UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q QUARTERLY REPORT UNDER SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarter Ended June 30, 2002 Commission File Number 0-13071 INTERPHASE CORPORATION (Exact name of registrant as specified in its charter) TEXAS 75-1549797 (State of incorporation) (IRS Employer Identification No.) 13800 SENLAC, DALLAS, TEXAS 75234 (Address of principal executive offices) (214)-654-5000 (Registrant's telephone number, including area code) - -------------------------------------------------------------------------------- Indicate by check mark whether the registrant (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for a much 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. Yes [X] No - -------------------------------------------------------------------------------- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at August 12, 2002 ----- ------------------------------ Common Stock, $.10 par value 5,514,276 INTERPHASE CORPORATION INDEX <Table> Part I - Financial Information Item 1. Consolidated Interim Financial Statements Consolidated Balance Sheets as of June 30, 2002 (unaudited) and December 31, 2001 3 Consolidated Statements of Operations for the three months and six months ended June 30, 2002 and 2001 (unaudited) 4 Consolidated Statements of Cash Flows for the six months ended June 30, 2002 and 2001 (unaudited) 5 Notes to Consolidated Interim Financial Statements 6-11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12-17 PART II - OTHER INFORMATION Item 6. Reports on Form 8-K and Exhibits 17 Signature 18 </Table> 2 INTERPHASE CORPORATION CONSOLIDATED BALANCE SHEETS (in thousands, except number of share data) <Table> <Caption> (unaudited) Jun. 30, Dec. 31, 2002 2001 --------------------------- ------------------- ASSETS Cash and cash equivalents $ 13,736 $ 10,415 Marketable securities 5,348 5,216 Restricted cash 3,500 3,500 Trade accounts receivable, less allowances for uncollectible accounts and returns of $270 and $370, respectively 4,617 5,046 Inventories 3,792 6,655 Prepaid expenses and other current assets 469 480 Income taxes receivable - 2,476 Deferred income taxes 1,644 1,636 --------------------------- ------------------- Total current assets 33,106 35,424 Machinery and equipment 6,293 6,117 Leasehold improvements 2,941 2,936 Furniture and fixtures 557 543 --------------------------- ------------------- 9,791 9,596 Less-accumulated depreciation and amortization (9,090) (8,653) --------------------------- ------------------- Total property and equipment, net 701 943 Capitalized software, net 282 335 Deferred income taxes, net 2,629 2,373 Other assets 204 168 --------------------------- ------------------- Total assets $ 36,922 $ 39,243 =========================== =================== LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES Accounts payable $ 1,036 $ 921 Deferred revenue 235 110 Accrued liabilities 1,498 1,615 Accrued compensation 1,259 1,177 --------------------------- ------------------- Total current liabilities 4,028 3,823 Long term debt 3,500 3,500 --------------------------- ------------------- Total liabilities 7,528 7,323 COMMITMENTS AND CONTINGENCIES Common stock redeemable; 40,662 and 121,996 shares, respectively 254 762 SHAREHOLDERS' EQUITY Common stock, $.10 par value; 100,000,000 shares authorized; 5,516,076 and 5,518,476 shares issued and outstanding, respectively 552 552 Additional paid in capital 37,310 37,324 Retained deficit (8,453) (6,394) Cumulative other comprehensive loss (269) (324) --------------------------- ------------------- Total shareholders' equity 29,140 31,158 --------------------------- ------------------- Total liabilities and shareholders' equity $ 36,922 $ 39,243 =========================== =================== </Table> The accompanying notes are an integral part of these consolidated financial statements. 3 INTERPHASE CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands except per share amounts) (unaudited) <Table> <Caption> Three Months Ended Jun. 30, Six Months Ended Jun. 30, - ----------------------------------- ---------------------------------- 2002 2001 2002 2001 - ----------------------------------- ---------------------------------- $ 6,016 $ 7,108 Revenues $ 12,316 $ 17,059 4,454 8,403 Cost of sales 8,262 13,294 - ----------------------------------- ---------------------------------- 1,562 (1,295) Gross margin 4,054 3,765 1,713 2,087 Research and development 3,362 4,300 1,610 2,172 Sales and marketing 2,981 4,222 815 1,031 General and administrative 1,569 2,126 Restructuring costs and other special - 2,091 charges - 2,091 - ----------------------------------- ---------------------------------- 4,138 7,381 Total operating expenses 7,912 12,739 - ----------------------------------- ---------------------------------- (2,576) (8,676) Operating loss (3,858) (8,974) - ----------------------------------- ---------------------------------- 134 103 Interest, net 327 186 (55) (184) Other, net 1 (221) - ----------------------------------- ---------------------------------- (2,497) (8,757) Loss before income taxes (3,530) (9,009) (1,004) (2,751) Benefit for income taxes (1,471) (2,815) - ----------------------------------- ---------------------------------- $ (1,493) $ (6,006) Net loss $ (2,059) $ (6,194) =================================== ================================== Loss per share $ (0.27) $ (1.05) Basic EPS $ (0.37) $ (1.08) - ----------------------------------- ---------------------------------- $ (0.27) $ (1.05) Diluted EPS $ (0.37) $ (1.08) - ----------------------------------- ---------------------------------- 5,565 5,727 Weighted average common shares 5,586 5,742 - ----------------------------------- ---------------------------------- Weighted average common and dilutive 5,565 5,727 shares 5,586 5,742 - ----------------------------------- ---------------------------------- </Table> The accompanying notes are an integral part of these consolidated financial statements. 4 INTERPHASE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (unaudited) <Table> <Caption> Six Months ended Jun. 30, ---------------------------------------- 2002 2001 ---------------------- ---------------- CASH FLOW FROM OPERATING ACTIVITIES: Net loss $ (2,059) $ (6,194) Adjustment to reconcile net loss to net cash provided by operating activities: Allowance for uncollectible accounts and returns 100 110 Depreciation and amortization 433 1,143 Deferred income taxes (264) 17 Tax benefit from stock option exercises - 94 Non-cash restructuring costs and other special charges - 6,002 Change in assets and liabilities: Trade accounts receivable 329 8,978 Inventories 2,863 385 Prepaid expenses and other current assets 17 163 Income taxes receivable 2,476 (2,913) Other assets (21) (18) Accounts payable, deferred revenue and accrued liabilities 88 (983) Accrued compensation 12 (717) Income tax payable - (78) Other 359 (256) ----------------------- --------------- Net adjustments 6,392 11,927 ----------------------- --------------- Net cash provided by operating activities 4,333 5,733 CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property, equipment, capitalized software and leasehold improvements (121) (276) Proceeds from sale of marketable securities 864 6,429 Purchases of marketable securities, net of unrealized holding period gain or loss (1,010) (6,763) ----------------------- --------------- Net cash used by investing activities (267) (610) CASH FLOWS FROM FINANCING ACTIVITIES: Payments on debt - (1,154) Purchase of redeemable common stock (508) (509) Purchase of common stock (14) - Proceeds from the exercise of stock options - 153 ----------------------- --------------- Net cash used by financing activities (522) (1,510) ----------------------- --------------- Effect of exchange rate changes on cash and cash equivalents (223) (44) ----------------------- --------------- Net increase in cash and cash equivalents 3,321 3,569 Cash and cash equivalents at beginning of period 10,415 10,587 ----------------------- --------------- Cash and cash equivalents at end of period $ 13,736 $ 14,156 ======================= =============== </Table> The accompanying notes are an integral part of these consolidated financial statements. 5 NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION Interphase Corporation and subsidiaries ("Interphase" or the "Company") enables rapid platform design and integration for the global voice and data communications markets through custom and off-the-shelf communications equipment, embedded software development suites, and systems integration and consulting services for telecom and enterprise networks. The company's products connect computer and telecommunication servers to Wide Area Networks (WANs), Local Area Networks (LANs) and Storage Area Networks (SANs) using Asynchronous Transfer Mode (ATM), Ethernet, Signaling System 7 (SS7), IP, Fibre Channel, HDLC, Frame Relay and Integrated Services Digital Network (ISDN) technologies. The accompanying consolidated interim financial statements include the accounts of Interphase Corporation and its wholly owned subsidiaries. Significant intercompany accounts and transactions have been eliminated. While the accompanying interim financial statements are unaudited, they have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of the Company, all material adjustments and disclosures necessary to fairly present the results of such periods have been made. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2001. Certain prior period amounts within the Consolidated Statements of Cash Flows have been reclassified to conform with the 2002 presentation. The preparation of financial statements, in conformity with accounting principles generally accepted in the United States, requires Company management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Areas involving significant estimates are the allowance for bad debts, warranty reserves, allowance for returns and inventory valuation. 