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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, 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, 4,452,349 shares as of August 12, 1998.
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INTERFACE SYSTEMS, INC.
FORM 10-Q
INDEX
Page No.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets at June 30, 1998
and September 30, 1997 3
Consolidated Statements of Operations for the Quarter
and Nine Month Periods Ended June 30, 1998 and 1997 4
Consolidated Statements of Cash Flows for the
Nine Months Ended June 30, 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
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 10
SIGNATURES 11
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PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
INTERFACE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, September 30,
1998 1997
------------- -------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 124,206 $ 830,086
Accounts receivable, net 3,000,337 3,010,737
Refundable income taxes 1,507,634 1,182,182
Inventories 2,808,265 3,841,747
Prepaid expenses and other 180,492 741,053
Deferred income taxes 306,721 475,000
Net current assets of discontinued operations 1,222,851 11,825,867
------------- -------------
Total current assets 9,150,506 21,906,672
Property and equipment, net 3,584,126 3,949,616
Property and equipment of discontinued operations -- 653,080
Goodwill, net 1,021,323 1,160,634
Software development costs, net 119,737 874,652
Other assets 215,045 285,853
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$ 14,090,737 $ 28,830,507
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable $ 2,620,500 $ 8,640,611
Accounts payable 567,392 1,738,596
Accrued expenses 733,098 630,287
Deferred revenue 517,233 638,709
Current portion of long-term debt 50,200 50,004
Current liabilities of discontinued operations 1,470,667 6,603,668
------------- -------------
Total current liabilities 5,959,090 18,301,875
Long-term debt 133,133 170,829
Deferred income taxes 565,000 615,000
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Total liabilities 6,657,223 19,087,704
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Stockholders' equity:
Common stock, no par value,
12,500,000 shares authorized; 4,424,950
shares issued and outstanding for both periods 445,235 442,495
Additional paid-in-capital 10,614,575 10,547,447
Cumulative translation adjustment (227,436) (281,441)
Retained deficit (3,398,860) (965,698)
-------------- --------------
Total stockholders' equity 7,433,514 9,742,803
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$ 14,090,737 $ 28,830,507
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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 Nine months ended
June 30, June 30,
1998 1997 1998 1997
---------- ----------- ----------- ------------
(unaudited) (unaudited)
Net revenues $4,826,340 $ 5,049,933 $15,515,872 $ 14,270,462
Cost of revenues 2,020,051 4,789,844 6,748,172 12,079,922
---------- ----------- ----------- ------------
Gross profit 2,806,289 260,089 8,767,700 2,190,540
Expenses:
Product development 952,704 967,809 2,800,916 2,105,465
Selling, general and administrative 1,927,006 2,270,997 5,994,773 6,208,945
---------- ----------- ----------- ------------
Operating income (loss) from
continuing operations (73,421) (2,978,717) (27,989) (6,123,870)
Interest expense (7,397) (32,901) (28,769) (117,632)
Other income 13,960 3,860 40,839 119,257
---------- ----------- ----------- ------------
Income (loss) from continuing
operations before income taxes (66,858) (3,007,758) (15,919) (6,122,245)
Income tax benefit - (865,150) (122,000) (1,668,680)
---------- ----------- ----------- ------------
Income (loss) from continuing operations (66,858) (2,142,608) 106,081 (4,453,565)
Income (loss) from discontinued operations -- (4,762,117) (748,243) (4,675,952)
Loss on disposal of discontinued operations -- -- (1,791,000) --
---------- ----------- ------------ ------------
Net loss $ (66,858) $(6,904,725) $(2,433,162) $ (9,129,517)
========== =========== =========== ============
Basic and diluted income (loss) per share:
Income (loss) from continuing operations $ (0.02) $ (0.49) $ 0.02 $ (1.00)
Income (loss) from discontinued operations -- (1.08) (0.57) (1.04)
---------- ----------- ----------- ------------
Net loss per share $ (0.02) $ (1.57) $ (0.55) $ (2.04)
========== =========== =========== ============
Weighted average shares outstanding 4,434,083 4,408,384 4,427,944 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
Nine Months Ended June 30,
1998 1997
------------ -----------
(unaudited)
Cash flows from operating activities:
Net loss $ (2,433,162) $(9,129,517)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Depreciation and amortization 1,385,001 1,875,945
Loss on sale of discontinued operations 1,014,288 --
Deferred income taxes 118,279 (1,179,000)
Gain on sale of securities -- (74,777)
Loss on sale of fixed assets -- 2,056
Write-off of software development costs -- 1,616,358
Change in operating assets and liabilities:
Accounts receivable 10,400 (1,576,634)
Refundable income taxes (325,452) (276,459)
Inventories 1,033,482 2,150,821
Prepaid expenses and other 560,561 809,815
Other assets 70,808 63,739
Accounts payable (1,171,204) (762,035)
Accrued expense 102,811 764,522
Deferred revenue (121,476) (114,639)
Discontinued operations - depreciation
and working capital changes 2,188,307 2,483,348
------------ -----------
Net cash used in operating activities 2,432,643 (3,346,457)
------------ -----------
Cash flows from investing activities:
Proceeds from sale of discontinued operations 2,920,500 --
Additions to property and equipment (125,285) (389,182)
Additions to software development costs -- (953,675)
Proceeds from sale of securities -- 177,612
------------ -----------
Net cash used in investing activities 2,795,215 (1,165,245)
------------ -----------
Cash flows from financing activities:
Change in notes payable (6,020,111) 3,432,201
Proceeds from issuance of stock 69,868 --
Reduction of long-term debt (37,500) (53,861)
------------ -----------
Net cash provided by financing activities (5,987,743) 3,378,340
------------ -----------
Effect of exchange rate changes on cash 54,005 80,249
------------ -----------
Net increase (decrease) in cash and cash equivalents (705,880) (1,053,113)
Cash and cash equivalents, beginning of period 830,086 1,694,725
------------ -----------
Cash and cash equivalents, end of period $ 124,206 $ 641,612
============ ===========
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 June 30, 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 a bank credit facility that provides for aggregate borrowings of
up to $3.5 million and expires February 28, 1999. As of June 30, 1998, $2.6
million was outstanding under this facility. Advances under the facility bear
interest at the bank's prime rate (8.5% at June 30, 1998) plus 1%, are payable
on demand and are collateralized by substantially all of the Company's assets.
