##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended June 30, 2004
    
    Commission File Number 0-13071
 INTERPHASE CORPORATION (Exact Name of Registrant as Specified in Its Charter)
 Texas
    
    75-1549797(State of Incorporation)
    
    (IRS Employer Identification No.)
 Parkway Centre I
2901 North Dallas Parkway, Suite 200
Plano, Texas 75093(Address of Principal Executive Offices) (214)654-5000(Registrants telephone number, including area code)   ü
    ü
   Indicate the number of shares outstanding of each of the issuers classes of
common stock, as of the latest practicable date. Class
    
    Outstanding at August 6, 2004Common Stock, $.10 par value
    
    5,732,033




---



INTERPHASE CORPORATION Index to Form 10-Q
Quarterly Period Ended June 30, 2004 Part I -Financial InformationItem 1. Financial Statements (unaudited)Condensed Consolidated Balance Sheets as of June 30, 2004 and December 31, 2003
    
    
    3Condensed Consolidated Statements of Operations for the three months and six months ended June 30, 2004 and 2003
    
    
    4Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2004 and 2003
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    10Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    14Item 4. Controls and Procedures
    
    
    14Part II  Other InformationItem 1. Legal Proceedings
    
    
    15Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    15Item 3. Defaults Upon Senior Securities
    
    
    15Item 4. Submission of Matters to a Vote of Security Holders
    
    
    15Item 5. Other Information
    
    
    15Item 6. Exhibits and Report on Form 8-K
    
    
    16Rule 13a-14(a)/15d-14(a) CertificationRule 13a-14(a)/15d-14(a) CertificationSection 1530 CertificationSection 1530 Certification
  2




---



##### Table of Contents



PART I
FINANCIAL INFORMATION 
 Item 1. FINANCIAL STATEMENTS INTERPHASE CORPORATION 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 
 June 30,
    
    December 31,2004
    
    2003ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    6,911
    
    
    $
    14,204Marketable securities
    
    
    14,801
    
    
    
    5,047Trade accounts receivable, less allowances for uncollectible
accounts and returns of $159 and $194, respectively
    
    
    5,058
    
    
    
    5,634Inventories
    
    
    2,931
    
    
    
    2,961Prepaid expenses and other current assets
    
    
    973
    
    
    
    751Income taxes receivable
    
    
    102
    
    
    
    Total current assets
    
    
    30,776
    
    
    
    28,597Machinery and equipment
    
    
    5,848
    
    
    
    5,626Leasehold improvements
    
    
    391
    
    
    
    392Furniture and fixtures
    
    
    552
    
    
    
    5606,791
    
    
    
    6,578Less-accumulated depreciation and amortization
    
    
    (5,312
    )
    
    
    (5,018
    )Total property and equipment, net
    
    
    1,479
    
    
    
    1,560Capitalized software, net
    
    
    360
    
    
    
    355Other assets
    
    
    180
    
    
    
    231Total assets
    
    $
    32,795
    
    
    $
    30,743LIABILITIES AND SHAREHOLDERS EQUITYCurrent Liabilities:Accounts payable
    
    $
    1,654
    
    
    $
    1,106Deferred revenue
    
    
    224
    
    
    
    373Accrued liabilities
    
    
    1,404
    
    
    
    1,684Accrued compensation
    
    
    1,659
    
    
    
    1,179Total current liabilities
    
    
    4,941
    
    
    
    4,342Deferred lease obligations
    
    
    66
    
    
    
    88Long-term debt
    
    
    3,500
    
    
    
    3,500Total liabilities
    
    
    8,507
    
    
    
    7,930Shareholders Equity:Common stock, $0.10 par value; 100,000,000 shares authorized; 5,713,633 and
5,680,179 shares issued and outstanding, respectively
    
    
    571
    
    
    
    568Additional paid in capital
    
    
    38,431
    
    
    
    38,218Accumulated deficit
    
    
    (14,194
    )
    
    
    (15,564
    )Cumulative other comprehensive loss
    
    
    (520
    )
    
    
    (409
    )Total shareholders equity
    
    
    24,288
    
    
    
    22,813Total liabilities and shareholders equity
    
    $
    32,795
    
    
    $
    30,743
 The accompanying notes are an integral part of these consolidated financial statements. 3




---



##### Table of Contents



INTERPHASE CORPORATION 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS 
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Revenue
    
    $
    10,129
    
    
    $
    7,357
    
    
    $
    19,327
    
    
    $
    14,870Cost of sales
    
    
    4,516
    
    
    
    3,661
    
    
    
    8,811
    
    
    
    7,383Gross margin
    
    
    5,613
    
    
    
    3,696
    
    
    
    10,516
    
    
    
    7,487Research and development
    
    
    1,909
    
    
    
    1,954
    
    
    
    4,006
    
    
    
    3,913Sales and marketing
    
    
    1,595
    
    
    
    1,561
    
    
    
    3,187
    
    
    
    3,361General and administrative
    
    
    1,041
    
    
    
    835
    
    
    
    2,068
    
    
    
    1,723Total operating expenses
    
    
    4,545
    
    
    
    4,350
    
    
    
    9,261
    
    
    
