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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 0-10902
INTERFACE SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
MICHIGAN 38-1857379
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5855 INTERFACE DRIVE, ANN ARBOR, MICHIGAN 48103
(Address of principal executive offices)
(734) 769-5900
(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. [ X ] Yes [ ] No
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date:
Common Stock, no par value, 4,721,175 shares as of July 31, 2000.
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INTERFACE SYSTEMS, INC.
FORM 10-Q
INDEX
Page No.
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Balance Sheets at June 30, 2000 and
September 30, 1999 3
Condensed Consolidated Statements of Operations for the
Quarter and Nine Month Periods Ended June 30, 2000 and 1999 4
Condensed Consolidated Statements of Cash Flows for the
Nine Months Ended June 30, 2000 and 1999 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations 8
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 10
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 11
Item 6. Exhibits and Reports on Form 8-K 11
SIGNATURES 11
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PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
INTERFACE SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, September 30,
2000 1999
----- -----
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 230,552 $ 1,575,139
Accounts receivable, net 2,551,420 3,689,511
Refundable income taxes -- 6,723
Inventories 470,497 915,977
Current portion of note receivable 18,896 --
Prepaid expenses and other 316,366 303,676
------------ ------------
Total current assets 3,587,731 6,491,026
Property and equipment, net 2,388,620 3,188,071
Goodwill, net 649,829 789,140
Note receivable 250,827 --
Other assets 29,497 55,194
------------ ------------
$ 6,906,504 $ 10,523,431
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,080,854 $ 912,018
Accrued expenses 1,214,399 1,140,155
Note payable 1,100,000 --
Deferred revenue 432,715 431,252
Current portion of long-term debt 50,200 50,200
------------ ------------
Total current liabilities 3,878,168 2,533,625
Long-term debt 33,133 70,633
Stockholders' equity:
Common stock, no par value, 25,000,000 shares authorized;
4,719,675 and 4,539,529 shares issued and outstanding at
June 30, 2000 and September 30, 1999, respectively 11,985,413 11,324,418
Cumulative translation adjustment (34,279) (53,117)
Accumulated deficit (8,955,931) (3,352,128)
------------ ------------
Total stockholders' equity 2,995,203 7,919,173
------------ ------------
$ 6,906,504 $ 10,523,431
============ ============
The accompanying notes are an integral part of these consolidated
financial statements.
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INTERFACE SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Quarter ended Nine months ended
June 30, June 30,
2000 1999 2000 1999
---- ---- ---- ----
(unaudited) (unaudited)
Net revenues $ 2,713,338 $ 5,201,865 $ 9,107,913 $15,275,093
Cost of revenues 937,191 1,996,230 3,355,775 6,164,043
------------- ------------ ------------- ------------
Gross profit 1,776,147 3,205,635 5,752,138 9,111,050
Expenses:
Product development 1,006,113 488,736 2,442,957 1,293,056
Selling, general and administrative 3,231,111 2,449,528 9,068,031 7,916,013
------------- ------------ ------------- ------------
Operating income (loss) (2,461,077) 267,371 (5,758,850) (98,019)
Interest expense (23,545) (3,091) (38,336) (20,203)
Other income 18,931 9,384 200,106 80,239
------------- ------------ ------------- ------------
Income (loss) before income taxes (2,465,691) 273,664 (5,597,080) (37,893)
Income tax expense -- 44,911 6,723 44,911
------------- ------------ ------------- ------------
Net income (loss) $ (2,465,691) $ 228,753 $ (5,603,803) $ (82,894)
============= ============= ============= =============
Basic and diluted income (loss) per share $ (0.52) $ 0.05 $ (1.21) $ (0.02)
============= ============ ============= =============
Weighted average shares outstanding 4,697,879 4,476,050 4,637,846 4,472,211
============= ============ ============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
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INTERFACE SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended June 30,
2000 1999
---- ----
(unaudited)
Cash flows from operating activities:
Net loss $ (5,603,803) $ (82,894)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Gain on sale of IGK (36,736) --
Depreciation and amortization 549,125 773,964
Change in operating assets and liabilities:
Accounts receivable 738,155 705,820
Refundable income taxes 6,723 1,507,634
Inventories 19,555 1,069,312
Prepaid expenses and other (32,621) (14,575)
Other assets 25,696 172,086
Accounts payable 402,885 (246,093)
Accrued expense 37,054 (590,379)
Deferred revenue 1,463 (406,826)
------------- -----------
Net cash provided by (used in) operating activities (3,892,504) 2,888,049