The amount available for borrowing at any one time is based on borrowing base
formulas relating to levels of accounts receivable, inventories and other bank
covenants. Under such formulas, approximately $800,000 was available to the
Company as of June 30, 1998.
Under the terms of the facility, the Company is required to maintain certain
minimum working capital, net worth and profitability levels and other specific
financial ratios. 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. As of June 30, 1998, the Company was in compliance
with the bank covenants.
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.
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
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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 third quarter ended June 30, 1998 were $4.8
million, a decrease of 4.4% over revenues of $5.0 million for the third quarter
of fiscal 1997. The decrease was due primarily to decreased sales of the
Company's Enterprise Networking products, which are impacted by large corporate
orders. Revenues for the nine months ended June 30, 1998 were $15.5 million, an
increase of 8.7% over revenues of $14.3 million for the same period of fiscal
1997. The increase for the nine month period was primarily due to increased
sales of Enterprise Networking products and to a lesser extent, increased sales
of Oasis products offset by decreased sales of printer products.
Cost of Revenues. Cost of revenues were $2.0 million and $4.8 million, or 41.9%
and 94.8% of net revenues for the quarters ended June 30, 1998 and 1997,
respectively; and $6.7 million and $12.1 million, or 43.5% and 84.6% of net
revenues for the nine months ended June 30, 1998 and 1997, respectively. Cost of
revenues decreased as a percentage of net revenues, primarily due to a decrease
in non-recurring charges for inventory and capitalized software development
costs. Cost of revenues includes amortization and write-off of capitalized
software development costs of $46,000 and $1.7 million for the quarters ended
June 30, 1998 and 1997, respectively; and $754,000 and $3.1 million for the nine
months ended June 30, 1998 and 1997, respectively. Cost of revenues also
includes non-recurring charges of $600,000 and $2.0 million for inventory
write-offs during the quarter and nine months ended June 30, 1997, respectively.
There were no inventory write-offs during the nine months ended June 30, 1998.
Additionally, the decrease in cost of revenues as a percentage of net revenues
resulted from increased sales of higher margin software products as a percentage
of net revenue.
Product Development Costs. Product development costs were $953,000 and $968,000,
or 19.7% and 19.2% of net revenues for the quarters ended June 30, 1998 and
1997, respectively; and $2.8 million and $2.1 million, or 18.1% and 14.8% of net
revenues for the nine months ended June 30, 1998 and 1997, respectively. The
absolute dollar increase for both periods primarily reflects a decrease in the
amount of expense deferred through capitalization of internally developed
software. Product development costs were reduced by the capitalization of
$10,000 and $1.1 million of software development costs during the quarter and
nine months ended June 30, 1997, respectively. No such costs were capitalized
during the nine months ended June 30, 1998.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $1.9 million and $2.3 million, or 39.9% and 45.0%
of net revenues for the quarters ended June 30, 1998 and 1997, respectively; and
$6.0 million and $6.2 million, or 38.6% and 43.5% of net revenues for the nine
months ended June 30, 1998 and 1997, respectively. The absolute dollar decrease
for both periods 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 nine months ended June 30, 1998
results from the utilization of net operating losses and other tax attributes.
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LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1998, the Company's primary sources of liquidity included cash and
cash equivalents of $124,000 and a short-term credit facility with a bank
providing for $3.5 million of borrowings, of which approximately $800,000 was
available.
For the nine months ended June 30, 1998, net cash of $2.4 million was provided
by operating activities compared to net cash of $3.3 million used in operating
activities for the same period of fiscal 1997. Cash was provided by operating
activities for the first nine months of fiscal 1998 primarily due to the sale of
the ISIL distribution business and decreased inventory partially offset by
decreased accounts payable and net loss for the period. Net cash of $6.0 million
was used in financing activities for the first nine months of fiscal 1998, due
primarily to a reduction in notes payable.
The Company has a bank credit facility that provides for aggregate borrowings of
up to $3.5 million and expires February 28, 1999. As of June 30, 1998, $2.6
million was outstanding under this facility. Advances under the facility bear
interest at the bank's prime rate (8.5% at June 30, 1998) plus 1%, are payable
on demand and are collateralized by substantially all of the Company's assets.
The amount available for borrowing at any one time is based on borrowing base
formulas relating to levels of accounts receivable, inventories and other bank
covenants. Under such formulas, approximately $800,000 was available to the
Company as of June 30, 1998.
Under the terms of the facility, the Company is required to maintain certain
minimum working capital, net worth and profitability levels and other specific
financial ratios. 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. As of June 30, 1998, the Company was in compliance
with the bank covenants.
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 Company believes it will renew the bank credit facility prior to the
expiration of the facility. 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 workstations 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
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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.
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.
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The Exhibits included herewith are set forth on the Index to Exhibits.
(b) Reports on Form 8-K dated May 19, 1998 and June 3, 1998 were filed on
May 20, 1998 and June 3, 1998, respectively.
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, 1998 /S/ John R. Ternes
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John R. Ternes
Vice President and Chief Financial Officer
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INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
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27 Financial Data Schedule