##### 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 March 31, 2005
    
    Commission File Number 0-13071
 INTERPHASE CORPORATION (Exact Name of Registrant as Specified in Its Charter)
 Texas
    
    75-1549797(State or other Jurisdiction of
    
    (IRS Employer Identification No.)Incorporation or organization)
 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)   þ o
   o þ
    Class
    
    Outstanding at May 5, 2005Common Stock, $.10 par value
    
    5,752,324




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INTERPHASE CORPORATION Index to Form 10-Q
Quarterly Period Ended March 31, 2005 Part I -Financial InformationItem 1.
    
    Condensed Consolidated Financial Statements (unaudited)Condensed Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004
    
    
    3Condensed Consolidated Statements of Operations for the three months ended March 31, 2005 and 2004
    
    
    4Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2005 and 2004
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    11Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    15Item 4.
    
    Controls and Procedures
    
    
    16Part II - Other InformationItem 1.
    
    Legal Proceedings
    
    
    16Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    16Item 3.
    
    Defaults Upon Senior Securities
    
    
    16Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    17Item 5.
    
    Other Information
    
    
    17Item 6.
    
    Exhibits
    
    
    17Rule 13a-14(a)/15d-14(a) CertificationRule 13a-14(a)/15d-14(a) CertificationSection 1350 CertificationSection 1350 Certification
  2




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##### Table of Contents



PART I
FINANCIAL INFORMATION 
 Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) INTERPHASE CORPORATION 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 March 31,
    
    
    December 31,2005
    
    
    2004ASSETSCash and cash equivalents
    
    $
    5,026
    
    
    $
    4,928Marketable securities
    
    
    15,173
    
    
    
    15,585Trade accounts receivable, less allowances
of $147 and $141, respectively
    
    
    4,305
    
    
    
    4,976Inventories
    
    
    4,251
    
    
    
    3,509Prepaid expenses and other current assets
    
    
    804
    
    
    
    956Income taxes receivable
    
    
    60
    
    
    
    246Total current assets
    
    
    29,619
    
    
    
    30,200Machinery and equipment
    
    
    6,121
    
    
    
    6,170Leasehold improvements
    
    
    374
    
    
    
    377Furniture and fixtures
    
    
    563
    
    
    
    5727,058
    
    
    
    7,119Less-accumulated depreciation and amortization
    
    
    (5,847
    )
    
    
    (5,729
    )Total property and equipment, net
    
    
    1,211
    
    
    
    1,390Capitalized software, net
    
    
    294
    
    
    
    310Other assets
    
    
    190
    
    
    
    198Total assets
    
    $
    31,314
    
    
    $
    32,098LIABILITIES AND SHAREHOLDERS EQUITYLiabilitiesAccounts payable
    
    $
    471
    
    
    $
    529Deferred revenue
    
    
    202
    
    
    
    244Accrued liabilities
    
    
    1,006
    
    
    
    1,423Accrued compensation
    
    
    1,160
    
    
    
    1,554Total current liabilities
    
    
    2,839
    
    
    
    3,750Deferred lease obligations
    
    
    64
    
    
    
    60Long-term debt
    
    
    3,500
    
    
    
    3,500Total liabilities
    
    
    6,403
    
    
    
    7,310Commitments and ContingenciesShareholders EquityCommon stock, $0.10 par value; 100,000,000
shares authorized; 5,750,824 and
5,750,824 shares issued and outstanding,
respectively
    
    
    575
    
    
    
    575Additional paid in capital
    
    
    38,633
    
    
    
    38,633Retained deficit
    
    
    (13,691
    )
    
    
    (13,846
    )Cumulative other comprehensive loss
    
    
    (606
    )
    
    
    (574
    )Total shareholders equity
    
    
    24,911
    
    
    
    24,788Total liabilities and shareholders equity
    
    $
    31,314
    
    
    $
    32,098
 The accompanying notes are an integral part of these condensed consolidated financial statements. 3




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INTERPHASE CORPORATION 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited) Three Months EndedMarch 31,2005
    
    
    2004Revenues
    
    $
    8,780
    
    
    $
    9,198Cost of sales
    
    
    4,028
    
    
    
    4,295Gross margin
    
    
    4,752
    
    
    
    4,903Research and development
    
    
    2,169
    
    
    
