Interphase (INPH) 10-Q 2008 Q1 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 March 31, 2008

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 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. (Check one):

Large accelerated filero	Accelerated filero	Non-accelerated filerþ	Smaller reporting companyo
		(Do not check if a smaller reporting company)

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 May 6, 2008, shares of common stock outstanding totaled 6,521,314.

INTERPHASE CORPORATION

Index to Form 10-Q
Quarterly Period Ended March 31, 2008

Part I -Financial Information
Item 1. Condensed Consolidated Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of March 31, 2008 and December 31, 2007	2
Condensed Consolidated Statements of Operations for the three months ended March 31, 2008 and 2007	3
Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2008 and 2007	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	14
Item 4. Controls and Procedures	15
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. Submission of Matters to a Vote of Security Holders	16
Item 5. Other Information	16
Item 6. Exhibits	16
Rule 13(a)-14(a)/15d-14(a) Certification
Rule 13(a)-14(a)/15d-14(a) Certification
Section 1350 Certification
Section 1350 Certification

PART I
FINANCIAL INFORMATION

Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

INTERPHASE CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(unaudited)

	March 31,			December 31,
ASSETS	2008			2007
Cash and cash equivalents	$	5,816		$	6,384
Marketable securities		13,617			14,185
Trade accounts receivable, less allowances of $140 and $173, respectively		6,938			7,550
Inventories		2,680			2,886
Prepaid expenses and other current assets		1,264			1,391
Total current assets		30,315			32,396
Machinery and equipment		7,120			6,962
Leasehold improvements		435			427
Furniture and fixtures		588			574
		8,143			7,963
Less-accumulated depreciation and amortization		(7,075	)		(6,879	)
Total property and equipment, net		1,068			1,084
Capitalized software, net		1,704			1,817
Other assets		1,256			883
Total assets	$	34,343		$	36,180
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Accounts payable	$	1,123		$	2,304
Deferred revenue		50			30
Accrued liabilities		1,220			1,387
Accrued compensation		1,517			1,645
Total current liabilities		3,910			5,366
Deferred lease obligations		39			52
Long-term debt		3,500			3,500
Total liabilities		7,449			8,918
Commitments and Contingencies
Shareholders’ Equity
Common stock, $0.10 par value; 100,000,000 shares authorized; 6,523,204 and 6,500,294 shares issued and outstanding, respectively		652			650
Additional paid in capital		42,318			42,267
Retained deficit		(15,732	)		(15,204	)
Cumulative other comprehensive loss		(344	)		(451	)
Total shareholders’ equity		26,894			27,262
Total liabilities and shareholders’ equity	$	34,343		$	36,180

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

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INTERPHASE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

	Three Months Ended
	March 31,
	2008			2007
Revenues	$	7,471		$	5,104
Cost of sales		3,134			2,405
Gross margin		4,337			2,699
Research and development		2,870			2,538
Sales and marketing		1,499			1,412
General and administrative		908			957
Restructuring charge		365			—
Total operating expenses		5,642			4,907
Loss from operations		(1,305	)		(2,208	)
Interest income, net		163			201
Other income, net		303			95
Loss before income tax		(839	)		(1,912	)
Income tax benefit		(311	)		(60	)
Net loss	$	(528	)	$	(1,852	)
Net loss per share:
Basic EPS	$	(0.08	)	$	(0.30	)
Diluted EPS	$	(0.08	)	$	(0.30	)
Weighted average common shares		6,295			6,076
Weighted average common and dilutive shares		6,295			6,076

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

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INTERPHASE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Three Months Ended
	March 31,
	2008			2007
Cash flows from operating activities:
Net loss	$	(528	)	$	(1,852	)
Adjustments to reconcile net loss to net cash used in operating activities:
Provision for uncollectible accounts and returns		(32	)		(8	)
Provision for excess and obsolete inventories		—			100
Depreciation and amortization		219			185
Amortization of restricted stock		50			77
Write-off of impaired capitalized software		69			—
Change in assets and liabilities:
Trade accounts receivable		644			1,850
Inventories		206			(53	)
Prepaid expenses and other current assets		218			2
Other assets		(296	)		—
Accounts payable, deferred revenue and accrued liabilities		(1,343	)		(474	)
Accrued compensation		(213	)		(789	)
Deferred lease obligations		(13	)		(8	)
Net cash used in operating activities		(1,019	)		(970	)
Cash flows from investing activities:
Purchase of property and equipment		(84	)		(75	)
Purchase of capitalized software		(57	)		(84	)
Proceeds from the sale of marketable securities		3,076			2,445
Purchase of marketable securities		(2,420	)		(4,595	)
Net cash provided by (used in) investing activities		515			(2,309	)
Cash flows from financing activities:
Proceeds from the exercise of stock options		2			104
Net cash provided by financing activities		2			104
Effect of exchange rate changes on cash and cash equivalents		(66	)		(12	)
Net decrease in cash and cash equivalents		(568	)		(3,187	)
Cash and cash equivalents at beginning of period		6,384			9,061
Cash and cash equivalents at end of period	$	5,816		$	5,874

