Interphase (INPH) 10-Q 2010 Q2 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2010

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from           to           

Commission File Number 0-13071

INTERPHASE CORPORATION

(Exact name of registrant as specified in its charter)

Texas	75-1549797
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

Parkway Centre I
2901 North Dallas Parkway, Suite 200
Plano, Texas 75093
(Address of Principal Executive Offices and Zip Code)

(214) 654-5000
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yeso Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filero Accelerated filero Non-accelerated filero Smaller Reporting Companyþ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ

As of August 6, 2010, shares of common stock outstanding totaled 6,830,262.

INTERPHASE CORPORATION

Index to Form 10-Q
Quarterly Period Ended June 30, 2010

Part I — Financial Information
Item 1. Condensed Consolidated Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009	2
Condensed Consolidated Statements of Operations for the three months and six months ended June 30, 2010 and 2009	3
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2009	4
Notes to Condensed Consolidated Financial Statements	5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3. Quantitative and Qualitative Disclosures About Market Risk	15
Item 4. Controls and Procedures	16
Part II — Other Information
Item 1. Legal Proceedings	16
Item 1A. Risk Factors	16
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	16
Item 3. Defaults Upon Senior Securities	16
Item 4. Removed and Reserved	16
Item 5. Other Information	16
Item 6. Exhibits	16
Exhibit 31(a)
Exhibit 31(b)
Exhibit 32(a)
Exhibit 32(b)

1

PART I
FINANCIAL INFORMATION

Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

INTERPHASE CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)

	June 30,			December 31,
	2010			2009
ASSETS
Cash and cash equivalents	$	4,602		$	8,115
Marketable securities		9,377			9,724
Trade accounts receivable, less allowances of $50 and $76, respectively		3,600			5,106
Inventories		1,750			1,699
Prepaid expenses and other current assets		2,041			2,202
Total current assets		21,370			26,846
Machinery and equipment		6,820			6,993
Leasehold improvements		415			430
Furniture and fixtures		563			587
		7,798			8,010
Less-accumulated depreciation and amortization		(7,248	)		(7,318	)
Total property and equipment, net		550			692
Capitalized software, net		682			912
Other assets		175			197
Total assets	$	22,777		$	28,647
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Accounts payable	$	1,028		$	1,257
Deferred revenue		211			161
Accrued liabilities		1,831			2,667
Accrued compensation		1,156			1,504
Total current liabilities		4,226			5,589
Deferred lease obligations		271			296
Long-term debt		3,500			3,500
Total liabilities		7,997			9,385
Commitments and Contingencies
Shareholders’ Equity
Common stock, $0.10 par value; 100,000,000 shares authorized; 6,830,262 and 6,911,494 shares issued and outstanding, respectively		683			691
Additional paid in capital		43,214			43,022
Retained deficit		(28,358	)		(23,784	)
Cumulative other comprehensive loss		(759	)		(667	)
Total shareholders’ equity		14,780			19,262
Total liabilities and shareholders’ equity	$	22,777		$	28,647

The accompanying notes are an integral part of these condensed consolidated financial statements.

2

INTERPHASE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2010			2009			2010			2009
Revenues	$	3,858		$	8,120		$	7,617		$	16,541
Cost of sales		2,077			3,664			3,977			7,068
Gross margin		1,781			4,456			3,640			9,473
Research and development		1,818			1,930			3,911			3,955
Sales and marketing		1,271			1,625			2,531			3,099
General and administrative		954			1,097			1,958			2,285
Total operating expenses		4,043			4,652			8,400			9,339
(Loss) income from operations		(2,262	)		(196	)		(4,760	)		134
Interest income, net		41			78			87			178
Other loss, net		(1	)		(3	)		(79	)		(6	)
(Loss) income before income tax		(2,222	)		(121	)		(4,752	)		306
Income tax benefit		(11	)		(195	)		(178	)		(475	)
Net (loss) income	$	(2,211	)	$	74		$	(4,574	)	$	781
Net (loss) income per share:
Basic EPS	$	(0.32	)	$	0.01		$	(0.67	)	$	0.11
Diluted EPS	$	(0.32	)	$	0.01		$	(0.67	)	$	0.11
Weighted average common shares		6,832			6,906			6,851			6,834
Weighted average common and dilutive shares		6,832			6,926			6,851			6,834

The accompanying notes are an integral part of these condensed consolidated financial statements.

3

INTERPHASE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

	Six Months Ended
	June 30,
	2010			2009
Cash flows from operating activities:
Net (loss) income	$	(4,574	)	$	781
Adjustments to reconcile net (loss) income to net cash used in operating activities:
Provision for uncollectible accounts and returns		(12	)		14
Provision for excess and obsolete inventories		100			100
Depreciation and amortization		393			426
Amortization of stock-based compensation		184			226
Change in assets and liabilities:
Trade accounts receivable		1,518			(1,804	)
Inventories		(151	)		(444	)
Prepaid expenses and other current assets		(110	)		1,412
Other assets		—			11
Accounts payable, deferred revenue and accrued liabilities		(719	)		211
Accrued compensation		(180	)		614
Deferred lease obligations		(25	)		148
Net cash (used in) provided by operating activities		(3,576	)		1,695
Cash flows from investing activities:
Purchase of property and equipment		(36	)		(85	)
Purchase of capitalized software		(25	)		(117	)
Proceeds from the sale of marketable securities		3,118			5,166
Purchase of marketable securities		(2,795	)		(2,932	)
Net cash provided by investing activities		262			2,032
Cash flows from financing activities:
Borrowings under credit facility		5,500			7,000
Payments on credit facility		(5,500	)		(7,000	)
Proceeds from the exercise of stock options		—			—
Net cash provided by financing activities		—			—
Effect of exchange rate changes on cash and cash equivalents		(199	)		32
Net (decrease) increase in cash and cash equivalents		(3,513	)		3,759
Cash and cash equivalents at beginning of period		8,115			7,383
Cash and cash equivalents at end of period	$	4,602		$	11,142

