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, 1997
[ ] 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)
Delaware 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)
(313) 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, $.10 par value, 4,408,383 shares as of July 31, 1997.
<PAGE>
INTERFACE SYSTEMS, INC.
FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets at June 30, 1997
and September 30, 1996
Consolidated Statements of Operations for the
Quarters and Nine Month Periods Ended
June 30, 1997 and 1996
Consolidated Statements of Cash Flows for the
Nine Months Ended June 30, 1997 and 1996
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative
Disclosures about Market Risk
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
INDEX TO EXHIBITS
<PAGE>
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
INTERFACE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, September 30,
1997 1996
------- -------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 641,612 $ 1,694,725
Accounts receivable, net 12,288,517 11,007,983
Refundable income taxes 1,654,552 1,378,093
Inventories 7,660,164 10,478,322
Prepaid expenses and other 471,314 1,232,423
Deferred income taxes 988,000 549,000
---------- ----------
Total current assets 23,704,159 26,340,546
Property and equipment, net 4,821,207 4,816,815
Goodwill, net 1,245,503 2,881,481
Software development costs, net 1,377,761 3,570,545
Other assets 568,356 1,269,572
---------- ----------
$31,716,986 $38,878,959
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable $ 9,123,747 $ 5,691,546
Accounts payable 8,312,157 9,088,765
Accrued expenses 1,471,446 693,767
Deferred revenue 166,064 280,703
Current portion of
long-term debt 25,900 52,400
---------- ----------
Total current liabilities 19,099,314 15,807,181
Long-term debt 207,433 234,794
Deferred income taxes 844,000 1,584,000
---------- ----------
Total liabilities 20,150,747 17,625,975
---------- ----------
Stockholders' equity:
Common stock, $.10 par value,
20,000,000 shares authorized;
4,408,383 and 4,535,879 shares
issued and outstanding 440,838 453,588
Additional paid-in-capital 10,497,336 11,122,063
Cumulative translation adjustment (155,802) (236,051)
Retained earnings 783,867 9,913,384
Total stockholders' equity 11,566,239 21,252,984
---------- ----------
$31,716,986 $38,878,959
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE> INTERFACE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Quarters ended Nine months ended
June 30, June 30,
1997 1996 1997 1996
------------------------------------------------------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C>
Net revenues $19,243,265 $16,655,495 $62,121,468 $57,272,235
Cost of revenues 20,555,934 14,548,005 58,965,735 48,344,748
---------- ---------- ---------- ----------
Gross profit (1,312,669) 2,107,490 3,155,733 8,927,487
Product development costs 967,809 543,729 2,105,465 1,411,477
Selling, general and
administrative expenses 5,403,143 3,370,863 11,791,955 8,332,313
---------- ---------- ---------- ----------
Loss from operations (7,683,621) (1,807,102) (10,741,687) (816,303)
Interest expense (200,210) (112,910) (515,014) (330,443)
Other income 113,956 55,772 383,727 164,096
Gain on sale of securities - - 74,777 -
---------- ---------- ---------- ----------
Loss before income taxes (7,769,875) (1,864,240) (10,798,197) (982,650)
Income tax benefit (865,150) (368,675) (1,668,680) (50,890)
---------- ---------- ---------- -----------
Net loss $(6,904,725) $(1,495,565) $(9,129,517) $ (931,760)
========== ========== ========== ==========
Net loss per share $(1.57) $ (0.33) $ (2.04) $ (0.21)
========== ========== ========== ==========
Weighted average shares outstanding 4,408,383 4,517,901 4,472,132 4,412,473
========== ========== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
<PAGE>
INTERFACE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended June 30,
1997 1996
--------------------------
(unaudited)
Cash flows from operating activities:
Net loss $(9,129,517) $(931,760)
Adjustments to reconcile net loss to
net cash provided by (used in)
operating activities:
Depreciation and amortization 2,141,173 2,397,846
Deferred income taxes (1,179,000) 40,000
Gain on sale of securities (74,777) -
Loss on sale of fixed assets 2,056 27,857
Write-off of software development
costs 1,616,358 -
Write-off of goodwill 1,456,320 -
Change in operating assets and
liabilities:
Accounts receivable (1,280,534) (1,331,264)
Refundable income taxes (276,459) -
Inventories 2,818,158 (1,994,419)
Prepaid expenses and other 658,274 (720,978)
Other assets 63,739 (185,378)
Accounts payable (776,608) 1,659,012
Accrued expense 777,679 85,739
Deferred revenue (114,639) (109,850)
---------- ---------
Net cash used in operating
activities (3,297,777) (1,063,195)
---------- ----------
Cash flows from investing activities:
Additions to notes receivable - (819,594)
Additions to property and equipment (437,862) (912,156)
Additions to software development
costs (953,675) (1,692,290)
Investment in foreign subsidiary - (39,137)
Proceeds from sale of securities 177,612 15,309
---------- ---------
Net cash used in investing
activities (1,213,925) (3,447,868)
---------- ---------
Cash flows from financing activities:
Increase in notes payable 3,432,201 1,214,610
Reduction of long-term debt (53,861) (38,350)
Sale of stock - 2,013,954
----------- ---------
Net cash provided by financing
activities 3,378,340 3,190,214
----------- ---------
Effect of exchange rate changes on cash 80,249 (38,202)
----------- ---------
Net decrease in cash and cash
equivalents (1,053,113) (1,359,051)
Cash and cash equivalents, beginning of
period 1,694,725 3,735,758
----------- ---------
Cash and cash equivalents, end of
period $ 641,612 $ 2,376,707
========== =========
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
INTERFACE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A - 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, 1996 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, 1997 are not
necessarily indicative of the results to be expected for any future period
or for the entire year.