------------- -----------
Cash flows from investing activities:
Proceeds from sale of IGK 1,078,556 --
Proceeds received on note issued on sale of IGK 80,277 --
Additions to property and equipment (353,248) (364,967)
------------- -----------
Net cash provided by (used in) investing activities 805,585 (364,967)
------------- -----------
Cash flows from financing activities:
Change in notes payable 1,100,000 (1,350,000)
Proceeds from issuance of stock 660,994 81,945
Reduction of long-term debt (37,500) (37,500)
------------- -----------
Net cash provided by (used in) financing activities 1,723,494 (1,305,555)
------------- -----------
Effect of exchange rate changes on cash 18,838 99,029
------------- -----------
Net increase (decrease) in cash and cash equivalents (1,344,587) 1,316,556
Cash and cash equivalents, beginning of period 1,575,139 301,206
------------- -----------
Cash and cash equivalents, end of period $ 230,552 $ 1,617,762
============= ===========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 20,180 $ 20,203
============= ===========
The accompanying notes are an integral part of these consolidated
financial statements.
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INTERFACE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
The interim consolidated financial statements of Interface Systems, Inc. have
been prepared by the Company without audit pursuant to the rules and regulations
of the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. The information included in this report
should be read in conjunction with the financial statements for the year ended
September 30, 1999 and notes thereto included in the Company's Annual Report on
Form 10-K.
In the opinion of management, the accompanying interim consolidated financial
statements reflect all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of the Company's financial
position, results of operations and cash flows for the periods presented. The
results for the quarter ended June 30, 2000 may not be indicative of the results
to be expected for future quarters or the fiscal year ending September 30, 2000.
For comparative purposes, certain amounts reported in prior years' financial
statements have been reclassified to conform to current year presentations.
2. Line-of-Credit
In May 2000, the Company and its bank entered into a commitment for a new credit
facility expanding borrowing capability from $3.5 to $5.0 million. On August 14,
2000, the Company and its bank executed a credit agreement dated as of June 1,
2000. As of June 30, 2000, there was $1.1 million outstanding under its
facility. Advances bear interest at the bank's prime rate (9.5% at June 30,
2000) plus 1%, are payable on demand and are collateralized by substantially all
of the Company's assets. The amount available for borrowing at any time is based
on borrowing base formulae relating to levels of accounts receivable, the value
of the Company's real property and improvements located in Ann Arbor, Michigan
and other bank covenants. Under such formulae in the new agreement, $2.1 million
would have been available to the Company at June 30, 2000.
Under the terms of the credit agreement, the Company is required to maintain
certain minimum working capital, net worth, and other specific financial ratios.
In addition, the credit agreement prohibits the payment of cash dividends and
contains certain restrictions on the Company's ability to borrow money or
purchase assets or interests in other entities without the prior written consent
of the bank. On July 7, 2000, the Company repaid all indebtedness under the
credit facility (see Note 6).
In connection with the new facility, the Company issued to the bank warrants to
purchase 20,000 shares of common stock at $13.44 per share. The warrants will be
fully exercisable and expire three years from the date of issuance.
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3. Impact of Recently Issued Accounting Standards
Various accounting pronouncements have been issued but which are not yet
effective including, but not limited to, Statement of Financial Accounting
Standards Nos. 133 and 138, "Accounting for Derivative Instruments and Hedging
Activities," which is effective for fiscal years beginning after June 15, 2000;
Securities and Exchange Commission Staff Accounting Bulletin No. 101, "Revenue
Recognition," which the Company must adopt no later than the fourth quarter of
fiscal 2001; and Financial Accounting Standards Board Interpretation No. 44,
"Accounting for Certain Transactions involving Stock Compensation, an
interpretation of APB Opinion No. 25," which generally is effective for all
periods after July 1, 2000, but certain conclusions in this Interpretation
cover specific events that occur after either December 15, 1998, or January 12,
2000. Management expects that adoption of these pronouncements will have
little, if any, impact on the Company's consolidated financial position or
results of operations.
