<PAGE>   1
 
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
 
                                   FORM 10-K
 
[ ] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934
   FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1997
 
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
   FOR THE TRANSITION PERIOD FROM        TO
 
                         COMMISSION FILE NUMBER 0-10902
 
                            INTERFACE SYSTEMS, INC.
             (Exact name of registrant as specified in its charter)
 
<TABLE>
<S>                                            <C>
                   DELAWARE                                      38-1857379
         (State or other jurisdiction                         (I.R.S. Employer
      of incorporation or organization)                     Identification No.)
  5855 INTERFACE DRIVE, ANN ARBOR, MICHIGAN                        48103
   (Address of principal executive offices)                      (Zip Code)
</TABLE>
 
       Registrant's telephone number, including area code (734) 769-5900
 
        Securities registered pursuant to Section 12(b) of the Act: None
 
          Securities registered pursuant to Section 12(g) of the Act:
                          Common Stock, par value $.10
 
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, and (2) has been subject to such filing requirements
for the past 90 days.
 
                              YES [X]       NO [ ]
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
 
The aggregate market value of the registrant's voting stock held by
non-affiliates as of December 1, 1997, computed by reference to the closing
price per share for such stock on the Nasdaq Stock Market National Market on
such date, was approximately $12,628,000 (assuming, but not admitting for any
purpose, that all executive officers and directors of the registrant may be
deemed affiliates).
 
The number of shares outstanding of the registrant's common stock as of December
1, 1997 was 4,424,944.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
<TABLE>
<CAPTION>
                   DOCUMENT
                   --------
<S>                                            <C>
     Portions of Proxy Statement for the                  Part of Form 10-K Report
     1998 Annual Meeting of Stockholders               into which it is incorporated
         (the "1998 Proxy Statement")                             Part III
</TABLE>
<PAGE>   2
 
                                     PART I
 
ITEM 1. BUSINESS
 
     Interface Systems, Inc. ("Interface Systems") was organized under the laws
of the State of Delaware in 1969 as a result of the consolidation of Kencorp,
Inc. with Interface, Inc. Interface Systems and its subsidiaries are referred to
herein as the "Company." The Company's executive offices are located at 5855
Interface Drive, Ann Arbor, Michigan 48103 and its telephone number is (734)
769-5900.
 
     The Company designs, manufactures and markets computer hardware and
software products and services (collectively referred to herein as "core
business products"), which are used primarily to connect remote users in large
enterprises to legacy applications on IBM mainframe computers. The Company's
core business products include Oasis document management software, Cleo data
communications products and IBM-compatible IPDs printers.
 
     Oasis enables the distribution of IBM AFP documents throughout enterprise
networks to a variety of destinations such as fax machines, desktop viewers and
HP-compatible laser printers. The Cleo Products Group of the Company ("Cleo")
designs, manufactures and markets specialty data communications systems. These
systems are largely aimed at linking personal and mini computers to other
personal computers and to large IBM mainframe computers via IBM's 3270, 3770,
APPC and 3780 protocols. Cleo specializes in connecting UNIX and Windows users
to IBM mainframe systems. Cleo's 3780 and A+ products are used for file transfer
in the EDI ("Electronic Data Interchange") and Electronic Commerce marketplaces.
 
     The Company's wholly-owned subsidiary, I.G.K. Industries, Inc. ("IGK"),
manufactures and markets printed circuit boards which are utilized in a variety
of applications, including personal computers, computer peripherals, medical
instrumentation and robotic modules, as well as printer controllers and
communications cards assembled and marketed by the Company.
 
     The Company's other wholly-owned subsidiary, Interface Systems
International, Ltd. ("ISIL") is a wholesale distributor of laser printers,
personal computers and supplies from other manufacturers. Located outside of
London, England in Slough, and in Birmingham, England, ISIL was also responsible
for selling and marketing the Company's core business products throughout Europe
until, effective July 1, 1997, the Company's operations in the United Kingdom
were restructured into two separate operating units, distribution and core
business products. ISIL is now solely responsible for the distribution business
and a newly-formed branch is responsible for core business products.
 
     On February 26, 1993, the Company distributed all of the outstanding stock
of its wholly-owned subsidiary, Nematron Corporation ("Nematron"), to
Interface's shareholders.
 
     On August 1, 1994, ISIL acquired the assets relating to the distribution
business of Mekom, plc., a wholly-owned subsidiary of Copymore, plc. The
purchased business distributes computer products and accessories to dealers
throughout the United Kingdom. As of August 1, 1995, the Company terminated its
use of the Mekom name and incorporated the functions of the Mekom business into
ISIL.
 
     This "Business" section contains forward-looking statements that involve
uncertainties. Actual results could differ materially from those in the forward
looking statements due to a number of uncertainties, including but not limited
to those discussed below and in "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Uncertainties Relating to
Forward- Looking Statements."
 
CORE BUSINESS PRODUCTS
 
DOCUMENT MANAGEMENT PRODUCTS
 
     The Company's "Oasis" product allows customers to distribute IBM AFP
documents to branch office locations where the documents can be viewed or
printed. This change in business process can result in substantial savings over
the existing method of centralized printing and courier delivery. The advent of
Microsoft's Windows NT as a preferred network server has allowed the Company to
concentrate its Oasis
<PAGE>   3
 
development efforts on this single platform. Core product functions include the
ability to deliver documents to Internet/Intranet attached printers as well as
LAN printers and viewers.
 
     In addition, Oasis delivers fax-compatible TIFF images to popular fax
servers for delivery of documents to remote fax machines. It also integrates
with archiving products to allow for storage and retrieval of a company's
strategic AFP documents.
 
     The Company also offers consulting, training and turnkey solutions in
conjunction with its Oasis offerings. 

DATA COMMUNICATIONS PRODUCTS
 
     The Company's Cleo Products Group designs and manufactures products used to
connect personal computers, work-stations and midrange computers to
IBM-compatible mainframes. A typical Cleo product combines terminal emulation
software and a communications board, which are installed in the PC, work-station
or midrange system.
 
     Cleo also focuses on providing connections to mainframe-based SNA (Systems
Network Architecture) networks for personal computers running UNIX operating
systems. The Cleo 3270 family of UNIX-to-SNA connectivity solutions has expanded
to include 3270 emulation, 3770 RJE emulation, HLLAPI (High-Level Language
Application Program Interface), and APPC (Advanced Program-to-Program
communications) capabilities. The Cleo TN3270E display emulator provides
mainframe access over TCP/IP (Internet/Intranet) networks.
 
     Since 1994, IBM mainframe users have looked beyond traditional SNA to
explore alternative enterprise networking solutions. In response, the Company
extended its Cleo line of Unix-to-mainframe connectivity products to work in
TCP/IP, X.25 and Token-Ring networks. The Company is also developing new Cleo
technology to support the Company's Oasis products and the client/server
approach to distributed computing. The Cleo 3270 client/server product was
completed in fiscal 1995.
 
     Cleo also specializes in communications for EDI and Electronic Commerce,
the automated transfer of standard business documents, such as purchase orders,
invoices and shipping notices, over computer networks. Cleo's 3780Plus is the
EDI industry's leading product for 3780/2780 RJE (Remote Job Entry) emulation in
BSC (Binary Synchronous Communications) networks. 3780Plus has now been
installed on over 85,000 computer systems worldwide. Changes continue to occur
in the Company's EDI communications business and, accordingly, the Company has
continued the development and enhancement of its 3780Plus products to ensure
compatibility with virtually every major PC and work-station platform. For
example, the Company developed a new Microsoft Windows-compatible version of its
popular 3780Plus batch file transfer package and added 3780Plus support for
Digital Equipment Corporation's new Alpha AXP work-stations. In fiscal 1995, the
Company introduced an asynchronous communications product line called A+, which
in fiscal 1996, the Company expanded to many additional platforms. A+ has also
been enhanced to include TCP/IP connections for communicating over intranets and
the Internet.
 
PRINTERS
 
     The Company currently produces approximately 15 models of IBM-compatible
mainframe and midrange system printers ranging in price from $1,000 to $16,000.
These products generally feature design and performance advantages over their
IBM equivalents including higher speed, unique large-character and bar code
printing capabilities, and versatile paper feed and handling options. The
Company competes in the medium and high performance network segments of the
market for IBM printers where users require reliable printers principally for
information processing, word processing, graphics and other business or
manufacturing applications. The Company does not compete in the low-end personal
computer segment of the market.
 
DOT MATRIX PRINTERS
 
     The Company produces dot matrix printers that are plug compatible
replacements for various IBM printers. Most of these printers support IBM's
proprietary intelligent printer control language, Intelligent Printer Data
Stream (IPDS). This language is a subset of IBM's Advanced Function Presentation
 
                                        2
<PAGE>   4
 
architecture (AFP), which is IBM's stated long-term architectural strategy for
managing printers connected to IBM mainframe and mid-range systems. The ISI 7224
replaces IBM's 4224, the ISI 7230 replaces IBM's 4230, the ISI 9210 replaces the
IBM 7210. The new ISI 9247 replaces IBM's 4247 and comes in 400 character per
second (cps) and 700 cps versions.
 
LASER PRINTERS
 
     The Company manufactures or adds unique value to IBM compatible laser
printers that offer throughput from 8 pages per minute (ppm) to 60 ppm. ISI's
laser printers offer features that are generally available only on larger and
more expensive IBM models, such as the ability to save electronic resources at
the printer (ARC AFP Resource Caching). This feature can greatly reduce the
time-to-first-print for complex forms and reduce network traffic. These features
provide unique advantages for large companies such as banks and manufacturing
companies. The Company continues to sell the 7028 and 7817 model printers. New
models introduced in 1997 included the 9308 and 9324 that offer modular
expandability and printing capability on paper measuring up to 11" x 17". The
Company also introduced 9140 and 9160 laser printers that are heavy duty 40 ppm
and 60 ppm models designed for printing up to one million pages per month with
very low cost per page.
 
