<PAGE> 1
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 DECEMBER 31, 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, 4,424,950 shares as of February 10, 1998.
<PAGE> 2
PART 1 - FINANCIAL INFORMATION
Item 1. Financial Statements
INTERFACE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, September 30,
1997 1997
------------------ -------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 1,323,314 $ 830,086
Accounts receivable, net 14,542,496 12,221,257
Refundable income taxes 1,241,210 1,182,182
Inventories 7,149,125 6,284,833
Prepaid expenses and other 908,104 913,314
Deferred income taxes 475,000 475,000
------------------ -------------
Total current assets 25,639,249 21,906,672
Property and equipment, net 4,416,867 4,602,696
Goodwill, net 1,114,197 1,160,634
Software development costs, net 519,668 874,652
Other assets 295,385 285,853
------------------ -------------
$ 31,985,366 $ 28,830,507
================== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable $ 7,600,120 $ 8,640,611
Accounts payable 12,392,296 8,124,581
Accrued expenses 890,529 847,970
Deferred revenue 541,079 638,709
Current portion of long-term debt 50,200 50,004
------------------ -------------
Total current liabilities 21,474,224 18,301,875
Long-term debt 158,133 170,829
Deferred income taxes 615,000 615,000
------------------ -------------
Total liabilities 22,247,357 19,087,704
------------------ -------------
Stockholders' equity:
Common stock, $.10 par value,
20,000,000 shares authorized; 4,424,950
shares issued and outstanding for both periods 442,495 442,495
Additional paid-in-capital 10,547,447 10,547,447
Cumulative translation adjustment (223,607) (281,441)
Retained deficit (1,028,326) (965,698)
------------------ -------------
Total stockholders' equity 9,738,009 9,742,803
------------------ -------------
$ 31,985,366 $ 28,830,507
================== =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
2
<PAGE> 3
INTERFACE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Quarter ended
December 31,
1997 1996
------------ ------------
<S> <C> <C>
(unaudited)
Net revenues $23,125,471 $19,594,397
Cost of revenues 18,619,643 16,965,507
----------- -----------
Gross profit 4,505,828 2,628,890
Product development costs 903,928 501,750
Selling, general and
administrative expenses 3,450,046 3,002,822
----------- -----------
Income (loss) from operations 151,854 (875,682)
Interest expense (220,831) (157,299)
Other income 6,349 114,340
----------- -----------
Loss before income taxes (62,628) (918,641)
Income tax benefit - (193,588)
----------- -----------
Net loss $ (62,628) $ (725,053)
=========== ===========
Net loss per share $ (0.01) $ (0.16)
=========== ===========
Weighted average shares outstanding 4,424,950 4,535,879
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE> 4
INTERFACE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Quarter Ended December 31,
1997 1996
---------------- ----------------
<S> <C> <C>
(unaudited)
Cash flows from operating activities:
Net loss $ (62,628) $ (725,053)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Depreciation and amortization 701,693 923,103
Gain on sale of securities - (74,777)
Loss on sale of fixed assets - 1,677
Change in operating assets and liabilities:
Accounts receivable (2,321,239) (1,406,571)
Refundable income taxes (59,028) (193,759)
Inventories (864,292) (794,603)
Prepaid expenses and other 5,210 (283,614)
Other assets (9,532) (85,944)
Accounts payable 4,267,715 1,688,405
Accrued expense 42,559 (229,797)
Deferred revenue (97,630) (27,831)
---------------- ----------------
Net cash used in operating activities 1,602,828 (1,208,764)
---------------- ----------------
Cash flows from investing activities:
Additions to property and equipment (114,443) (404,435)
Additions to software development costs - (533,692)
Investment in foreign subsidiary - (3,681)
Reduction of notes receivable - 35,026
Proceeds from sale of securities - 177,612
---------------- ----------------
Net cash used in investing activities (114,443) (729,170)
---------------- ----------------
Cash flows from financing activities:
Change in notes payable (1,040,491) 268,718
Reduction of long-term debt (12,500) (34,772)
---------------- ----------------
Net cash provided by financing activities (1,052,991) 233,946
---------------- ----------------
Effect of exchange rate changes on cash 57,834 10,667
---------------- ----------------
Net increase (decrease) in cash and cash
equivalents 493,228 (1,693,321)
Cash and cash equivalents, beginning of period 830,086 1,694,725
---------------- ----------------
Cash and cash equivalents, end of period $ 1,323,314 $ 1,404
================ ================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE> 5
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 December 31, 1997 are not necessarily indicative
of the results to be expected for any future period or for the entire year.
2. Borrowings
The Company has bank credit facilities which provide for aggregate borrowings
of up to $11.5 million. As of December 31, 1997, $7.6 million was outstanding
under these facilities. Advances under these facilities bear interest at the
bank's prime rate (8.5% at December 31, 1997) plus 1%, are payable on demand
and are collateralized by substantially all of the Company's assets. The
credit facilities expire February 28, 1998 and are subject to renewal
thereafter. The amount available for borrowing at any one time under the
facilities is based on borrowing base formulas relating to levels of accounts
receivable, inventories and other bank covenants. Under such formulas,
approximately $3.9 million was available to the Company as of December 31,
1997.
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. As of December 31, 1997, the Company was in
compliance with the bank covenants.
3. 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.
5
<PAGE> 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Net Revenues. Revenues for the first quarter ended December 31, 1997 were
$23.1 million, an increase of 18.0% over revenues of $19.6 million for the
first quarter of fiscal 1997. Core business revenue for the quarter increased
25.2% from the first quarter of fiscal 1997, due primarily to increased Cleo
Electronic Networking (EN) sales, which are impacted by large corporate orders.