4. Comprehensive Income
SFAS No. 130, "Reporting Comprehensive Income", establishes standards for
reporting and display of comprehensive income and its components in a full set
of financial statements. Comprehensive income is the total of net income and all
other non-owner changes in equity. The components of comprehensive income, are
as follows:
Quarters ended June 30, Six months ended June 30,
------------------------ -------------------------
2000 1999 2000 1999
---- ---- ---- ----
Net Loss $ (2,465,691) $ 228,753 $ (5,603,803) $ (82,894)
Change in foreign currency translation 21,827 49,397 18,839 99,029
------------- --------------- ------------ -------------
Comprehensive Loss $ (2,443,864) $ 278,150 $ (5,584,965) $ 16,135
============= =============== ============ =============
5. Sale of Wholly Owned Subsidiary
On December 22, 1999, the Company sold its subsidiary, I.G.K. Industries, Inc.
("IGK") for $1,450,000, which resulted in a $37,000 gain. The purchaser acquired
all assets and assumed all current liabilities of IGK. Also included in the sale
was the building that housed IGK's operations, which was owned by the Company
and leased by IGK.
6. Merger Agreement
On June 28, 2000, the Company entered into a merger agreement with Tumbleweed
Communications Corp. ("Tumbleweed") whereby the Company agreed to merge with a
newly formed subsidiary of Tumbleweed. The Company's stockholders are expected
to receive 0.264 shares of Tumbleweed common stock for each share of the
Company's common stock. In addition, outstanding options and warrants will be
converted into options or warrants to purchase 0.264 shares of Tumbleweed common
stock with an appropriate adjustment to the exercise price to reflect the
exchange ratio. In connection with the merger, the Company granted Tumbleweed an
option to purchase 19.9% of the total number of shares of the Company issued and
outstanding at June 28, 2000 if an event occurs which would entitle Tumbleweed
to terminate the merger agreement and which would entitle Tumbleweed to receive
a termination fee. In connection with the merger, Tumbleweed also agreed to
purchase $3,000,000 of convertible subordinate promissory notes of the Company
and, on July 7, 2000, purchased $2,000,000 of such notes.
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7. Litigation
On July 7, 2000, several parties, including Congressional Securities, Inc. and
David H. Zimmer, filed complaints against the Company, its President and Chief
Executive Officer and certain other third parties. The complaints generally
allege that the Company and its officers intentionally made statements
containing material omissions or misrepresentations in an effort to induce
plaintiffs to purchase stock in the Company. The complaints allege violations of
the federal securities laws and other complaints allege fraudulent and negligent
misrepresentations, defamation and tortious interference with business
relations. The complaints seek compensatory and punitive damages allegedly
incurred as a result of the decline in the market price of shares of the
Company's common stock after a dramatic stock market correction that occurred in
April 2000. On July 17, 2000, at least one of the complaints was amended. These
actions are in a preliminary stage and the Company and its named officer have
just recently been served process in these actions. However, the Company
believes that these actions are without merit, and the Company and its named
officer intend to vigorously defend these claims. Although the final resolution
of this litigation cannot be presently determined, management of the Company
does not believe it will have material adverse effect on the Company's business,
or the future consolidated financial statements, although such adverse effects
could be possible.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OPERATIONS
The Company is currently completing a transition plan that is focused on the
movement from the manufacturing of hardware (printers, circuit boards and
peripheral equipment) to the development and marketing of higher margin and
higher growth software solutions. The progress related to the plan is evidenced
by the current structure of the Company. Currently, the Company is organized
around two software solutions groups: L2i(TM) (Legacy-to-Internet) and Cleo.
On June 28, 2000, the Company entered into an Agreement and Plan of Merger with
Tumbleweed Communications Corp., a Delaware corporation ("Tumbleweed"), and
Maize Acquisition Sub, Inc. ("Maize"), a Delaware corporation and a direct
wholly-owned subsidiary of Tumbleweed (the "Merger Agreement"). Pursuant to the
Merger Agreement, Maize will merge with and into the Company and the Company
will become a wholly-owned subsidiary of Tumbleweed. Under the terms of the
agreement, the Company's shareholders will receive a fixed exchange ratio of
0.264 Tumbleweed common shares for each share of the Company's common stock and
each outstanding option to purchase shares of the Company's common stock under
the Company's employee stock option plans will be assumed by Tumbleweed. The
boards of directors of both companies have approved the transaction. The
completion of the transaction is subject to certain closing conditions,
including the approval of the Company's shareholders. In connection with the
acquisition, the companies announced their intent to divest the Cleo solutions
group.