DISTRIBUTION BUSINESS
 
     In 1994, the Company's wholly-owned subsidiary ISIL in the U.K. acquired
the Mekom distribution business, a division of Copymore, plc. The Mekom
business, located in Birmingham, England and ISIL's distribution business in
Slough now operate as the ISIL distribution business. The primary products
distributed include Canon printers, Kyocera printers, IBM desktop printers and
Toshiba laptop personal computers. ISIL also provides supplies and consumables
for the products it distributes.
 
CIRCUIT BOARD BUSINESS
 
     The Company, through its wholly owned subsidiary I.G.K., manufactures
printed circuit boards. The circuit boards are single sided, double sided and
multi-layered, with up to 10 layers.
 
MARKETING
 
     The Company's customers include end-users, original equipment
manufacturers, distributors, value-added-resellers and system integrators. The
Company sells or leases its products domestically utilizing direct advertising,
Company sales personnel, independent manufacturers' representatives and
distributors. The Company has sales offices and personnel in Ann Arbor,
Michigan; Boston, Massachusetts; Loves Park, Illinois; King of Prussia,
Pennsylvania; and Irvine, California; and manufacturers' representatives in New
York, North Carolina, Michigan, Kentucky, Illinois, Indiana, and Ohio.
 
     Sales of the Company's core business products in Europe are made through
the Company's U.K. sales branch which sells to OEM's and other distributors
throughout Europe and the Eastern Hemisphere. The Company has written agreements
with most of its foreign distributors.
 
     The following table sets forth certain information with respect to the
Company's domestic and export sales during the fiscal years ended September 30,
1997, 1996 and 1995 (in thousands):
 
<TABLE>
<CAPTION>
                                                        1997       1996       1995
                                                        ----       ----       ----
<S>                                                    <C>        <C>        <C>
Domestic Revenues..................................    $17,157    $15,175    $17,109
Foreign Revenues...................................     64,688     59,408     53,134
                                                       -------    -------    -------
Net Revenues.......................................    $81,845    $74,583    $70,243
                                                       =======    =======    =======
</TABLE>
 
     See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
 
     The Company markets its line of 3270-compatible printers and Oasis printing
and viewing solutions primarily to Fortune 1,000 companies. The Company's Cleo
products are sold to companies which have IBM mainframes or which access IBM
mainframes from micro or midrange computers. The Company's customers include
Chrysler Corp., CVS Corporation, Digital Equipment Corp., Electronic Data
Systems Corp.,
 
                                        3
<PAGE>   5
 
International Business Machines Corporation, Lucent Technologies, Boeing
Computer Services, Honda of America MFG, Inc., Mercy Center Hospital, Northwest
Airlines, Sears Roebuck and Co., Standard Electrik Lorenz Aktieng Ensellschaft,
Sterling Commerce, Inc., Morristown Memorial Hospital, Union Pacific Railroad,
Allstate, Inc., Charles Schwab and Kroger Company.
 
     The Company maintains a printer service department which provides direct
service for customers in Southeastern Michigan and Columbus, Ohio. Elsewhere,
the Company provides service through third parties, primarily Vanstar
Corporation, which has offices throughout the United States. Service to export
customers is performed by the personnel of each foreign distributor. The Company
trains and supports the personnel of Vanstar Corporation and its foreign
distributors at the Company's headquarters. Communication products are serviced
by a technical support group located at corporate headquarters in Ann Arbor,
Michigan.
 
MANUFACTURING AND SUPPLY
 
     The Company's manufacturing operations consist primarily of the assembly of
parts purchased from other sources, including printer mechanisms, logic boards
and power supplies. These parts are assembled into finished products which
support the software developed at the Company. IGK manufactures printed circuit
boards which are sold to the Company and to other customers. The Company has
purchased and designed a variety of assembly and test equipment to reduce the
cost and ensure the quality of the assembly process. A computerized system
developed for the Company is used to manage purchasing, production, scheduling
and inventory.
 
     Some components used in the Company's products are currently purchased from
single or limited sources of supply. The Company purchases most of its printer
mechanisms from Canon. ISIL distribution purchases the majority of their
products from Canon, Kyocera, Toshiba and IBM. The Company believes that the
loss of one or more suppliers would not have a material long-term impact on its
operations.
 
     The Company believes that backlog is not significant in its business
because of the relatively short time span (approximately 24 hours to 30 days)
between receipt of customer orders and product delivery. In addition, orders on
hand may be subject to cancellation by the customer without substantial penalty.
 
COMPETITION
 
     The Company operates in a highly competitive environment with several
well-established competitors, many of which have substantially greater resources
than the Company. Several of these competitors are independent suppliers,
offering one or more types of products in competition with the Company. The
Company believes that there is no single competitor across all business lines.
However, IBM and Microsoft can have a major impact on most of the Company's
markets.
 
     Previously, the Company competed primarily on price. The Company currently
differentiates itself from its competitors through unique product features and
value-added services for reliability and ease of use. With respect to printers,
the Company competes primarily on the basis of its ability to offer IBM
plug-compatible printers that offer advantages in software and hardware design
and performance over their IBM counterparts. Competition is becoming more
difficult as IBM is no longer obligated to purchase its desk top printers from a
single source (Lexmark). Significant reductions in IBM printer prices have
adversely affected the Company's revenues and margins. The Company does not
expect any further significant industry-wide price reductions.
 
     The Company's printers are designed to be compatible with the IBM
mainframe, AS/400 and RS/6000 product lines. As IBM has periodically introduced
new products or modified its lines of products, the Company has made appropriate
modifications to its printers. If IBM discontinued or significantly redesigned
its product lines, the Company's printer business could be adversely affected.
With respect to Oasis printing and viewing software, the Company competes
primarily with IBM products on the basis of the features it offers. Several
other smaller companies have also entered the market with products that are
competitive with Oasis.
 
                                        4
<PAGE>   6
 
     Competition for Cleo products consists of many large and smaller companies
selling competing IBM 3270 products, and a limited number of small companies
selling IBM 3780 products. Cleo has an excellent reputation in the IBM 3780
market, and in the UNIX to IBM mainframe connectivity market. Management
believes that Cleo is viewed by the IBM connectivity communications industry as
a company offering quality and high performance products, and engineering
services capable of customizing user requirements.
 
     The Company's business is subject to the computer industry trend toward
distributed data processing, client server technology and the extension of
legacy systems to intranets. The Company believes these trends offer new
opportunities as well as new competition, for the Company's printer, Oasis and
Cleo products.
 
     The Company is adapting to the changing marketplace by merging its printer
and communications technology for some of its new product development, including
Oasis products. The Company continues to see a resurgence of interest in the
mainframe as the source of data from legacy systems. While the environment
continues to be favorable for our Oasis products, there is competition from
companies, including IBM, which have products capable of performing functions
similar to Oasis.
 
     Competition in Europe for core business product sales is similar to that in
the United States. Competition for the Company's distribution business in the
U.K. consists of several distributors who are larger and carry broader product
lines than those of the Company, as well as many smaller competitors.
 
PRODUCT DEVELOPMENT
 
     Since its inception, the Company has maintained a product development
program and continues to supplement existing research and development
capabilities through active recruiting of technical personnel and development of
proprietary technology. In addition to merging the Company's sales and marketing
for its communications and printer products, the Company is combining product
development personnel. This combination supports development of the Company's
Oasis products which utilize both connectivity and printing software. The
Company currently has a staff of approximately 28 persons who work closely with
marketing and field personnel to determine emerging user needs in data
processing, and who continually review and evaluate technological changes
affecting the Company's primary market.
 
     The Company places emphasis on research and product development and the
employment of highly skilled and motivated individuals in these areas.
Management believes that a strong product development staff is an important
factor contributing to the Company's ability to compete successfully in the
markets in which its products are sold. During the fiscal years ended September
30, 1997, 1996 and 1995, the Company expended approximately $3.7 million, $2.0
million and $1.5 million, respectively, for product development. All of such
costs were sponsored by the Company. These figures do not include software
development costs which are capitalized under Financial Accounting Standards No.
86, of approximately $1.0 million, $2.3 million and $2.0 million for the fiscal
years ended September 30, 1997, 1996 and 1995, respectively. See Note 1 of Notes
to Consolidated Financial Statements. See also "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
 
EMPLOYEES
 
     As of December 1, 1997, the Company employed approximately 220 employees.
None of the Company's employees are represented by a collective bargaining
agreement, and the Company believes its employee relations to be good.
 
ITEM 2. PROPERTIES
 
     The Company's principal office and manufacturing facilities occupy
approximately 66,000 square feet in two buildings located in Ann Arbor,
Michigan. The facilities were designed and built to the Company's specifications
and the Company believes that they are adequate for its present and for its
future operations.
 
     The Company also rents office space in Slough and Birmingham, England;
Massachusetts; Pennsylvania and Illinois, with an annual rental expense expected
of $502,000 for fiscal 1998.
 
                                        5
<PAGE>   7
 
ITEM 3. LEGAL PROCEEDINGS
 
     Not applicable.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
     Not applicable.
 
                                        6
<PAGE>   8
 
                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
     The Company's Common Stock is traded on the Nasdaq Stock Market National
Market under the symbol "INTF." The following table sets forth, for the periods
indicated, the range of high and low sales prices for the Common Stock as
reported on the Nasdaq Stock Market National Market:
 
<TABLE>
<CAPTION>
                        FISCAL 1996                            HIGH     LOW
                        -----------                            ----     ---
<S>                                                           <C>      <C>
First Quarter...............................................  $12.75   $ 4.75
Second Quarter..............................................   19.50    10.75
Third Quarter...............................................   18.50     7.75
Fourth Quarter..............................................    9.00     5.62
</TABLE>
 
<TABLE>
<CAPTION>
                        FISCAL 1997                            HIGH     LOW
                        -----------                            ----     ---
<S>                                                           <C>      <C>
First Quarter...............................................  $ 6.50   $ 3.37
Second Quarter..............................................    6.37     3.62
Third Quarter...............................................    5.37     2.62
Fourth Quarter..............................................    4.62     2.87
</TABLE>
 
     The last reported sale price for the Company's Common Stock on December 1,
1997, as reported on the Nasdaq Stock Market National Market, was $3.00. On
December 1, 1997, there were approximately 800 holders of record of the
Company's Common Stock.
 