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

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INTERPHASE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE 1. — BASIS OF PRESENTATION

Interphase Corporation and subsidiaries (“Interphase” or the “Company”) provide robust building blocks, highly integrated subsystems and innovative gateway appliances for the converged communications network. Building on a 30-year history of providing advanced Input/Output (I/O) solutions for telecommunications and enterprise applications, and addressing the need for high speed connectivity, Interphase has established a key role in delivering next generation AdvancedTCA^® (Advanced Telecommunications Computing Architecture or ATCA) and AdvancedMC™ (Advanced Mezzanine Card or AMC) solutions to the marketplace. The Company’s products enable telecommunications equipment manufacturers to deploy robust and highly scalable network infrastructure equipment into Third Generation Wireless (3G), IP Multimedia Subsystem (IMS), Voice over IP (VoIP) and Broadband Access Networks worldwide, enabling the delivery of advanced IPTV and Triple Play services. See Note 10 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 standard 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 ended March 31, 2008, are not necessarily indicative of the results that may be expected for the year ending December 31, 2008. Certain prior period amounts in Note 10 have been reclassified to conform with current period classifications. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2007.

NOTE 2. — STOCK-BASED COMPENSATION

The Company accounts for stock-based compensation in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payments.” The Company had no unvested stock options nor were any stock options granted during the three months ended March 31, 2008 or 2007, and as a result the Company recorded no stock-based compensation expense related to stock options during the three months ended March 31, 2008 or 2007.

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

	Number of			Weighted Average
	Options			Option Price
Balance, December 31, 2007		1,698,801		$	9.67
Granted		—			—
Exercised		(500	)		4.12
Canceled		(1,500	)		7.36
Balance, March 31, 2008		1,696,801		$	9.67

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 one to four years, and in some cases is subject to the achievement of certain performance conditions. During the three months ended March 31, 2008, there were 82,700 shares granted at a weighted average market price of $8.96. 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 $50,000 and $77,000 for

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INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

the three months ended March 31, 2008 and 2007, respectively. As of March 31, 2008, there was approximately $1.4 million of total unamortized compensation cost related to unvested restricted stock remaining to be recognized.

The following summarizes the restricted stock activity for the first quarter of 2008:

				Weighted
	Restricted Stock			Average Grant
	Shares			Date Value
Nonvested restricted stock at December 31, 2007		207,560		$	8.53
Granted		82,700			8.96
Vested		(4,835	)		11.06
Cancelled/Forefeited		(60,290	)		10.13
Nonvested restricted stock at March 31, 2008		225,135		$	8.21

NOTE 3. — 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):

	March 31, 2008		December 31, 2007
Raw materials	$	1,933	$	2,038
Work-in-process		455		594
Finished goods		292		254
Total	$	2,680	$	2,886

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. Writedowns for the three months ended March 31, 2007 were $100,000. There were no such writedowns during the three months ended March 31, 2008.

NOTE 4. — 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 as hedges under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and therefore any change in the market value of these contracts is recognized as a gain or loss in other income in the period of the change. For the three months ended March 31, 2008, the Company recognized a gain of approximately $316,000 related to these foreign exchange contracts. For the three months ended March 31, 2007, the Company recognized a gain of approximately $67,000 related to these foreign exchange contracts. At March 31, 2008 the Company had two foreign exchange contracts outstanding to acquire approximately 1.1 million Euros for each contract on specified dates during the next four months. At March 31, 2008, the Company recorded $293,000 in prepaid expenses and other current assets, related to the fair value of its outstanding foreign exchange contracts. There was one such contract outstanding at December 31, 2007, the Company recorded $167,000 on the balance sheet in prepaid expenses and other current assets for this contract.