    8,997Income (loss) from operations
    
    
    1,068
    
    
    
    (654
    )
    
    
    1,255
    
    
    
    (1,510
    )Interest income, net
    
    
    61
    
    
    
    57
    
    
    
    89
    
    
    
    127Other income, net
    
    
    5
    
    
    
    19
    
    
    
    8
    
    
    
    36Income (loss) before income tax
benefit
    
    
    1,134
    
    
    
    (578
    )
    
    
    1,352
    
    
    
    (1,347
    )Income tax provision (benefit)
    
    
    39
    
    
    
    (57
    )
    
    
    (18
    )
    
    
    Net income (loss)
    
    $
    1,095
    
    
    $
    (521
    )
    
    $
    1,370
    
    
    $
    (1,347
    )Earnings (loss) per share  basic
    
    $
    0.19
    
    
    $
    (0.09
    )
    
    $
    0.24
    
    
    $
    (0.24
    )Earnings (loss) per share  diluted
    
    $
    0.18
    
    
    $
    (0.09
    )
    
    $
    0.21
    
    
    $
    (0.24
    )Weighted average common shares
    
    
    5,706
    
    
    
    5,514
    
    
    
    5,698
    
    
    
    5,514Weighted average common and
dilutive shares
    
    
    6,234
    
    
    
    5,514
    
    
    
    6,413
    
    
    
    5,514
 The accompanying notes are an integral part of these consolidated financial statements. 4




---



##### Table of Contents



INTERPHASE CORPORATION 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
 Six Months EndedJune 30,2004
    
    2003Cash flows from operating activities:Net income (loss)
    
    $
    1,370
    
    
    $
    (1,347
    )Adjustments to reconcile net income (loss) to net cash (used in) provided
by operating activities:Provision for uncollectible accounts and returns
    
    
    14
    
    
    
    Provision for excess and obsolete inventory
    
    
    200
    
    
    
    400Depreciation and amortization
    
    
    402
    
    
    
    462Change in assets and liabilities:Trade accounts receivable
    
    
    562
    
    
    
    453Inventories
    
    
    (170
    )
    
    
    (338
    )Prepaid expenses and other current assets
    
    
    (226
    )
    
    
    90Income taxes receivable
    
    
    (102
    )
    
    
    (55
    )Other assets
    
    
    46
    
    
    
    (3
    )Accounts payable, deferred revenues and accrued liabilities
    
    
    124
    
    
    
    (363
    )Accrued compensation
    
    
    507
    
    
    
    35Deferred lease obligations
    
    
    (22
    )
    
    
    25Net cash provided by (used in) operating activities
    
    
    2,705
    
    
    
    (641
    )Cash flows from investing activities:Purchase of property and equipment
    
    
    (253
    )
    
    
    (249
    )Purchase of capitalized software
    
    
    (79
    )
    
    
    (313
    )Proceeds from sale of marketable securities
    
    
    700
    
    
    
    1,485Purchase of marketable securities
    
    
    (10,597
    )
    
    
    (1,606
    )Net cash used in investing activities
    
    
    (10,229
    )
    
    
    (683
    )Cash flows from financing activities:Proceeds from the exercise of stock options
    
    
    216
    
    
    
    8Net cash provided by financing activities
    
    
    216
    
    
    
    8Effect of exchange rate changes on cash and cash equivalents
    
    
    15
    
    
    
    11Net decrease in cash and cash equivalents
    
    
    (7,293
    )
    
    
    (1,305
    )Cash and cash equivalents at beginning of period
    
    
    14,204
    
    
    
    9,857Cash and cash equivalents at end of period
    
    $
    6,911
    
    
    $
    8,552
 The accompanying notes are an integral part of these consolidated financial statements. 5




---



##### Table of Contents



INTERPHASE CORPORATION 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 NOTE 1.    BASIS OF PRESENTATION Interphase Corporation and subsidiaries (Interphase or the Company) enables
rapid platform design and integration for the global voice, video, and data
communications markets through custom and off-the-shelf communications
equipment, embedded software development suites, and systems integration and
consulting services for carrier and private networks. The Companys products
provide communications computing and connectivity of telecommunications and
computer systems to Wide Area Networks (WANs), Local Area Networks (LANs), and
Storage Area Networks (SANs) using Asynchronous Transfer Mode (ATM), Ethernet,
Signaling System 7 (SS7), IP, Fibre Channel, HDLC, Frame Relay and
multi-protocol networking technologies. See Note 8 for information regarding
the Companys revenues related to North America and foreign countries. The accompanying condensed consolidated financial statements include the
accounts of Interphase Corporation and its wholly owned subsidiaries.
Significant intercompany accounts and transactions have been eliminated in
consolidation. The Company has no involvement with any variable interest
entity covered by the scope of FASB Interpretation (FIN) No. 46R,
Consolidation of Variable Interest Entities. While the accompanying condensed consolidated financial statements are
unaudited, they have been prepared by the Company pursuant to the rules and
regulations of the Securities and Exchange Commission. In the opinion of the
Company, all material standard adjustments and disclosures necessary to fairly
present the results of such periods have been made. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States
of America have been condensed or omitted pursuant to the rules and regulations
of the Securities and Exchange Commission. Operating results for the three
months and six months ended June 30, 2004, are not necessarily indicative of
the results that may be expected for the year ending December 31, 2004. These
financial statements should be read in conjunction with the consolidated
financial statements and notes thereto for the year ended December 31, 2003. Reclassifications Certain reclassifications have been made to the condensed consolidated
financial statements for the period ended June 30, 2003, to correspond with the
presentation used at June 30, 2004, and for the periods then ended. 6