The accompanying notes are an integral part of these condensed consolidated financial statements.

4

INTERPHASE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1. — BASIS OF PRESENTATION

Interphase Corporation (NASDAQ: INPH) delivers solutions for LTE and WiMAX, interworking gateways, packet processing, network connectivity, and security for key applications for the communications, aerospace-defense, and enterprise markets. Founded in 1974, Interphase provides expert engineering design and contract manufacturing services, in addition to its COTS portfolio, and plays a leadership role in next generation AdvancedTCA^® (ATCA), AdvancedMC™ (AMC), PCI-X, and PCIe standards and solutions. Interphase is headquartered in Plano, Texas, with sales offices across the globe. Clients include Alcatel-Lucent, Emerson Network Power, Fujitsu Ltd., Hewlett Packard, Samsung, and Sun Microsystems. See Note 11 for information regarding the Company’s revenues related to North America and foreign countries.

The accompanying condensed consolidated financial statements include the accounts of Interphase Corporation and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated. While the accompanying condensed consolidated 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 of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. Operating results for the three months and six months ended June 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2009.

NOTE 2. — STOCK-BASED COMPENSATION

The Company recorded stock-based compensation expense related to stock options of approximately $4,000 included in operating expense during the three and six months ended June 30, 2010. These stock options vest over a four year period and expire ten years from the date of grant. In addition to the options generating compensation expense, the Company has 100,000 unvested options related to a grant made in the fourth quarter of 2009 with performance-based vesting criteria. Based on the performance conditions not being deemed probable at June 30, 2010, no compensation expense related to these options has been recorded. There were no unvested stock options during the three and six months ended June 30, 2009, and as a result the Company recorded no stock-based compensation expense related to stock options during the three and six months ended June 30, 2009. The weighted-average remaining contractual life of stock options outstanding and exercisable was 2.67 years at June 30, 2010 and 2.59 years at December 31, 2009.

The Company uses the Black-Scholes option-pricing model to estimate the fair value of stock options awarded on the date of grant. There were no options granted during the three or six months ended June 30, 2009. The weighted average fair value of stock options on the date of grant and the assumptions used to estimate the fair value of the stock options using the Black-Scholes option-pricing model granted during the three and six months ended June 30, 2010 were as follows:

	Three months ended					Six months ended
	June 30,					June 30,
	2010			2009		2010			2009
Weighted average risk free interest rates		3.87	%		N/A		3.87	%		N/A
Weighted average life (in years)		10			N/A		10			N/A
Expected volatility		66.09	%		N/A		66.11	%		N/A
Expected dividend yield		—			N/A		—			N/A
Weighted average grant-date fair value per share of options granted	$	1.99			N/A	$	1.99			N/A

5

INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The following table summarizes stock option activity under the Company’s stock option plans:

	Number of			Weighted Average
	Options			Option Price
Balance, December 31, 2009		1,449,771		$	8.16
Granted		23,700			2.63
Exercised		—			—
Cancelled		(282,900	)		14.31
Balance, June 30, 2010		1,190,571		$	6.58

The Interphase Corporation 2004 Long-Term Stock Incentive Plan provides for grants of bonus stock awards (“restricted stock”) to the Company’s directors and certain employees at no cost to the recipient. Holders of restricted stock are entitled to cash dividends, if any, and to vote their respective shares. Restrictions limit the sale or transfer of these shares during a predefined vesting period, currently ranging from three to five years, and in some cases vesting is subject to the achievement of certain performance conditions. Upon issuance of restricted stock under the plan, unearned compensation equivalent to the market value at the date of grant is recorded as a reduction to shareholders’ equity and subsequently amortized to expense over the respective restriction periods. Compensation expense related to restricted stock was approximately $87,000 and $113,000 for the three months ended June 30, 2010 and 2009, respectively. Compensation expense related to restricted stock was approximately $180,000 and $226,000 for the six months ended June 30, 2010 and 2009, respectively. As of June 30, 2010, there is approximately $713,000 of total unamortized compensation expense related to unvested restricted stock remaining to be recognized, which is expected to be recognized over a weighted-average period of 3.2 years. At December 31, 2009, there was approximately $1.1 million of total unamortized compensation expense related to unvested restricted stock remaining to be recognized which was expected to be recognized over a weighted-average period of 3.5 years. The following summarizes the restricted stock activity for the six months ended June 30, 2010:

	Restricted			Weighted Average
	Stock Shares			Grant Date Value
Nonvested restricted stock at December 31, 2009		484,258		$	2.84
Granted		—			—
Vested		(55,651	)		4.59
Cancelled/Forefeited		(81,232	)		2.02
Nonvested restricted stock at June 30, 2010		347,375		$	2.75