    2,097Sales and marketing
    
    
    1,518
    
    
    
    1,592General and administrative
    
    
    946
    
    
    
    1,027Total operating expenses
    
    
    4,633
    
    
    
    4,716Income from operations
    
    
    119
    
    
    
    187Interest income, net
    
    
    76
    
    
    
    28Other (expense) income, net
    
    
    (4
    )
    
    
    3Income before income tax
    
    
    191
    
    
    
    218Income tax provision (benefit)
    
    
    36
    
    
    
    (57
    )Net income
    
    $
    155
    
    
    $
    275Net income per share:Basic EPS
    
    $
    0.03
    
    
    $
    0.05Diluted EPS
    
    $
    0.03
    
    
    $
    0.04Weighted average common shares
    
    
    5,751
    
    
    
    5,695Weighted average common and dilutive shares
    
    
    5,992
    
    
    
    6,556
 The accompanying notes are an integral part of these condensed consolidated financial statements. 4




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INTERPHASE CORPORATION 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 Three Months EndedMarch 31,2005



    2004Cash flows from operating activities:Net income
    
    $
    155
    
    
    $
    275Adjustments to reconcile net income to net cash (used in) provided by
operating activities:Provision for uncollectible accounts and returns
    
    
    17
    
    
    
    Provision for excess and obsolete inventories
    
    
    100
    
    
    
    100Depreciation and amortization
    
    
    197
    
    
    
    202Change in assets and liabilities:Trade accounts receivable
    
    
    654
    
    
    
    1,388Inventories
    
    
    (842
    )
    
    
    127Prepaid expenses and other current assets
    
    
    147
    
    
    
    (304
    )Income taxes receivable
    
    
    179
    
    
    
    (102
    )Other assets
    
    
    1
    
    
    
    1Accounts payable, deferred revenue and accrued liabilities
    
    
    (511
    )
    
    
    164Accrued compensation
    
    
    (349
    )
    
    
    72Deferred lease obligations
    
    
    4
    
    
    
    (11
    )Net cash (used in) provided by operating activities
    
    
    (248
    )
    
    
    1,912Cash flows from investing activities:Purchase of property and equipment
    
    
    (7
    )
    
    
    (155
    )Purchase of capitalized software
    
    
    (14
    )
    
    
    (58
    )Proceeds from the sale of marketable securities
    
    
    2,349
    
    
    
    286Purchase of marketable securities, net of unrealized holding period gain or loss
    
    
    (1,971
    )
    
    
    Net cash provided by investing activities
    
    
    357
    
    
    
    73Cash flows from financing activities:Proceeds from the exercise of stock options
    
    
    
    
    
    
    111Net cash provided by financing activities
    
    
    
    
    
    
    111Effect of exchange rate changes on cash and cash equivalents
    
    
    (11
    )
    
    
    9Net increase in cash and cash equivalents
    
    
    98
    
    
    
    2,105Cash and cash equivalents at beginning of period
    
    
    4,928
    
    
    
    14,204Cash and cash equivalents at end of period
    
    $
    5,026
    
    
    $
    16,309
 The accompanying notes are an integral part of these condensed consolidated financial statements. 5




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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 interworking 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. 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 ended March 31, 2005, are not necessarily indicative of the results
that may be expected for the year ending December 31, 2005. These financial statements should be
read in conjunction with the consolidated financial statements and notes thereto for the year ended
December 31, 2004. 6




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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 (SFAS)
No. 123, Accounting for Stock-Based Compensation, and SFAS No. 148, Accounting for Stock-Based
Compensation Transition and Disclosure. Had the Company elected to adopt the expense recognition
provisions of SFAS No. 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 endedMarch 31,2005
    
    
    2004Net income as reported
    
    $
    155
    
    
    $
    275Add: 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
    
    
    (360
    )
    
    
    (442
    )Pro forma net loss
    
    $
    (205
    )
    
    $
    (167
    )Earnings (loss) per common share:As reported  basic
    
    $
    0.03
    
    
    $
    0.05Pro forma  basic
    
    $
    (0.04
    )
    
    $
    (0.03
    )As reported  diluted
    
    $
    0.03
    
    
    $
    0.04Pro forma  diluted
    
    $
    (0.04
    )
    