6 2. RESTRUCTURING COSTS AND OTHER SPECIAL CHARGES In the second quarter 2001, the Company announced a restructuring program designed to allow the Company to continue aggressive funding of its development organizations, while preserving cash levels and securing new design-ins. As a result of the restructuring program, continued decline in predicted revenue and customers' cautious expectations regarding market recovery, the Company recorded restructuring costs and other special charges of $2.1 million, classified as operating expenses, and an additional excess and obsolete inventory charge of $4.4 million, classified as cost of sales. The restructuring program resulted in the reduction of approximately 22% of the Company's workforce, impacting all business functions in North America. As a result, the Company recorded a workforce reduction charge of $483,000 relating to severance and fringe benefits. In addition, the Company wrote off $123,000 of nonutilized fixed assets. Due to the decline in business conditions, decline in legacy product revenues and the diminished expected future benefits from the purchased intangibles related to the acquisition of Synaptel, S.A. in 1996, the Company recorded a charge of $1.5 million related to the impairment of developed technology and assembled workforce during the second quarter 2001. These intangible assets, purchased in the acquisition of Synaptel, S.A., relate to the Company's legacy product lines. In the second quarter 2000, the Company developed a strategy to end-of-life many of its legacy products in an effort to focus its resources on its new product lines. This strategy resulted in increased sales of legacy products in 2000; however, legacy product sales declined in the first quarter of 2001, and continued to decline through the second quarter of 2001. Management did not expect significant revenues from its legacy product lines in future periods. The Company wrote off $5.9 million of excess and obsolete inventory during the second quarter of 2001, resulting in an additional charge to cost of sales of $4.4 million. Approximately 74% of the write-off relates to the Company's legacy product lines. The remaining $1.5 million of excess and obsolete inventory written off was charged against the already established reserve. This additional excess and obsolete inventory charge was due to a sudden and significant decrease in predicted revenue and was calculated in accordance with the Company's established policy. 7 Only the severance and fringe benefit payments relating to the workforce reduction impacted cash flow. A summary of the restructuring costs and other special charges is outlined as follows (in thousands): <Table> <Caption> Second Quarter Cash Payments Third Fourth and Quarter Quarter Accrual Total Noncash Cash Cash Balance at Charge Charges Payments Payments Dec. 31, 2001 -------------- ---------------- -------------- -------------- ------------------ Workforce reduction $ 483 $ 17 $ 384 $ 82 $ - Fixed asset write-off 123 123 - - - Impairment of purchased intangibles 1,485 1,485 - - - Excess and obsolete inventory charge 4,394 4,394 - - - ------------- ---------------- -------------- -------------- ------------------ $ 6,485 $6,019 $ 384 $ 82 $ - ============= ================ ============== ============== ================== </Table> 3. INVENTORIES Inventories are valued as 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): <Table> <Caption> Jun. 30, 2002 Dec. 31, 2001 ------------------ ------------------ Raw Materials $ 2,751 $ 4,740 Work-in-Process 786 1,397 Finished Goods 255 518 ------------------ ------------------ Total $ 3,792 $ 6,655 ================== ================== </Table> 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 our products. Future events may cause significant fluctuations in our operating results. 8 4. CREDIT FACILITY The Company has a $5 million revolving credit facility with a bank. The revolving credit facility matures on June 30, 2003 and is secured throughout the term of the credit facility by a ninety-day certificate of deposit issued by the bank in the principal amount equal to the stated principal amount of the promissory note. Management intends to extend the revolving credit facility past the current expiration date. The certificate of deposit is reflected as restricted cash on the accompanying balance sheet. The credit facility bears interest at the rate of approximately 1% per annum above the certificate of deposit rate, which is currently 1.44%, and includes certain restrictive covenants including, among others, a tangible net worth restriction. As of June 30, 2002, the Company was in compliance with all restrictive covenants included in the revolving credit facility. At June 30, 2002, the Company had borrowings of $3.5 million and availability under the revolving credit facility was $1.5 million. 