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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 MARCH 31, 1998
[ ] 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, 4,424,950 shares as of May 12, 1998.
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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:
Consolidated Balance Sheets at March 31, 1998
and September 30, 1997 3
Consolidated Statements of Operations for the Quarter
and Six Month Periods Ended March 31, 1998 and 1997 4
Consolidated Statements of Cash Flows for the
Six Months Ended March 31, 1998 and 1997 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations 7
Item 3. Quantitative and Qualitative
Disclosures about Market Risk 10
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 10
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
CONSOLIDATED BALANCE SHEETS
March 31, September 30,
1998 1997
------------- ---------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 1,048,583 $ 830,086
Accounts receivable, net 2,708,868 3,010,737
Refundable income taxes 1,507,634 1,182,182
Inventories 3,169,797 3,841,747
Prepaid expenses and other 300,224 741,053
Deferred income taxes 309,000 475,000
Net current assets of discontinued operations 11,165,524 11,825,867
------------- -------------
Total current assets 20,209,630 21,906,672
Property and equipment, net 3,701,648 3,949,616
Property and equipment of discontinued operations 327,667 653,080
Goodwill, net 1,067,760 1,160,634
Software development costs, net 166,216 874,652
Other assets 244,187 285,853
------------- -------------
$ 25,717,108 $ 28,830,507
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable $ 7,609,420 $ 8,640,611
Accounts payable 1,428,420 1,738,596
Accrued expenses 563,482 630,287
Deferred revenue 541,840 638,709
Current portion of long-term debt 50,200 50,004
Current liabilities of discontinued operations 7,473,513 6,603,668
------------- -------------
Total current liabilities 17,666,875 18,301,875
Long-term debt 145,633 170,829
Deferred income taxes 565,000 615,000
------------- -------------
Total liabilities 18,377,508 19,087,704
------------- -------------
Stockholders' equity:
Common stock, no par value,
12,500,000 shares authorized; 4,424,950
shares issued and outstanding for both periods 442,495 442,495
Additional paid-in-capital 10,547,447 10,547,447
Cumulative translation adjustment (318,340) (281,441)
Retained deficit (3,332,002) (965,698)
-------------- --------------
Total stockholders' equity 7,339,600 9,742,803
------------- -------------
$ 25,717,108 $ 28,830,507
============= ================
The accompanying notes are an integral part of these
consolidated financial statements.
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INTERFACE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Quarter ended Six months ended
March 31, March 31,
1998 1997 1998 1997
---- ---- ---- ----
(unaudited) (unaudited)
Net revenues $5,066,318 $ 4,861,140 $ 10,690,528 $ 9,030,253
Cost of revenues 2,336,183 4,500,873 4,728,124 7,212,403
------------- ------------ ------------- ------------
Gross profit 2,730,135 360,267 5,962,404 1,817,850
Expenses:
Product development 944,285 625,780 1,848,213 1,127,530
Selling, general and administrative 1,890,463 2,107,239 4,067,765 4,089,508
------------- ------------ ------------- ------------
Operating income (loss) from
continuing operations (104,613) (2,372,752) 46,426 (3,399,188)
Interest expense (15,643) (54,364) (21,372) (116,806)
Other income 19,543 1,091 25,885 115,432
------------- ------------ ------------- ------------
Income (loss) from continuing
operations before income taxes (100,713) (2,426,025) 50,939 (3,400,562)
Income tax benefit (122,000) (609,943) (122,000) (803,530)
-------------- ------------- ------------- ------------
Income (loss) from continuing operations 21,287 (1,816,082) 172,939 (2,597,032)
Income (loss) from discontinued operations (533,963) 316,353 (748,243) 372,250
Loss on disposal of discontinued operations (1,791,000) -- (1,791,000) --
-------------- ------------ ------------- ------------
Net loss $ (2,303,676) $ (1,499,729) $(2,366,304) $ (2,224,782)
============== ============ ============= ============
Basic and diluted income (loss) per share:
Income (loss) from continuing operations $ 0.01 $ (0.41) $ 0.04 $ (0.58)
Income (loss) from discontinued operations (0.53) 0.07 (0.57) 0.08
------------- ------------ ------------- ------------
Net loss per share $ (0.52) $ (0.34) $ (0.53) $ (0.50)
============= ============ ============= ============
Weighted average shares outstanding 4,424,950 4,408,384 4,424,950 4,472,132
============= ============ ============= ============
The accompanying notes are an integral part of these
consolidated financial statements.