     The Company had warrants, which were granted in August 1983 and extended in
May 1995. During the year ended September 30, 1996, 264,450 of the warrants were
exercised at a price of $6.50 per warrant, and the remaining warrants expired.
 
     The Company initiated the payment of cash dividends during fiscal 1994.
Dividends of $0.04 per share, when declared, were paid quarterly to holders of
Common Stock. A quarterly dividend of $0.04 per share was paid through November
1995. At a Board of Directors meeting on January 12, 1996, the Directors
suspended indefinitely the payment of a dividend. The payment of dividends in
the future will depend on the Company's business prospects and other factors
considered by the Company's Board of Directors, including any restrictions on
such payment under the Company's credit facilities. The Company's credit
facilities currently restrict the payment of cash dividends.
 
     On August 8, 1997, the Company issued an aggregate 16,566 shares of its
Common Stock to 21 of its employees in lieu of accrued vacation time. In issuing
these shares of Common Stock, the Company valued each share at $4.00. The
closing price of the Common Stock on that date was $3.13. The Company did not
register, and does not plan to register, such Common Stock under the Securities
Act of 1933, as amended (the "Act"), based upon exemptions from registration set
forth in Section 4(2) of the Act and Regulation D. The Company relied upon these
exemptions based upon the limited number of employees involved, investment
representations made to the Company by each employee and the negotiated nature
of the transactions.
 
                                        7
<PAGE>   9
 
ITEM 6. SELECTED FINANCIAL DATA
 
     The following selected financial data were derived from the Company's
audited Consolidated Financial Statements. The information set forth below
should be read in conjunction with the Company's Consolidated Financial
Statements and related Notes included elsewhere in this report.
 
<TABLE>
<CAPTION>
                                                            FISCAL YEAR ENDED SEPTEMBER 30,
                                                  ----------------------------------------------------
                                                    1997       1996       1995       1994       1993
                                                    ----       ----       ----       ----       ----
                                                         (IN THOUSANDS, EXCEPT PER SHARE DATA)
<S>                                               <C>         <C>        <C>        <C>        <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Net revenues..................................    $ 81,845    $74,583    $70,243    $39,012    $33,782
Gross profit..................................       6,742     10,786     12,727     14,512     13,248
Operating income (loss).......................     (12,368)    (2,792)       767      4,418      3,222
Net income (loss).............................     (10,879)    (1,963)       166      2,835      1,705
Net income (loss) per share...................       (2.47)      (.44)       .04        .68        .41
Dividends per share...........................          --         --        .16        .16         --
Weighted average shares outstanding...........       4,411      4,440      4,239      4,170      4,141
CONSOLIDATED BALANCE SHEET DATA:
Working capital...............................    $  3,605    $10,533    $11,622    $12,420    $11,328
Total assets..................................      28,831     38,879     33,952     31,899     25,362
Long-term debt................................         171        235        287        334        487
Stockholders' equity..........................       9,743     21,253     21,214     21,421     19,139
</TABLE>
 
NOTES:
 
(1) The operating loss for fiscal 1997 includes non-recurring charges of $6.2
    million related to the write-off of inventory and capitalized software
    development costs and $2.0 million related to write-off of goodwill and
    restructuring the Company's operations in the United Kingdom. See
    "Management's Discussion and Analysis of Financial Condition and Results of
    Operations."
 
(2) The above includes the operating results of the distribution business
    acquired from Mekom, plc. since August 1, 1994.
 
(3) Fiscal 1994 includes a $127,000 charge for an accounting change which
    reflects the Company's adoption of SFAS 109, "Accounting for Income Taxes"
    in the first quarter of 1994.
 
(4) Fiscal 1993 includes non-recurring expenses of $163,000 related to the net
    loss for the period of Nematron, a former wholly-owned subsidiary of the
    Company which was spun-off in February 1993, and the cost of the spin-off.
 
                                        8
<PAGE>   10
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS
 
     The following table sets forth, for the periods indicated, certain
financial data as a percentage of net revenues.
 
<TABLE>
<CAPTION>
                                                                  YEAR ENDED SEPTEMBER 30,
                                                                -----------------------------
                                                                1997        1996        1995
                                                                ----        ----        ----
<S>                                                             <C>         <C>         <C>
Net revenues................................................    100.0%      100.0%      100.0%
Cost of revenues............................................     91.8        85.5        81.9
                                                                -----       -----       -----
Gross profit................................................      8.2        14.5        18.1
Product development costs...................................      4.5         2.6         2.1
Selling, general and administrative expenses................     18.8        15.6        15.0
                                                                -----       -----       -----
Operating income (loss).....................................    (15.1)       (3.7)        1.1
Interest and other income...................................      0.1         0.3         0.3
Interest expense............................................     (0.9)       (0.5)       (0.4)
                                                                -----       -----       -----
Income (loss) before income taxes...........................    (15.9)       (3.9)        1.0
Provision (benefit) for income taxes........................     (2.6)       (1.3)        0.8
                                                                -----       -----       -----
Net income (loss)...........................................    (13.3)%      (2.6)%       0.2%
                                                                =====       =====       =====
</TABLE>
 
RESULTS OF OPERATIONS
 
     Net Revenues. Net revenues increased 9.7% to $81.8 million for fiscal 1997
from $74.6 million for fiscal 1996, and increased 6.2% for fiscal 1996 from
$70.2 million for fiscal 1995. The increase for both years was primarily due to
increased ISIL distribution revenue, which comprised 77.0% and 75.1% of net
revenues for fiscal 1997 and 1996, respectively. Core product sales for fiscal
1997 were slightly higher than for fiscal 1996, and for fiscal 1996 decreased
approximately 16% from fiscal 1995. During fiscal 1997, the Company increased
its focus on core business products and plans to continue to do so in the
future. Cleo EN sales, which are impacted by large corporate orders, were up
significantly in fiscal 1997 but down in fiscal 1996. Printer products sales
decreased in both fiscal 1997 and 1996 as a result of increased competition and
greater emphasis on selling Oasis products. Oasis sales increased for both years
but were not significant in relation to total sales.
 
     Cost of Revenues. Cost of revenues was 91.8%, 85.5% and 81.9% of net
revenues for fiscal 1997, 1996 and 1995, respectively. For fiscal 1997, cost of
revenues included $6.2 million of non-recurring charges related to the write-off
of inventory and capitalized software development costs. The inventory
adjustments consisted of $2.1 million for core product printer inventory and
$1.4 million for slow moving distribution business inventory and related fair
market value reductions, that resulted from a decline in market conditions and
continued product price erosion; and of $1.1 million that resulted from several
accounting errors related to the recording of inventory at ISIL. The capitalized
software development costs write-off of $1.6 million for fiscal 1997 reflects
the Company's shift towards greater emphasis on software products.
 
     Cost of revenues, excluding the effect of the non-recurring charges,
decreased to 84.2% of net revenues for fiscal 1997 from 85.5% for the prior
year. The decrease resulted from improved gross margins for distribution sales
and increased sales of core business software products, which have higher gross
margins, offset by increased distribution sales as a percentage of total net
revenues and an increase of $237,000 in amortization of capitalized software
development costs. Margins in the distribution business are very low due to the
nature of the business, which has gross margins of 6% to 8%, as well as
competitive pressures which can drive margins even lower on very large sales.
 
     The increase in cost of revenues for fiscal 1996 compared to fiscal 1995
was primarily due to increased distribution sales as a percentage of total net
revenues. In addition, the increase was due to higher core product costs due to
$180,000 in charges from a printer products vendor for cancellation of purchase
orders, $100,000 of higher royalty payments on licensed software and an increase
of $225,000 in amortization of capitalized software development costs.
 
                                        9
<PAGE>   11
 
     Product Development Costs. Product development costs were $3.7 million,
$2.0 million and $1.5 million, or 4.5%, 2.6% and 2.1% of net revenues for fiscal
1997, 1996 and 1995, respectively. The absolute dollar increase for both years
was primarily due to a decrease of $1.4 million and $336,000 for fiscal 1997 and
1996, respectively, in the amount of expense deferred through capitalization of
internally developed software as compared with the prior fiscal year. The
reduction in capitalization of internally developed software reflects a change
in the Company's strategy towards greater emphasis on developing software
products.
 
     Selling, General and Administrative Expenses. Selling, general and
administrative expenses were $15.4 million, $11.6 million and $10.5 million, or
18.8%, 15.6% and 15.0% of net revenues for fiscal 1997, 1996 and 1995,
respectively. The absolute dollar increase for fiscal 1997 was due to a $1.5
million write-off of goodwill related to the Company's investment in its
operations in the United Kingdom; a $540,000 charge for restructuring the U.K.
operations; increased selling and marketing personnel to support the growth in
the U.K. distribution business; marketing expenses incurred to promote the Oasis
products; 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 July 1997, the Company's U.K. operations were restructured into two
separate entities, 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%.
 
     Interest Expense. Interest expense was $730,000, $340,000 and $264,000 for
fiscal 1997, 1996 and 1995, respectively. The increases were due to increased
borrowing, primarily at ISIL, for working capital purposes.
 
     Income Taxes. The Company recorded an income tax benefit of 16.2% and 33.0%
for fiscal 1997 and 1996, respectively, as a result of its ability to carry back
a portion of each year's net operating loss to recover income taxes paid in
prior years. The tax benefit for these years was below the statutory rate
because the losses at ISIL and the amortization and write-off of goodwill are
not eligible for tax benefit. For fiscal 1995, the provision for income taxes
resulted in an effective tax rate of 76.4%, which reflected the non-deductible
ISIL losses and non-deductible amortization of goodwill.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     At September 30, 1997, the Company's primary sources of liquidity included
cash and cash equivalents of $830,000 and short-term credit facilities with a
bank providing for approximately $11.5 million of borrowings, of which $600,000
was available.
 