6

INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

NOTE 5. — INCOME TAXES

SFAS No. 109, “Accounting for Income Taxes,” requires that a valuation allowance be established when it is “more likely than not” that all or a portion of a deferred tax asset will not be realized. A review of all available positive and negative evidence needs to be considered, including a 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.

Forming a conclusion on a valuation allowance is difficult when there is negative evidence such as cumulative losses in recent years. Cumulative losses weigh heavily in the overall assessment. As a result of a review undertaken at December 31, 2002, the Company concluded that it was appropriate to establish a full valuation allowance for its net deferred tax assets. 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 we continued to provide a full valuation allowance for our net deferred tax assets at March 31, 2008 and March 31, 2007. During each of the three months ended March 31, 2008 and March 31, 2007, the Company recorded a tax benefit related to its operations in France. This benefit was primarily the result of a 10% research and development tax credit during 2007, which increased to a 30% research and development tax credit during 2008.

The Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), on January 1, 2007. At March 31, 2008 and December 31, 2007, the Company had an uncertain U.S. tax position of approximately $80,000 related to foreign operations. Due to the net operating loss position in the U.S., the Company would not incur tax, interest or penalty currently or in the near future. As such, no adjustment was made to equity and there is no impact on the Company’s effective tax rate. The Company does not anticipate any event in the next twelve months that would cause a change to this position. The Company will recognize any penalties and interest when necessary as tax expense. The U.S. federal returns for the years ended December 31, 2004 and after are open for IRS examination. The year ended December 31, 2002 generated a loss and the 2002 net operating loss (NOL) is still being used by the Company. The IRS may audit up to the NOL amount generated from the year ended December 31, 2002 until the statute of limitations expiration on open tax years.

The Company is also subject to income tax in France. At March 31, 2008, the Company had an uncertain tax position of approximately $368,000, of which $349,000 is related to a potential tax liability, $14,000 is related to potential interest, and $5,000 is related to a potential penalty. The uncertain tax position in France is expected to have a favorable impact on the effective tax rate in the amount of $349,000. At December 31, 2007, the Company had an uncertain tax position of approximately $266,000, of which $249,000 is related to a potential tax liability, $13,000 is related to potential interest, and $4,000 is related to a potential penalty. The Company does not anticipate any event in the next twelve months that would cause a change to this position. The French income tax returns for the years ended December 31, 2005 and subsequent remain open for examination.

NOTE 6. — RESTRUCTURING CHARGE

On March 27, 2008, the Company adopted a plan to restructure its United States based business operations to balance its current spending with recent revenue trends. The primary goal of the restructuring program is to improve the ability of the Company to invest in future business opportunities that are designed to provide the Company with increased growth potential and greater revenue diversification in the coming years and better align the Company’s skills with its future direction. Under the restructuring plan, the Company reduced its workforce by 14 employees. As a result of the restructuring program, the Company recorded a restructuring charge of $365,000, classified as an operating expense. There will be an additional charge of approximately $40,000 associated with a facility closure during the second quarter of 2008 related to lease termination costs.

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INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

These amounts will be paid out under the restructuring plan and will be complete by the end of the fourth quarter 2008. As of March 31, 2008, approximately $358,000 relating to future cash payments under this plan was included in accrued liabilities.

			Cash payments		Remaining
	Restructuring		during quarter ended		Liability as of
Description	Charge		March 31, 2008		March 31, 2008
Severance & Fringe Benefits	$	365	$	7	$	358
Lease Obligation		—		—		—
Total	$	365	$	7	$	358

NOTE 7. — CREDIT FACILITY

The Company maintains a $5.0 million revolving bank credit facility with a maturity date of July 31, 2009 and interest rate of LIBOR plus 1.0% (6.25% at March 31, 2008 and December 31, 2007). In an attempt to mitigate interest rate fluctuations, the Company from time to time may enter into agreements with our lender to fix the interest rate; our agreement at March 31, 2008 expires on July 31, 2008. 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.