NOTE B - BORROWINGS
On February 19, 1997, the Company renewed its credit facilities with a bank
which provide for aggregate borrowings of up to $11.5 million. As of June
30, 1997, $9.1 million was outstanding under these facilities. Advances
under these facilities bear interest at the bank's prime rate (8.5% at June
30, 1997) plus 1/2%, are payable on demand and are collateralized by
substantially all of the Company's assets. The credit facilities expire
August 31, 1997 and are subject to renewal thereafter.
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. 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.
NOTE C - TREASURY SHARES ACQUIRED
In January 1997, the Company acquired 127,495 shares of its Common
Stock valued at $637,476, upon the default in payment of all principal and
interest due and owing as of such date by a former officer of the Company
under the terms of a note payable owed by such officer to the Company. The
value of the shares is equal to all indebtedness which was owed to the
Company at the time of default.
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Results of Operations
Net Revenues. Revenues for the third quarter ended June 30, 1997 were
$19.2 million, an increase of 15.0% over revenues of $16.7 million for the
third quarter of fiscal 1996. Revenues for the first nine months of fiscal
1997 were $62.1 million, an increase of 8.4% over revenues of $57.3 million
for the same period of fiscal 1996. The increases for both the quarter and
nine month periods were primarily due to increased distribution revenue of
Interface Systems International Ltd. ("ISIL") and increased sales of
Enterprise Networking core products, offset by a decrease in sales of
printer products.
Cost of Revenues. Cost of revenues were $20.6 million and $14.5 million,
or 106.8% and 87.4% of net revenues for the quarters ended June 30, 1997 and
1996, respectively. For the quarter ended June 30, 1997, cost of revenues
included non-recurring charges of $4.6 million consisting of a $1.3 million
write-off of capitalized software development; a $1.4 million reserve for
ISIL slow moving inventory and fair market value reductions due to a decline
<PAGE>
in market conditions and continued product price erosion; a $1.1 million
write-off that resulted from several accounting errors related to the
recording of inventory at ISIL; and $800,000 in various adjustments
resulting from an audit, which is in process, of the June 30, 1997 balance
sheet of the ISIL distribution business. As a result of the accounting
errors, the Company is taking corrective action, including the balance sheet
audit discussed above.
Cost of revenues were $59.0 million and $48.3 million, or 94.9% and 84.4% of
net revenues for the nine months ended June 30, 1997 and 1996, respectively.
For the nine months ended June 30, 1997, cost of revenues included
non-recurring charges of $6.2 million consisting of the charges discussed
above, and in addition, a $1.4 million reserve for printer inventory and a
$320,000 write-off of capitalized software development costs.
Cost of revenues for the third quarter and the first nine months of fiscal
1997, excluding the effect of the non-recurring charges, was 82.9% and 84.9%
of net revenues, respectively. Excluding the effect of the non-recurring
charges, cost of revenues as a percentage of net revenues for the third
quarter declined due to higher sales of core business software products
which have higher gross profit margins.
Product Development Costs. Product development costs were $1.0 million and
$544,000, or 5.0% and 3.3% of net revenues for the quarters ended June 30,
1997 and 1996, respectively. Product development costs were $2.1 million
and $1.4 million, or 3.3% and 2.5% of net revenues for the nine months ended
June 30, 1997 and 1996, respectively. The absolute dollar increase for both
periods primarily reflects a decrease of $460,000 and $560,000 in the
amount of expense deferred through capitalization of internally developed
software for the quarter and nine month periods ended June 30, 1997 as
compared with the same periods in the prior fiscal year.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $5.4 million and $3.4 million, or 28.1% and
20.2% of net revenues for the quarters ended June 30, 1997 and 1996,
respectively. Selling, general and administrative expenses were $11.8
million and $8.3 million, or 19.0% and 14.6% of net revenues for the nine
months ended June 30, 1997 and 1996, respectively. The absolute dollar
increase for the third quarter was primarily due to the write-off of $1.5
million in goodwill related to the Company's investment in its operations in
the United Kingdom. For the nine months ended June 30, 1997, the absolute
dollar increase was due to the goodwill write-off, increased selling and
marketing personnel in the United Kingdom to support the growth in ISIL's
distribution business and to various expenses associated with an interim
management team, the hiring of a new CEO in January 1997 and other
organizational and management changes. In addition, the increase for the
first nine months of fiscal 1997 is due to marketing expenses incurred to
promote the Company's Oasis products.