     Net cash used in operating activities was $2.2 million for fiscal 1997
compared to net cash used in operating activities of $1.0 million for fiscal
1996. The increase in cash used in operating activities for fiscal 1997 was
primarily due to a net operating loss of $10.9 million and an increase in
accounts receivable of $1.2 million partially offset by non-cash charges of $7.7
million for write-offs of inventory, capitalized software development costs and
goodwill, and by depreciation and amortization of $3.4 million.
 
     Net cash used in investing activities was $1.5 million for fiscal 1997
compared to $4.3 million for the same period of fiscal 1996. The decrease in
cash used in investing activities for fiscal 1997 was primarily due to a
decrease in additions to property and equipment and software development costs.
At September 30, 1997, the Company did not have any material capital expenditure
requirements.
 
     Net cash provided by financing activities was $2.9 million for fiscal 1997
compared to $3.3 million for the same period of fiscal 1996. For fiscal 1997,
cash was provided primarily from borrowings under the Company's credit
facilities. For fiscal 1996, cash was provided from borrowings as well as from
the exercise of the Company's stock warrants.
 
     Working capital was $3.6 million as of September 30, 1997 compared to $10.5
million as of September 30, 1996. The decrease in working capital was primarily
due to the decrease in cash and cash equivalents and inventory and the increase
in notes payable, offset by the decrease in accounts payable.
 
                                       10
<PAGE>   12
 
     The Company has bank credit facilities which provide for aggregate
borrowings of up to $11.5 million. As of September 30, 1997, $8.6 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 (8.5% at September 30, 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.
 
     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 September 30, 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 has guaranteed up to 4.9 million pounds sterling ($7.9 million)
of ISIL's trade payables to two of ISIL's vendors for inventory purchases.
 
     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 Financial Condition and Results of Operations -- Uncertainties
Relating to Forward-Looking Statements."
 
UNCERTAINTIES RELATING TO FORWARD-LOOKING STATEMENTS
 
     "Item 7. Management's Discussion and Analysis of Results of Operations" and
other parts of this Form 10-K contain "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, those discussed in this section. Factors that could cause future
results to differ from these expectations include 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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
     Not applicable.
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
 
     The financial statements and schedules filed herewith are set forth in the
Index to Financial Statements and Supplementary Data (on Page F-1 of the
separate financial section which follows page 12 of this report) and are
incorporated herein by reference.
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
 
     Not applicable.
 
                                       11
<PAGE>   13
 
                                    PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
 
     The information required by this Item is incorporated herein by reference
to the Company's 1998 Proxy Statement under the captions "Election of
Directors", "Further Information -- Executive Officers" and "Reporting of
Beneficial Ownership by Directors and Executive Officers."
 
ITEM 11. EXECUTIVE COMPENSATION.
 
     The information required by this Item is incorporated herein by reference
to the Company's 1998 Proxy Statement under the caption "Executive
Compensation."
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
 
     The information required by this Item is incorporated herein by reference
to the Company's 1998 Proxy Statement under the captions "Further Information --
Principal Stockholders" and "Further Information -- Stock Ownership of
Management."
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
 
     The information required by this Item is incorporated herein by reference
to the Company's 1998 Proxy Statement under the caption "Certain Relationships
and Related Transactions."
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
 
     (a) Financial Statements, Schedules and Exhibits
 
          1-2. The financial statements and schedules filed herewith are set
     forth in the Index to Consolidated Financial Statements (on page F-1 of the
     separate financial section which follows page 12 of this report) and are
     incorporated herein by reference.
 
          3. The exhibits filed herewith are set forth in the Index to Exhibits
     (on the first page of the separate exhibit section which follows the
     financial section of this report) and are incorporated herein by reference.
     The following are the Company's management contracts and compensatory plans
     and arrangements which are required to be filed as Exhibits to this Form
     10-K:
 
<TABLE>
<CAPTION>
EXHIBIT
  NO.                              DESCRIPTION
-------                            -----------
<S>        <C>
10.01      1982 Incentive Stock Option Plan, effective May 21, 1982, as
           amended, with Form of Stock Option Agreement with Stock
           Appreciation Rights -- incorporated by reference to the
           Company's Registration Statement on Form S-1, filed on July
           15, 1983 (File No. 2-84204).
10.02      Amended and Restated 1992 Stock Option Plan.
10.03      Amended and Restated 1993 Stock Option Plan for Non-Employee
           Directors.
10.04      Letter Agreement between the Company and Robert A. Nero
           dated January 10, 1997 relating to employment terms.
</TABLE>
 
     (b) The Company filed no current reports on Form 8-K during the last
quarter of the Company's fiscal year ended September 30, 1997.
 
                                       12
<PAGE>   14
 
                            INTERFACE SYSTEMS, INC.
                                AND SUBSIDIARIES
 
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
                       AND FINANCIAL STATEMENT SCHEDULES
 
<TABLE>
<CAPTION>
                                                                 PAGE
                                                                 ----
<S>                                                           <C>
Report of Independent Public Accountants....................     F-2
Report of Independent Certified Public Accountants..........     F-3
Financial Statements
  Consolidated Statements of Operations.....................     F-4
  Consolidated Balance Sheets...............................     F-5
  Consolidated Statements of Cash Flows.....................     F-6
  Consolidated Statements of Stockholders' Equity...........     F-7
Notes to Consolidated Financial Statements..................  F-8 - F-15
Financial Statement Schedule
  Schedule II -- Consolidated Schedule of Valuation and
     Qualifying Accounts....................................     S-1
</TABLE>
 
                                       F-1
<PAGE>   15
 
                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
To the Board of Directors of
Interface Systems, Inc.:
 
     We have audited the accompanying consolidated balance sheet of Interface
Systems, Inc. (a Delaware corporation) and subsidiaries as of September 30,
1997, and the related consolidated statements of operations, stockholders'
equity and cash flows for the year then ended. The consolidated balance sheet of
Interface Systems, Inc. and subsidiaries as of September 30, 1996, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the two years in the period ended September 30, 1996, were
audited by other auditors whose report dated November 14, 1996, expressed an
unqualified opinion on those statements. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audit.
 
     We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
 
     In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Interface Systems, Inc. and
subsidiaries as of September 30, 1997, and the results of their operations and
their cash flows for the year then ended in conformity with generally accepted
accounting principles.
 
     Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in the accompanying
index is presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in the audit of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
 
                                          /s/ ARTHUR ANDERSEN LLP
 
Detroit, Michigan
November 6, 1997
 
                                       F-2
<PAGE>   16
 
               REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
 
To the Board of Directors
Interface Systems, Inc.
Ann Arbor, Michigan
 
     We have audited the accompanying consolidated balance sheet of Interface
Systems, Inc. and subsidiaries as of September 30, 1996, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the two years in the period ended September 30, 1996. We have also
audited the schedule listed in the accompanying index for each of the two years
in the period ended September 30, 1996. These financial statements and the
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedule based on our
audits.
 
     We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
 
     In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Interface Systems, Inc. and
subsidiaries at September 30, 1996, and the results of their operations and
their cash flows for each of the two years in the period ended September 30,
1996 in conformity with generally accepted accounting principles.
 
     Also, in our opinion, the schedule presents fairly, in all material
respects, the information set forth therein for each of the two years in the
period ended September 30, 1996.
 
                                          /s/ BDO SEIDMAN, LLP
 
Troy, Michigan
November 14, 1996
 
                                       F-3
<PAGE>   17
 
                    INTERFACE SYSTEMS, INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
<TABLE>
<CAPTION>
                                                              YEARS ENDED SEPTEMBER 30,
                                                       ----------------------------------------
                                                           1997          1996          1995
                                                           ----          ----          ----
<S>                                                    <C>            <C>           <C>
Net revenues.........................................  $ 81,845,463   $74,583,111   $70,243,216
Cost of revenues.....................................    75,103,139    63,797,610    57,516,563
                                                       ------------   -----------   -----------
     Gross profit....................................     6,742,324    10,785,501    12,726,653
Product development costs............................     3,718,807     1,956,404     1,453,605
Selling, general and administrative expenses.........    15,391,857    11,621,102    10,506,062
                                                       ------------   -----------   -----------
                                                         19,110,664    13,577,506    11,959,667
                                                       ------------   -----------   -----------
     Operating income (loss).........................   (12,368,340)   (2,792,005)      766,986
Interest expense.....................................      (730,979)     (340,376)     (263,758)
Interest and other income............................       119,427       200,343       203,158
                                                       ------------   -----------   -----------
     Income (loss) before income taxes...............   (12,979,892)   (2,932,038)      706,386
Provision (benefit) for income taxes.................    (2,100,810)     (969,000)      540,000
                                                       ------------   -----------   -----------
Net income (loss)....................................  $(10,879,082)  $(1,963,038)  $   166,386
                                                       ============   ===========   ===========
Net income (loss) per share..........................        $(2.47)       $(0.44)        $0.04
                                                       ============   ===========   ===========
Weighted average shares outstanding..................     4,411,328     4,440,262     4,238,889
                                                       ============   ===========   ===========
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       F-4
<PAGE>   18
 