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INTERFACE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended March 31,
1998 1997
---- ----
(unaudited)
Cash flows from operating activities:
Net loss $ (2,366,304) $(2,224,782)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Depreciation and amortization 1,132,489 1,650,801
Loss on sale of discontinued operations (1,791,000) --
Deferred income taxes 116,000 --
Gain on sale of securities -- (74,777)
Loss on sale of fixed assets -- 2,056
Write-off of software development costs -- 357,358
Change in operating assets and liabilities:
Accounts receivable 301,869 (967,008)
Refundable income taxes (325,452) (424,189)
Inventories 671,950 1,355,741
Prepaid expenses and other 440,829 117,017
Other assets 41,666 (248,393)
Accounts payable (310,176) 1,629,343
Accrued expense (66,805) (238,990)
Deferred revenue (96,869) (67,033)
Discontinued operations - depreciation
and working capital changes 3,646,601 (3,392,674)
------------ -----------
Net cash used in operating activities 1,394,798 (2,525,530)
------------ -----------
Cash flows from investing activities:
Additions to property and equipment (83,211) (365,822)
Additions to software development costs -- (953,675)
Reduction of notes receivable -- 52,811
Proceeds from sale of securities -- 177,612
------------ -----------
Net cash used in investing activities (83,211) (1,089,074)
------------ -----------
Cash flows from financing activities:
Change in notes payable (1,031,191) 2,655,393
Reduction of long-term debt (25,000) (41,361)
------------ -----------
Net cash provided by financing activities (1,056,191) 2,614,032
------------ -----------
Effect of exchange rate changes on cash (36,899) 16,835
------------ -----------
Net increase (decrease) in cash and cash equivalents 218,497 (983,737)
Cash and cash equivalents, beginning of period 830,086 1,694,725
------------ ----------
Cash and cash equivalents, end of period $ 1,048,583 $ 710,988
============ ==========
The accompanying notes are an integral part of these
consolidated financial statements.
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INTERFACE SYSTEMS, INC.
NOTES TO 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, 1997 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 March 31, 1998 are not necessarily indicative of
the results to be expected for any future period or for the entire year.
Certain prior year amounts have been reclassified to conform to the 1998
financial statement presentation. As more thoroughly discussed in Note 2,
Interface Systems International, Ltd. ("ISIL") is presented as a discontinued
operation for all periods presented.
2. SALE OF INTERFACE SYSTEMS INTERNATIONAL LTD. DISTRIBUTION BUSINESS;
DISCONTINUED OPERATIONS
In May 1998, the Company consummated a sale of substantially all assets and
certain liabilities of the distribution business of ISIL to Fayrewood plc, a
U.K. company quoted on the Alternative Investment Market of the London Stock
Exchange. The sale did not include the assumption by Fayrewood of all of ISIL's
liabilities, and therefore, no assurances can be given that claims will not be
made against the Company in the future arising out of ISIL's former operations.
Such claims could have a material adverse effect on the Company's financial
condition and results of operations.
The consideration of $3.6 million is approximately equal to 83% of the net
assets sold and is subject to audit. The net assets sold, estimated at $4.3
million, consist of accounts receivable (exclusive of certain aged receivables),
inventory and fixed assets, net of accounts payable. The consideration is
payable in cash with an initial payment of $2.9 million and the balance of the
consideration due in approximately 60 days upon completion of an audit of the
net assets sold. The Company recorded a charge of approximately $1.8 million in
the quarter ended March 31, 1998 for the loss on sale and related expenses.