In July, 1997, the ISIL operations were restructured into two separate
units, distribution and core, to focus each unit on its respective market
and on a return to profitability. Separate managing directors have been
appointed to run the new operating units. In addition, the combined ISIL
workforce was reduced by 15 employees, or approximately 18%. The reductions
were made in July 1997, and the related expense will be taken in the fourth
quarter.
Interest Expense. For the third quarter of fiscal 1997, interest expense
increased to $200,000 from $113,000 for the same period of 1996. For the
first nine months of fiscal 1997, interest expense increased to $515,000
from $330,000 for the same period of 1996. The increases were due to
increased borrowing, primarily at ISIL for working capital purposes.
Income Taxes. The effective tax rate for the quarter and nine month
periods ended June 30, 1997 was a benefit of 11.1% and 15.5%, respectively.
The tax benefit for these periods was below the statutory rate because the
losses at ISIL and the goodwill write-off are not eligible for tax benefit.
<PAGE>
Liquidity and Capital Resources
At June 30, 1997, the Company's primary sources of liquidity included cash
and cash equivalents of $642,000 and short-term credit facilities with a
bank providing for $11.5 million of borrowings, of which $2.4 million was
available.
For the first nine months of fiscal 1997, net cash of $3.3 million was used
in operating activities compared to net cash of $1.1 million used in
operating activities for the same period of fiscal 1996. Cash was used in
operating activities for the first nine months of fiscal 1997 primarily as a
result of net operating losses for the period and increased accounts
receivable partially offset by decreased inventory and non-cash charges.
Net cash used in investing activities was $1.2 million for the first nine
months of fiscal 1997 compared with $3.4 million for the same period of
fiscal 1996.
In February 1997, the Company renewed its credit facilities with a bank
which provide for aggregate borrowings of up to $11.5 <PAGE>
million. As of June 30, 1997, $9.2 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 1/2%, are payable on demand and are collateralized
by substantially all of the Company's assets. The credit facilities expire
August 31, 1997 and are subject to renewal thereafter. The Company
currently is conducting discussions with the bank to renew the credit
facilities.
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 June 30, 1997. The
bank waived this default through an amendment to the facilities, which
amendment also changed the minimum net worth requirement. 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
facility and future operating cash flows are sufficient for near term
operating needs. The Company believes it will renew the bank credit
facilities prior to expiration of the facilities.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Not applicable.
PART 2 - 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) A report on Form 8-K dated June 24, 1997 was filed on June 27,
1997.
All other items omitted are not applicable or the answers thereto are negative.
<PAGE>
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, 1997 /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)
<PAGE>
INDEX TO EXHIBITS
10.1 Second Amendment to Credit Authorization Agreement between the
Company and NBD Bank dated August 11, 1997
27 Financial Data Schedule
SECOND AMENDMENT TO CREDIT AUTHORIZATION
AGREEMENT
THIS SECOND AMENDMENT TO CREDIT AUTHORIZATION AGREEMENT, dated as of
August 11, 1997 (this "Amendment") by and between Interface Systems, Inc., a
Delaware Corporation, the ("Borrower") and NBD Bank, a Michigan banking
corporation (the "Bank").
RECITALS
A. The Borrower and the Bank are parties to a Credit
Authorization Agreement dated as of February 19, 1997, as
amended by a First Amendment To Credit Authorization
Agreement dated as of April 21, 1997 (as amended the
"Agreement").
B. The Borrower has defaulted under the Agreement due to a
breach of the Net Worth covenant in section 9.3(i), for the
month ended June 30, 1997.
C. The Borrower has requested that the Bank waive such covenant
default, and the Bank is willing to do so strictly in
accordance with the terms hereof, and provided the Agreement
is amended as set forth herein, and the Borrower has agreed
to such amendment.
AGREEMENT
Based upon these recitals, the parties agree as follows:
1. Upon satisfaction of the conditions set forth in paragraph 4
hereof, the Agreement shall hereby be amended as of the
effective date hereof as follows:
A. The definition of "Net Worth" in section 9.3(i)
shall be deleted in its entirety and the following
shall be inserted in place thereof:
Net Worth. Permit its Net Worth to be less
than $11,500,000 at June 30, 1997 and increasing thereafter by 75% of
monthly net income, without reduction for any loss periods.