                    INTERFACE SYSTEMS, INC. AND SUBSIDIARIES
 
                          CONSOLIDATED BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                                      SEPTEMBER 30,
                                                                --------------------------
                                                                   1997           1996
                                                                   ----           ----
<S>                                                             <C>            <C>
                           ASSETS
Current assets:
  Cash and cash equivalents.................................       $830,086     $1,694,725
  Accounts receivable, less allowance for doubtful accounts
     of $283,180 in 1997 and $165,000 in 1996...............     12,221,257     11,007,983
  Refundable income taxes...................................      1,182,182      1,378,093
  Inventories...............................................      6,284,833     10,478,322
  Prepaid expenses and other................................        913,314      1,232,423
  Deferred income taxes.....................................        475,000        549,000
                                                                -----------    -----------
          Total current assets..............................     21,906,672     26,340,546
Property and equipment, net.................................      4,602,696      4,816,815
Goodwill, net...............................................      1,160,634      2,881,481
Software development costs, net.............................        874,652      3,570,545
Notes receivable............................................             --        810,173
Other assets................................................        285,853        459,399
                                                                -----------    -----------
                                                                $28,830,507    $38,878,959
                                                                ===========    ===========
               LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Notes payable.............................................     $8,640,611     $5,691,546
  Accounts payable..........................................      8,124,581      9,088,765
  Accrued expenses..........................................        847,970        693,767
  Deferred revenue..........................................        638,709        280,703
  Current portion of long-term debt.........................         50,004         52,400
                                                                -----------    -----------
          Total current liabilities.........................     18,301,875     15,807,181
Long-term debt, less current portion........................        170,829        234,794
Deferred income taxes.......................................        615,000      1,584,000
Commitments
Stockholders' equity:
  Common stock, $.10 par value, 20,000,000 shares
     authorized; 4,424,950 and 4,535,879 shares issued and
     outstanding in 1997 and 1996 respectively..............        442,495        453,588
  Additional paid-in-capital................................     10,547,447     11,122,063
  Cumulative translation adjustment.........................       (281,441)      (236,051)
  Retained earnings (deficit)...............................       (965,698)     9,913,384
                                                                -----------    -----------
          Total stockholders' equity........................      9,742,803     21,252,984
                                                                -----------    -----------
                                                                $28,830,507    $38,878,959
                                                                ===========    ===========
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       F-5
<PAGE>   19
 
                    INTERFACE SYSTEMS, INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                                                 YEARS ENDED SEPTEMBER 30,
                                                         ------------------------------------------
                                                             1997           1996           1995
                                                             ----           ----           ----
<S>                                                      <C>             <C>            <C>
Cash flows from operating activities:
  Net income (loss)..................................    $(10,879,082)   $(1,963,038)   $   166,386
  Adjustments to reconcile net income (loss) to net
     cash provided by (used in) operating activities:
     Depreciation....................................         912,384        895,800        811,778
     Amortization....................................       2,466,299      2,370,065      2,160,499
     Inventory write-off and obsolescence
       provision.....................................       4,660,472        371,314      1,047,652
     Deferred income taxes...........................        (895,000)        67,000        151,000
     Gain on sale of securities......................         (74,777)            --             --
     Loss on sale of fixed assets....................         176,829         38,468         24,727
     Write-off of software development costs.........       1,616,358             --             --
     Write-off of goodwill...........................       1,456,320             --             --
     Change in operating assets and liabilities:
       Accounts receivable...........................      (1,213,274)      (939,155)      (621,373)
       Refundable income taxes.......................         195,911       (918,066)      (460,027)
       Inventories...................................        (466,983)    (3,489,432)      (672,627)
       Prepaid expenses and other....................         339,866       (577,194)      (159,632)
       Other assets..................................        (119,750)      (306,335)        10,591
       Accounts payable..............................        (964,184)     3,018,691        389,276
       Accrued expenses..............................         205,971        343,390       (445,743)
       Deferred revenue..............................         358,006         50,040         31,427
                                                         ------------    -----------    -----------
     Net cash provided by (used in) operating
       activities....................................      (2,224,634)    (1,038,452)     2,433,934
                                                         ------------    -----------    -----------
Cash flows from investing activities:
  Additions to property and equipment................        (787,837)    (1,133,159)    (1,756,236)
  Additions to software development costs............        (953,675)    (2,333,675)    (1,998,022)
  Change in notes receivable.........................          86,581       (810,173)            --
  Proceeds from sale of securities...................         177,612             --             --
                                                         ------------    -----------    -----------
     Net cash used in investing activities...........      (1,477,319)    (4,277,007)    (3,754,258)
                                                         ------------    -----------    -----------
Cash flows from financing activities:
  Increase in notes payable..........................       2,949,065      1,324,228      2,224,258
  Reduction of long-term debt........................         (66,361)       (51,752)      (142,270)
  Sale of stock......................................              --      2,039,832        292,797
  Cash dividends paid................................              --             --       (669,892)
                                                         ------------    -----------    -----------
     Net cash provided by financing activities.......       2,882,704      3,312,308      1,704,893
                                                         ------------    -----------    -----------
Effect of exchange rate changes on cash..............         (45,390)       (37,882)         3,907
                                                         ------------    -----------    -----------
Net increase (decrease) in cash and cash
  equivalents........................................        (864,639)    (2,041,033)       388,476
Cash and cash equivalents, beginning of period.......       1,694,725      3,735,758      3,347,282
                                                         ------------    -----------    -----------
Cash and cash equivalents, end of period.............    $    830,086    $ 1,694,725    $ 3,735,758
                                                         ============    ===========    ===========
Supplemental disclosure of cash flow information:
  Cash paid for interest.............................    $    720,566    $   340,376    $   263,758
  Cash paid (refunded) for income taxes..............      (1,323,683)       332,136        712,682
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       F-6
<PAGE>   20
 
                    INTERFACE SYSTEMS, INC. AND SUBSIDIARIES
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
 
<TABLE>
<CAPTION>
                           COMMON STOCK       ADDITIONAL    CUMULATIVE      RETAINED
                       --------------------     PAID-IN     TRANSLATION     EARNINGS
                        SHARES      AMOUNT      CAPITAL     ADJUSTMENT     (DEFICIT)        TOTAL
                        ------      ------    ----------    -----------    ---------        -----
<S>                    <C>         <C>        <C>           <C>           <C>            <C>
Balance, September
  30, 1994...........  4,153,368   $415,337   $ 8,827,685    $(202,076)   $ 12,379,928   $ 21,420,874
  Net income.........         --         --            --           --         166,386        166,386
  Sale of stock......     59,050      5,905       286,892           --              --        292,797
  Cash dividends --
     $.16 per
     share...........         --         --            --           --        (669,892)      (669,892)
  Foreign currency
     translation.....         --         --            --        3,907              --          3,907
                       ---------   --------   -----------    ---------    ------------   ------------
Balance, September
  30, 1995...........  4,212,418    421,242     9,114,577     (198,169)     11,876,422     21,214,072
  Net loss...........         --         --            --           --      (1,963,038)    (1,963,038)
  Sale of stock......    323,461     32,346     2,007,486           --              --      2,039,832
  Foreign currency
     translation.....         --         --            --      (37,882)             --        (37,882)
                       ---------   --------   -----------    ---------    ------------   ------------
Balance, September
  30, 1996...........  4,535,879    453,588    11,122,063     (236,051)      9,913,384     21,252,984
  Net loss...........         --         --            --           --     (10,879,082)   (10,879,082)
  Sale of stock......     16,566      1,657        50,111           --              --         51,768
  Retirement of
     stock...........   (127,495)   (12,750)     (624,727)          --              --       (637,477)
  Foreign currency
     translation.....         --         --            --      (45,390)             --        (45,390)
                       ---------   --------   -----------    ---------    ------------   ------------
Balance, September
  30, 1997...........  4,424,950   $442,495   $10,547,447    $(281,441)   $   (965,698)  $  9,742,803
                       =========   ========   ===========    =========    ============   ============
</TABLE>
 
  The accompanying notes are an integral part of these consolidated financial
                                  statements.
 
                                       F-7
<PAGE>   21
 
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1. SIGNIFICANT ACCOUNTING POLICIES
 
BASIS OF PRESENTATION
 
     The accompanying consolidated financial statements include the accounts of
Interface Systems, Inc. (the "Company") and its wholly-owned subsidiaries,
I.G.K. Industries, Inc. ("I.G.K.") and Interface Systems International, Ltd.
("ISIL"). All significant intercompany transactions and balances have been
eliminated in consolidation.
 
DESCRIPTION OF BUSINESS
 
     The Company and its subsidiaries develop, manufacture and sell computer
peripherals and data communications software primarily in the United States and
Europe.
 
REVENUE RECOGNITION
 
     Revenues from product sales are recognized upon shipment to the customer.
Lease and service revenues are recognized ratably over the contractual period or
as the services are performed. Revenues from licenses of software products are
recognized when the product is shipped and the Company has no further obligation
to the customer. Deferred revenue represents advance billings on service
contracts.
 
CONCENTRATIONS OF CREDIT RISK
 
     Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of cash, cash equivalents and
accounts receivable. At times such cash and equivalents in banks are in excess
of the respective financial institution's FDIC insurance limit. With respect to
accounts receivable, the Company attempts to minimize credit risk by reviewing
all customers' credit history before extending credit and by monitoring
customers' credit exposure on a continuing basis. The Company establishes an
allowance for possible losses on accounts receivable based upon factors
surrounding the credit risk of specific customers, historical trends and other
information.
 
FAIR VALUES OF FINANCIAL INSTRUMENTS
 
     The amounts reported for cash and cash equivalents, accounts receivable,
accounts payable, notes payable and accrued expenses approximate fair value due
to the short maturity of these items.
 
SOFTWARE DEVELOPMENT COSTS
 
     In accordance with Statement of Financial Accounting Standards ("SFAS") No.
86, "Accounting for the Costs of Computer Software to be Sold, Leased or
Otherwise Marketed," the costs of developing new software products are
capitalized after technological feasibility is established. The establishment of
technological feasibility and the ongoing assessment of recoverability of
capitalized software development costs require considerable judgment by
management with respect to certain external factors, including, but not limited
to, anticipated future gross product revenues, estimated economic product lives
and changes in software and hardware technology.
 
     Amortization of capitalized software development costs is provided on a
product-by-product basis using the straight-line method over the remaining
estimated economic lives of the respective products or three years, whichever
is less. Accumulated amortization was $2,365,749 and $3,928,353 at September
30, 1997 and 1996, respectively. Amortization expense was $2,033,210,
$1,796,117 and $1,572,096 for the years ended September 30, 1997, 1996 and
1995, respectively, and is included in cost of revenues.
 