NOTE 3. — MARKETABLE SECURITIES

Accounting Standards Codification (“ASC”) Topic 820, “Fair Value Measurements and Disclosures,” defines the levels used to measure fair value into the following hierarchy:

1.	Level 1 — Valuations based on quoted prices in active markets for identical assets and liabilities. This level provides the most reliable evidence of fair value.
2.	Level 2 — Valuation based on one or more quoted prices in markets that are not active; quoted prices for similar assets or liabilities in active markets; inputs that are observable other than quoted prices for the asset or the liability; or inputs that are derived principally from or corroborated by observable market data by correlation or other means.
3.	Level 3 — Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

6

INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The Company’s marketable securities are classified as “available-for-sale” and are presented at estimated fair value based on quoted prices for similar assets in active markets with any unrealized gains or losses included in other comprehensive loss. Realized gains and losses are computed based on the specific identification method and were not material for the periods presented. Marketable securities are used to secure the Company’s credit facility.

Financial assets, measured at fair value, by level within the fair value hierarchy were as follows (in thousands):

		June 30, 2010							December 31, 2009
				Unrealized			Estimated						Estimated
	Fair Value			Gain			Fair				Unrealized		Fair
	Hierarchy	Cost		(Loss)			Value		Cost		Gain		Value
Agencies	Level 2	$	1,578	$	4		$	1,582	$	3,350	$	29	$	3,379
Asset Backed	Level 2		2,222		8			2,230		2,065		17		2,082
Corporate Bonds	Level 2		1,900		(1	)		1,899		976		1		977
Municipal Bonds and US Treasuries	Level 2		3,649		17			3,666		3,276		10		3,286
Total		$	9,349	$	28		$	9,377	$	9,667	$	57	$	9,724

NOTE 4. — 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 (in thousands):

	June 30, 2010		December 31, 2009
Raw materials	$	1,405	$	1,399
Work-in-process		271		218
Finished goods		74		82
Total	$	1,750	$	1,699

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 the Company’s products. Future events may cause significant fluctuations in the Company’s operating results. Inventories are written down when needed to ensure the Company carries inventory at the lower of cost or market. There were no writedowns during the three months ended June 30, 2010 and 2009. Writedowns were $100,000 for each of the six months ended June 30, 2010 and 2009.

NOTE 5. — DERIVATIVE FINANCIAL INSTRUMENTS

The Company is exposed to adverse movements in foreign currency exchange rates because it conducts business on a global basis and in some cases in foreign currencies. The Company’s operations in France are transacted in the local currency and converted into U.S. Dollars based on published exchange rates for the periods reported and are therefore subject to risk of exchange rate fluctuations.

In an attempt to mitigate the risk described above, the Company may enter into, from time to time, foreign exchange contracts to purchase a fixed amount of Euros on a fixed date in the future at a fixed rate determined at the contract date. These derivative financial instruments do not meet the criteria to qualify for hedge accounting treatment and therefore any change in the market value of these contracts resulting in a gain or loss is recognized as other loss, net in the period of the change. For the three months ended June 30, 2010, the Company recognized a gain of approximately $5,000 related to a foreign exchange contract. For the six months ended June 30, 2010, the Company recognized a loss of approximately $62,000 related to a foreign exchange contract. There were no foreign exchange contracts held by the Company at any point during the six months ended June 30, 2009, and thus there was no related gain or loss. There were no foreign exchange contracts outstanding at June 30, 2010 or December 31, 2009.

7

INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 6. — INCOME TAXES

The Company records a valuation allowance when it is “more likely than not” that all or a portion of a deferred tax asset will not be realized. Management reviews all available positive and negative evidence, including the Company’s current and past performance, the market environment in which the Company operates, the utilization of past tax credits, length of carry back and carry forward periods, existing contracts or sales backlog that will result in future profits, as well as other factors. The Company continues to maintain a valuation allowance on all of the net deferred tax assets for the periods presented. Until an appropriate level of profitability is sustained, the Company expects to continue to record a full valuation allowance on future tax benefits except for those that may be generated in foreign jurisdictions.

The effective tax rate differed from the U.S. statutory rate as the Company continued to provide a full valuation allowance for its net deferred tax assets at June 30, 2010 and December 31, 2009. During the three and six months ended June 30, 2010, the Company recorded a tax benefit related to its operations in France. This benefit was primarily the result of a 30% research and development tax credit, net of taxable income in France.

NOTE 7. — RESTRUCTURING CHARGE

On December 11, 2009, the Company adopted a plan to restructure its worldwide operations. The primary goal of the restructuring program was to align the Company’s current spending with recent revenue trends and to enable additional investments in strategic growth areas for the Company. Under the restructuring plan, the Company reduced its workforce by 12 positions. As a result of the restructuring plan, the Company recorded a restructuring charge of $1.2 million, classified as an operating expense, in the fourth quarter of 2009 of which approximately $1.1 million has resulted in or will result in cash expenditures to cover employee severance and benefits. The remaining $173,000 included in the restructuring charge related to certain non-cash software impairment charges.