5. COMPREHENSIVE INCOME The following table shows the Company's comprehensive income (in thousands): <Table> <Caption> Three months ended June 30, Six months ended June 30, 2002 2001 2002 2001 ----------------- ---------------- --------------- ---------------- Net loss $ (1,493) $ (6,006) $ (2,059) $ (6,194) Other comprehensive income: Unrealized holding (loss) gain arising during period, net of tax (51) (49) 14 52 Foreign currency translation adjustment 222 (76) 41 (207) ----------------- ---------------- --------------- ---------------- Comprehensive loss $ (1,322) $ (6,131) $ (2,004) $ (6,349) ================= ================ =============== ================ </Table> 6. NET INCOME PER COMMON AND COMMON DILUTIVE SHARE Diluted earnings per share consist only of the dilutive impact of stock options, using the treasury stock method. Due to the Company's net losses for the periods presented, the effect of dilutive securities would have been antidilutive. Options that would have otherwise been included in the calculation of diluted earnings per common share were 12,869 and 20,444 stock options for the three-month periods ended June 30, 2002 and 2001 and 31,778 and 91,180 stock options for the six-month periods ended June 30, 2002 and 2001, respectively. 9 7. SEGMENT INFORMATION The Company is principally engaged in the business of enabling rapid platform design and integration for the global voice and data communications markets through custom and off-the-shelf communications equipment, embedded software development suites, and systems integration and consulting services for telecom and enterprise 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 revenue and long lived assets related to North America and other foreign countries as of and for the three-month periods and six-month periods ended June 30, 2002 and 2001 are as follows: (in thousands) <Table> <Caption> Three months ended June 30: Six months ended June 30: Revenue 2002 2001 2002 2001 - ----------------------- --------------------- -------------------- --------------------- -------------------- North America $ 4,610 $ 5,769 $ 8,659 $ 14,004 Europe 1,100 1,127 2,540 2,565 Pac Rim 306 212 1,117 490 -------------------- ------------------- --------------------- -------------------- Total $ 6,016 $ 7,108 $ 12,316 $ 17,059 ===================== ==================== ===================== ==================== </Table> Geographic long-lived assets consist of property and equipment and capitalized software, net of the related accumulated depreciation and amortization. (in thousands) <Table> <Caption> Long-lived assets June 30, 2002 December 31, 2001 - ------------------------- ---------------------- ---------------------- North America $ 810 $ 1,116 Europe 172 160 Pacific Rim 1 2 ---------------------- ---------------------- Total $ 983 $ 1,278 ====================== ====================== </Table> Additional information regarding revenue by product line is as follows: (in thousands) <Table> <Caption> Three months ended June 30: Six months ended June 30: Revenue 2002 2001 2002 2001 - ------------------------- -------------------- --------------------- ------------------ --------------------- Telecom $ 2,827 $ 1,382 $ 4,986 $ 3,941 Combo 2,111 2,075 4,739 3,201 LAN 486 953 1,282 3,916 Storage 313 2,361 751 4,830 WAN 24 186 112 526 Other 255 151 446 645 -------------------- --------------------- ------------------ --------------------- Total $ 6,016 $ 7,108 $ 12,316 $ 17,059 ==================== ===================== ================== ===================== </Table> 8. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." The most significant changes made by SFAS No. 141 are: 1) requiring that the purchase method of accounting be used for all business combinations initiated after June 30, 2001; and 2) establishing specific criteria for the recognition of intangible assets separately from goodwill. SFAS No. 142 primarily addresses the accounting for acquired goodwill and intangible assets. The provisions of 10 SFAS No. 142 are effective for fiscal years beginning after December 15, 2001. The most significant changes made by SFAS No. 142 are: 1) goodwill and indefinite-lived intangible assets are no longer amortized; 2) goodwill will be tested annually and whenever events or circumstances occur indicating that goodwill might be impaired; and 3) the amortization period of intangible assets with finite lives will no longer be limited to forty years. The Company adopted SFAS No. 141 effective July 1, 2001, and SFAS No. 142 effective January 1, 2002, however, as the Company's goodwill was determined to be impaired and was written off in the fourth quarter of 2001, the adoption of these standards did not have a material effect on the Company's financial position or results of operations for the periods ended June 30, 2002. The following tables show the impact that SFAS No. 142 would have had if adopted as of January 1, 2001: (in thousands) <Table> <Caption> Three months ended Jun. 30, Six months ended Jun. 30, 2002 2001 2002 2001 --------------- ---------------- ------------------ ------------------ Reported net loss $(1,493) $(6,006) $(2,059) $ (6,194) Goodwill amortization - 60 - 120 --------------- ---------------- ------------------ ------------------ Adjusted net loss $(1,493) $(5,946) $(2,059) $ (6,074) =============== ================ ================== ================== </Table> <Table> <Caption> Three months ended Jun. 30, Six months ended Jun. 30, 2002 2001 2002 2001 --------------- ---------------- ------------------ ------------------ Basic loss per share: Reported