749 $ 1,116
Europe 149 160
Pacific Rim 1 2
------------------------------
Total $ 899 $ 1,278
==============================
Additional information regarding revenue by product line is as follows: (in
thousands)
Three months ended Sept. 30: Nine months ended Sept. 30:
Revenue 2002 2001 2002 2001
- -------------------------------------------------------------------------------------------------------------
Telecom $ 3,441 $1,307 $ 8,429 $ 5,230
Combo 1,856 1,649 6,593 4,877
LAN 208 894 1,490 4,828
Storage 262 568 1,013 5,398
WAN 35 19 147 545
Other 220 166 666 784
--------------------------------------------------------------------------
Total $ 6,022 $ 4,603 $ 18,338 $ 21,662
=========================================================================
9. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," and
SFAS No. 142, "Goodwill and Other Intangible Assets." The most significant
changes made by SFAS No. 141 are: 1) requiring that the purchase method of
accounting be used for all business combinations initiated after June 30, 2001;
and 2) establishing specific criteria for the recognition of intangible assets
separately from goodwill. SFAS No. 142 primarily addresses the accounting for
acquired goodwill and intangible assets. The provisions of
10
SFAS No. 142 are effective for fiscal years beginning after December 15, 2001.
The most significant changes made by SFAS No. 142 are: 1) goodwill and
indefinite-lived intangible assets are no longer amortized; 2) goodwill will be
tested annually and whenever events or circumstances occur indicating that
goodwill might be impaired; and 3) the amortization period of intangible assets
with finite lives will no longer be limited to forty years. The Company adopted
SFAS No. 141 effective July 1, 2001, and SFAS No. 142 effective January 1, 2002,
however, as the Company's goodwill was determined to be impaired and was written
off in the fourth quarter of 2001, the adoption of these standards did not have
a material effect on the Company's financial position or results of operations
for the periods ended September 30, 2002.
The following tables show the impact that SFAS No. 142 would have had if adopted
as of January 1, 2001: (in thousands)
Three months ended Sept. 30, Nine months ended Sept. 30,
2002 2001 2002 2001
------------------------------------------------------------------
Reported net loss $ (721) $(1,456) $(2,780) $(7,650)
Goodwill amortization - 60 - 180
------------------------------------------------------------------
Adjusted net loss $ (721) $(1,396) $(2,780) $(7,470)
==================================================================
Three months ended Sept. 30, Nine months ended Sept. 30,
Basic loss per share: 2002 2001 2002 2001
------------------------------------------------------------------
Reported net loss $(0.13) $ (0.26) $ (0.50) $ (1.34)
Goodwill amortization -- 0.01 -- 0.03
------------------------------------------------------------------
Adjusted basic net loss per share $(0.13) $ (0.25) $ (0.50) $ (1.31)
==================================================================
Three months ended Sept. 30, Nine months ended Sept. 30,
Diluted loss per share: 2002 2001 2002 2001
------------------------------------------------------------------
Reported net loss $(0.13) $ (0.26) $ (0.50) $ (1.34)
Goodwill amortization -- 0.01 -- 0.03
------------------------------------------------------------------
Adjusted diluted net loss per share $(0.13) $ (0.25) $ (0.50) $(1.31)
==================================================================
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." SFAS No. 143 requires the fair value of a liability for an asset
retirement obligation to be recognized in the period that it is incurred if a
reasonable estimate of fair value can be made. The associated asset retirement
costs are capitalized as part of the carrying amount of the long-lived asset.
SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The
adoption of SFAS No. 143 is not expected to have a material impact on the
Company's results of operations, financial position or cash flows.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS No. 144 addresses financial accounting and
reporting for the impairment of long-lived assets and for long-lived assets to
be disposed of. This statement supersedes SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of;"
however, this statement retains the fundamental provisions of SFAS No. 121 for
(a) recognition and measurement of the impairment of long-lived assets to be
held and used, and (b) measurement of long-lived assets to be disposed of by
sale. This statement also supersedes the accounting and reporting provisions of
APB Opinion No. 30, "Reporting the Results of Operations -- Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions" for segments of a business to be
11
disposed of. SFAS No. 144 is effective for fiscal years beginning after December
15, 2001. The Company adopted this standard effective January 1, 2002. The
adoption of this standard did not have a material effect on the Company's
financial position or results of operations for the periods ended September 30,
2002.
In April 2002, the FASB issued SFAS No. 145, "Recission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections as
of April 2002," which rescinded or amended various existing standards. One
change addressed by this standard pertains to treatment of extinguishments of
debt as an extraordinary item. SFAS No. 145 rescinds SFAS No. 4, "Reporting
Gains and Losses from Extinguishment of Debt" and states that an extinguishment
of debt cannot be classified as an extraordinary item unless it meets the
unusual or infrequent criteria outlined in Accounting Principles Board Opinion
No. 30 "Reporting the Unusual and Infrequently Occurring Events and
Transactions." The provisions of this statement are effective for fiscal years
beginning after May 15, 2002 and extinguishments of debt that were previously
classified as an extraordinary item in prior periods that do not meet the
criteria in Opinion 30 for classification as an extraordinary item shall be
reclassified. The adoption of SFAS No. 145 is not expected to have a material
impact on the Company's results of operations, financial position or cash flows.
In June 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated with
Exit or Disposal Activities," which requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to an exit or disposal plan. The provisions of this
statement are effective for exit or disposal activities initiated after December
31, 2002 and are not expected to have a material impact on the Company's results
of operations, financial position or cash flows.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This report contains forward-looking statements about the business, financial
condition and prospects of the Company. These statements are made under the
"safe harbor" provisions of the Private Securities Litigation Reform Act of
1995. The actual results of the Company could differ materially from those
indicated by the forward-looking statements because of various risks and
uncertainties, including without limitation, changes in product demand, the
availability of products, changes in competition, economic conditions, various
inventory risks due to changes in market conditions and other risks indicated in
the Company's filings and reports with the Securities and Exchange Commission.
All the foregoing risks and uncertainties are beyond the ability of the Company
to control, and in many cases, the Company cannot predict the risks and
uncertainties that could cause its actual results to differ materially from
those indicated by the forward-looking statements. When used in this report, the
words "believes," "plans," "expects," "intends" and "anticipates" and similar
expressions as they relate to the Company or its management are intended to
identify forward-looking statements.
12
APPLICATION OF CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are based on the selection and
application of significant accounting policies, which require management to make
significant 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.
Management believes that the following are some of the more critical judgment
areas in the application of the Company's accounting policies that affect the
Company's financial condition and results of operations.
REVENUE RECOGNITION: Revenues consist of product and service revenues and are
recognized in accordance with SEC Staff Accounting Bulletin ("SAB") 101,
"Revenue Recognition." Product revenues are recognized upon shipment, provided
fees are fixed and determinable, a customer purchase order is obtained, and
collection is probable. Revenues from reseller agreements are recognized when
the product is sold through to the end customer unless an established return
history supports recognizing revenue upon shipment, less a provision for
estimated sales returns. The Company maintains its allowance for returns as a
reduction to accounts receivable. Deferred revenue consists of revenue from
reseller arrangements and certain arrangements with extended payment terms.
Revenue from extended payment terms is recognized in the period the payment
becomes due if all other revenue recognition criteria have been met. Service
revenue is recognized as the services are performed. The Company offers to its
customers a limited warranty that its products will be free from defect in the
materials and workmanship for a specified period. The Company has established a
warranty reserve, as a component of accrued liabilities, for any potential
claims.