Accordingly, the operating results of ISIL have been segregated from continuing
operations and reported as a separate line item on the Company's consolidated
statement of operations. In addition, the assets and liabilities of ISIL,
excluding its note payable, have been reclassified on the Company's consolidated
balance sheets and reported as assets and liabilities of the discontinued
operation. The Company has restated its prior financial statements to present
the operating results of ISIL as a discontinued operation.
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3. BORROWINGS
The Company has bank credit facilities which provide for aggregate borrowings of
up to $11.5 million. As of March 31, 1998, $7.6 million was outstanding under
these facilities. Advances under these facilities bear interest at the bank's
prime rate (8.5% at March 31, 1998) plus 1%, are payable on demand and are
collateralized by substantially all of the Company's assets. The credit facility
covering $3.5 million of the aggregate borrowings expires February 28, 1999 and
the facility covering the balance of the borrowings is subject to review on
August 28, 1998. The amount available for borrowing at any one time under the
facilities is based on borrowing base formulas relating to levels of accounts
receivable, inventories and other bank covenants. Under such formulas,
approximately $1.4 million was available to the Company as of March 31, 1998.
Under the terms of the agreements, the Company is required to maintain certain
minimum working capital, net worth and profitability levels and other specific
financial ratios. The Company was in violation of the minimum net worth covenant
of the credit facilities at March 31, 1998. The Bank waived the default through
an amendment to the facilities. In addition, the agreements prohibit the payment
of cash dividends and contain 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.
4. EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings per Share." The Company
adopted the new standard for the quarter ended December 31, 1997, as required by
the statement. The implementation of this standard had no effect on the
consolidated financial statements for the periods presented.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
SALE OF INTERFACE SYSTEMS INTERNATIONAL LTD. DISTRIBUTION BUSINESS;
DISCONTINUED OPERATIONS
In May 1998, the Company consummated a sale of substantially all assets and
certain liabilities of the distribution business of ISIL to Fayrewood plc, a
U.K. company quoted on the Alternative Investment Market of the London Stock
Exchange. The sale did not include the assumption by Fayrewood of all of ISIL's
liabilities, and therefore, no assurances can be given that claims will not be
made against the Company in the future arising out of ISIL's former operations.
Such claims could have a material adverse effect on the Company's financial
condition and results of operations.
The consideration of $3.6 million is approximately equal to 83% of the net
assets sold and is subject to audit. The net assets sold, estimated at $4.3
million, consist of accounts receivable (exclusive of certain aged receivables),
inventory and fixed assets, net of accounts payable. The consideration is
payable in cash with an initial payment of $2.9 million and the balance of the
consideration due in approximately 60 days upon completion of an audit of the
net assets sold. The Company recorded a charge of approximately $1.8 million in
the quarter ended March 31, 1998 for the loss on sale and related expenses.
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Accordingly, the operating results of ISIL have been segregated from continuing
operations and reported as a separate line item on the Company's consolidated
statement of operations. In addition, the assets and liabilities of ISIL,
excluding its note payable, have been reclassified on the Company's consolidated
balance sheets and reported as assets and liabilities of the discontinued
operation. The Company has restated its prior financial statements to present
the operating results of ISIL as a discontinued operation.
RESULTS OF OPERATIONS
Net Revenues. Revenues for the second quarter ended March 31, 1998 were $5.1
million, an increase of 4.2% over revenues of $4.9 million for the second
quarter of fiscal 1997. The increase was due primarily to increased sales of
Oasis Document Server software and related consulting and integration services.
Revenues for the first six months of fiscal 1998 were $10.7 million, an increase
of 18.4% over revenues of $9.0 million for the same period of fiscal 1997. The
increase for the six month period was primarily due to increased sales of
Enterprise Network products as well as increased sales of Oasis products offset
by decreased sales of printer products.