NOTE 8. — COMPREHENSIVE INCOME

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

	Three months ended
	March 31,
	2008			2007
Net loss	$	(528	)	$	(1,852	)
Other comprehensive income:
Unrealized holding gain arising during period, net of tax		42			12
Foreign currency translation adjustment		65			15
Comprehensive loss	$	(421	)	$	(1,825	)

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INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

NOTE 9. — 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 dilutive potential common shares. Earnings per share are calculated as follows (in thousands, except per share data):

	Three months ended
	March 31,
	2008			2007
Basic loss per share:
Net loss	$	(528	)	$	(1,852	)
Weighted average common shares outstanding		6,295			6,076
Basic loss per share	$	(0.08	)	$	(0.30	)
Diluted loss per share:
Net loss	$	(528	)	$	(1,852	)
Weighted average common shares outstanding		6,295			6,076
Dilutive stock options and restricted stock		—			—
Weighted average common shares outstanding - - assuming dilution		6,295			6,076
Diluted loss per share	$	(0.08	)	$	(0.30	)
Outstanding stock options and unvested restricted stock that were not included in the diluted calculation because their effect would be anti - dilutive		1,271			1,467

NOTE 10. — SEGMENT INFORMATION

The Company is principally engaged in the design, development, and manufacturing of high-performance connectivity products utilizing advanced technologies being used in next generation telecommunication networks and enterprise data 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 revenues related to North America and foreign countries is as follows (in thousands):

	Three months ended
	March 31,
	2008		2007
Revenues:
Pacific Rim	$	3,065	$	1,864
North America		2,507		2,998
Europe		1,899		242
Total	$	7,471	$	5,104

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INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

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

	Three months ended
	March 31,
	2008		2007
Product Revenues:
Broadband telecom	$	5,779	$	4,042
Enterprise		433		727
Professional services		117		41
Other		1,142		294
Total	$	7,471	$	5,104

NOTE 11. — RECENTLY ISSUED ACCOUNTING PROUNOUCEMENTS

In September 2006, the FASB issued SFAS No. 157 “Fair Value Measurements”. SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States, and expands disclosures about fair value measurements. The Company was subject to the provisions of SFAS 157 beginning January 1, 2008. The Company’s adoption of SFAS 157 did not have a material impact on its Condensed Consolidated Financial Statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”. SFAS 159 allows entities the option to measure eligible financial instruments at fair value as of specified dates. Such election, which may be applied on an instrument by instrument basis, is typically irrevocable once elected. SFAS 159 was effective for fiscal years beginning after November 15, 2007. The Company’s adoption of SFAS 159 did not have a material impact on its Condensed Consolidated Financial Statements as it did not elect the fair value option for any financial assets or liabilities.

In December 2007, the FASB issued SFAS No. 141, “Business Combinations” (Revised 2007). SFAS 141R will change the accounting for business combinations. Under SFAS 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition date fair value with limited exceptions. SFAS 141R will change the accounting treatment and disclosure for certain specific items in a business combination. SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. SFAS 141R will have an impact on accounting for business combinations once adopted but the effect is dependent upon acquisitions at that time.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — An amendment of ARB No.51”. SFAS 160 establishes new accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 was effective for fiscal years beginning on or after December 15, 2008. The Company’s adoption of this statement will not have a material impact on its Condensed Consolidated Financial Statements.

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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, our 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”, and “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 increased to $7.5 million for the three months ended March 31, 2008, compared to $5.1 million for the same period in the prior year. The increase was primarily attributable to broadband telecom revenue, which increased approximately 43% to approximately $5.8 million for the three months ended March 31, 2008, compared to $4.0 million in the comparable period. Our enterprise product revenue decreased by approximately 40% to $433,000 for the three months ended March 31, 2008, compared to $727,000 for the same period in the previous year. The first quarter of 2008 revenues included a one-time project cancellation fee of $973,000 for unique customer requirements for product development work that was discontinued. All other revenues composed primarily of security, legacy networking, professional services and storage product lines decreased approximately 15% to $286,000, compared to approximately $335,000 in the comparable period.

During the first quarter of 2008, sales to four customers individually accounted for approximately 32%, 20%, 11% and 10% of total revenues respectively. During the first quarter of 2007, sales to two customers individually accounted for approximately 33% and 10% of total revenues respectively. No other customer accounted for more than 10% of our consolidated revenue in the periods presented.