ALLOWANCE FOR DOUBTFUL ACCOUNTS: Management is required to estimate the
collectibility of the Company's trade receivables. A considerable amount of
judgment is required in assessing the realization of these receivables,
including the current creditworthiness of each customer and related aging of the
past due balances. Management evaluates specific accounts when they become aware
of a situation where a customer may not be able to meet its financial
obligations due to a deterioration of its financial viability, credit ratings or
bankruptcy. The reserve requirements are based on the best facts available to
management and reevaluated and adjusted as additional information is received.
The reserves also are determined by using percentages applied to certain aged
receivable categories based on historical results.
INVENTORIES: Inventories are valued at the lower of cost or market and include
material, labor and manufacturing overhead. Cost is determined on a first-in,
first-out basis. Valuing inventory at the lower of cost or market involves an
inherent level of risk and uncertainty due to technology trends in the industry
and customer demand for our products. In assessing the ultimate realization of
inventories, management is required to make judgments as to future demand
requirements and compare that with the current or committed inventory levels.
Reserve requirements generally increase as projected demand requirements
decrease due to market conditions, technological and product life cycle changes
as well as longer than previously expected usage periods. The Company has
experienced significant changes in required reserves in recent periods due to
changes
13
in strategic direction, such as discontinuances of product lines as well as
declining market conditions. It is possible that significant changes in required
inventory reserves may continue to occur in the future if there is a further
decline in market conditions.
DEFERRED TAXES: As of September 30, 2002, the Company had net deferred tax
assets of $4.9 million, reflecting net operating loss carryforwards and
temporary differences which will reduce taxable income in future years.
Management is required to assess the realization of the deferred tax assets.
Significant changes in circumstances may require adjustments during interim
periods. The future tax benefits related to the domestic deferred tax assets are
not reserved as it has been more likely than not that they will be realized due
to their relatively long carryforward periods. Although realization is not
assured, management has concluded at this point that it is more likely than not
that the net deferred tax assets will be realized. However, the Company has
incurred significant losses from operations over recent quarters and due to
uncertain market conditions and the difficulty in determining reliable
forecasts, management's long and short-term forecasts will require frequent
reassessment. As a result, the Company may need to establish valuation
allowances for all or a portion of the net deferred tax assets.
Management has discussed the application of these critical accounting policies
with the Board of Directors and Audit Committee. There was no adoption of any
accounting policies during the three months ended September 30, 2002.
RESULTS OF OPERATIONS
REVENUES: Total revenues for the three months ended September 30, 2002 were $6
million. Revenues for the same period in 2001 ("comparative period") were $4.6
million. Telecom product revenues increased to $3.4 million for the three months
ended September 30, 2002, from $1.3 million in the comparative period. Telecom
product revenues have been growing steadily throughout 2002, as some of the
Company's design wins have been moving into production. However, the
telecommunications equipment market continues to struggle through a prolonged
contraction. Combo product revenues also increased reaching $1.9 million for the
three months ended September 30, 2002 compared to $1.6 million in the
comparative period. These increases were partially offset by the anticipated
decline in revenues from the Company's legacy product lines. Legacy product
revenues decreased from $1.3 million in the comparative period to $257,000 for
the three months ended September 30, 2002.
Two customers individually accounted for 43% and 28% of the Company's third
quarter 2002 revenue. In the comparative period, one customer individually
accounted for 42% of the Company's revenue.
Total revenues for the nine months ended September 30, 2002 were $18.3 million.
Revenues for the nine months ended September 30, 2001 were $21.7 million. The
reduction in revenues was generally due to the continued market slowdown, which
has significantly reduced computer and communications equipment purchasing by
key customers, as well as the discontinuance of several lines of legacy
technologies. Legacy revenues decreased from $6.5 million for the nine months
ended September 30, 2001 to $1.7 million for the nine months ended September 30,
2002. In addition to the decrease in legacy technologies, revenues from Fibre
Channel products decreased from $4.2
14
million for the nine months ended September 30, 2001 to $980,000 for the nine
months ended September 30, 2002. The decrease in legacy and Fibre Channel
revenues was partially offset by revenue growth in combo technologies and the
telecom product line. Combo technologies revenue increased to $6.6 million for
the nine months ended September 30, 2002 from $4.9 million for the nine months
ended September 30, 2001. Telecom product revenues increased to $8.4 million for
the nine months ended September 30, 2002 from $5.2 million for the nine months
ended September 30, 2001.