net loss $(0.27) $(1.05) $(0.37) $(1.08) Goodwill amortization - 0.01 - 0.02 --------------- ---------------- ------------------ ------------------ Adjusted basic net loss per share $(0.27) $(1.04) $(0.37) $(1.06) =============== ================ ================== ================== </Table> <Table> <Caption> Three months ended Jun. 30, Six months ended Jun. 30, 2002 2001 2002 2001 --------------- ---------------- ------------------ ------------------ Diluted loss per share: Reported net loss $(0.27) $(1.05) $(0.37) $(1.08) Goodwill amortization - 0.01 - 0.02 --------------- ---------------- ------------------ ------------------ Adjusted diluted net loss per share $(0.27) $(1.04) $(0.37) $(1.06) =============== ================ ================== ================== </Table> In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial accounting and reporting for the impairment of long-lived assets and for long-lived assets to be disposed of. This statement supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of;" however, this statement retains the fundamental provisions of SFAS No. 121 for (a) recognition and measurement of the impairment of long-lived assets to be held and used, and (b) measurement of long-lived assets to be disposed of by sale. This statement also supersedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" for segments of a business to be disposed of. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. The Company adopted this standard effective January 1, 2002. The adoption of this standard did not have a material effect on the Company's financial position or results of operations for the periods ended June 30, 2002. 11 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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, changes in product demand, the availability of products, changes in competition, economic conditions, various inventory risks due to changes in market conditions and other risks 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," "intent" and "anticipates" and similar expressions as they relate to the Company or its management are intended to identify forward-looking statements. RESULTS OF OPERATIONS Revenues consist of product and service revenues and are recognized in accordance with SEC Staff Accounting Bulletin ("SAB") 101, "Revenue Recognition." Product revenues are recognized upon shipment, provided fees are fixed and determinable, a customer purchase order is obtained, and collection is probable. Revenues from reseller agreements are recognized when the product is sold through to the end customer unless an established return history supports recognizing revenue upon shipment, less a provision for estimated sales returns. The Company maintains its allowance for returns as a reduction to accounts receivable. Deferred revenue consists of revenue from reseller arrangements and certain arrangements with extended payment terms. Revenue from extended payment terms is recognized in the period the payment becomes due if all other revenue recognition criteria have been met. Service revenue is recognized as the services are performed. The Company offers to its customers a limited warranty that its products will be free from defect in the materials and workmanship for a specified period. The Company has established a warranty reserve, as a component of accrued liabilities, for any potential claims. REVENUES: Total revenues for the three months ended June 30, 2002 were $6 million. Revenues for the same period in 2001 ("comparative period") were $7.1 million. The reduction in revenues is generally due to the continued market slowdown, which has significantly reduced computer and communications equipment purchasing by key customers, as well as the discontinuance of several lines of legacy technologies. Legacy revenues decreased from $1.7 million for the three months ended June 30, 2001 to $513,000 for the three months ended June 30, 2002. In addition to the decrease in legacy technologies, revenues from Fibre Channel products decreased from $1.8 million for the three months ended June 30, 2001 to $310,000 for the three months ended June 30, 2002. The decrease in legacy and Fibre Channel revenues was partially offset by revenue growth in the telecom product line. Telecom product revenues increased to $2.8 million in the second quarter 2002 from $1.4 million in the comparative period. 