Gross Margin

For the three months ended March 31, 2008, gross margin, as a percentage of sales, was 58% compared to 53% for the same period in the prior year. The increase in gross margin percentage is primarily due to the cancellation charge of $973,000 in the first quarter of 2008, which had no cost of sales associated. Also, we recorded $100,000 less in obsolete inventory charges in the first quarter of 2008 compared to the first quarter of 2007 as well as benefited from increased factory utilization as production volumes increased when compared to the first quarter of 2007, all of which contributed to increased gross margin. However, our product mix did partially offset these factors. We believe that pricing pressures in the industry may dampen gross margins in future periods and it may become increasingly 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 $2.9 million and $2.5 million for the three months ended March 31, 2008 and 2007, respectively. Much of our research and development resources are located in France and as such those costs are subject to exchange rate fluctuations with the Euro and the Dollar. The Euro was significantly stronger against the dollar in the first quarter of 2008 compared to the first quarter of 2007. This exchange rate fluctuation resulted in an increase to research and development expense of approximately $175,000 year over year. Also, included in research and development expenses in the first quarter of

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2008 is a charge of approximately $70,000 related to software procured for a product that was subsequently discontinued. Finally, we continued to invest in the area of project related research and development activities as we prepare for several new product introductions. As a percentage of total revenue, research and development expense was approximately 38% in the first quarter of 2008 compared to approximately 50% for the same period in the prior year. The decrease in research and development costs as a percentage of total revenue is due to revenue increasing at a higher rate than research and development expense for the period. We anticipate that spending on research and development will decrease in the near future as a result of the restructuring plan undertaken in the first quarter of 2008, subject to fluctuations in currency exchange rates because much of our development expense is associated with our engineering lab in France. We will continue to take steps to attempt to mitigate the impact of currency exposure by strategically acquiring foreign exchange contracts to purchase a fixed amount of Euros on a specific date in the future at a predetermined rate established by contract (see Item 3 — Foreign Currency Risk).

Sales and Marketing

Sales and marketing expenses were $1.5 million and $1.4 million for the three months ended March 31, 2008 and 2007, respectively. The increase in sales and marketing expense was primarily due to increased variable compensation paid to our sales force during the first three months of 2008. As a percentage of total revenue, sales and marketing expense was approximately 20% in the first quarter of 2008, compared to approximately 28% for the same period in the prior year. The decrease in sales and marketing expense as a percentage of total revenue is due to revenues increasing at a higher rate than sales and marketing expense for the period. We anticipate that sales and marketing expense will decrease slightly in the near future as a result of the restructuring plan undertaken in the first quarter of 2008. We continue to monitor the level of sales and marketing costs concurrently with actual revenue results.

General and Administrative

General and administrative expenses were $908,000 and $957,000 for the three months ended March 31, 2008 and 2007, respectively. As a percentage of total revenue, general and administrative expenses were approximately 12% in the first quarter 2008 and 19% for the same period in the prior year. The increase in general and administrative expenses as a percentage of total revenue is primarily due to revenue increasing while general and administrative expenses decreased slightly. We will continue to monitor the level of general and administrative costs concurrently with actual revenue results.

Restructuring Charge

On March 27, 2008, we adopted a plan to restructure our United States based business operations to balance our current spending with recent revenue trends. The primary goal of the restructuring program is to improve our ability to invest in future business opportunities that are designed to provide us with increased growth potential and greater revenue diversification in the coming years and better align our skills with our future direction. Under the restructuring plan, we reduced our workforce by 14 employees. As a result of the restructuring program, the Company recorded a restructuring charge of $365,000, classified as operating expense. There will be an additional charge of approximately $40,000 associated with a facility closure during the second quarter of 2008 related to lease termination costs. We currently estimate that activities related to the restructuring plan will remove over $1.5 million of annualized operating costs. See Note 6 in Notes to Condensed Consolidated Financial Statements for more information. There were no such restructuring activities during 2007.

Interest Income, Net

Interest income, net of interest expense, increased to $163,000 for the three months ended March 31, 2008 from $201,000 in the comparable period in the prior year. The decrease in interest income, net for the three month period is primarily due to lower cash and investment balances as well as lower rates of return on our investments in the first quarter of 2008 compared to the same period in 2007, resulting in decreased interest income during the period.