RESULTS OF OPERATIONS
Net Revenues. Revenues for the third quarter ended June 30, 2000 were $2.7
million, a decrease of 47.8% over revenues of $5.2 million for the third quarter
of fiscal 1999. Revenues for the first nine months of fiscal 2000 were $9.1
million, a decrease of 40.4% over revenues of $15.3 million for the same period
of fiscal 1999. The decrease for the quarter and the nine-month period was
primarily due to the curtailment of the printer business, the sale of
IGK that occurred at the end of the first quarter, and decreased sales of the
Cleo solutions group. The above declines were partially offset by the increased
sales of the L2i solutions, MyCopy(TM), e-Bill Bridge(TM), Document Server and
related professional services.
Cost of Revenues. Cost of revenues were $937,000 and $2.0 million or 34.5% and
38.4% of net revenues for the quarters ended June 30, 2000 and 1999,
respectively; and $3.4 million and $6.2
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million, or 36.8% and 40.4% of net revenues for the nine months of fiscal 2000
and 1999, respectively. The decrease for the quarter and the nine-month period
resulted from a decline in overall sales as well as a change in the sales mix
from lower margin hardware products to the more profitable L2i software
solutions and consulting services.
Product Development Costs. Product development costs were $1.0 million and
$489,000, or 37.1% and 9.4% of net revenues for the quarters ended June 30, 2000
and 1999, respectively; and $2.4 million and $1.3 million, or 26.8% and 8.5% of
net revenues for the first nine months of fiscal 2000 and 1999, respectively.
The increase for the quarter and nine month periods was primarily due to the
investment the Company is making with respect to enhancements of its L2i
software solutions.
Selling, General, and Administrative Expenses. Selling, general, and
administrative expenses were $3.2 million and $2.4 million, or 119.1% and 47.1%
of net revenues for the quarters ended June 30, 2000 and 1999, respectively; and
$9.1 million and $7.9 million, or 99.6% and 51.8% of net revenues for the first
nine moths of fiscal 2000 and 1999, respectively. The increase was primarily due
to the addition of sales and marketing staff located at the Company's
headquarters facility and the East Coast and professional fees related to the
implementation of our growth plan.
Interest and Other Income. Interest and other income for the first nine months
of fiscal 2000 was primarily composed of the $37,000 gain on the sale of IGK.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2000, the Company's primary sources of liquidity included cash and
cash equivalents of $231,000, a short-term credit facility with a bank providing
for a $3.5 million line of credit prior to the renewal discussed below and a
note purchase agreement with Tumbleweed.
In May 2000, the Company and its bank entered into a commitment for a new credit
facility expanding borrowing capability from $3.5 to $5.0 million. On August 14,
2000, the Company and its bank executed a credit agreement dated as of June 1,
2000. Advances bear interest at the bank's prime rate (9.5% at June 30, 2000)
plus 1%, are payable on demand and are collateralized by substantially all of
the Company's assets. The amount available for borrowing at any time is based on
borrowing base formulae relating to levels of accounts receivable, the value of
the Company's real property and improvements located in Ann Arbor, Michigan and
other bank covenants. Under such formulae in the new agreement, $2.1 million
would have been available to the Company at June 30, 2000.
Under the terms of the credit agreement, the Company is required to maintain
certain minimum working capital, net worth, and other specific financial ratios.
In addition, the credit agreement prohibits the payment of cash dividends and
contains certain restrictions on the Company's ability to borrow money or
purchase assets or interests in other entities without the prior written consent
of the bank. On July 7, 2000, the Company repaid all indebtedness under the
credit facility with proceeds from the issuance of $2,000,000 of convertible
subordinated promissory notes to Tumbleweed.