The following table summarizes the timing of payments under the restructuring plan (in thousands):

					Cash payments,		Cash payments,
			Cash payments		net of currency		net of currency
			and non-cash		translation		translation
			charges during		adjustments,		adjustments,		Remaining
			quarter ended		during quarter		during quarter		liability as
	Restructuring		December 31,		ended March 31,		ended June 30,		of June 30,
Description	charge		2009		2010		2010		2010
Severance & Fringe Benefits	$	1,063	$	84	$	530	$	132	$	317
Non-Utilized Fixed Assets		173		173		—		—		—
Total	$	1,236	$	257	$	530	$	132	$	317

NOTE 8. — CREDIT FACILITY

The Company maintains a $5.0 million revolving bank credit facility maturing December 19, 2013 with an applicable interest rate on any outstanding balances under the credit facility based on LIBOR plus an applicable margin rate of 1.0% to 1.5%, based on certain factors included in our credit agreement. At June 30, 2010 and December 31, 2009, the Company’s interest rate on the $3.5 million borrowings under the revolving credit facility was 2.0% and 1.3%, respectively. The unused portion of the credit facility is subject to an unused facility fee ranging from .25% to .75% depending on total deposits with the creditor. All borrowings under this facility are secured by marketable securities. The borrowings of $3.5 million are classified as long-term debt on the Company’s balance sheets.

8

INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 9. — COMPREHENSIVE (LOSS) INCOME

The following table shows the Company’s comprehensive (loss) income (in thousands):

	Three months ended					Six months ended
	June 30,					June 30,
	2010			2009		2010			2009
Net (loss) income	$	(2,211	)	$	74	$	(4,574	)	$	781
Other comprehensive (loss) income:
Unrealized holding gain (loss) arising during period, net of tax		5			48		(9	)		94
Foreign currency translation adjustment		(95	)		123		(83	)		8
Comprehensive (loss) income	$	(2,301	)	$	245	$	(4,666	)	$	883

NOTE 10. — EARNINGS PER SHARE

Basic earnings per share are computed by dividing reported earnings available to common shareholders by weighted average common shares outstanding. Diluted earnings per share give effect to the potential issuance of dilutive common shares. Earnings per share are calculated as follows (in thousands, except per share data):

	Three months ended					Six months ended
	June 30,					June 30,
	2010			2009		2010			2009
Basic net (loss) income per share:
Net (loss) income	$	(2,211	)	$	74	$	(4,574	)	$	781
Weighted average common shares outstanding		6,832			6,906		6,851			6,834
Basic net (loss) income per share	$	(0.32	)	$	0.01	$	(0.67	)	$	0.11
Diluted net (loss) income per share:
Net (loss) income	$	(2,211	)	$	74	$	(4,574	)	$	781
Weighted average common shares outstanding		6,832			6,906		6,851			6,834
Dilutive stock options		—			20		—			—
Weighted average common shares outstanding — assuming dilution		6,832			6,926		6,851			6,834
Diluted net (loss) income per share	$	(0.32	)	$	0.01	$	(0.67	)	$	0.11
Outstanding stock options that were not included in the diluted calculation because their effect would be anti-dilutive		1,167			1,242		1,167			1,545

NOTE 11. — SEGMENT INFORMATION

The Company is principally engaged in providing solutions for LTE and WiMAX, interworking gateways, packet processing, network connectivity and security for key applications for the communications, aerospace-defense, and enterprise markets. 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.

9

INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Geographic revenues related to North America and foreign regions is as follows (in thousands):

	Three months ended				Six months ended
	June 30,				June 30,
	2010		2009		2010		2009
Revenues:
Pacific Rim	$	1,786	$	2,616	$	2,528	$	6,846
Europe		1,095		2,878		2,745		5,012
North America		977		2,626		2,344		4,683
Total	$	3,858	$	8,120	$	7,617	$	16,541

Additional information regarding revenues by product-line is as follows (in thousands):

	Three months ended				Six months ended
	June 30,				June 30,
	2010		2009		2010		2009
Product Revenues:
Broadband telecom	$	3,204	$	7,229	$	6,414	$	15,219
Enterprise		346		345		563		434
Professional services		117		257		277		506
Other		191		289		363		382
Total	$	3,858	$	8,120	$	7,617	$	16,541

NOTE 12. — RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In October 2009, the FASB issued ASU 2009-13, “Multiple-Deliverable Revenue Arrangements — a consensus of the FASB Emerging Issues Task Force,” to amend certain guidance in FASB ASC 605-25, “Revenue Recognition — Multiple-Element Arrangements.” The amended guidance in ASC 605-25 modifies the separation criteria by eliminating the criterion that requires objective and reliable evidence of fair value for the undelivered items and eliminates the use of the residual method of allocation. Instead, the amended guidance requires that arrangement consideration be allocated at the inception of the arrangement to all deliverables based on their relative selling price. The amended guidance in ASC 605-25 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early application and retrospective application permitted. The Company prospectively applied the amended guidance in ASC 605-25 beginning January 1, 2010. The Company’s adoption of this statement did not have an impact on its Condensed Consolidated Financial Statements.

10

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

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, reliance on a limited number of customers, failure to see spending improvements in the telecommunications and computer networking industries, significant changes in product demand, the availability of products, changes in competition, various inventory risks due to changes in market conditions and other risks and uncertainties 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”, “anticipates” and similar expressions as they relate to the Company or its management are intended to identify forward-looking statements.