GROSS MARGIN: Gross margin as a percentage of revenues was 43% for the third
quarter 2002 and 38% for the comparative period. The increase in the gross
margin percentage primarily relates to cost improvement strategies implemented
in certain product lines as well as improved operating efficiency in the
Company's repair organization. These increases in gross margin were partially
offset by a larger reserve for inventory obsolescence charge for the three
months ended September 30, 2002 relative to the comparative period.
The gross margin percentage for the nine months ended September 30, 2002 and
2001 was 36% and 26%, respectively. The increase in the gross margin percentage
primarily relates to an excess and obsolete inventory charge of $4.4 million
incurred during the second quarter 2001 compared to an excess and obsolete
inventory charge of $1.1 million incurred during the second quarter 2002. This
increase was partially offset by the change in product mix. Gross margin as a
percentage of revenues, before considering the excess and obsolete inventory
charges, was 42% and 46% for the nine months ended September 30, 2002 and 2001,
respectively.
RESEARCH AND DEVELOPMENT: The Company's investment in the development of new
products through research and development was $1.8 million for both the three
months ended September 30, 2002 and the comparative period. As a percentage of
revenue, research and development expenses were 30% in the third quarter 2002
and 39% in the comparative period. Research and development expenses decreased
as a percentage of revenue due to the increase in revenue from the comparative
period.
The Company's investment in the development of new products through research and
development was $5.2 million and $6.1 million for the nine months ended
September 30, 2002 and 2001, respectively. As a percentage of revenue, research
and development expenses were 28% for the nine months ended September 30, 2002
and 28% for the nine months ended September 30, 2001. Approximately 57% of the
decrease in research and development expenses for the nine months ended
September 30, 2002 was due to a reduction in headcount associated with the
Company's restructuring program and other cost reduction initiatives implemented
at the end of the second quarter 2001. The remaining portion of the decrease
primarily related to decreased spending on legacy sustaining engineering,
partially offset by an increase in telecommunications development spending.
SALES AND MARKETING: Sales and marketing expenses were $1.4 million in the third
quarter 2002 and $1.3 million in the comparative period. As a percentage of
revenue, sales and marketing expenses were 24% in the third quarter 2002 and 29%
in the comparative period. Sales and marketing expenses decreased as a
percentage of revenue due to the increase in revenue from the comparative
period.
15
Sales and marketing expenses were $4.4 million and $5.5 million for the nine
months ended September 30, 2002 and 2001, respectively. As a percentage of
revenue, sales and marketing expenses were 24% for the nine months ended
September 30, 2002 and 26% for the nine months ended September 30, 2001. The
decrease in sales and marketing expenses for the nine months ended September 30,
2002 was primarily due to a reduction in headcount associated with the Company's
restructuring program and other cost reduction initiatives implemented at the
end of the second quarter 2001. In addition, commission and sales bonus expense
was down approximately 12%, period over period, due to lower revenue levels.
Sales and Marketing expenses were relatively flat as a percentage of revenues.
GENERAL AND ADMINISTRATIVE: General and administrative expenses were $846,000 in
the third quarter 2002 and $795,000 in the comparative period. As a percentage
of revenue, general and administrative expenses were 14% in the third quarter
2002 and 17% in the comparative period. General and administrative expenses
decreased as a percentage of revenues due to the increase in revenues.