In connection with the transactions contemplated by the Merger Agreement
described above, Tumbleweed agreed to purchase an aggregate of $3,000,000 of
Convertible Subordinated Promissory Notes of the Company (the "Notes") pursuant
to a Convertible Subordinated Note Purchase Agreement, dated as of June 28,
2000, by and between the Company and Tumbleweed (the "Note Purchase Agreement").
At Tumbleweed's option, or upon the occurrence of certain specified events, the
Notes are convertible into shares of the Company's common stock. At June 30,
2000, no Notes had been issued pursuant to the Note Purchase Agreement. On
July 7, 2000, Tumbleweed purchased $2,000,000 of such Notes.
Cash provided by investing activities was $805,000 in the first nine months of
fiscal 2000 primarily due to the proceeds received from the sale of IGK.
Cash provided by financing activities was $1.7 million in the first nine months
of fiscal 2000 and was primarily composed of the borrowings under the credit
facility and proceeds from the issuance of stock.
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or purchase assets or interests in other entities without the prior written
consent of the bank. On July 7, 2000, the Company repaid all indebtedness under
the credit facility with proceeds from the issuance of $2,000,000 of convertible
subordinated promissory notes to Tumbleweed.
The Company believes that its existing cash balances, available credit facility
and future operating cash flows will be sufficient for near term operating
needs. The foregoing statements are "forward looking statements" within the
meaning of the Securities Exchange Act of 1934. The extent to which such sources
will be sufficient to meet the Company's anticipated cash requirements is
subject to a number of uncertainties including the ability of the Company's
operations to generate sufficient cash to support operations, and other
uncertainties described in "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Uncertainties Relating to Forward-Looking
Statements."
UNCERTAINTIES RELATING TO FORWARD-LOOKING STATEMENTS
"Management's Discussion and Analysis of Results of Operations" contain
"forward-looking statements" within the meaning of the Securities Exchange Act
of 1934, as amended, based on current management expectations. Actual results
could differ materially from those in the forward-looking statements due to a
number of uncertainties, including, but not limited to, those discussed in this
section. Factors that could cause future results to differ from these
expectations include general economic conditions particularly related to demand
for the Company's products and services; changes in Company strategy; product
life cycles; competitive factors (including the introduction or enhancement of
competitive products); pricing pressures; the Company's success in and expense
associated with developing, introducing and shipping new products; software
defects and latent technological deficiencies in new products; changes in
operating expenses; inability to attract or retain consulting, sales and/or
engineering talent; changes in customer requirements; and evolving industry
standards; and the inability to close the merger with Tumbleweed.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has no material market risk exposure.
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS:
On June 28, 2000, in order to facilitate the acquisition of the Company pursuant
to the Merger Agreement, the Company and Tumbleweed entered into a Stock Option
Agreement (the "Stock Option Agreement") pursuant to which the Company granted
Tumbleweed an option to purchase 939,215 shares of the Company's common stock,
subject to adjustment, at $13.33 per share. The option is exercisable if an
event occurs which would entitle Tumbleweed to terminate the Merger Agreement
and which would entitle Tumbleweed to receive a termination fee.
The Company granted the option to Tumbleweed without registration under the
Securities Act of 1933, as amended (the "Act"), in reliance upon Section 4(2)
of the Act and Regulation D promulgated thereunder. The Company relied upon
this exemption based upon the limited number of purchasers, the provision to
Tumbleweed of financial and other information concerning the Company,
investment representations made by Tumbleweed in the Stock Option Agreement,
the lack of general solicitation, and actions taken by the Company to restrict
resale without registration of the securities to be acquired upon exercise of
the option, including the requirement that each certificate representing shares
acquired upon exercise of the option bear a restrictive legend.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
4.1 Credit Agreement between the Company and Bank One, Michigan, dated as
of June 1, 2000 (To be filed by amendment)
27 Financial Data Schedule
(b) No reports on Form 8-K have been filed during the quarter for which this
report is filed.
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SIGNATURES
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.
INTERFACE SYSTEMS, INC.
Date: August 14, 2000 /S/ Brian D. Brooks
-------------------
Brian D. Brooks
Vice President and Chief Financial Officer
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Exhibit Index
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Exhibit No. Description
- - ----------- -----------
4.1 Credit Agreement between the Company and Bank One,
Michigan, dated as of June 1, 2000.*
27 Financial Data Schedule
* To be filed by amendment