12 Two customers individually accounted for 35% and 33% of the Company's second quarter 2002 revenue. In the comparative period, two customers individually accounted for 36% and 17% of the Company's revenue. Total revenues for the six months ended June 30, 2002 were $12.3 million. Revenues for the six months ended June 30, 2001 were $17.1 million. The reduction in revenues is generally due to the continued market slowdown, which has significantly reduced computer and communications equipment purchasing by key customers, as well as the discontinuance of several lines of legacy technologies. Legacy revenues decreased from $5.2 million for the six months ended June 30, 2001 to $1.4 million for the six months ended June 30, 2002. In addition to the decrease in legacy technologies, revenues from Fibre Channel products decreased from $4.1 million for the six months ended June 30, 2001 to $733,000 for the six months ended June 30, 2002. The decrease in legacy and Fibre Channel revenues was partially offset by revenue growth in combo technologies and the telecom product line. Combo technologies revenue increased to $4.7 million for the six months ended June 30, 2002 from $3.2 million for the six months ended June 30, 2001. Telecom product revenues increased to $5 million for the six months ended June 30, 2002 from $3.9 million for the six months ended June 30, 2001. GROSS MARGIN: Gross margin as a percentage of sales was 26% for the second quarter 2002 and a negative 18% for the comparative period. The increase in the gross margin percentage primarily relates to an excess and obsolete inventory charge of $4.4 million incurred during the second quarter 2001 compared to an excess and obsolete inventory charge of $1.1 million incurred during the second quarter 2002. Gross margin as a percentage of sales, before considering the excess and obsolete inventory charges, was 44% for the second quarter 2002 and the comparative period. The gross margin percentage for the six months ended June 30, 2002 and 2001 was 33% and 22%, respectively. The increase in the gross margin percentage primarily relates an excess and obsolete inventory charge of $4.4 million incurred during the second quarter 2001 compared to an excess and obsolete inventory charge of $1.1 million incurred during the second quarter 2002. This increase was partially offset by the change in product mix. Gross margin as a percentage of sales, before considering the excess and obsolete inventory charges, was 41% and 48% for the six months ended June 30, 2002 and 2001, respectively. RESEARCH AND DEVELOPMENT: The Company's investment in the development of new products through research and development was $1.7 million in the second quarter 2002 and $2.1 million in the comparative period. As a percentage of revenue, research and development expenses were 28% in the second quarter 2002 and 29% in the comparative period. Approximately 70% of the decrease in research and development expenses for the three months ended June 30, 2002, was due to a reduction in headcount associated with the Company's restructuring program and other cost reduction initiatives implemented at the end of the second quarter 2001. The remaining portion of the decrease primarily related to decreased spending on legacy sustaining engineering, partially offset by an increase in telecommunications development spending. Research and development costs were relatively flat as a percentage of sales. 13 The Company's investment in the development of new products through research and development was $3.4 million and $4.3 million for the six months ended June 30, 2002 and 2001, respectively. As a percentage of revenue, research and development expenses were 27% for the six months ended June 30, 2002 and 25% for the six months ended June 30, 2001. Approximately 56% of the decrease in research and development expenses for the six months ended June 30, 2002, was due to a reduction in headcount associated with the Company's restructuring program and other cost reduction initiatives implemented at the end of the second quarter 2001. The remaining portion of the decrease primarily related to decreased spending on legacy sustaining engineering, partially offset by an increase in telecommunications development spending. Research and development costs as a percentage of sales increased due to the decrease in revenues. SALES AND MARKETING: Sales and marketing expenses were $1.6 million in the second quarter 2002 and $2.2 million in the comparative period. As a percentage of revenue, sales and marketing expenses were 27% in the second quarter 2002 and 31% in the comparative period. The decrease in sales and marketing expenses for the three months ended June 30, 2002, was primarily due to a reduction in headcount associated with the Company's restructuring program and other cost reduction initiatives implemented at the end of the second quarter 2001. Sales and marketing expenses decreased as a percentage of revenue due to the expense reduction being greater than the revenue reduction. Sales and marketing expenses were $3 million and $4.2 million for the six months ended June 30, 2002 and 2001, respectively. As a percentage of revenue, sales and marketing expenses were 24% for the six months ended June 30, 2002 and 25% for the six months ended June 30, 2001. The decrease in sales and marketing expenses for the six months ended June 30, 2002, was primarily due to a reduction in headcount associated with the Company's restructuring program and other cost reduction initiatives implemented at the end of the second quarter 2001. Sales and Marketing expenses were relatively flat as a percentage of sales. GENERAL AND ADMINISTRATIVE: General and administrative expenses were $815,000 in the second quarter 2002 and $1 million in the comparative period. As a percentage of revenue, general