     On an ongoing basis, management reviews the valuation and amortization of
capitalized software development costs. As part of its review, management
considers the value of future cash flows attributable to the capitalized
development costs in evaluating potential impairment of the asset. Based on such
review, the
 
                                       F-8
<PAGE>   22
 
Company wrote off $1,616,358 of capitalized software development costs as a
component of cost of revenues during fiscal 1997.
 
FOREIGN CURRENCY TRANSLATION
 
     Assets and liabilities of foreign subsidiaries are translated at exchange
rates in effect on the balance sheet date, and revenue and expenses are
translated using a weighted average exchange rate during the period. Cumulative
adjustments resulting from translation of financial statements are reflected as
a separate component of stockholders' equity.
 
CASH AND CASH EQUIVALENTS
 
     Cash and cash equivalents includes investments in highly liquid investments
with maturities of ninety days or less.
 
INVENTORIES
 
     Inventories are valued at the lower of cost (determined on a first-in,
first-out basis) or market. At September 30, inventories consist of the
following:
 
<TABLE>
<CAPTION>
                                                            1997          1996
                                                            ----          ----
<S>                                                      <C>           <C>
Finished goods.......................................    $3,974,354    $ 4,709,066
Purchased parts......................................     2,596,273      4,173,938
Work-in-process......................................       321,300      1,153,172
Service and demo.....................................       643,432        797,768
                                                         ----------    -----------
                                                          7,535,359     10,833,944
     Less: valuation allowance.......................     1,250,526        355,622
                                                         ----------    -----------
                                                         $6,284,833    $10,478,322
                                                         ==========    ===========
</TABLE>
 
PROPERTY AND EQUIPMENT
 
     Property and equipment are stated at cost. Depreciation is provided using
the straight-line method over the following estimated useful lives of the
assets: buildings and improvements -- 33 years; and machinery and equipment -- 3
to 10 years. At September 30, the components of property and equipment are as
follows:
 
<TABLE>
<CAPTION>
                                                             1997          1996
                                                             ----          ----
<S>                                                       <C>           <C>
Land..................................................    $  231,383    $  231,383
Buildings and improvements............................     2,709,863     2,680,088
Machinery and equipment...............................     6,073,832     6,309,387
                                                          ----------    ----------
                                                           9,015,078     9,220,858
     Less: accumulated depreciation...................     4,412,382     4,404,043
                                                          ----------    ----------
                                                          $4,602,696    $4,816,815
                                                          ==========    ==========
</TABLE>
 
GOODWILL
 
     Goodwill represents the cost in excess of fair value of the net assets of
businesses acquired and is being amortized using the straight-line method over
15 years. Accumulated amortization expense at September 30, 1997 and 1996 was
$1,527,776 and $1,934,142, respectively.
 
IMPAIRMENT OF LONG-LIVED ASSETS
 
     In fiscal 1997, the Company adopted SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of"
which requires an evaluation of long-lived assets for impairment whenever events
or changes in circumstances indicate that the carrying amount of the asset may
 
                                       F-9
<PAGE>   23
 
not be recoverable. During the third quarter of fiscal 1997, management's
evaluation indicated that the goodwill related to the Company's investment in
its operations in the United Kingdom was impaired and, consequently, the
$1,456,320 carrying value of the related goodwill was written off as a component
of operating expense during fiscal 1997.
 
RESEARCH AND DEVELOPMENT EXPENSES
 
     Research and development expenses are expensed in the period incurred.
These costs, representing engineering salaries, fringe benefits, other direct
expenses and a portion of the Company's overhead, are included in the
accompanying consolidated financial statements as product development costs.
 
STOCK PLANS
 
     The Company uses the intrinsic value method prescribed in APB Opinion No.
25, "Accounting for Stock Issued to Employees," and related interpretations in
accounting for its stock option plans. Under APB 25, when the exercise price of
employee stock options equals or exceeds the market price of the underlying
stock on the date of grant, no compensation expense is recognized. As
supplemental information, the Company has provided pro forma disclosure of the
fair value of stock options granted during fiscal 1997 and 1996 in accordance
with the requirements of SFAS 123, "Accounting for Stock-Based Compensation."
 
INCOME (LOSS) PER SHARE
 
     Income (loss) per share amounts have been calculated using the weighted
average number of shares and common stock equivalents outstanding for the
respective periods. The antidilutive effect of outstanding options of the
Company is excluded from the earnings (loss) per share calculations presented in
the consolidated statements of operations.
 
     In February 1997, SFAS 128, "Earnings per Share," was issued and is
required to be adopted for the quarter ended December 31, 1997. At that time,
the Company will be required to change the method currently used to compute
earnings per share and to restate all prior periods. Under the new requirements
for calculating earnings per share, the dilutive effect of stock options will be
excluded. There is no impact on primary earnings per share for the years ended
September 30, 1997, 1996 and 1995. Diluted earnings per share is not materially
different for the fiscal years ended September 30, 1997, 1996, and 1995, as
reported.
 
USE OF ESTIMATES
 
     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and the
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.
 
RECLASSIFICATIONS
 
     For comparative purposes, amounts in prior years have been reclassified to
conform to current year presentations.
 
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
 
     In 1997, SFAS 130, "Reporting Comprehensive Income," SFAS 131, "Disclosures
About Segments of an Enterprise and Related Information," and SOP 97-2,
"Software Revenue Recognition," were issued and are effective for fiscal years
commencing after December 15, 1997. The Company is required to adopt the
provisions of SFAS 130 and 131 and SOP 97-2 in fiscal year 1999 and expects the
adoption will not impact results of operations or financial position but will
require additional disclosures.
 
                                      F-10
<PAGE>   24
 
2. NOTES RECEIVABLE
 
     Notes receivable consist of the following at September 30:
 
<TABLE>
<CAPTION>
                                                               1997        1996
                                                               ----        ----
<S>                                                          <C>         <C>
Note receivable due from a former officer of the Company,
  (see Note 7)...........................................    $     --    $600,000
Notes receivable due from two officers of the Company,
  bearing interest at 5.50%, collateralized by common
  stock, due February 1998...............................     105,000     125,000
Note receivable due from a former officer of the Company,
  bearing interest at 5.79% due in monthly installments,
  through June 1998, unsecured...........................      18,592      85,173
                                                             --------    --------
                                                             $123,592    $810,173
                                                             ========    ========
</TABLE>
 
     The notes receivable balance of $123,592 at September 30, 1997 is included
in prepaid expenses and other in the accompanying consolidated balance sheet.
 
3. LINES-OF-CREDIT AND NOTES PAYABLE
 
     The Company has bank credit facilities which provide for aggregate
borrowings of up to $11.5 million. As of September 30, 1997, $8,640,611 was
outstanding under these facilities. Advances under these facilities bear
interest at the bank's prime rate (8.5% at September 30, 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 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 $600,000 was available to the Company as of September 30, 1997.
 
     Under the terms of the credit agreements, the Company is required to
maintain certain minimum working capital, net worth and profitability levels and
other specific financial ratios. In addition, the credit 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 September 30, 1997, the
Company was in compliance with the bank covenants.
 
4. LONG-TERM DEBT
 
     At September 30, long-term debt consists of the following:
 
<TABLE>
<CAPTION>
                                                               1997        1996
                                                               ----        ----
<S>                                                          <C>         <C>
Installment loan payable to a bank in monthly
  installments of $4,167 plus interest at the bank's
  prime rate (8.5% at September 30, 1997) plus 1%, due
  February 2002, collateralized by substantially all of
  the Company's assets...................................    $220,833    $259,039
Installment loan payable to a bank, paid in full during
  1997...................................................          --      28,155
                                                             --------    --------
                                                              220,833     287,194
Less current maturities..................................      50,004      52,400
                                                             --------    --------
                                                             $170,829    $234,794
                                                             ========    ========
</TABLE>
 
5. RETIREMENT PLAN
 
     The Company has a 401(k) plan which covers substantially all domestic
employees. Participants may make contributions equal to a percentage of their
compensation, subject to Internal Revenue Code limitations. The Company matches
100% of the amount contributed by participants, up to 4% of participant
compensation, and may make additional contributions as approved by the Board of
Directors. The Company recognized
 
                                      F-11
<PAGE>   25
 
approximately $274,000, $298,000 and $299,000 of expense related to this plan
for the years ended September 30, 1997, 1996 and 1995, respectively. In
addition, ISIL maintains a defined contribution pension plan for all eligible
employees. ISIL recognized approximately $100,333, $140,000 and $112,000 of
expense related to this plan for the years ended September 30, 1997, 1996 and
1995, respectively.
 
6. COMMITMENTS
 
     The Company has various operating leases which require future minimum
rental payments in excess of one year as follows: 1998 - $502,000; 1999 -
$330,000; 2000 - $265,000; 2001 - $216,000; and 2002 - $172,000. Rent expense
for the years ended September 30, 1997, 1996 and 1995 was approximately
$552,000, $200,000 and $375,000, respectively.
 
7. STOCKHOLDERS' EQUITY
 
     In January 1997, the Company acquired 127,495 shares of its Common Stock
valued at $637,477, 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.
 
     In August 1997, the Company issued 16,566 shares of common stock to
employees in exchange for accrued vacation.
 
8. STOCK OPTIONS
 
     The Company currently grants stock options under two plans, the 1992 Stock
Option Plan (the "1992 Plan") and the 1993 Stock Option Plan for Non-Employee
Directors (the "Directors Plan"). The Company had previously granted options
under the 1982 Stock Option Plan which expired in 1992. At September 30, 1997,
options to purchase 30,700 shares of common stock were outstanding and
exercisable under this Plan.
 
     The 1992 Plan provides for the grant of both incentive stock options and
non-qualified options to officers and key employees. Options under the 1992 Plan
are granted at not less than market price on the date of grant, are exercisable
at the rate of 33% per year after one year from the date of grant and have a
term of ten years. The 1992 Plan has 800,000 shares of common stock authorized
for grant. At September 30, 1997, options to purchase 402,433 shares of common
stock were available for grant, 397,567 were outstanding and 41,332 were
exercisable under the 1992 Plan.
 