Other Income, Net

Other income, net was $303,000 for the three months ended March 31, 2008, compared to $95,000 for the same period in the prior year. The increase in other income for the three months ended March 31, 2008 primarily relates to the change in market value of our foreign exchange derivative financial instruments which resulted in other

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income of approximately $316,000 and $67,000 for the three months ended March 31, 2008 and 2007, respectively. See Note 4 in Notes to Condensed Consolidated Financial Statements for more information on derivative financial instruments.

Income Taxes

Our tax benefit rate was 37% for the three months ended March 31, 2008, compared to a tax benefit rate of 3% for the three months ended March 31, 2007.

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 March 31, 2008 and March 31, 2007. During each of the three months ended March 31, 2008 and March 31, 2007, we recorded a tax benefit related to our operations in France. This benefit was primarily the result of a research and development tax credit that increased in 2008 to 30% from the previous rate of 10% used during 2007.

Net Loss

We reported net loss of $528,000 and $1.9 million for the three months ended March 31, 2008 and 2007, respectively. Basic loss per share for the three months ended March 31, 2008 and 2007 was ($0.08) and ($0.30), respectively.

LIQUIDITY AND CAPITAL RESOURCES

Consolidated Cash Flows

Cash and cash equivalents decreased approximately $568,000 and $3.2 million for the three months ended March 31, 2008 and 2007, respectively. Cash flows are impacted by operating, investing and financing activities.

Operating Activities

Trends in cash flows from operating activities for the three months ended March 31, 2008 and 2007 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 restricted stock. Cash used in operating activities totaled $1.0 million for the three months ended March 31, 2008, compared to a net loss of $528,000. Provision for uncollectible accounts and returns decreased slightly for the three months ended March 31, 2008 compared to the same period in 2007. Provision for excess and obsolete inventories decreased by $100,000 for the three months ended March 31, 2008, compared to the same period in 2007. Depreciation and amortization increased slightly for the three months ended March 31, 2008, compared to the same period in 2007. Amortization of restricted stock decreased slightly for the three months ended March 31, 2008, compared to the three months ended March 31, 2007. See Note 2 in Notes to Condensed Consolidated Financial Statements for more information on restricted stock.

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 $515,000 for the three months ended March 31, 2008 and cash used in investing activities totaled $2.3 million for the three months ended March 31, 2007. Cash used in and provided by investing activities in each of the periods 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 $141,000 for the three months ended March 31, 2008, compared to $159,000 for the three months ended March 31, 2007. The additions for the three months ended March 31, 2008 and three months ended March 31, 2007, primarily related to software and equipment purchases for our engineering and manufacturing functions. Purchases of marketable securities decreased to $2.4 million for the three months ended March 31, 2008, compared to $4.6 million for the three months ended March 31, 2007. Proceeds from the sale of marketable securities increased to $3.1 million for the three months ended March 31, 2008, compared to $2.5 million for the three months ended March 31, 2007.

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Financing Activities

Net cash provided by financing activities totaled $2,000 for the three months ended March 31, 2008 and $104,000 for the three months ended March 31, 2007 and related to proceeds from employees exercising stock options.

Commitments

Commitments

At March 31, 2008, we had no material commitments to purchase capital assets; however, planned capital expenditures for 2008 are estimated at approximately $1.0 million, a significant portion of which relates to our investment in future phases of our new Enterprise Performance Management system. The remaining planned purchases relate to engineering, manufacturing and general office equipment. Our significant long-term obligations as of March 31, 2008, 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 2008.

Off-Balance Sheet Arrangements

At March 31, 2008, we had two foreign exchange contracts outstanding to acquire approximately 1.1 million Euros for each contract on specified dates during the next four months. At March 31, 2008, we recorded $293,000 on the balance sheet in prepaid expenses and other current assets, related to the fair value of these outstanding foreign exchange contracts. There was one such contract outstanding at December 31, 2007, we recorded $167,000 on the balance sheet in prepaid expenses and other current assets for this contract.

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.

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, 2007.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency Risk

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 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 $663,000 and $410,000 for the three months ended March 31, 2008, and 2007, respectively.