---



##### Table of Contents



INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Stock-Based Compensation The Company has elected to follow Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees, (APB 25) and related
interpretations in accounting for its employee stock options. Under APB 25,
compensation expense is recorded when the exercise price of employee stock
options is less than the fair value of the underlying stock on the date of
grant. The Company has implemented the disclosure-only provisions of Statement
of Financial Accounting Standards No. (SFAS) 123, Accounting for Stock-Based
Compensation, and SFAS 148, Accounting for Stock-Based Compensation
Transition and Disclosure. Had the Company elected to adopt the expense
recognition provisions of SFAS 123, the pro forma impact on net income and
earnings per share would have been as follows (in thousands, except per share
data): Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net income (loss) as reported
    
    $
    1,095
    
    
    $
    (521
    )
    
    $
    1,370
    
    
    $
    (1,347
    )Add: APB 25 expense, net of related tax effects
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Less: Total stock-based employee compensation
expense determined under fair value methods for
all awards, net of related tax effects
    
    
    (537
    )
    
    
    (500
    )
    
    
    (979
    )
    
    
    (1,113
    )Pro forma net income (loss)
    
    $
    558
    
    
    $
    (1,021
    )
    
    $
    391
    
    
    $
    (2,460
    )Earnings (loss) per common share:As reported  basic
    
    $
    0.19
    
    
    $
    (0.09
    )
    
    $
    0.24
    
    
    $
    (0.24
    )Pro forma  basic
    
    $
    0.10
    
    
    $
    (0.20
    )
    
    $
    0.07
    
    
    $
    (0.49
    )As reported  diluted
    
    $
    0.18
    
    
    $
    (0.09
    )
    
    $
    0.21
    
    
    $
    (0.24
    )Pro forma  diluted
    
    $
    0.09
    
    
    $
    (0.20
    )
    
    $
    0.06
    
    
    $
    (0.49
    )
 NOTE 2.    INVENTORIES Inventories are valued at the lower of cost or market and include material,
labor and manufacturing overhead. Cost is determined on a first-in, first-out
basis (in thousands): June 30, 2004
    
    December 31, 2003Raw materials
    
    $
    1,832
    
    
    $
    1,907Work-in-process
    
    
    688
    
    
    
    745Finished goods
    
    
    411
    
    
    
    309Total
    
    $
    2,931
    
    
    $
    2,961
 Valuing inventory at the lower of cost or market involves an inherent level of
risk and uncertainty due to technology trends in the industry and customer
demand for the Companys products. Future events may cause significant
fluctuations in the Companys operating results. 7




---



##### Table of Contents



INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) NOTE 3.    DEFERRED TAXES SFAS 109, Accounting for Income Taxes, requires that a valuation allowance be
established when it is more likely than not that all or a portion of a
deferred tax asset will not be realized. A review of all available positive
and negative evidence needs to be considered, including a companys current and
past performance, the market environment in which the company operates, the
utilization of past tax credits, length of carry back and carry forward
periods, existing contracts or sales backlog that will result in future
profits, as well as other factors. Forming a conclusion that a valuation allowance is not needed is difficult when
there is negative evidence such as cumulative losses in recent years.
Cumulative losses weigh heavily in the overall assessment. As a result of a
review undertaken at December 31, 2002, the Company concluded that it was
appropriate to establish a full valuation allowance for its net deferred tax
assets. The Company continues to maintain a full valuation allowance on the
tax benefits. Until an appropriate level of profitability is sustained, the
Company expects to continue to record a full valuation allowance on future tax
benefits and does not expect to recognize any significant tax benefits in
future results of operations. During the third quarter of 2003, the Internal Revenue Service concluded a
federal income tax audit of the Company related to the tax years 1996 through
2001, resulting in a refund due the Company. During the first quarter of 2004,
after conducting a thorough review of the Companys IRS transcripts, the
Company discovered that the IRS had not paid allowable interest on this refund.
As a result, the Company recognized a tax benefit of approximately $100,000
during the first quarter of 2004. This tax benefit is partially offset by
taxes on foreign income. NOTE 4.    CREDIT FACILITY The Company maintains a $5 million revolving bank credit facility. The credit
facility bears interest at the rate of LIBOR plus 2.0% (3.375% at June 30,
2004), matures on July 30, 2005 and all borrowings are secured by marketable
securities. The borrowings of $3.5 million are classified as long-term debt on
the accompanying balance sheet. NOTE 5.    EXIT ACTIVITIES During the second quarter of 2003, the Company committed to an exit plan
regarding one of its leased facilities, the lease for which was scheduled to
expire during the first quarter of 2005. The Company had previously held this
facility open for storage, overflow use, and anticipated growth. However, it
was determined that the facility would not be needed for such uses and the
Company began pursuing subleasing opportunities. As a result of this exit
plan, the Company recorded a charge of approximately $109,000 during the second
quarter of 2003, classified as operating expenses, related to net termination
costs associated with the lease of the facility. In May 2004, the Company
entered into a sublease termination agreement with the landlord of the leased
facility resulting in an additional charge of approximately $42,000. A
reconciliation showing the changes to the liability account during the six
month period is as follows (in thousands): Liability at December 31, 2003
    