RESULTS OF OPERATIONS

Revenue

Total revenue decreased to $3.9 million for the three months ended June 30, 2010, compared to $8.1 million for the same period in the prior year. The decrease was primarily attributable to broadband telecom revenue, which decreased to $3.2 million for the three months ended June 30, 2010, compared to $7.2 million in the comparable period in the prior year. This decrease is mainly a result of market share trends in the thriving Asian markets as they shifted away from tier 1 telecom equipment manufacturers, which compose a significant portion of our customer base, toward local or regional manufacturers. Our professional services revenue decreased to $117,000 for the three months ended June 30, 2010, compared to $257,000 in the comparable period in the prior year. Our enterprise product revenue remained consistent at approximately $345,000 for the three months ended June 30, 2010 and 2009. All other revenues decreased to $191,000 for the three months ended June 30, 2010, compared to $289,000 for the same period in the prior year.

During the second quarter of 2010, sales to two customers individually accounted for approximately 42% and 15%, respectively, of our total revenues. During the second quarter of 2009, sales to three customers individually accounted for approximately 25%, 24% and 16%, respectively, of our total revenues. No other customer accounted for more than 10% of our total revenue in the periods presented.

Total revenue decreased to $7.6 million for the six months ended June 30, 2010, compared to $16.5 million in the comparable period for the prior year. The decrease in revenue is primarily attributable to a significant decrease in our broadband telecom revenues, which decreased to approximately $6.4 million for the six months ended June 30, 2010, compared to $15.2 million for the same period in the prior year. Our broadband telecom revenue trends during the first half of 2010 reflect the market share shifts described earlier. Our professional services revenues decreased to $277,000 for the six months ended June 30, 2010, compared to $506,000 in the comparable period in the prior year. Our enterprise product revenues increased to $563,000 for the six months ended June 30, 2010, compared to $434,000 for the same period in the prior year. All other revenues remained relatively consistent at $363,000 for the six months ended June 30, 2010 compared to $382,000 for the six months ended June 30, 2009.

Gross Margin

For the three months ended June 30, 2010, gross margin, as a percentage of sales, was 46% compared to 55% for the same period in the prior year. The decrease in our gross margin percentage in the second quarter of 2010 was primarily due to decreased utilization of our manufacturing facility. Also, contributing to the decrease, we experienced an unfavorable shift in our product mix toward lower margin products in the second quarter of 2010 when compared to the same period in the prior year.

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Gross margin as a percentage of sales was 48% and 57% for the six months ended June 30, 2010 and 2009, respectively. The decrease in gross margin is primarily due to two factors. During the six months ended June 30, 2010, there was a decrease in factory utilization compared to the same period in the prior year which negatively impacted our gross margin. Also, contributing to the decrease, we experienced an unfavorable shift in our product mix toward lower margin products during the first six months of 2010, when compared to the same period in the prior year. We believe that pricing pressures in the industry may dampen our gross margin in future periods and it may continue to be challenging to offset these pressures with incremental supplier cost reductions and factory productivity improvements.

Research and Development

Our investment in the development of new products through research and development was $1.8 million and $1.9 million for the three months ended June 30, 2010 and 2009, respectively. As a percentage of total revenue, research and development expense was approximately 47% in the second quarter of 2010 as compared to approximately 24% for the same period for the prior year. The increase in research and development expense as a percentage of total revenue is due to revenue significantly decreasing while research and development expense remained relatively constant.

Our investment in research and development was $3.9 million and $4.0 million for the six months ended June 30, 2010 and 2009, respectively. As a percentage of total revenue, research and development expense was approximately 51% for the six months ended June 30, 2010 and 24% for the six months ended June 30, 2009. The increase in research and development expense as a percentage of total revenue is due to revenue significantly decreasing while research and development expense remained relatively constant. We will continue to monitor the level of our investments in research and development concurrently with actual revenue and profit results.

Sales and Marketing

Sales and marketing expenses were $1.3 million and $1.6 million for the three months ended June 30, 2010 and 2009, respectively. The decrease in sales and marketing expense is primarily the result of two factors. First, there was a decrease in commission and variable compensation of approximately $210,000 compared to the same period in the prior year. In addition, sales and marketing expense decreased by approximately $90,000 during the three months ended June 30, 2010 compared to the same period in the prior year as the result of the restructuring plan we undertook in the fourth quarter of 2009. As a percentage of total revenue, sales and marketing expense was approximately 33% for the second quarter of 2010 and 20% for the second quarter of 2009. The increase in sales and marketing expense as a percentage of total revenue is due to revenue decreasing at a higher rate than sales and marketing expense for the period.

Sales and marketing expenses were $2.5 million and $3.1 million for the six months ended June 30, 2010 and 2009, respectively. The decrease in sales and marketing expense is primarily the result of a decrease in commission and variable compensation of approximately $430,000 compared to the same period in the prior year. Additionally, sales and marketing expense decreased by approximately $170,000 during the six months ended June 30, 2010 compared to the same period in the prior year as the result of the restructuring plan we undertook in the fourth quarter of 2009. See Note 7 in the Notes to Condensed Consolidated Financial Statements for more information on the restructuring plan. As a percentage of total revenue, sales and marketing expense was approximately 33% for the six months ended June 30, 2010 and 19% for the six months ended June 30, 2009. The increase in sales and marketing expense as a percentage of total revenue is due to revenue decreasing at a higher rate than sales and marketing expense for the period. We will continue to monitor the level of our investments in sales and marketing concurrently with actual revenue and profit results.