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 as hedges under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” and therefore any changes in the market

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value of these contracts are recognized as a gain or loss in the period of the change. For the three months ended March 31, 2008, the Company recognized a gain of approximately $316,000 related to these foreign exchange contracts. For the three months ended March 31, 2007, the Company recognized a gain of approximately $67,000 related to these foreign exchange contracts. At March 31, 2008 the Company had two foreign exchange contracts outstanding to acquire approximately 1.1 million Euros for each contract on specified dates during the next four months. At March 31, 2008, the Company classified as a $293,000 asset on the balance sheet and included in prepaid expenses and other current assets, related to the fair value of its outstanding foreign exchange contracts. There was one such contract outstanding at December 31, 2007 classified as a $167,000 asset on the balance sheet and included in prepaid expenses and other current assets.

Market Price Risk

We had no equity hedge contracts outstanding as of March 31, 2008 or December 31, 2007.

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 March 31, 2008. This potential change is based on sensitivity analyses performed on our marketable securities at March 31, 2008. 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 March 31, 2007.

We maintain a $5.0 million revolving credit facility maturing July 31, 2009 with an interest rate of London Interbank Offered Rate (LIBOR) plus 1.0% (6.25% at March 31, 2008 and December 31, 2007). In an attempt to mitigate interest rate fluctuations, we from time to time may enter into agreements with our lender to fix the interest rate; our agreement at March 31, 2008 expires on July 31, 2008. A hypothetical 100 basis point increase in LIBOR would increase annual interest expense on this credit facility by approximately $35,000. All borrowings under this facility are secured by marketable securities. The borrowings of $3.5 million are classified as long-term debt on the balance sheet.

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 or in other factors that could significantly affect the Company’s internal controls subsequent to the date of the evaluation by the Company’s CEO and CFO, including any corrective actions with regard to significant deficiencies and material weaknesses.

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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, 2007.

Item 2. UNREGISTERED SALES OF EQUITY 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

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. (4)
4 (a)	Rights Agreement dated as of December 7, 2000 by and between the Company and Computershare Investor Services, LLC as Rights Agent. (3)
10 (a)	Lease on Facility at Parkway Center, Phase I, Plano, Texas. (5)
10 (b)	Lease on Facility at 2105 Luna Road, Carrollton, Texas. (5)
10 (c)	Note and Credit Agreement between Interphase Corporation and Comerica Bank, including Amendment dated November 5, 2004. (6)
10 (d)	Employment Agreement with Gregory B. Kalush, dated March 12, 1999. *(8)
10 (e)	Employment, Confidentiality, and Non-Competition Agreement with Thomas N. Tipton, Jr., dated December 19, 2005. *(8)
10 (f)	Employment, Confidentiality, and Non-Competition Agreement with Randall E. McComas, dated February 15, 2002. *(8)
10 (g)	Employment Agreement with Deborah A. Shute, dated November 24, 1999. *(8)
10 (h)	Employment, Confidentiality, and Non-Competition Agreement with James W. Gragg, dated November 1, 2004. *(8)
10 (i)	Employment, Confidentiality, and Non-Competition Agreement with Prasad Kallur, dated May 23, 2005. *(8)
10 (j)	Interphase Corporation 2004 Long-Term Stock Incentive Plan *(7)
10 (k)	Employment, Confidentiality, and Non-Competition Agreement with Marc E. DeVinney dated August 31, 2007. *(9)
31 (a)	Rule 13a-14(a)/15d-14(a) Certification. (10)
31 (b)	Rule 13a-14(a)/15d-14(a) Certification. (10)
32 (a)	Section 1350 Certification. (10)
32 (b)	Section 1350 Certification. (10)

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(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 Report on Form 10-K for the year ended December 31, 1999, and incorporated herein by reference.
(3)	Filed as an exhibit to Form 8-K on January 9, 2001, and incorporated herein by reference.
(4)	Filed as an exhibit to Report on Form 8-K on July 31, 2007, and incorporated herein by reference.
(5)	Filed as an exhibit to Report on Form 10-Q for the quarter ended September 30, 2002, and incorporated herein by reference.
(6)	Filed as an exhibit to Report on Form 10-K for the year ended December 31, 2004, and incorporated herein by reference.
(7)	Filed as an exhibit to Schedule 14a on March 31, 2005 and incorporated herein by reference.
(8)	Filed as an exhibit to Report on Form 10-K for the year ended December 31, 2005, and incorporated herein by reference.
(9)	Filed as an exhibit to Report on Form 8-K on August 31, 2007, and incorporated herein by reference.
(10)	Filed herewith

* Management contract or compensatory plan or arrangement.

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: May 13, 2008	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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