Cost of Revenues. Cost of revenues were $2.3 million and $4.5 million, or 46.1%
and 92.6% of net revenues for the quarters ended March 31, 1998 and 1997,
respectively; and $4.7 million and $7.2 million, or 44.2% and 79.9% of net
revenues for the six months ended March 31, 1998 and 1997, respectively. Cost of
revenues decreased as a percentage of net revenues due primarily to write-offs
in the second quarter of fiscal 1997 of $1.8 million related to printer business
inventory and capitalized software development costs. Additionally, the decrease
resulted from higher sales of core business software products, which have higher
gross profit margins. Cost of revenues included amortization of capitalized
software development costs of $353,000 and $470,000 for the quarters ended March
31, 1998 and 1997, respectively, and $708,000 and $1,011,000 for the six months
ended March 31, 1998 and 1997, respectively. In the future, amortization of
capitalized software development costs is expected to be less than $50,000 per
quarter.
Product Development Costs. Product development costs were $944,000 and $626,000,
or 18.6% and 12.9% of net revenues for the quarters ended March 31, 1998 and
1997, respectively; and $1,848,000 and $1,128,000, or 17.3% and 12.5% of net
revenues for the six months ended March 31, 1998 and 1997, respectively. The
absolute dollar increase for both periods primarily reflects a decrease of
$420,000 and $1,087,000 in the amount of expense deferred through capitalization
of internally developed software for the quarter and six months ended March 31,
1998, respectively, as compared with the same periods of fiscal 1997.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $1.9 million and $2.1 million, or 37.3% and 43.3%
of net revenues for the quarters ended March 31, 1998 and 1997, respectively;
and were $4.1 million and $4.1 million, or 38.1% and 45.3% of net revenues for
the six months ended March 31, 1998 and 1997, respectively. The absolute dollar
decrease for the second quarter was primarily due to a reduction in the
Company's core business sales force in the United Kingdom offset by an increase
in marketing expenses to promote sales of Oasis Document Server software and
related consulting and integration services.
Income Taxes. The income tax benefit for the quarter and six months ended March
31, 1998 results from the utilization of net operating losses and other tax
attributes.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1998, the Company's primary sources of liquidity included cash and
cash equivalents of $1.0 million and short-term credit facilities with a bank
providing for $11.5 million of borrowings, of which approximately $1.4 million
was available.
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For the six months ended March 31, 1998, net cash of $1.4 million was provided
by operating activities compared to net cash of $ 2.2 million used in operating
activities for the same period of fiscal 1997. Cash was provided by operating
activities for the first six months of fiscal 1998 primarily due to increased
accounts payable, decreased inventory and non-cash charges partially off-set by
increased accounts receivable and net loss for the period. Net cash used in
financing activities was $1.1 million for the first six months of fiscal 1998
due primarily to a reduction in notes payable.
The Company has bank credit facilities which provide for aggregate borrowings of
up to $11.5 million. As of March 31, 1998, $7.6 million was outstanding under
these facilities. The borrowings are used primarily by ISIL in the operation of
its distribution business. Advances under these facilities bear interest at the
bank's prime rate plus 1%, are payable on demand and are collateralized by
substantially all of the Company's assets. The credit facility covering $3.5
million of the borrowings expires February 28, 1999 and the facility covering
the balance of the borrowings is subject to review on August 28, 1998.
Under the terms of the agreements, the Company is required to maintain certain
minimum working capital, net worth and profitability levels and other specific
financial ratios. The Company was in violation of the minimum net worth covenant
of the credit facilities at March 31, 1998. The Bank waived the default through
an amendment to the facilities. In addition, the agreements prohibit the payment
of cash dividends and contain 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.