    $
    (0.03
    )
 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): March 31, 2005
    
    
    December 31, 2004Raw materials
    
    $
    2,687
    
    
    $
    1,818Work-in-process
    
    
    939
    
    
    
    747Finished goods
    
    
    625
    
    
    
    944Total
    
    $
    4,251
    
    
    $
    3,509
 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




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INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) NOTE 3. - DEFERRED TAXES SFAS No. 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. 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.  LOSS CONTINGENCY In 2004, the Company agreed to perform a minor repair, at no cost to a customer, of approximately
1,800 units that were shipped between December 2003 and April 2004. The actual cost to repair the
units was insignificant. However, the Company estimated that other costs including shipping related
charges and installation related charges could be more significant. The Company had estimated that
the range of the potential liability was between approximately $225,000 and $650,000 but could not
determine an amount within that range which was more likely than another. Therefore, in accordance
with Financial Accounting Standards Board Interpretation No. 14, Reasonable Estimation of the
Amount of a Loss  an Interpretation of FASB Statement No. 5, the Company had recorded, in accrued
liabilities, the minimum liability amount of approximately $225,000 at December 31, 2004. During the first quarter of 2005, the Company completed the transaction described above resulting
in a total cost of $300,000. As noted above, the Company had previously recorded a liability in
the amount of $225,000, therefore, the Company recorded an additional charge of $75,000 in cost of
sales during the three months ended March 31, 2005. NOTE 5. - CREDIT FACILITY The Company maintains a $5 million revolving bank credit facility with a maturity date of July 31,
2007 and interest rate of LIBOR plus 1.0% (3.5% at March 31, 2005). All borrowings under this
facility are secured by marketable securities. The borrowings of $3.5 million are classified as
long-term debt on the accompanying balance sheets. 8




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NOTE 6. - COMPREHENSIVE INCOME The following table shows the Companys comprehensive income (in thousands): Three months endedMarch 31,2005
    
    
    2004Net income
    
    $
    155
    
    
    $
    275Other comprehensive income (loss):Unrealized holding loss arising during
period, net of tax
    
    
    (34
    )
    
    
    (9
    )Foreign currency translation adjustment
    
    
    2
    
    
    
    26Comprehensive income
    
    $
    123
    
    
    $
    292
 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 endedMarch 31,2005
    
    
    2004Basic earnings per share:Net income
    
    $
    155
    
    
    $
    275Weighted average common shares outstanding
    
    
    5,751
    
    
    
    5,695Basic earnings per share
    
    $
    0.03
    
    
    $
    0.05Diluted earnings per share:Net income
    
    $
    155
    
    
    $
    275Weighted average common shares outstanding
    
    
    5,751
    
    
    
    5,695Dilutive stock options
    
    
    241
    
    
    
    861Weighted average common shares outstanding  assuming dilution
    
    
    5,992
    
    
    
    6,556Diluted earnings per share
    
    $
    0.03
    
    
    $
    0.04Outstanding stock options that were not included in the diluted
calculation because their effect would be anti-dilutive
    
    
    1,601
    
    
    
    343
 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. Geographic revenues related to North America and foreign countries is as follows (in thousands): Three months endedMarch 31,2005
    
    
    2004Revenues:North America
    
    $
    4,715
    
    
    $
    6,706Europe
    
    
    2,806
    
    
    
    1,082Pacific Rim
    
    
    1,259
    
    
    
    1,410Total
    
    $
    8,780
    
    
    $
    9,198
 9




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INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) Additional information regarding revenues by product-line is as follows (in thousands): Three months endedMarch 31,2005
    
    
    2004Product Revenues:Broadband telecom
    
    $
    4,857
    
    
    $
    5,779SlotOptimizer
    
    
    2,911
    
    
    
    2,434LAN/WAN
    
    
    149
    
    
    
    387Storage
    
    
    124
    
    
    
    189Professional Services
    
    
    213
    
    
    
    95Other
    
    
    526
    
    
    