    $
    76Rent and settlement payments
    
    
    (178
    )Cost of not subleasing
    
    
    60Sublease termination charge
    
    
    42Liability at June 30, 2004
    
    $
    0Total costs to date
    
    $
    256
 8




---



##### Table of Contents



INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) NOTE 6.    COMPREHENSIVE INCOME (LOSS) The following table shows the Companys comprehensive income (loss) (in
thousands): Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Net income (loss)
    
    $
    1,095
    
    
    $
    (521
    )
    
    $
    1,370
    
    
    $
    (1,347
    )Other comprehensive income (loss):Unrealized holding (loss) gain arising
during period, net of tax
    
    
    (134
    )
    
    
    18
    
    
    
    (143
    )
    
    
    36Foreign currency translation adjustment
    
    
    6
    
    
    
    (46
    )
    
    
    32
    
    
    
    (84
    )Comprehensive income (loss)
    
    $
    967
    
    
    $
    (549
    )
    
    $
    1,259
    
    
    $
    (1,395
    )
 NOTE 7.    EARNINGS PER SHARE Basic earnings per share are computed by dividing reported earnings available
to common shareholders by weighted average common shares outstanding. Diluted
earnings per share give effect to dilutive potential common shares. Earnings
per share are calculated as follows (in thousands, except per share data): Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Basic earnings per share:Net income (loss)
    
    $
    1,095
    
    
    $
    (521
    )
    
    $
    1,370
    
    
    $
    (1,347
    )Weighted average common shares outstanding
    
    
    5,706
    
    
    
    5,514
    
    
    
    5,698
    
    
    
    5,514Basic earnings (loss) per share
    
    $
    0.19
    
    
    $
    (0.09
    )
    
    $
    0.24
    
    
    $
    (0.24
    )Diluted earnings per share:Net income (loss)
    
    $
    1,095
    
    
    $
    (521
    )
    
    $
    1,370
    
    
    $
    (1,347
    )Weighted average common shares outstanding
    
    
    5,706
    
    
    
    5,514
    
    
    
    5,698
    
    
    
    5,514Dilutive stock options
    
    
    528
    
    
    
    
    
    
    
    715
    
    
    
    Weighted average common shares
outstanding  assuming dilution
    
    
    6,234
    
    
    
    5,514
    
    
    
    6,413
    
    
    
    5,514Diluted earnings (loss) per share
    
    $
    0.18
    
    
    $
    (0.09
    )
    
    $
    0.21
    
    
    $
    (0.24
    )Outstanding stock options that were not
included in the diluted calculation because
their effect would be anti-dilutive
    
    
    926
    
    
    
    1,832
    
    
    
    656
    
    
    
    2,111
 NOTE 8.    SEGMENT INFORMATION The Company is principally engaged in the design, development, and
manufacturing of high-performance connectivity products utilizing advanced
technologies being used in next generation telecommunication networks and
enterprise data/storage networks. Except for revenue performance, which is
monitored by
product line, the chief operating decision-makers review financial information
presented on a consolidated basis for purposes of making operating decisions
and assessing financial performance. Accordingly, the Company considers itself
to be in a single industry segment. 9




---



##### Table of Contents



INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Geographic revenue related to North America and foreign countries for the three
months and six months ended June 30, 2004 and 2003 is as follows (in
thousands): Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Revenue:North America
    
    $
    7,222
    
    
    $
    5,084
    
    
    $
    13,929
    
    
    $
    10,160Europe
    
    
    1,801
    
    
    
    935
    
    
    
    2,883
    
    
    
    1,923Pacific Rim
    
    
    1,106
    
    
    
    1,338
    
    
    
    2,515
    
    
    
    2,787Total
    
    $
    10,129
    
    
    $
    7,357
    
    
    $
    19,327
    
    
    $
    14,870
 Additional information regarding revenue by product-line is as follows (in
thousands): Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Product Revenue:Broadband telecom
    
    $
    6,670
    
    
    $
    3,825
    
    
    $
    12,449
    
    
    $
    7,244SlotOptimizer
    
    
    2,570
    
    
    
    2,782
    
    
    
    5,004
    
    
    
    5,618Professional Services
    
    
    174
    
    
    
    
    
    
    
    269
    
    
    
    497LAN
    
    
    210
    
    
    
    561
    
    
    
    473
    
    
    
    793Storage
    
    
    35
    
    
    
    34
    
    
    
    224
    
    
    
    394WAN
    
    
    3
    
    
    
    53
    
    
    
    127
    
    
    
    97Other
    
    
    467
    
    
    
    102
    
    
    
    781
    
    
    