General and Administrative

General and administrative expenses were $1.0 million and $1.1 million for the three months ended June 30, 2010 and 2009, respectively. As a percentage of total revenue, general and administrative expenses were approximately 25% in the second quarter of 2010 and 14% for the same period in the prior year. The increase as a percentage of revenue is due to revenues decreasing at a higher rate than general and administrative expenses for the period.

General and administrative expenses were $2.0 million and $2.3 million for the six months ended June 30, 2010 and 2009, respectively. The decrease in general and administrative expense is primarily driven by a decrease in the funding of potential variable compensation awards during the six months ended June 30, 2010, compared to the same period in the prior year. As a percentage of total revenue, general and administrative expense was approximately 26% for the six months ended June 30, 2010 and 14% for the six months ended June 30, 2009. The increase as a percentage of revenue is due to revenues decreasing at a higher rate than general and administrative expenses for the period. We will continue to monitor the level of general and administrative costs concurrently with actual revenue and profit results.

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Interest Income, Net

Interest income, net of interest expense, decreased to $41,000 for the three months ended June 30, 2010 from $78,000 in the comparable period in the prior year. Interest income, net of interest expense, was $87,000 for the six months ended June 30, 2010 and $178,000 for the six months ended June 30, 2009. The decrease in interest income, net for each period primarily relates to lower investment balances and lower rates of return on our investments during the three and six months ended June 30, 2010 compared to the same periods in 2009.

Other Loss, Net

Other loss, net, was $1,000 and $3,000 for the three months ended June 30, 2010 and 2009, respectively. Other loss, net, was $79,000 and $6,000 for the six months ended June 30, 2010 and 2009, respectively. The other loss, net during the periods presented for 2010, primarily relates to the change in market value of a foreign exchange derivative financial instrument. The financial instrument resulted in a gain of approximately $5,000 during the three months ended June 30, 2010 and a net loss of $62,000 for the six months ended June 30, 2010. During, the three and six months ended June 30, 2009, we had no such foreign exchange derivative financial instruments. See Note 5 in the Notes to Condensed Consolidated Financial Statements for more information.

Income Taxes

Our tax benefit rate for the six months ended June 30, 2010 was 4%, compared to a tax benefit rate of 155% for the six months ended June 30, 2009.

The effective tax rate differed from the U.S. statutory rate as we continued to provide a full valuation allowance for our net deferred tax assets at June 30, 2010 and June 30, 2009. During each of the six months ended June 30, 2010 and June 30, 2009, we recorded a tax benefit related to our operations in France. This benefit was primarily the result of a 30% research and development tax credit, net of taxable income in France.

Net (Loss) Income

We reported a net loss of $2.2 million for the three months ended June 30, 2010 and net income of $74,000 for the three months ended June 30, 2009. Basic loss per share for the three months ended June 30, 2010 was ($0.32). Basic and diluted earnings per share for the three months ended June 30, 2009 was $0.01. The Company reported a net loss of $4.6 million and a net income of $781,000 for the six months ended June 30, 2010 and June 30, 2009, respectively. Basic loss per share for the six months ended June 30, 2010 was ($0.67). Basic and diluted earnings per share for the six months ended June 30, 2009 was $0.11.

LIQUIDITY AND CAPITAL RESOURCES

Consolidated Cash Flows

Cash and cash equivalents decreased $3.5 million from December 31, 2009 to June 30, 2010 and increased $3.8 million from December 31, 2008 to June 30, 2009. Cash flows are impacted by operating, investing and financing activities.

Operating Activities

Trends in cash flows from operating activities for the six months ended June 30, 2010 and 2009 are generally similar to the trends in our earnings except for provision for uncollectible accounts and returns, provision for excess and obsolete inventories, depreciation and amortization and amortization of stock-based compensation. Cash used by operating activities totaled $3.6 million for the six months ended June 30, 2010, compared to a net loss of $4.6 million. Provision for uncollectible accounts and returns decreased $26,000 for the six months ended June 30, 2010 compared to the same period in 2009. Provision for excess and obsolete inventories remained consistent for the six months ended June 30, 2010, compared to the same period in 2009. Depreciation and amortization decreased slightly for the six months ended June 30, 2010 compared to the same period in 2009. Amortization of stock-based compensation decreased $42,000 for the six months ended June 30, 2010, compared to the six months ended June 30, 2009. See Note 2 in Notes to Condensed Consolidated Financial Statements for more information on stock based compensation.

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Changes in assets and liabilities result primarily from the timing of production, sales, purchases and payments. Such changes in assets and liabilities generally tend to even out over time and result in trends in cash flows from operating activities generally reflecting earnings trends.