    314Total
    
    $
    8,780
    
    
    $
    9,198
 NOTE 9.  RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In October 2004, the American Jobs Creation Act of 2004 was enacted into law. The new law provides
for a special 85% deduction for certain dividends received in 2005 from controlled foreign
corporations. Because certain details in the new law lack clarification, and the impact of the
special dividend received deduction to the Company is dependent, in part, on the Companys 2005
foreign and domestic taxable income, the Company has not yet determined whether it will benefit
from the new law. In 2005, the Company plans to evaluate both clarifying guidance on the new law
from the IRS and its year-to-date taxable income activity to determine the level of benefit, if
any, the Company will derive from the special dividend received deduction. Beginning in 2005, the new law also provides for a special deduction from U.S. taxable income equal
to a stipulated percentage of a U.S. companys qualified income from domestic manufacturing
activities (as defined). Although the Company believes that the majority of its operations meet
the definition of qualified domestic manufacturing activities, the Company does not expect to
benefit from the special manufacturing deduction in 2005, primarily because the Company projects
its U.S. taxable income in 2005 will be fully offset by its existing U.S. net operating loss
carryforwards. In December 2004, the
FASB issued SFAS No. 123(R), Share Based Payments, which replaces SFAS No.
123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for
Stock Issued to Employees and amends SFAS No. 95, Statement of Cash Flows. SFAS No. 123(R)
requires all share-based payments to employees, including grants of employee stock options, to be
recognized in the income statement based on their fair values. As such, pro forma disclosure in
lieu of expensing is no longer an alternative. After the Securities and Exchange Commissions new
rule amending the compliance date, the new standard is effective for annual reporting periods
beginning after June 15, 2005. Therefore, the Company will be required to adopt the provisions of
SFAS 123(R) as of January 1, 2006. The Company is currently assessing the impact that the
statement may have on its financial statements. In December 2004, the FASB issued SFAS No. 151 Inventory Costs, an Amendment of ARB No. 43,
Chapter 4. SFAS No. 151 clarifies the accounting for abnormal amounts of idle facility expense,
freight, handling costs and wasted material and requires that these items be recognized as current
period charges. SFAS No. 151 applies only to inventory costs incurred during periods beginning
after the effective date and also requires that the allocation of fixed production overhead to
conversion costs be based on the normal capacity of the production facilities. SFAS No. 151 is
effective for the Companys fiscal year beginning January 1, 2006. The Company is currently
assessing the impact, if any, of the adoption of the provisions of SFAS No. 151. In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, which amends APB
Opinion No. 29. The guidance in APB No. 29, Accounting for Nonmonetary Transactions, is based on
the principle that exchanges of nonmonetary assets should be measured based on the fair value of
the 10




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assets exchanged. The amendment made by SFAS No. 153 eliminates the exception for exchanges of
similar productive assets and replaces it with a broader exception for exchanges of nonmonetary
assets that do not have commercial substance. The provisions of the statement are effective for
exchanges taking place in fiscal periods beginning after June 15, 2005. The Company does not
believe the adoption of this statement will have a material impact on our financial statements. 
 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, our 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 Revenue Total revenue decreased to $8.8 million for the three months ended March 31, 2005, compared to $9.2
million for the same period in the prior year. The decrease was primarily attributable to
Broadband telecom revenue, which decreased approximately 16% to $4.9 million for the three months
ended March 31, 2005, compared to $5.8 million in the comparable period. The decrease in revenue
was partially offset by an increase in SlotOptimizer revenue, which increased approximately 20% to
$2.9 million during the first quarter of 2005, compared to $2.4 million for the comparable period
in the prior year. In addition, the Companys revenues related to professional services increased
to $213,000 for the three months ended March 31, 2005, compared to $95,000 for the same period in
the prior year. All other revenues composed primarily of security, legacy networking and storage
product lines, decreased approximately 10% to $799,000 for the three months ended March 31, 2005,
compared to $890,000 for the same period in the prior year. Revenue was impacted by our largest
telecom customer migrating to a more cost effective Interphase controller board for their
application. This migration makes for a more competitive solution offering which our customer will
be selling in very price sensitive markets. Although we anticipate some volume growth due to this
migration, we do not anticipate that growth to be sufficient enough to replace the revenue impacted
by the transition. The Company believes that it will experience revenue growth again if the
telecommunications market continues to improve. However, customer forecasts continue to be
unreliable and unpredictable. The Companys customer base is beginning to diversify as sales to three customers individually
accounted for approximately 25%, 18% and 18% of the Companys first quarter 2005 revenues,
respectively. During the first quarter of 2004, sales to two customers accounted for approximately
52% and 21% of total revenue respectively. No other customer accounted for more than 10% of the
Companys consolidated revenue in the periods presented. Gross Margin For the three months ended March 31, 2005, gross margin, as a percentage of sales, was 54% compared
to 53% for the same period in the prior year. The increase in the gross margin percentage
primarily relates to the Companys improved manufacturing efficiencies and achieved reductions in
material costs for certain product lines due, in part, to increased production volumes. The
Company believes that pricing pressures in 11