Interface Systems International Ltd. distribution revenue increased 16.0%
over the same quarter of fiscal 1997 and comprised 75.7% and 77.0% of net
revenues for the quarters ended December 31, 1997 and 1996, respectively.
Cost of Revenues. Cost of revenues were $18.6 million and $17.0 million, or
80.5% and 86.6% of net revenues for the quarters ended December 31, 1997 and
1996, respectively. The decrease in cost of revenues as a percentage of net
revenues for the first quarter resulted from higher sales of core business
software products, primarily Cleo EN, which have higher gross profit margins.
Cost of revenues includes amortization of capitalized software development
costs of $355,000 and $541,000 from the quarters ended December 31, 1997 and
1996, respectively.
Product Development Costs. Product development costs were $904,000 and
$502,000, or 3.9% and 2.6% of net revenues for the quarters ended December 31,
1997 and 1996, respectively. The absolute dollar increase for the quarter
primarily reflects a decrease of $667,000 in the amount of expense deferred
through capitalization of internally developed software for the quarter ended
December 31, 1997 as compared with the same quarter of fiscal 1997.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $3.5 million and $3.0 million, or 14.9% and 15.3%
of net revenues for the quarters ended December 31, 1997 and 1996, respectively.
The absolute dollar increase for the first quarter was primarily due to the
addition of sales, marketing and administrative personnel, particularly at key
management positions, commissions associated with the increase in revenues and
professional fees associated with the restructuring of the Company's operations
in the United Kingdom.
Interest Expense. For the first quarter ended December 31, 1997, interest
expense increased to $221,000 from $157,000 for the same quarter last year.
The increases were due to increased borrowing, primarily at ISIL for working
capital purposes.
LIQUIDITY AND CAPITAL RESOURCES
At December 31, 1997, the Company's primary sources of liquidity included cash
and cash equivalents of $1.3 million and short-term credit facilities with a
bank providing for $11.5 million of borrowings, of which approximately $3.9
million was available.
For the quarter ended December 31, 1997, net cash of $1.6 million was provided
by operating activities compared to net cash of $1.2 million used in operating
activities for the same quarter of fiscal 1997. Cash was provided by operating
activities for the first quarter of fiscal 1998 primarily due to increased
accounts payable and to non-cash charges partially off set by increased
accounts receivable and
6
<PAGE> 7
inventory. Net cash used in financing activities was $1.1 million for the
first quarter of fiscal 1998 due primarily to a reduction in notes payable.
The Company has bank credit facilities which provide for aggregate borrowings
of up to $11.5 million. As of December 31, 1997, $7.6 million was outstanding
under these facilities. The borrowings are used primarily by ISIL in the
operation of its distribution business. Advances under these facilities bear
interest at the bank's prime rate plus 1%, are payable on demand and are
collateralized by substantially all of the Company's assets. The credit
facilities expire February 28, 1998 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 compliance with the bank covenants at
December 31, 1997. In addition, the agreements prohibit the payment of cash
dividends and contain certain restrictions on the Company's ability to borrow
money or purchase assets or interests in other entities without the prior
written consent of the bank.
The Company believes that its existing cash balances, available credit
facilities and future operating cash flows will be sufficient for near term
operating needs. The Company believes it will renew the bank credit facilities
prior to expiration of the facilities. The foregoing statements are "forward
looking statements" within the meaning of the Securities Exchange Act of 1934.
The extent to which such sources will be sufficient to meet the Company's
anticipated cash requirements is subject to a number of uncertainties including
the ability of the Company's operations to generate sufficient cash to support
operations, and other uncertainties described in "Management's Discussion and
Analysis of Results of Operations - Uncertainties Relating to Forward-Looking
Statements."
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, component price increases, delays in introduction of planned
hardware and software products, software defects and latent technological
deficiencies in new products, changes in operating expenses, inability to
attract or retain sales and/or engineering talent, changes in customer
requirements and evolving industry standards.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
7
<PAGE> 8
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
27 Financial Data Schedule
(b) No reports on Form 8-K have been filed during the quarter for which this
report is filed.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
INTERFACE SYSTEMS, INC.
Date: February 13, 1998 /S/ John R. Ternes
------------------------------------------------
John R. Ternes
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer
and a duly authorized officer of the Registrant)
8
<PAGE> 9
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
- ------- --- -----------
27 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> SEP-30-1998
<PERIOD-END> DEC-31-1997
<CASH> 1,323,314
<SECURITIES> 0
<RECEIVABLES> 14,542,496
<ALLOWANCES> 0
<INVENTORY> 7,149,125
<CURRENT-ASSETS> 25,639,249
<PP&E> 4,416,867
<DEPRECIATION> 0
<TOTAL-ASSETS> 31,985,366
<CURRENT-LIABILITIES> 21,474,224
<BONDS> 0
0
0
<COMMON> 10,989,942
<OTHER-SE> (1,251,933)
<TOTAL-LIABILITY-AND-EQUITY> 31,985,366
<SALES> 23,125,471
<TOTAL-REVENUES> 23,125,471
<CGS> 18,619,643
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 220,831
<INCOME-PRETAX> (62,628)
<INCOME-TAX> 0
<INCOME-CONTINUING> (62,628)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (62,628)
<EPS-PRIMARY> (0.01)
<EPS-DILUTED> (0.01)
</TABLE>