2. From and after the effective date of this Amendment,
references to the "Agreement" in the Credit Authorization Agreement, the
Note, the Security Documents, and all other documents executed pursuant to
the Credit Authorization Agreement shall be deemed references to the Credit
Authorization Agreement as amended hereby.
3. The Borrower represents to the Bank that:
(a) (i) The execution, delivery and performance
of this amendment by the Borrower and all
agreements and documents delivered pursuant
hereto by the Borrower have been duly
authorized by all necessary action and do
not and will not require any consent or
approval of its shareholders, violate any
provision of any law, rule, regulation,
order, writ, judgment, injunction, decree,
determination or award presently in effect
having applicability to it or of its
articles of incorporation or by-laws; (ii)
no authorization, consent, approval,
license, exemption of or filing a
registration with any court or governmental
department, commission, board, bureau,
agency or instrumentality, domestic or
foreign, is or will be necessary to the
valid execution, delivery, or performance
by the Borrower of this amendment and all
agreements and documents delivered pursuant
hereto and (iii) this Amendment and all
agreements and documents delivered pursuant
hereto by the Borrower are the legal, valid
binding obligations of the Borrower
enforceable against it in accordance with
the terms thereof.
(b) After giving effect to the amendment
contained herein and effected pursuant
hereto, the representations and warranties
contained in Section 10.0 of the Agreement
are true and correct on and as of the
effective date hereof with the same force
and effect as if made on and as of such
effective date.
(c) Other than the Existing Default, as defined
in and to be waived pursuant to paragraph
5, no Events of Acceleration (as defined in
Section 11.0 of the Agreement) and no
default shall have occurred and be
continuing or will exist under the
Agreement as of the effective date hereof.
4. This Amendment shall not become effective until it
shall be duly executed by the Borrower and the
Bank.
5. The Borrower acknowledges that an Event of
Acceleration has occurred because the Borrower has
breached a covenant contained in Section 9.3(i) of
the Agreement for the month of the Borrower ended
June 30, 1997 (the "Existing Default"). The
Borrower acknowledges that the Bank has the ability
to accelerate all indebtedness and exercise all of
its rights and remedies under the Agreement. In
consideration of the execution of this Amendment
and subject to the satisfaction of the condition
required by Paragraph 4 hereof, the Bank agrees to
waive the Existing Default, provided that such
waiver shall waive only the Existing Default and
does not waive any other Events of Acceleration,
including without limitation any future Events of
Acceleration caused by any violation of Section
9.3(i). This waiver shall not be deemed to be a
waiver, or a consent to any modification or
amendment, of any other term or condition of the
Agreement or any term or condition of any
agreement, instrument, or document referred to
therein or executed pursuant thereto, or to
prejudice any present or future right which the
Bank now has or may have hereunder.
6. The terms used but not defined herein shall have
the respective meanings ascribed thereto in the
Agreement. Except as expressly contemplated
hereby, the Agreement, and all related notes,
guaranties, certificates, instruments and other
documents, are hereby ratified and confirmed and
shall remain in full force and effect, and the
Borrower acknowledges that it has no defense,
offset, or counterclaim thereunder.
7. This Amendment shall be governed by and in
accordance with the laws of the State of Michigan.
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to
be duly executed and delivered as of the day and year first written above.
INTERFACE SYSTEMS, INC.
/S/
----------------------------
By: David O. Shupp
Its: Treasurer
NBD BANK
/S/
---------------------------
By: Michael Kelly
Its: First Vice President
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> SEP-30-1997
<PERIOD-START> OCT-01-1996
<PERIOD-END> JUN-30-1997
<CASH> 641,612
<SECURITIES> 0
<RECEIVABLES> 12,288,517
<ALLOWANCES> 0
<INVENTORY> 7,660,164
<CURRENT-ASSETS> 23,704,159
<PP&E> 4,821,207
<DEPRECIATION> 0
<TOTAL-ASSETS> 31,716,986
<CURRENT-LIABILITIES> 19,099,314
<BONDS> 0
<COMMON> 10,938,174
0
0
<OTHER-SE> 628,055
<TOTAL-LIABILITY-AND-EQUITY> 31,716,986
<SALES> 62,121,468
<TOTAL-REVENUES> 62,121,468
<CGS> 58,965,735
<TOTAL-COSTS> 72,863,155
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (515,014)
<INCOME-PRETAX> (10,798,197)
<INCOME-TAX> (1,668,680)
<INCOME-CONTINUING> (10,798,197)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,129,517)
<EPS-PRIMARY> (2.04)
<EPS-DILUTED> (2.04)
</TABLE>