    227Total
    
    $
    10,129
    
    
    $
    7,357
    
    
    $
    19,327
    
    
    $
    14,870
 
 Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS This report contains forward-looking statements about the business, financial
condition and prospects of the Company. These statements are made under the
safe harbor provisions of the Private Securities Litigation Reform Act of
1995. The actual results of the Company could differ materially from those
indicated by the forward-looking statements because of various risks and
uncertainties, including without limitation, the Companys reliance on a
limited number of customers, failure to see spending improvements in the
telecommunications and computer networking industries, significant changes in
product demand, the availability of products, changes in competition, various
inventory risks due to changes in market conditions and other risks and
uncertainties indicated in the Companys filings and reports with the
Securities and Exchange Commission. All the foregoing risks and uncertainties
are beyond the ability of the Company to control, and in many cases, the
Company cannot predict the risks and uncertainties that could cause its actual
results to differ materially from those indicated by the forward-looking
statements. When used in this report, the words believes, plans,
expects, intends, and anticipates and similar
expressions as they relate to the Company or its management are intended to
identify forward-looking statements. RESULTS OF OPERATIONS Revenues:Total revenue increased approximately 38% to $10.1 million for the
three months ended June 30, 2004, compared to $7.4 million for the same period
in the prior year. The increase in revenue was primarily attributable to
steadily increasing Broadband telecom product revenue, which increased
approximately 74% to $6.7 million for the three months ended June 30, 2004,
compared to $3.8 million in the comparable period. In addition, during the
second quarter of 2004, the Company recognized $174,000 in professional
services revenue and $205,000 of revenue related to contract manufacturing.
There was no revenue from professional services or contract manufacturing
during the second quarter of 2003. The 10




---



##### Table of Contents



professional services revenue
recognized during the three months ended June 30, 2004 relates to a single
software customization contract. The Company expects to receive similar
revenue levels from this contract for the remainder of 2004. The increases to
revenue were partially offset by a decline of approximately 8% in SlotOptimizer
product revenue to $2.6 million for the three months ended June 30, 2004 from
$2.8 million for the same period in the prior year. All other revenues
including legacy and storage product revenues decreased to $510,000 for the
three months ended June 30, 2004 from $751,000 for the three months ended June
30, 2003. The Company believes it will continue to experience revenue growth
if the telecommunications equipment market continues to stabilize. However,
customer forecasts continue to be unpredictable. Two customers individually accounted for 45% and 23% of the Companys second
quarter 2004 revenues. For the same period in 2003, three customers
individually accounted for 42%, 32% and 12% of the Companys revenues. Total revenue increased approximately 30% to $19.3 million for the six months
ended June 30, 2004, compared to $14.9 million in the comparable period of the
prior year. The increase in revenue was primarily attributable to Broadband
telecom product revenue which increased approximately 72% to $12.4 million for
the six months ended June 30, 2004, from $7.2 million for the same period in
the prior year. In addition, during the six months ended June 30, 2004, the
Company recognized $378,000 of revenue related to contract manufacturing while
there was no such revenue during the same period in the prior year. The
increases to revenue were partially offset by a decline of approximately 11% in
SlotOptimizer product revenue to $5 million for the six months ended June 30,
2004 from $5.6 million for the six months ended June 30, 2003. All other
revenues including professional services, legacy and storage product revenues
decreased to approximately $1.5 million for the six months ended June 30, 2004
from $2 million for the six months ended June 30, 2003. Gross Margin:Gross margin as a percentage of sales was 55% for the second
quarter 2004 and 50% for the same period in 2003. The increase in the gross
margin percentage primarily relates to the continued shift towards more
complex, and thus, higher margin products. In addition, the Company improved
manufacturing efficiencies and achieved reductions in material costs of certain
product lines due to increased production volumes. The Company believes that
its gross margin, as a percentage of sales, will be near 50% for the near
future. Gross margin for the six months ended June 30, 2004 and 2003 was 54% and 50%,
respectively. The increase in the gross margin percentage primarily relates to
the continued shift towards more complex, and thus, higher margin products. In
addition, the Company improved manufacturing efficiencies and achieved
reductions in material costs of certain product lines due to increased
production volumes. Research and Development:The Companys investment in the development of new
products through research and development was $1.9 million and $2.0 million for
the three months ended June 30, 2004 and 2003, respectively. As a percentage
of revenues, research and development expenses were 19% in the second quarter
2004 and 27% for the same period in the prior year. The decrease in research
and development costs as a percentage of total revenue is due to revenue
increasing while research and development expenses remained relatively flat.
The Company anticipates that spending on research and development will remain
steady in the near future as the Company continues to invest in development of
our
current and future products, however, the Company will continue to monitor the
level of its investments concurrently with actual revenue results. The Companys investment in the development of new products through research
and development was $4.0 million and $3.9 million for the six months ended June
30, 2004 and 2003, respectively. As a percentage of revenues, research and
development expenses were 21% for the six months ended June 30, 2004 and 26%
for the six months ended June 30, 2003. The decrease in research and
development costs as a percentage of total revenue is due to revenue increasing
while research and development expenses remained relatively flat. Sales and Marketing:Sales and marketing expenses were $1.6 million in the
second quarter of both 2004 and 2003. As a percentage of revenues, sales and
marketing expenses were 16% in the second quarter 2004 and 21% for the same
period in the prior year. The decrease in sales and marketing expense as a
percentage of total revenue is due to revenue increasing while sales and
marketing expenses remained relatively flat. 11