and administrative expenses were 14% in the second quarter 2002 and 15% in the comparative period. The decrease in general and administrative expenses for the three months ended June 30, 2002, is primarily the result of a reduction in headcount associated with the Company's restructuring program and cost reduction initiatives implemented at the end of the second quarter 2001. General and administrative expenses were relatively flat as a percentage of sales. General and administrative expenses were $1.6 million and $2.1 million for the six months ended June 30, 2002 and 2001, respectively. As a percentage of revenue, general and administrative expenses were 13% for the six months ended June 30, 2002 and 12% for the six months ended June 30, 2001. The decrease in general and administrative expenses for the six months ended June 30, 2002, is primarily the result of a reduction in headcount associated with the Company's restructuring program and cost reduction initiatives implemented at the end of the second quarter 2001. General and administrative expenses were relatively flat as a percentage of sales. 14 RESTRUCTURING COSTS AND OTHER SPECIAL CHARGES: In the second quarter 2001, the Company announced a restructuring program designed to allow the Company to continue aggressive funding of its development organizations, while preserving cash levels and securing new design-ins. As a result of the restructuring program, continued decline in predicted revenue and customers' cautious expectations regarding market recovery, the Company recorded restructuring costs and other special charges of $2.1 million, classified as operating expenses, and an additional excess and obsolete inventory charge of $4.4 million, classified as cost of sales. The restructuring program resulted in the reduction of approximately 22% of the Company's workforce, impacting all business functions in North America. As a result, the Company recorded a workforce reduction charge of $483,000 relating to severance and fringe benefits. In addition, the Company wrote off $123,000 of nonutilized fixed assets. Due to the decline in business conditions, decline in legacy product revenues and the diminished expected future benefits from the purchased intangibles related to the acquisition of Synaptel, S.A. in 1996, the Company recorded a charge of $1.5 million related to the impairment of developed technology and assembled workforce during the second quarter 2001. These intangible assets, purchased in the acquisition of Synaptel, S.A., relate to the Company's legacy product lines. In the second quarter 2000, the Company developed a strategy to end-of-life many of its legacy products in an effort to focus its resources on its new product lines. This strategy resulted in increased sales of legacy products in 2000; however, legacy product sales declined in the first quarter of 2001, and continued to decline through the second quarter of 2001. Management did not expect significant revenues from its legacy product lines in future periods. INTEREST INCOME, NET: Interest income, net of interest expense, was $134,000 in the second quarter 2002 and $103,000 in the comparative period. The increase relates to higher daily cash levels available for investment and lower borrowing interest rates. Interest income, net of interest expense, was $327,000 and $186,000 for the six months ended June 30, 2002 and 2001, respectively. The increase relates to higher daily cash levels available for investment and lower borrowing interest rates. OTHER INCOME (EXPENSE), NET: Other income (expense), net, was ($55,000) in the second quarter 2002 and ($184,000) in the comparative period. Other income (expense), net in the comparative period includes the amortization of goodwill and purchased intangibles. As the carrying value of the Company's goodwill and purchased intangibles exceeded its fair value, the Company wrote off the carrying amount of its goodwill in the fourth quarter of 2001 and its purchased intangibles in the second quarter of 2001. Accordingly, the decrease in other (expense) is primarily due to the elimination of amortization expense related to these items. Other income (expense), net was $1,000 and ($221,000) for the six months ended June 30, 2002 and 2001, respectively. Other income (expense), net in the six months ended June 30, 2001, includes the amortization of goodwill and purchased intangibles. As the carrying value of the Company's goodwill and purchased intangibles exceeded its fair value, the Company wrote off the carrying amount of its goodwill in the fourth quarter of 15 2001 and its purchased intangibles in the second quarter of 2001. Accordingly, the decrease in other (expense) is primarily due to the elimination of amortization expense related to these items. INCOME TAXES: The Company's effective income tax rate was (40%) for the second quarter 2002 and (31%) for the comparative period. The effective rate for the second quarter 2002 differed from the statutory rate due to foreign income, which is offset by foreign loss carryforwards. The effective rate for the second quarter 2001 included