     Effective June 10, 1997, the Company offered current option holders except
for executive officers the opportunity to exchange outstanding options for an
equal number of options of the Company's common stock, at a price of $4 per
share (market price $3). Option holders representing 106,067 shares of common
stock accepted this offer and the Company canceled the previous options and
granted new options under the 1992 Plan. The options vest over three years
effective from the new date of grant.
 
     The Directors Plan provides for the issuance of non-qualified options to
non-employee directors and has 175,000 shares of common stock authorized for
grant. Options under the Directors Plan are granted at market price on the date
of grant, are exercisable at the rate of 33% per year after one year from the
date of grant and have a term of ten years. The Directors Plan provides for an
initial grant of 5,100 to a non-employee director upon joining the Board of
Directors and grants of 5,100 on every third anniversary thereafter. In
addition, the Plan was recently amended, subject to shareholder approval, to
provide discretionary grants with vesting determined at the time of grant. On
August 8, 1997, the Board of Directors approved a one time grant to each
non-employee director of an option to purchase 12,000 shares of common stock at
$4.00 (market price $3.13). The grant is subject to shareholder approval and
will become immediately exercisable if shareholder approval is obtained. At
September 30, 1997, options to purchase 71,500 shares of common stock were
available for grant, 103,500 were outstanding and 24,800 were exercisable under
the Directors Plan.
 
     The weighted average fair value of options granted during fiscal 1997 and
fiscal 1996 was $2.32 and $5.15 respectively. At September 30, 1996, 270,523
options were exercisable at a weighted average exercise price of $5.71.
 
                                      F-12
<PAGE>   26
 
     The following table summarizes stock option activity through September 30,
1997:
 
<TABLE>
<CAPTION>
                                                          NUMBER      WEIGHTED AVERAGE
                                                         OF SHARES     EXERCISE PRICE
                                                         ---------    ----------------
<S>                                                      <C>          <C>
Balance, September 30, 1995..........................     449,399          $ 6.61
  Granted............................................     101,700           10.59
  Exercised..........................................     (59,011)          (5.44)
  Canceled...........................................     (83,422)          (7.07)
Balance, September 30, 1996..........................     408,666            6.86
  Granted............................................     419,268            3.94
  Canceled...........................................    (296,167)          (7.10)
Balance, September 30, 1997..........................     531,767          $ 4.59
</TABLE>
 
     The following table summarizes information about options outstanding as of
September 30, 1997:
 
<TABLE>
<CAPTION>
                                                  OPTIONS OUTSTANDING                        OPTIONS EXERCISABLE
                                   -------------------------------------------------    -----------------------------
                                                  WEIGHTED AVERAGE
                                                    CONTRACTUAL          WEIGHTED                         WEIGHTED
                                     NUMBER          REMAINING           AVERAGE          NUMBER          AVERAGE
   RANGE OF EXERCISE PRICES        OUTSTANDING      LIFE (YEARS)      EXERCISE PRICE    EXERCISABLE    EXERCISE PRICE
   ------------------------        -----------    ----------------    --------------    -----------    --------------
<S>                                <C>            <C>                 <C>               <C>            <C>
$3.22 - $ 3.81.................       60,800            8.29              $ 3.58          12,700           $3.63
 4.00 -   4.75.................      372,067            9.48                4.07           6,000            4.31
 5.25 -   5.38.................       62,000            6.04                5.35          57,332            5.27
 7.19 -  16.25.................       36,900            6.03               10.43          20,800            9.23
                                     -------                                              ------
     Total.....................      531,767            8.71              $ 4.59          96,832           $5.85
                                     =======                                              ======
</TABLE>
 
     Using the intrinsic value method of accounting for the value of stock
options granted during fiscal 1997 and 1996, no compensation cost was recorded
in the accompanying consolidated statement of operations. Pro forma information
regarding net loss and related per share data is required by SFAS 123, and has
been determined as if the Company had accounted for its stock options using the
fair value method of SFAS 123. The fair value for these options was estimated at
the date of the grant using a Black-Scholes option pricing model with the
following weighted average assumptions for fiscal 1997 and 1996: risk free
interest rate of 6.3% and 5.6%, respectively; dividend yield of 0%; expected
volatility of 67.8% and 64.7%, respectively; and expected life of the options of
3 years.
 
     For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information is as follows:
 
<TABLE>
<CAPTION>
                                                           1997           1996
                                                           ----           ----
<S>                                                    <C>             <C>
Net loss as reported...............................    $(10,879,802)   $(1,963,038)
Pro forma net loss.................................     (11,142,206)    (2,068,661)
Net loss per share as reported.....................    $      (2.47)   $     (0.44)
Pro forma net loss per share.......................           (2.53)         (0.47)
</TABLE>
 
     The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because changes in the subjective input assumptions can materially
affect the fair value estimate, in management's opinion, the existing models do
not necessarily provide a reliable single measure of the fair value of the
Company's stock options. Because the SFAS 123 method of accounting has not been
applied to options granted prior to October 1, 1995, the resulting pro forma
compensation cost may not be representative of that to expect in future years.
 
                                      F-13
<PAGE>   27
 
9. INCOME TAXES
 
     A summary of income (loss) before income taxes and components of the
provision (benefit) for income taxes for the fiscal years ended September 30, is
as follows:
 
<TABLE>
<CAPTION>
                                                             1997           1996           1995
                                                             ----           ----           ----
<S>                                                      <C>             <C>            <C>
Income (loss) before income taxes:
     Domestic........................................    $ (7,572,504)   $(2,950,287)   $ 1,558,281
     Foreign.........................................      (5,407,388)        18,249       (851,895)
                                                         ------------    -----------    -----------
                                                         $(12,979,892)   $(2,932,038)   $   706,386
                                                         ============    ===========    ===========
Provisions (benefit) for income taxes:
     Current-federal.................................    $ (1,205,810)   $(1,036,000)   $   389,000
     Deferred-federal................................        (895,000)        67,000        151,000
                                                         ------------    -----------    -----------
                                                         $ (2,100,810)   $  (969,000)   $   540,000
                                                         ============    ===========    ===========
</TABLE>
 
     A reconciliation of the consolidated income tax provision (benefit) at the
Federal statutory rate and the consolidated income tax provision (benefit) at
the Company's effective rate for the fiscal years ended September 30 is as
follows:
 
<TABLE>
<CAPTION>
                                                                1997          1996         1995
                                                                ----          ----         ----
<S>                                                          <C>            <C>          <C>
Federal statutory provision (benefit)....................    $(4,413,000)   $(997,000)   $ 240,000
Losses without tax benefit...............................      1,958,000       (6,000)     289,000
Amortization and write-off of goodwill...................        240,000       97,000       97,000
Benefits of FSC non-taxable income.......................             --      (18,000)     (51,000)
Research and development credits.........................             --           --      (33,000)
Other....................................................        114,190      (45,000)      (2,000)
                                                             -----------    ---------    ---------
Consolidated income tax provision (benefit)..............    $(2,100,810)   $(969,000)   $ 540,000
                                                             ===========    =========    =========
</TABLE>
 
     Deferred income taxes represent temporary differences in the recognition of
certain items for income tax and financial reporting purposes. The components of
the Company's deferred taxes at September 30 are as follows:
 
<TABLE>
<CAPTION>
                                                            1997           1996
                                                            ----           ----
<S>                                                      <C>            <C>
Deferred tax liabilities --
  Depreciation and amortization......................    $   615,000    $1,584,000
                                                         ===========    ==========
Deferred tax assets --
ISIL net operating loss carryforwards................    $ 1,400,000    $  544,000
Receivable and inventory reserves....................        349,000            --
Tax credits..........................................        174,000       291,000
Accrued liabilities..................................        126,000       206,000
Other................................................             --        52,000
Valuation allowance..................................     (1,574,000)     (544,000)
                                                         -----------    ----------
     Net long-term deferred income taxes.............    $   475,000    $  549,000
                                                         ===========    ==========
</TABLE>
 
     ISIL has net operating loss carry forwards of approximately $4,100,000
available for tax reporting purposes which can be used to offset its future
taxable income through the year 2012. The related deferred tax benefit is fully
offset by an evaluation allowance as realizability of the tax benefit is not
assured.
 
                                      F-14
<PAGE>   28
 
10. GEOGRAPHIC AND INDUSTRY SEGMENT INFORMATION
 
     The Company operates in two geographic regions: the United States and
Europe. The Company operates in a single business segment, the development,
manufacture and sale of computer peripherals and data communications software.
The following table shows net revenues, net income (loss) and identifiable
assets by geographic region for the fiscal years ended September 30:
 
<TABLE>
<CAPTION>
                                                           1997          1996          1995
                                                           ----          ----          ----
<S>                                                    <C>            <C>           <C>
Net revenues:
  United States......................................  $ 18,505,583   $16,981,582   $19,664,665
  Europe.............................................    64,688,347    59,407,749    53,134,600
  Intercompany.......................................    (1,348,467)   (1,806,220)   (2,556,049)
                                                       ------------   -----------   -----------
     Total net revenues..............................  $ 81,845,463   $74,583,111   $70,243,216
                                                       ============   ===========   ===========
Net income (loss):
  United States......................................  $ (5,471,694)  $(1,981,287)  $ 1,018,281
  Europe.............................................    (5,407,388)       18,249      (851,895)
                                                       ------------   -----------   -----------
     Total net income (loss).........................  $(10,879,082)  $(1,963,038)  $   166,386
                                                       ============   ===========   ===========
Identifiable assets:
  United States......................................  $ 17,860,727   $24,217,086   $23,462,758
  Europe.............................................    14,041,919    17,187,624    12,925,606
  Eliminations.......................................    (3,072,139)   (2,525,751)   (2,435,914)
                                                       ------------   -----------   -----------
     Total identifiable assets.......................  $ 28,830,507   $38,878,959   $33,952,450
                                                       ============   ===========   ===========
</TABLE>
 
11. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
 
     The following is a summary of selected quarterly financial data for the
years ended September 30, 1997 and 1996.
 