---



##### Table of Contents



Sales and marketing expenses were $3.2 million and $3.4 million for the six
months ended June 30, 2004 and 2003, respectively. As a percentage of
revenues, sales and marketing expenses were 16% for the six months ended June
30, 2004 and 23% for the six months ended June 30, 2003. Approximately 92% of
the decrease in sales and marketing expenses for the six months ended June 30,
2004 related to a reduction in spending on sales and marketing headcount
including contract labor. The remaining portion of the decrease is due to
reductions in variable marketing communication activities and general overhead
spending. The decrease in sales and marketing expense as a percentage of total
revenue is due to revenue increasing while sales and marketing expenses
decreased. General and Administrative:General and administrative expenses were $1.0
million for the second quarter 2004 and $835,000 for the same period in the
prior year. As a percentage of revenues, general and administrative expenses
were 10% in the second quarter 2004 and 11% for the same period in the prior
year. Approximately 72% of the increase related to increased employee
compensation and variable expenses tied to increased revenues. The remainder
of the increase is primarily related to increased professional fees. However,
general and administrative expenses decreased as a percentage of revenues due
to revenue increasing at a higher rate than general and administrative
expenses. General and administrative expenses were $2.1 million and $1.7 million for the
six months ended June 30, 2004 and 2003, respectively. As a percentage of
revenues, general and administrative expenses were 11% for the six months ended
June 30, 2004 and 12% for the six months ended June 30, 2003. Approximately
80% of the increase related to increased employee compensation and variable
expenses tied to increased revenues. The remainder of the increase is
primarily related to increased professional fees. The decrease as a percentage
of total revenue is due to revenue increasing at a higher rate than general and
administrative expenses. Interest Income, Net:Interest income, net of interest expense, was $61,000 in
the second quarter 2004 and $57,000 for the same period in the prior year.
Interest income, net of interest expense, was $89,000 for the six months ended
June 30, 2004 and $127,000 for the six months ended June 30, 2003. The
decrease during the six months ended June 30, 2004, primarily relates to lower
daily cash investments levels and lower investment rates of return. Other Income, Net:Other income, net, was $5,000 in the second quarter 2004,
compared to $19,000 for the same period in the prior year. Other income, net
was $8,000 for the six months ended June 30, 2004 and $36,000 for the six
months ended June 30, 2003. Income Taxes:The Companys effective tax benefit rate was 1% for the six
months ended June 30, 2004 compared to a benefit rate of zero for the six
months ended June 30, 2003. During the third quarter of 2003, the Internal Revenue Service concluded a
federal income tax audit of the Company related to the tax years 1996 through
2001, resulting in a refund due the Company. During the first quarter of 2004,
after conducting a thorough review of the Companys IRS transcripts, the
Company discovered that the IRS had not paid allowable interest on this refund.
As a result, the Company recognized a tax benefit of approximately $100,000
during the first quarter of 2004. This tax benefit is partially offset by
taxes on foreign income. The effective tax rates for the periods presented differ from the U.S.
statutory rate as the Company continues to provide a full valuation allowance
for its net deferred tax assets at June 30, 2004. Net
Income (Loss):The Company reported net income of $1.1 million in the
second quarter 2004 and a net loss of $521,000 for the same period in the prior
year. The Company reported net income of $1.4 million for the six months ended
June 30, 2004 and a net loss of $1.3 million for the six months ended June 30,
2003. 12