Investing Activities

Cash provided by investing activities totaled $262,000 and $2.0 million for the six months ended June 30, 2010 and 2009, respectively. Cash provided by investing activities in each of the periods presented related principally to proceeds from the sale of marketable securities, disbursements for additions to property and equipment, capitalized software and our investments in marketable securities. Additions to property and equipment and capitalized software were $61,000 for the six months ended June 30, 2010 compared to $202,000 for the six months ended June 30, 2009. The additions for the six months ended June 30, 2010 primarily related to software and equipment purchases for our engineering and manufacturing functions. The additions for the six months ended June 30, 2009 primarily related to enhancements to our enterprise performance management system and software purchases for our engineering function. Purchases of marketable securities were $2.8 million and $2.9 million for the six months ended June 30, 2010 and 2009, respectively. Proceeds from the sale of marketable securities decreased to $3.1 million for the six months ended June 30, 2010 compared to $5.2 million for the same period in 2009.

Financing Activities

There was no net cash provided by or used in financing activities for the six months ended June 30, 2010 or 2009.

Commitments

Commitments

At June 30, 2010, we committed to purchase $400,000 of software development services during the next four months. There were no material commitments to purchase capital assets. However, planned capital expenditures for the remainder of 2010 are estimated at approximately $200,000, a significant portion of which relates to enhancements to our internal technology infrastructure, manufacturing equipment and engineering tools. Our significant long-term obligations as of June 30, 2010, are our operating leases on facilities and future debt payments related to our credit facility. To date, we have not paid any dividends and do not anticipate paying any dividends in 2010.

Off-Balance Sheet Arrangements

At June 30, 2010 and December 31, 2009, we did not have any off-balance sheet arrangements including foreign exchange contracts.

Other

Management believes that cash generated from operations and borrowing availability under the revolving credit facility, together with cash on hand, will be sufficient to meet our liquidity needs for working capital, capital expenditures and debt service. To the extent that our actual operating results or other developments differ from our expectations, our liquidity could be adversely affected.

We periodically evaluate our liquidity requirements, alternative uses of capital, capital needs and available resources in view of, among other things, our capital expenditure requirements and estimated future operating cash flows. As a result of this process, we have in the past, and may in the future, seek to raise additional capital, refinance or restructure indebtedness, issue additional securities, repurchase shares of our common stock or take a combination of such steps to manage our liquidity and capital resources. In the normal course of business, we may review opportunities for acquisitions, joint ventures or other business combinations. In the event of any such transaction, we may consider using available cash, issuing additional equity securities or increasing our indebtedness or our subsidiaries’ indebtedness.

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Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and other material included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency Risk

We are exposed to adverse movements in foreign currency exchange rates because we conduct business on a global basis and in some cases in foreign currencies. Our operations in France are measured in the local currency and converted into U.S. Dollars based on published exchange rates for the periods reported and are therefore subject to risk of exchange rate fluctuations. The Euro to U.S. Dollar translation accounted for charges of approximately $204,000 and $459,000 for the three months ended June 30, 2010, and 2009, respectively. The Euro to U.S. Dollar translation accounted for charges of approximately $709,000 and $879,000 for the six months ended June 30, 2010 and 2009, respectively.

In an attempt to mitigate the risk described above, we may enter into, from time to time, foreign exchange contracts to purchase a fixed amount of Euros on a fixed date in the future at a fixed rate determined at the contract date. These derivative financial instruments do not meet the criteria to qualify as hedges and therefore any change in the market value of these contracts resulting in a gain or loss is recognized as other loss, net in the period of the change. For the three months ended June 30, 2010, we recognized a gain of approximately $5,000 related to a foreign exchange contract. For the six months ended June 30, 2010, we recognized a loss of $62,000. There were no foreign exchange contracts held at any point during the three or six months ended June 30, 2009, and thus there was no related gain or loss. There was no foreign exchange contract outstanding as of June 30, 2010 or December 31, 2009.

Market Price Risk

We had no equity hedge contracts outstanding as of June 30, 2010 or December 31, 2009.

Interest Rate Risk

Our investments are subject to interest rate risk. Interest rate risk is the risk that our financial condition and results of operations could be adversely affected due to movements in interest rates. We invest our 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 our money market funds and the short-term nature of our time deposits and debt securities portfolio, these assets are particularly sensitive to changes in interest rates. We manage this risk through investments with shorter-term maturities and varying maturity dates.

A hypothetical 50 basis point increase in interest rates would be expected to result in an approximate decrease of less than 1% in the fair value of our available-for-sale securities at June 30, 2010. This potential change is based on sensitivity analyses performed on our marketable securities at June 30, 2010. Actual results may differ materially. We estimate that the same hypothetical 50 basis point increase in interest rates would have resulted in an approximate decrease of less than 1% in the fair value of our available-for-sale securities at December 31, 2009.

We maintain a $5.0 million revolving bank credit facility maturing December 19, 2013 with an applicable interest rate on any outstanding balances under the credit facility based on LIBOR plus an applicable margin rate of 1.0% to 1.5%, based on certain factors included in our credit agreement. At June 30, 2010 and December 31, 2009, our interest rate on the $3.5 million borrowings under the revolving credit facility was 2.0% and 1.3%, respectively. The unused portion of the credit facility is subject to an unused facility fee ranging from .25% to .75% depending on total deposits with the creditor. All borrowings under this facility are secured by marketable securities. The borrowings of $3.5 million are classified as long-term debt on the accompanying balance sheets.