<TABLE>
<CAPTION>
                                                     QUARTER ENDED
                                --------------------------------------------------------
                                DECEMBER 31,    MARCH 31,     JUNE 30,     SEPTEMBER 30    FISCAL YEAR
                                ------------    ---------     --------     ------------    -----------
<S>                             <C>            <C>           <C>           <C>             <C>
1997
------------------------------
Net Revenues..................  $19,594,397    $23,319,188   $19,243,265    $19,688,613    $81,845,463
Gross Profit..................    2,628,890      1,875,135    (1,312,669)     3,550,968      6,742,324
Net Income (Loss).............     (725,053)    (1,499,729)   (6,904,725)    (1,749,575)   (10,879,082)
Net Earnings (Loss) Per
  Share.......................        (0.16)         (0.34)        (1.57)         (0.40)         (2.47)
1996
------------------------------
Net Revenues..................  $18,710,574    $21,906,167   $16,655,495    $17,310,875    $74,583,111
Gross Profit..................    3,308,153      3,511,844     2,107,490      1,858,014     10,785,501
Net Income (Loss).............      200,024        363,994    (1,495,565)    (1,031,491)    (1,963,038)
Net Earnings (Loss) Per
  Share.......................         0.05           0.08         (0.33)         (0.23)         (0.44)
</TABLE>
 
                                      F-15
<PAGE>   29
 
                            INTERFACE SYSTEMS, INC.
 
                                  SCHEDULE II
                             CONSOLIDATED SCHEDULE
                       OF VALUATION & QUALIFYING ACCOUNTS
 
<TABLE>
<CAPTION>
                                                                 BALANCE     BALANCE
                                                                BEGINNING     END OF
                        DESCRIPTION                             OF PERIOD     PERIOD
                        -----------                             ---------    -------
<S>                                                             <C>          <C>
Allowance for doubtful accounts
For the year ended September 30:
       1997.................................................    $165,000     $283,180
       1996.................................................    $248,000     $165,000
       1995.................................................    $133,000     $248,000
</TABLE>
 
                                       S-1
<PAGE>   30
 
                                   SIGNATURES
 
     Pursuant to the requirements of Section 13 or 15(d) 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.
 
Dated: December 29, 1997
                                          By:      /s/ ROBERT A. NERO
                                            ------------------------------------
                                               Robert A. Nero, President and
                                                and Chief Executive Officer
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
 
<TABLE>
<CAPTION>
                  SIGNATURE                                    TITLE                         DATE
                  ---------                                    -----                         ----
<S>                                              <C>                                   <C>
 
             /s/ ROBERT A. NERO                  President, Chief Executive Officer    December 29, 1997
---------------------------------------------    and Director (Principal Executive
               Robert A. Nero                    Officer)
 
             /s/ JOHN R. TERNES                  Vice President and Chief Financial    December 29, 1997
---------------------------------------------    Officer (Principal Financial and
               John R. Ternes                    Accounting Officer)
 
         /s/ GEORGE W. PERRETT, JR.              Vice President -- Operations,         December 29, 1997
---------------------------------------------    Secretary and Director
           George W. Perrett, Jr.
 
             /s/ DAVID O. SCHUPP                 Vice President, Treasurer and         December 29, 1997
---------------------------------------------    Director
               David O. Schupp
 
            /s/ GARNEL F. GRABER                 Chairman and Director                 December 29, 1997
---------------------------------------------
              Garnel F. Graber
 
            /s/ BRUCE E. RHOADES                 Director                              December 29, 1997
---------------------------------------------
              Bruce E. Rhoades
 
             /s/ DAVID C. SEIGLE                 Director                              December 29, 1997
---------------------------------------------
               David C. Seigle
 
            /s/ ROBERT A. SEIGLE                 Director                              December 29, 1997
---------------------------------------------
              Robert A. Seigle
 
             /s/ LLOYD A. SEMPLE                 Director                              December 29, 1997
---------------------------------------------
               Lloyd A. Semple
</TABLE>
<PAGE>   31
 
                               INDEX TO EXHIBITS
 
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                            DESCRIPTION
-------                           -----------
<S>       <C>                                                           
 
3.01      Certificate of Incorporation of the Company, as amended --
          incorporated by reference to Exhibit 3(a) to the Company's
          Form 10-K Report for the fiscal year ended September 30,
          1996........................................................
3.02      Bylaws of the Company, as amended -- incorporated by
          reference to Exhibit 3(b) to the Company's Form 10-K Report
          for the fiscal year ended September 30, 1996................
4.01      Credit Authorization Agreement dated February 19, 1997
          between Interface Systems, Inc. (the "Company") and NBD Bank
          ("NBD") -- incorporated by reference to Exhibit 10.01 to the
          Company's Form 10-Q Report for the quarter ended March 31,
          1997........................................................
4.02      Credit Authorization Agreement dated February 19, 1997
          between I.G.K. Industries and NBD -- incorporated by
          reference to Exhibit 10.02 to the Company's Form 10-Q Report
          for the quarter ended March 31, 1997........................
4.03      Debenture dated March 10, 1997 between Interface Systems
          International Limited and The First National Bank of Chicago
          -- incorporated by reference to Exhibit 10.03 to the
          Company's Form 10-Q Report for the quarter ended March 31,
          1997........................................................
4.04      Master Demand Business Loan Note dated February 19, 1997
          (the "Company") -- incorporated by reference to Exhibit
          10.04 to the Company's Form 10-Q Report for the quarter
          ended March 31, 1997........................................
4.05      Master Demand Business Loan Note dated February 19, 1997
          (I.G.K.) -- incorporated by reference to Exhibit 10.05 to
          the Company's Form 10-Q Report for the quarter ended March
          31, 1997....................................................
4.06      Continuing Pledge Agreement dated February 19, 1997 between
          the Company and NBD -- incorporated by reference to Exhibit
          10.06 to the Company's Form 10-Q Report for the quarter
          ended March 31, 1997........................................
4.07      Continuing Security Agreement dated February 19, 1997
          between the Company and NBD -- incorporated by reference to
          Exhibit 10.07 to the Company's Form 10-Q Report for the
          quarter ended March 31, 1997................................
4.08      Continuing Security Agreement dated February 19, 1997
          between I.G.K. and NBD -- incorporated by reference to
          Exhibit 10.08 to the Company's Form 10-Q Report for the
          quarter ended March 31, 1997................................
4.09      Future Advance Mortgage dated February 19, 1997 between
          Interface and NBD -- incorporated by reference to Exhibit
          10.09 to the Company's Form 10-Q Report for the quarter
          ended March 31, 1997........................................
4.10      Future Advance Mortgage dated February 19, 1997 between
          I.G.K. and NBD -- incorporated by reference to Exhibit 10.10
          to the Company's Form 10-Q Report for the quarter ended
          March 31, 1997..............................................
4.11      Continuing Guaranty between the Company and NBD --
          incorporated by reference to Exhibit 10.11 to the Company's
          Form 10-Q Report for the quarter ended March 31, 1997.......
4.12      Continuing Guaranty and Indemnity for International Credits
          between the Company and NBD -- incorporated by reference to
          Exhibit 10.12 to the Company's Form 10-Q Report for the
          quarter ended March 31, 1997................................
4.13      Continuing Guaranty and Indemnity for International Credits
          between I.G.K. and NBD -- incorporated by reference to
          Exhibit 10.13 to the Company's Form 10-Q Report for the
          quarter ended March 31, 1997................................
4.14      First Amendment to Credit Authorization Agreement dated
          February 19, 1997 between the Company and NBD Bank dated
          April 21, 1997..............................................
</TABLE>
<PAGE>   32
<TABLE>
<CAPTION>
EXHIBIT
NUMBER                            DESCRIPTION
-------                           -----------
<S>       <C>                                                           
4.15      Second Amendment to Credit Authorization Agreement dated
          February 19, 1997 between the Company and NBD Bank dated
          August 11, 1997 -- incorporated by reference to Exhibit 10.1
          to the Company's Form 10-Q Report for the quarter ended June
          30, 1997....................................................
4.16      Credit Authorization Agreement dated August 31, 1997 between
          the Company and NBD Bank....................................
4.17      Installment Business Loan Note/Security Agreement dated
          August 31, 1997 between the Company and NBD Bank............
4.18      First Amendment to Credit Authorization Agreement dated
          August 31, 1997 between the Company and NBD Bank dated
          December 10, 1997...........................................
4.19      Guarantee of the Company in favor of Toshiba Information
          Systems (UK) Limited with respect to certain obligations of
          ISIL dated November 18, 1994................................
4.20      Guarantee of the Company in favor of Canon (UK) Limited with
          respect to certain obligations of ISIL dated November 14,
          1994........................................................
10.01     1982 Incentive Stock Option Plan, effective May 21, 1982, as
          amended, with Form of Stock Option Agreement with Stock
          Appreciation Rights -- incorporated by reference to the
          Company's Registration Statement on Form S-1, filed on July
          15, 1983 (File No. 2-84204).................................
10.02     Amended and Restated 1992 Stock Option Plan.................
10.03     Amended and Restated 1993 Stock Option Plan for Non-Employee
          Directors...................................................
10.04     Letter Agreement between the Company and Robert A. Nero
          dated January 10, 1997, relating to Employment Terms........
21        Subsidiaries of the Registrant -- incorporated by reference
          to Exhibit 21 to the Company's Form 10-K Report for the
          fiscal year ended September 30, 1996........................
23.01     Consent of Arthur Andersen, LLP.............................
23.02     Consent of BDO Seidman, LLP.................................
27        Financial Data Schedule.....................................
</TABLE>
 
-------------------------
                                     * * *
 
     The Registrant will furnish to any stockholder a copy of any of the
exhibits listed above upon written request and upon payment of a specified
reasonable fee, which fee shall be equal to the Registrant's reasonable expenses
in furnishing the exhibit to the stockholder. Requests for exhibits and
information regarding the applicable fee shall be directed to: John R. Ternes,
at the address of the principal executive offices set forth on the cover of this
Report on Form 10-K.