---



##### Table of Contents



LIQUIDITY AND CAPITAL RESOURCES Consolidated Cash Flows Cash and cash equivalents decreased $7.3 million in the six months ended June
30, 2004 primarily due to the purchase of approximately $10.6 million of
marketable securities partially offset by cash provided by operating
activities. Cash and cash equivalents decreased $1.3 million in the six months
ended June 30, 2003. Cash flows are impacted by operating, investing and
financing activities. Operating Activities Trends in cash flows from operating activities for the six months ended June
30, 2004 and 2003 are generally similar to the trends in the Companys earnings
except for provision for uncollectible accounts and returns, provision for
excess and obsolete inventory, depreciation and amortization. Cash provided by
operating activities totaled $2.7 million for the six months ended June 30,
2004, compared to a net income of $1.4 million. Cash used by operating
activities was $641,000 for the six months ended June 30, 2003, compared to a
net loss of $1.3 million. Provision for uncollectible accounts and returns
increased slightly for the six month period ended June 30, 2004 compared to the
same period in 2003. Provision for excess and obsolete inventory has decreased
period over period as the Companys inventory turns continue to improve.
Depreciation and amortization decreased slightly for the six months ended June
30, 2004 compared to the six months ended June 30, 2003. Changes in assets and liabilities result primarily from the timing of
production, sales, purchases and payments. Such changes in assets and
liabilities generally tend to even out over time and result in trends in cash
flows from operating activities generally reflecting earnings trends. Investing Activities Cash used in investing activities totaled $10.2 million for the six months
ended June 30, 2004 compared to $683,000 for the six months ended June 30,
2003. Cash used in investing activities in each of the periods related
principally to additions to property and equipment, capitalized software and
the Companys investments in marketable securities. Additions to property and
equipment and capitalized software in each of the periods focused on software
and equipment purchases for the sales, engineering and information technology
functions of the Company. Financing Activities Net cash provided by financing activities totaled $216,000 for the six months
ended June 30, 2004 compared to $8,000 for the six months ended June 30, 2003,
and related to proceeds from the exercise of stock options. Commitments and Contingencies At June 30, 2004, the Company had no material commitments to purchase capital
assets. The Companys significant long-term obligations for the period then
ended are its operating leases on facilities and future debt payments related
to the Companys credit facility. To date, the Company has not paid any
dividends and does not anticipate paying any for the remainder of 2004. Other Management believes that cash generated from operations and borrowing
availability under the revolving credit facility, together with cash on hand,
will be sufficient to meet the Companys liquidity needs for working capital,
capital expenditures and debt service. To the extent that the Companys actual
operating results or other developments differ from the Companys expectations,
Interphases liquidity could be adversely affected. The Company periodically evaluates its liquidity requirements, alternative uses
of capital, capital needs and available resources in view of, among other
things, its capital expenditure requirements, and estimated future operating
cash flows. As a result of this process, the Company has in the past and may
in the future 13




---



##### Table of Contents



seek to raise additional capital, refinance or restructure
indebtedness, issue additional securities, repurchase shares of its common
stock or take a combination of such steps to manage its liquidity and capital
resources. In the normal course of business, the Company may review
opportunities for acquisitions, joint ventures or other business combinations
in the component products industry. In the event of any such transaction, the
Company may consider using available cash, issuing additional equity securities
or increasing the indebtedness of the Company or its subsidiaries. Managements Discussion and Analysis of Financial Condition and Results of
Operations in this Form 10-Q should be read in conjunction with Managements
Discussion and Analysis of Financial Condition and Results of Operations and
other material included in the Companys Annual Report on Form 10-K for the
year ended December 31, 2003. 
 Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Foreign Currency Risk The Company is exposed to adverse movements in foreign currency exchange rates
because it conducts business on a global basis and in some cases in foreign
currencies. The Companys operations in France are measured in the local
currency and converted into U.S. Dollars based on published exchange rates for
the periods reported and are therefore subject to risk of exchange rate
fluctuations. The Euro to U.S. Dollar translation accounted for charges of
approximately $217,000 and $150,000 for the three months ended June 30, 2004
and 2003, respectively. The Euro to U.S. Dollar translation accounted for a
charge of approximately $507,000 and $237,000 for the six months ended June 30,
2004 and 2003, respectively. Market Price Risk The Company had no equity hedge contracts outstanding as of June 30, 2004 or
December 31, 2003. Interest Rate Risk The Companys investments are subject to interest rate risk. Interest rate
risk is the risk that the Companys financial condition and results of
operations could be adversely affected due to movements in interest rates. The
Company invests its cash in a variety of interest-earning financial
instruments, including bank time deposits, money market funds, and variable
rate and fixed rate obligations of corporations and national governmental
entities and agencies. Due to the demand nature of the Companys money market
funds and the short-term nature of the Companys time deposits and debt
securities portfolio, these assets are particularly sensitive to changes in
interest rates. The Company manages this risk through investments with
shorter-term maturities and varying maturity dates. If the Companys
short-term assets were reinvested in a declining interest rate environment, the
Company would experience an immediate negative impact on interest income. The
opposite holds true in a rising interest rate environment. 
 Item 4. CONTROLS AND PROCEDURES  (a)
    
    Evaluation of Disclosure Controls and Procedures. The Companys
management, under the supervision of our Chief Executive Officer
(CEO) and Chief Financial Officer (CFO), performed an evaluation of
the effectiveness of the design and operation of the Companys
disclosure controls and procedures as of the end of the period covered
by this quarterly report. Based on that evaluation, the CEO and CFO
concluded that the Companys disclosure controls and procedures are
effective.(b)
    
    Changes in Internal Controls. The Company maintains a system of
internal controls that are designed to provide reasonable assurance
that its books and records accurately reflect, in all material
respects, the transactions of the Company and that its established
policies and procedures are adhered to. There were no significant
changes to the Companys internal controls or in other factors that
could significantly affect the Companys internal controls subsequent
to the date of the evaluation by the Companys CEO and CFO, including
any corrective actions with regard to significant deficiencies and
material weaknesses. 14




---



##### Table of Contents



PART II
OTHER INFORMATION 
 Item 1. LEGAL PROCEEDINGS None. 
 Item 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES None. 
 Item 3. DEFAULTS UPON SENIOR SECURITIES None. 
 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On May 6, 2004, the annual meeting of shareholders of the Company was held.
The following matters were voted upon and approved at the meeting: An election of directors of the Company to serve until the next annual meeting
for the Company was held. The following six individuals were elected as
Directors of the Company: Nominee
    