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the industry may dampen gross margins in future periods
and it may become increasingly challenging to offset these pressures with incremental supplier cost
reductions and factory productivity improvements. Research and Development The Companys investment in the development of new products through research and development was
$2.2 million and $2.1 million for the three months ended March 31, 2005 and 2004, respectively.
The increase in research and development expense primarily relates to foreign currency changes as
the dollar dropped in value relative to the Euro. As a percentage of total revenue, research and
development expense was approximately 25% in the first quarter of 2005 as compared to approximately
23% for the same period for the prior year. The increase in research and development costs as a
percentage of total revenue is due to revenue decreasing while research and development expense
increased slightly. The Company anticipates that spending on research and development will remain
steady in the near future, except for fluctuations in currency exchange rates because much of the
Companys development expense is associated with its engineering lab in France (see Item 3 
Foreign Currency Risk), as the Company continues to invest in development of our current and future
products, however, the Company will continue to monitor the level of research and development costs
concurrently with actual revenue results. Sales and Marketing Sales and marketing expenses were $1.5 million and $1.6 million for the three months ended March
31, 2005 and 2004, respectively. The decrease in sales and marketing expense quarter over quarter
is primarily due to reduced sales commission and bonus costs. As a percentage of total revenue,
sales and marketing expense was approximately 17% for both the first quarter of 2005 and the
comparable period. General and Administrative General and administrative expenses were $946,000 and $1.0 million for the three months ended March
31, 2005 and 2004, respectively. The decrease in general and administrative expense period over
period is primarily related to a decrease in compensation expenses. As a percentage of total
revenue, general and administrative expenses remained at approximately 11% for both the first
quarter of 2005 and the comparable period. Interest Income, Net Interest income, net of interest expense, increased to $76,000 for the three months ended March 31,
2005 from $28,000 in the comparable period. The increase in interest income, net period over
period is primarily due to the Company converting a large portion of its cash to marketable
securities during the second quarter of 2004 thus improving the overall investment rate of return. Other (Expense) Income, Net Other (expense) income, net, was an expense of $4,000 for the three months ended March 31, 2005,
compared to an income of $3,000 for the same period in the prior year. Income Taxes The Companys effective tax rate was 19% for the three months ended March 31, 2005 compared to a
tax benefit rate of 26% for the same period in the prior year. The effective tax provision rate for the periods presented differed from the U.S. statutory rate as
the Company continued to provide a full valuation allowance for its net deferred tax assets at
March 31, 2005 and March 31, 2004. The Company also incurred taxes on foreign income during the
periods presented. 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 12