The Company believes that its existing cash balances, available credit
facilities and future operating cash flows will be sufficient for near term
operating needs. The Company believes it will renew the bank credit facilities
prior to expiration of the facilities. 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 Results of Operations - Uncertainties Relating to Forward-Looking
Statements."
INTERFACE SYSTEMS YEAR 2000 DISCLOSURE
Interface Systems, Inc. initiated a Year 2000 Project in 1997.
The Company has determined that its products are Year 2000 compliant. The
Company is currently implementing plans to upgrade or replace business
computers, network servers and work stations and other components of its
information technology infrastructure for Year 2000 compliance. The Company does
not expect that the cost to modify its information technology infrastructure to
be Year 2000 compliant will be material to its financial condition or results of
operations. The Company does not anticipate any material disruption in its
operations as a result of any failure by the Company to be in compliance. The
Company does not currently have complete information concerning the Year 2000
compliance of its suppliers or customers, and is in the process of gathering
additional information concerning whether its vendors are Year 2000 compliant
and their timetables for addressing any deficiencies. In the event that any of
the Company's significant suppliers or customers do not successfully and timely
achieve Year 2000 compliance, the Company's business or operations could be
adversely affected.
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UNCERTAINTIES RELATING TO FORWARD-LOOKING STATEMENTS
"Management's Discussion and Analysis of Results of Operations" contains
"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: 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 results of the audit of the ISIL net assets sold, component price
increases, delays in introduction of planned hardware and software products,
software defects and latent technological deficiencies in new products, changes
in operating expenses, inability to attract or retain sales and/or engineering
talent, changes in customer requirements and evolving industry standards.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
PART II - OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Shareholders was held on February 20, 1998 in
Ann Arbor, Michigan, and was adjourned to March 20,1 998 in order to provide
stockholders with additional opportunity to vote their shares of stock with
respect to the matters voted upon at the Annual Meeting. There were four matters
voted on, which were: (I) the election of directors; (ii) the approval of a
change in the Company's state of incorporation from Delaware to Michigan; (iii)
the approval of the adoption of the Employee Stock Purchase Plan; and (iv) the
approval of an amendment to the 1993 Stock Plan for Non-Employee Directors to
provide the board with discretionary authority to grant options. All director
nominees were elected and the other proposals were approved. The following table
sets forth the results of the voting on the matters voted on.
(1) Election of Directors Votes For Votes Against
--------------------- --------- -------------
Garnel F. Graber 3,794,811 173,373
Robert A. Nero 3,824,910 143,274
Bruce E. Rhoades 3,822,785 145,399
David C. Seigle 3,710,944 257,240
Robert A. Seigle 3,711,340 256,844
Lloyd A. Semple 3,818,518 149,666
(2) Approval of change in the company's state of incorporation to Michigan.
For Against Abstain Non-Vote
--- ------- ------- --------
2,273,877 44,426 22,439 1,627,442
(3) Approval of Employee Stock Purchase Plan
For Against Abstain Non-Vote
--- ------- ------- --------
2,197,314 101,041 57,226 1,612,603
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(4) Approval of Amendment to 1993 Stock Plan for Non-Employee Directors
For Against Abstain Non-Vote
--- ------- ------- --------
3,144,483 699,225 66,941 57,535
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
3(i) Articles of Incorporation, as amended
3(ii) Bylaws
10.1 Third Amendment to Credit Authorization Agreement
10.2 Non-Qualified Stock Option Agreement dated as of January 15, 1995
between Interface Systems, Inc., and David O. Schupp.
10.3 Interface Systems, Inc. 1993 Stock Plan for Non-Employee Directors
10.4 Interface Systems, Inc. Employee Stock Purchase Plan
27 Financial Data Schedule
(b) No reports on Form 8-K have been filed during the quarter for which this
report is filed.
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: May 20, 1998 /S/ John R. Ternes
------------------
John R. Ternes
Vice President and Chief
Financial Officer
(Principal Financial and
Accounting Officer
and a duly authorized
officer of the Registrant)
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