    Votes Cast For
    
    Votes WithheldPaul N. Hug
    
    
    4,860,113
    
    
    
    154,599Gregory B. Kalush
    
    
    4,839,213
    
    
    
    175,499Randall D. Ledford
    
    
    4,860,113
    
    
    
    154,599Michael J. Myers
    
    
    4,860,313
    
    
    
    154,399Kenneth V. Spenser
    
    
    4,857,413
    
    
    
    157,299S. Thomas Thawley
    
    
    4,582,714
    
    
    
    431,998
 A proposal to ratify and approve the Companys 2004 long-term stock incentive
plan was ratified and approved: For
    
    Against
    
    Abstain
    
    Not Voted3,845,299
    
    
    568,066
    
    
    
    601,347
    
    
    
    
 
 Item 5. OTHER INFORMATION None. 15




---



##### Table of Contents



Item 6. EXHIBITS AND REPORT ON FORM 8-K Exhibits 2(a)
    
    Stock Purchase Agreement, dated June 29, 1996, between Interphase
Corporation, Synaptel and Philippe Oros, Xavier Sutter, Francois Lecerf,
Schroder Ventures French Enterprise Fund LPI (USA), Schroder ventures
French Enterprise Fund UKLP (UK) and Schroder Ventures Holding Limited
(UK). (1)3(a)
    
    Articles of Incorporation of the Registrant. (2)3(b)
    
    Amendment to Articles of Incorporation of the Registrant. (3)3(c)
    
    Amended and Restated Bylaws of the Registrant adopted on December 5,
1995 and amended on January 19, 1999. (4)4(a)
    
    Rights Agreement dated December 7, 2000 by and between the Company
and Computershare Investor Services, LLC as Rights Agent. (5)10(a)
    
    Master Revolving Note and Credit Agreement dated July 25, 2003 (6)31(a)
    
    Rule 13a-14(a)/15d-14(a) Certification (7)31(b)
    
    Rule 13a-14(a)/15d-14(a) Certification (7)32(a)
    
    Section 1350 Certification (7)32(b)
    
    Section 1350 Certification (7)(1)
    
    Filed as an exhibit to Report on Form 8-K on August 6, 1996, and
incorporated herein by reference.(2)
    
    Filed as an exhibit to Registration Statement No. 2-86523 on Form S-1 and
incorporated herein by reference.(3)
    
    Filed as an exhibit to Report on Form 10-K for the year ended December
31, 1999, and incorporated herein by reference.(4)
    
    Filed as an exhibit to Report on Form 10-K for the year ended December
31, 2001, and incorporated herein by reference.(5)
    
    Filed as an exhibit to Form 8-K on January 9, 2001, and incorporated
herein by reference.(6)
    
    Filed as an exhibit to Report on Form 10-Q for the quarter ended June 30,
2003, and incorporated herein by reference.(7)
    
    Filed herein.
 Report on Form 8-K None. 
 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. INTERPHASE CORPORATION(Registrant)By:
    
    /s/ Steven P. KovacSteven P. KovacChief Financial Officer,Vice President of Finance andTreasurer(Principal Financial andAccounting Officer)Plano, TexasAugust 13, 2003
 16




---



##### Table of Contents



INDEX TO EXHIBITS 2 (a)
    
    Stock Purchase Agreement, dated June 29, 1996, between Interphase
Corporation, Synaptel and Philippe Oros, Xavier Sutter, Francois Lecerf,
Schroder Ventures French Enterprise Fund LPI (USA), Schroder ventures
French Enterprise Fund UKLP (UK) and Schroder Ventures Holding Limited
(UK). (1)3 (a)
    
    Articles of Incorporation of the Registrant. (2)3 (b)
    
    Amendment to Articles of Incorporation of the Registrant. (3)3 (c)
    
    Amended and Restated Bylaws of the Registrant adopted on December
5, 1995 and amended on January 19, 1999. (4)4 (a)
    
    Rights Agreement dated December 7, 2000 by and between the Company
and Computershare Investor Services, LLC as Rights Agent. (5)10 (a)
    
    Master Revolving Note and Credit Agreement dated July 25, 2003 (6)31 (a)
    
    Rule 13a-14(a)/15d-14(a) Certification (7)31 (b)
    
    Rule 13a-14(a)/15d-14(a) Certification (7)32 (a)
    
    Section 1350 Certification (7)32 (b)
    
    Section 1350 Certification (7)
  (1)
    
    Filed as an exhibit to Report on Form 8-K on August 6, 1996, and
incorporated herein by reference.(2)
    
    Filed as an exhibit to Registration Statement No. 2-86523 on Form
S-1 and incorporated herein by reference.(3)
    
    Filed as an exhibit to Report on Form 10-K for the year ended
December 31, 1999, and incorporated herein by reference.(4)
    
    Filed as an exhibit to Report on Form 10-K for the year ended
December 31, 2001, and incorporated herein by reference.(5)
    
    Filed as an exhibit to Form 8-K on January 9, 2001, and
incorporated herein by reference.(6)
    
    Filed as an exhibit to Report on Form 10-Q for the quarter ended
June 30, 2003, and incorporated herein by reference.(7)
    
    Filed herein.