General and administrative expenses were $2.4 million and $2.9 million for the
nine months ended September 30, 2002 and 2001, respectively. As a percentage of
revenue, general and administrative expenses were 13% for both the nine months
ended September 30, 2002 and 2001. The decrease in general and administrative
expenses for the nine months ended September 30, 2002 is primarily the result of
a reduction in headcount associated with the Company's restructuring program and
cost reduction initiatives implemented at the end of the second quarter 2001.
RESTRUCTURING COSTS AND OTHER SPECIAL CHARGES: In the second quarter 2001, the
Company announced a restructuring program designed to allow the Company to
continue aggressive funding of its development organizations, while preserving
cash levels and securing new design-ins. As a result of the restructuring
program, continued decline in predicted revenue and customers' cautious
expectations regarding market recovery, the Company recorded restructuring costs
and other special charges of $2.1 million, classified as operating expenses, and
an additional excess and obsolete inventory charge of $4.4 million, classified
as cost of sales.
The restructuring program resulted in the reduction of approximately 22% of the
Company's workforce, impacting all business functions in North America. As a
result, the Company recorded a workforce reduction charge of $483,000 relating
to severance and fringe benefits. In addition, the Company wrote off $123,000 of
nonutilized fixed assets.
Due to the decline in business conditions, decline in legacy product revenues
and the diminished expected future benefits from the purchased intangibles
related to the acquisition of Synaptel, S.A. in 1996, the Company recorded a
charge of $1.5 million related to the impairment of developed technology and
assembled workforce during the second quarter 2001. These intangible assets,
purchased in the acquisition of Synaptel, S.A., relate to the Company's legacy
product lines. In the second quarter 2000, the Company developed a strategy to
end-of-life many of its legacy products in an effort to focus its resources on
its new product lines. This strategy resulted in increased sales of legacy
products in 2000; however, legacy product revenues declined in the first quarter
of
16
2001, and continued to decline through the second quarter of 2001. Management
did not expect significant revenues from its legacy product lines in future
periods.
INTEREST INCOME, NET: Interest income, net of interest expense, was $100,000 in
the third quarter 2002 and $231,000 in the comparative period. The decrease
primarily relates to lower investment rates of return.
Interest income, net of interest expense, was $427,000 and $417,000 for the nine
months ended September 30, 2002 and 2001, respectively.
OTHER INCOME (EXPENSE), NET: Other income (expense), net, was $23,000 in the
third quarter 2002 and ($395,000) in the comparative period. Other income
(expense), net in the comparative period includes charges related to the
amortization of goodwill of $60,000 and a charge of $334,000 due to the other
than temporary impairment of certain marketable securities received in the sale
of the Company's VOIP business. As the carrying value of the Company's goodwill
exceeded its fair value, the Company wrote off the carrying amount of its
goodwill in the fourth quarter of 2001. Additionally, there were no charges
related to impairment of marketable securities during the three months ended
September 30, 2002.
Other income (expense), net was $24,000 and ($616,000) for the nine months ended
September 30, 2002 and 2001, respectively. Other income (expense), net in the
nine months ended September 30, 2001, included charges for the amortization of
goodwill of $180,000 and purchased intangibles of $330,000. As the carrying
value of the Company's goodwill and purchased intangibles exceeded its fair
value, the Company wrote off the carrying amount of its goodwill in the fourth
quarter of 2001 and its purchased intangibles in the second quarter of 2001. In
addition to the elimination of amortization expense related to goodwill and
purchased intangibles during the third quarter 2001, the Company recorded a
charge of $334,000 due to the other than temporary impairment of certain
marketable securities received in the sale of the Company's VOIP business.
INCOME TAXES: The Company's effective income tax rate was (43%) for the nine
months ended September 30, 2002, and (33%) for the nine months ended September
30, 2001. The effective rate for the nine months ended September 30, 2002,
differed from the statutory rate due to foreign income, which is offset by
foreign loss carryforwards. The effective rate for the nine months ended
September 30, 2001 included the impact of nondeductible goodwill and purchased
intangibles amortization.