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Item 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure 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 as of the end of the period covered by this quarterly report. Based on that evaluation, the CEO and CFO concluded that the Company’s disclosure controls and procedures are designed and, are effective, to give reasonable assurance that the information required to be disclosed by the Company in reports that it files under the Exchange Act is accumulated and communicated to management, including the CEO and CFO, to allow timely decisions regarding disclosure and that information is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC.

Changes in Internal Controls

The Company maintains a system of internal controls that is designed to provide reasonable assurance that its books and records accurately reflect, in all material respects, the transactions of the Company and that its established policies and procedures are adhered to. There were no changes to the Company’s internal controls over financial reporting during the quarter ended June 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

PART II
OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

None.

Item 1A. RISK FACTORS

There have been no material changes from the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

Item 3. DEFAULTS UPON SENIOR SECURITIES

None.

Item 4. (REMOVED AND RESERVED)

Item 5. OTHER INFORMATION

None.

Item 6. EXHIBITS

Exhibits

3 (a)	Certificate of Incorporation of the registrant. (1)
3 (b)	Amendment to Articles of Incorporation of the registrant. (2)
3 (c)	Amended and Restated Bylaws of the registrant adopted on July 27, 2007. (3)
4 (a)	Rights Agreement dated as of December 7, 2000 by and between the Company and Computershare Investor Services, LLC as Rights Agent. (4)
10 (a)	Lease on Facility at Parkway Center, Phase I, Plano, Texas. (5)
10 (b)	Second Amendment to lease on Facility at Parkway Center, Phase 1, Plano, Texas (6)
10 (c)	Lease on Facility at 2105 Luna Road, Carrollton, Texas. (7)

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10 (d)	Note and Credit Agreement between Interphase Corporation and Texas Capital Bank. (8)
10 (e)	First Amendment to Loan Agreement between Interphase Corporation and Texas Capital Bank. (9)
10 (f)	Amended and Restated Employment, Confidentiality, and Non-Competition Agreement with Gregory B. Kalush, dated December 30, 2008. *(10)
10 (g)	Amended and Restated Employment, Confidentiality, and Non-Competition Agreement with Thomas N. Tipton, Jr. dated December 30, 2008. *(10)
10 (h)	Amended and Restated Employment, Confidentiality, and Non-Competition Agreement with Randall E. McComas, dated December 30, 2008. *(10)
10 (i)	Amended and Restated Employment, Confidentiality, and Non-Competition Agreement with Deborah A. Shute, dated December 30, 2008. *(10)
10 (j)	Amended and Restated Employment, Confidentiality, and Non-Competition Agreement with James W. Gragg, dated December 30, 2008. *(10)
10 (k)	Amended and Restated Employment, Confidentiality, and Non-Competition Agreement with Marc E. DeVinney, dated December 30, 2008. *(10)
10 (l)	Amended and Restated Employment, Confidentiality, and Non-Competition Agreement with Yoram Solomon, dated December 30, 2008. *(10)
10 (m)	Employment, Confidentiality, and Non-Competition Agreement with Yoram Solomon, dated November 17, 2008* (11)
10 (n)	Employment, Confidentiality, and Non-Competition Agreement with H. Keith Seawright, dated April 6, 2010* (12)
10 (o)	Interphase Corporation 2004 Long-Term Stock Incentive Plan *(13)
31 (a)	Rule 13a-14(a)/15d-14(a) Certification. (14)
31 (b)	Rule 13a-14(a)/15d-14(a) Certification. (14)
32 (a)	Section 1350 Certification. (14)
32 (b)	Section 1350 Certification. (14)

(1)	Filed as an exhibit to Registration Statement No. 2-86523 on Form S-1 and incorporated herein by reference.
(2)	Filed as an exhibit to Annual Report on Form 10-K for the year ended December 31, 1999, and incorporated herein by reference.
(3)	Filed as an exhibit to Current Report on Form 8-K on July 31, 2007, and incorporated herein by reference.
(4)	Filed as an exhibit to Current Report on Form 8-K on January 9, 2001, and incorporated herein by reference.
(5)	Filed as an exhibit to Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, and incorporated herein by reference.
(6)	Filed as an exhibit to Annual Report on Form 10-K for the year ended December 31, 2008, and incorporated herein by reference.
(7)	Filed as an exhibit to Current Report on Form 8-K on December 10, 2008, and incorporated herein by reference.
(8)	Filed as an exhibit to Current Report on Form 8-K on December 24, 2008, and incorporated herein by reference.
(9)	Filed as an exhibit to Quarterly Report on Form 10-Q for the quarter ended March 31, 2009, and incorporated herein by reference
(10)	Filed as an exhibit to Current Report on Form 8-K on December 31, 2008, and incorporated herein by reference.
(11)	Filed as an exhibit to Current Report on Form 8-K on November 17, 2008, and incorporated herein by reference.
(12)	Filed as an exhibit to Current Report on Form 8-K on April 7, 2010, and incorporated herein by reference.
(13)	Filed as an exhibit to Schedule 14a on March 31, 2004 and incorporated herein by reference.
(14)	Filed herewith
*	Management contract or compensatory plan or arrangement.

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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: August 10, 2010	By:	/s/ Thomas N. Tipton Jr.
		Thomas N. Tipton Jr.
		Chief Financial Officer, Vice President of Finance and Treasurer (Principal Financial and Accounting Officer)

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