the impact of nondeductible goodwill and purchased intangibles amortization. NET LOSS: The Company reported a net loss of $1.5 million in the second quarter 2002 and a net loss of $6 million in the comparative period. The Company reported a net loss of $2.1 million for the six months ended June 30, 2002 and a net loss of $6.2 million for the six months ended June 30, 2001. LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2002, cash and cash equivalents totaled $13.7 million, an increase of $3.3 million from the December 31, 2001 balance of $10.4 million. The increase was attributable to cash provided by operating activities of $4.3 million, partially offset by cash used by investing activities of $267,000 and cash used by financing activities of $522,000. Cash provided by operating activities was primarily comprised of a decrease in inventories of $2.9 million, a decrease in income taxes receivable of $2.5 million and a decrease in accounts receivable of $329,000, partially offset by cash used to fund operations of $2.1 million. Cash used by investing activities was primarily comprised of purchases of marketable securities of $1 million and fixed asset additions of $121,000, partially offset by proceeds from the sale of marketable securities of $864,000. Cash used by financing activities was primarily comprised of the purchase of redeemable common stock of $508,000. At June 30, 2002, the Company had no material commitments to purchase capital assets. The Company's significant long-term obligations are its operating leases on its facilities, future debt payments and repurchase of Interphase common stock from Motorola, Inc. (described below). The Company has not paid any dividends since its inception and does not anticipate paying any dividends in 2002. In October 2001, the Company announced that its Board of Directors had authorized the repurchase of up to $5 million of its common stock. Purchases are authorized to be made from time to time during a twenty-four month period in the open market or in privately negotiated transactions depending on market conditions. The Company will cancel all shares that it repurchases. The repurchase plan does not obligate the Company to repurchase any specific number of shares and may be suspended at any time. The Company repurchased and cancelled shares with a market value of approximately $6,000 during the three months ended June 30, 2002. The Company has a $5 million revolving credit facility with a financial institution. The revolving credit facility expires in June 2003. As of June 30, 2002, the Company had borrowings of $3.5 million classified as long-term debt on its balance sheet. These borrowings are fully collateralized by a certificate of deposit. 16 Effective October 1998, the Company approved a stock repurchase agreement with Motorola, Inc. to purchase ratably from October 1998 to July 2002, all of the shares owned by Motorola for $4.1 million at $6.25 per share. Under the terms of the agreement, Motorola retains the right as an equity owner and has assigned its voting rights to the Company. The Company cancels the stock upon each repurchase. Prior to the repurchase agreement, Motorola owned approximately 12% of the Company's outstanding common stock. The future scheduled payments are classified as redeemable common stock in the accompanying consolidated balance sheets. As of June 30, 2002, 619,338 shares have been repurchased for $3.9 million and retired and 40,662 shares remain to be repurchased. The Company expects that its cash, cash equivalents, marketable securities and proceeds from its credit facility will be adequate to meet foreseeable cash needs for the next twelve months. However, it is possible that the Company may require additional sources of financing earlier than anticipated, as a result of unexpected cash needs or opportunities, an expanded growth strategy or disappointing operating results. Additional funds may not be available on satisfactory terms when needed, whether within the next twelve to eighteen months or thereafter. ITEM 6. REPORT ON FORM 8-K AND EXHIBITS REPORT ON FORM 8-K The Company filed a report on Form 8-K with the Securities and Exchange Commission on June 19, 2002, reporting on changes in Registrant's Certifying Accountant. <Table> <Caption> EXHIBITS NO. DESCRIPTION ----------- ----------- 99.1 Certification Pursuant to 18 U.S.C Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.2 Certification Pursuant to 18 U.S.C Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 </Table> 17 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. INTERPHASE CORPORATION (Registrant) Date: August 14, 2002 /s/ Steven P. Kovac -------------------------------------------- Steven P. Kovac Chief Financial Officer, Vice President of Finance and Treasurer (Principal Financial and Accounting Officer) 18 INDEX TO EXHIBITS <Table> <Caption> EXHIBITS NO. DESCRIPTION ----------- ----------- 99.1 Certification Pursuant to 18 U.S.C Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 99.2 Certification Pursuant to 18 U.S.C Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 </Table>