NET LOSS: The Company reported a net loss of $721,000 in the third quarter 2002
and a net loss of $1.5 million in the comparative period. The Company reported a
net loss of $2.8 million for the nine months ended September 30, 2002 and a net
loss of $7.7 million for the nine months ended September 30, 2001.
17
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2002, cash and cash equivalents totaled $12.4 million, an
increase of $1.9 million from the December 31, 2001 balance of $10.4 million.
The increase was attributable to cash provided by operating activities of $3
million and the effect of exchange rate changes of $110,000, partially offset by
cash used by investing activities of $406,000 and cash used by financing
activities of $783,000. Cash provided by operating activities was primarily
comprised of a decrease in income taxes receivable of $2.5 million due to an
income tax refund received in the second quarter, a decrease in inventories of
$910,000 and a decrease in accounts receivable of $701,000, partially offset by
cash used to fund operations of $2.8 million. Cash used by investing activities
was primarily comprised of purchases of marketable securities of $1.2 million
and fixed asset additions of $233,000, partially offset by proceeds from the
sale of marketable securities of $1 million. Cash used by financing activities
was primarily comprised of the purchase of redeemable common stock of $762,000.
At September 30, 2002, the Company had no material commitments to purchase
capital assets. The Company's significant long-term obligations are its
operating leases on its facilities and future debt payments. The Company has not
paid any dividends since its inception and does not anticipate paying any
dividends in 2002.
In October 2001, the Company announced that its Board of Directors had
authorized the repurchase of up to $5 million of its common stock. Purchases are
authorized to be made from time to time during a twenty-four month period in the
open market or in privately negotiated transactions depending on market
conditions. The Company will cancel all shares that it repurchases. The
repurchase plan does not obligate the Company to repurchase any specific number
of shares and may be suspended at any time. As of September 30, 2002, the
Company had repurchased and cancelled shares at a combined purchase price of
approximately $25,000 during the program.
The Company has a $5 million revolving credit facility with a financial
institution. The revolving credit facility expires in June 2004. As of September
30, 2002, the Company had borrowings of $3.5 million under the facility
classified as long-term debt on its balance sheet. These borrowings are fully
collateralized by a certificate of deposit.
Effective October 1998, the Company approved a stock repurchase agreement with
Motorola, Inc. to purchase ratably from October 1998 to July 2002, all of the
shares owned by Motorola for $4.1 million at $6.25 per share. Under the terms of
the agreement, Motorola retained the right as an equity owner and had assigned
its voting rights to the Company. The Company canceled the stock upon each
repurchase. Prior to the repurchase agreement, Motorola owned approximately 12%
of the Company's outstanding common stock. In July 2002, the Company made its
final repurchase of stock from Motorola and therefore has no further obligation
under the agreement.
The Company expects that its cash, cash equivalents, marketable securities and
proceeds from its credit facility will be adequate to meet foreseeable cash
needs for the next twelve months. However, it is possible that the Company may
require additional sources of financing earlier than anticipated, as a result of
unexpected cash needs or opportunities, an expanded growth strategy or
disappointing operating results. Additional funds may
18
not be available on satisfactory terms when needed, whether within the next
twelve to eighteen months or thereafter.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency Risk
Due to the fact that the Company conducts business on a global basis in various
foreign currencies, it is exposed to adverse movements in foreign currency
exchange rates. The Company's operations in France are measured in the local
currency converted to the U.S. dollar equivalent based on published exchange
rates for the periods reported and are therefore subject to risk of exchange
rate fluctuations. Foreign currency translation and transaction gains and losses
were not significant.
Market Price Risk
The Company maintains a minority equity investment in a publicly traded Company
and recorded a $334,000 net after tax loss during 2001 on this investment. The
Company has no equity hedge contracts outstanding as of September 30, 2002 or
December 31, 2001.
Interest Rate Risk
The Company's investments are subject to interest rate risk. Interest rate risk
is the risk that the Company's financial condition and results of operations
could be adversely affected due to movements in interest rates. The Company
invests its cash in a variety of interest-earning financial instruments,
including bank time deposits, money market funds, and variable rate and fixed
rate obligations of corporations and national governmental entities and
agencies. Due to the demand nature of the Company's money market funds and the
short-term nature of the Company's time deposits and debt securities portfolio,
these assets are particularly sensitive to changes in interest rates. The
Company manages this risk through investments with shorter-term maturities and
varying maturity dates. If the Company's short-term assets are reinvested in a
declining interest rate environment, the Company would experience an immediate
negative impact on other income. The opposite holds true in a rising interest
rate environment.
ITEM 4. CONTROLS AND PROCEDURES
The Company's management, under the supervision of our Chief Executive Officer
("CEO") and Chief Financial Officer ("CFO"), performed an evaluation of the
effectiveness of the design and operation of the Company's disclosure controls
and procedures within 90 days before the filing date of this quarterly report.
Based on that evaluation, the CEO and CFO concluded that the Company's
disclosure controls and procedures are effective. There have been no significant
changes in the Company's internal controls or in other factors that could
significantly affect disclosure controls subsequent to the date of this
evaluation.
19
PART II
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORT ON FORM 8-K
EXHIBITS
99.1 Certification Pursuant to 18 U.S.C Section 1350, As Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification Pursuant to 18 U.S.C Section 1350, As Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
10.1 Lease on facility at Parkway Center, Phase I, Plano, Texas
10.2 Lease on facility at 2105 Luna Road, Carrollton, Texas
REPORTS ON FORM 8-K
None
20
SIGNATURE
Pursuant to 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.
INTERPHASE CORPORATION
(Registrant)
Date: November 14, 2002
/s/ Steven P. Kovac
---------------------------
Steven P. Kovac
Chief Financial Officer,
Vice President of Finance
and Treasurer
(Principal Financial and
Accounting Officer)
21
CERTIFICATION PURSUANT TO RULE 13a-14(b)
I, Gregory B. Kalush, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Interphase
Corporation (the Company);
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the Company as of, and for, the periods presented in
this quarterly report;
4. The Company's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14) for the Company and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the Company, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) evaluated the effectiveness of the Company's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the Evaluation Date); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Company's other certifying officer and I have disclosed, based on
our most recent evaluation, to the Company's auditors and the Audit
Committee of the Company's Board of Directors:
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the Company's ability
to record, process, summarize and report financial data and have
identified for the Company's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Company's internal
controls; and
6. The Company's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 14, 2002 Signature: /s/ Gregory B. Kalush
----------------------- ------------------------
Chief Executive Officer
22
CERTIFICATION PURSUANT TO RULE 13a-14(b)
I, Steven P. Kovac, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Interphase
Corporation (the Company);
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the Company as of, and for, the periods presented in
this quarterly report;
4. The Company's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14) for the Company and we have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the Company, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
(b) evaluated the effectiveness of the Company's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the Evaluation Date); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The Company's other certifying officer and I have disclosed, based on
our most recent evaluation, to the Company's auditors and the Audit
Committee of the Company's Board of Directors:
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the Company's ability
to record, process, summarize and report financial data and have
identified for the Company's auditors any material weaknesses in
internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Company's internal
controls; and
6. The Company's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: November 14, 2002 Signature: /s/ Steven P. Kovac
------------------------ ------------------------
Chief Financial Officer
23
EXHIBIT INDEX
EXHIBITS DESCRIPTION
-------- -----------
99.1 Certification Pursuant to 18 U.S.C Section 1350, As Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2 Certification Pursuant to 18 U.S.C Section 1350, As Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
10.1 Lease on facility at Parkway Center, Phase I, Plano, Texas
10.2 Lease on facility at 2105 Luna Road, Carrollton, Texas