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a tax benefit of approximately $100,000 during the first
quarter of 2004. As noted above, this tax benefit was partially offset by taxes on foreign income. Net Income The Company reported net income of $155,000 for the three months ended March 31, 2005, as compared
to a net income of $275,000 for the same period in the prior year. Basic and diluted earnings per
share for the three months ended March 31, 2005 were $0.03 and $0.03, respectively, compared to
$0.05 and $0.04, respectively for the comparable period. LIQUIDITY AND CAPITAL RESOURCES Consolidated Cash Flows Cash and cash equivalents increased $98,000 in the three months ended March 31, 2005 and increased
$2.1 million in the three months ended March 31, 2004. Cash flows are impacted by operating,
investing and financing activities. Operating Activities Trends in cash flows from operating activities for the three months ended March 31, 2005 and 2004
are generally similar to the trends in the Companys earnings except for provision for
uncollectible accounts and returns, provision for excess and obsolete inventories and depreciation
and amortization. Cash used in operating activities totaled $248,000 for the three months ended
March 31, 2005, compared to a net income of $155,000. Cash provided by operating activities was
$1.9 million for the three months ended March 31, 2004, compared to a net income of $275,000.
Provision for uncollectible accounts and returns increased slightly for the three months ended
March 31, 2005 compared to the same period in 2004. Depreciation and amortization decreased
slightly for the three months ended March 31, 2005 compared to the three months ended March 31,
2004. 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 provided by investing activities totaled $357,000 for the three months ended March 31, 2005
compared to $73,000 for the three months ended March 31, 2004. Cash provided by 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 decreased to $21,000 for the three months ended March 31,
2005 compared to $213,000 for the three months ended March 31, 2004. The additions for the three
months ended March 31, 2005 primarily related to software and equipment purchases for the
engineering function of the Company. The additions for the three months ended March 31, 2004 were
focused on software and equipment purchases for the sales, engineering and information technology
functions of the Company. Purchases of marketable securities increased significantly for the three
months ended March 31, 2005 to $2.0 million as the Company adjusted its investment strategy in the
second quarter of 2004. The Company did not purchase any marketable securities during the three
months ended March 31, 2004. Proceeds from the sale of marketable securities increased to $2.3
million for the three months ended March 31, 2005 compared to $286,000 for the same period in 2004. Financing Activities The Company did not participate in any financing activities during the three months ended March 31,
2005. Net cash provided by financing activities totaled $111,000 for the three months ended March
31, 2004 and related to proceeds from employees exercising stock options. 13




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Commitments and Contingencies Commitments At March 31, 2005, the Company had no material commitments to purchase capital assets, however,
planned capital expenditures for 2005 are estimated at approximately $1.0 million, the majority of
which relates to the Companys engineering tools and general office equipment. The Companys
significant long-term obligations as of March 31, 2005, 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 dividends in 2005. Contingencies In 2004, the Company agreed to perform a minor repair, at no cost to a customer, of approximately
1,800 units that were shipped between December 2003 and April 2004. The actual cost to repair the
units was insignificant. However, the Company estimated that other costs including shipping related
charges and installation related charges could be more significant. The Company had estimated that
the range of the potential liability was between approximately $225,000 and $650,000 but could not
determine an amount within that range which was more likely than another. Therefore, in accordance
with Financial Accounting Standards Board Interpretation No. 14, Reasonable Estimation of the
Amount of a Loss  an Interpretation of FASB Statement No. 5, the Company had recorded, in accrued
liabilities, the minimum liability amount of approximately $225,000 at December 31, 2004. During the first quarter of 2005, the Company completed the transaction described above resulting
in a total cost of $300,000. As noted above, the Company had previously recorded a liability in
the amount of $225,000, therefore, the Company recorded an additional charge of $75,000 in cost of
sales during the three months ended March 31, 2005. 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 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, 2004. Recently Issued Accounting Pronouncements In October 2004, the American Jobs Creation Act of 2004 was enacted into law. The new law provides
for a special 85% deduction for certain dividends received in 2005 from controlled foreign
corporations. Because certain details in the new law lack clarification, and the impact of the
special dividend received deduction to the Company is dependent, in part, on the Companys 2005
foreign and domestic taxable income, the Company has not yet determined whether it will benefit
from the new law. In 2005, the Company plans to evaluate both clarifying guidance on the new law
from the Internal Revenue Service and 14




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its year-to-date taxable income activity to determine the
level of benefit, if any, the Company will derive from the special dividend received deduction. Beginning in 2005, the new law also provides for a special deduction from U.S. taxable income equal
to a stipulated percentage of a U.S. companys qualified income from domestic manufacturing
activities (as defined). Although the Company believes that the majority of its operations meet
the definition of qualified domestic manufacturing activities, the Company does not expect to
benefit from the special manufacturing deduction in 2005, primarily because the Company projects
its U.S. taxable income in 2005 will be fully offset by its existing U.S. net operating loss
carryforwards. In December 2004, the FASB issued SFAS No. 123(R), Share Based Payments, which replaces SFAS No.
123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for
Stock Issued to Employees and amends SFAS No. 95, Statement of Cash Flows. SFAS No. 123(R)
requires all share-based payments to employees, including grants of employee stock options, to be
recognized in the income statement based on their fair values. As such, pro forma disclosure in
lieu of expensing is no longer an alternative. After the Securities and Exchange Commissions new
rule amending the compliance date, the new standard is effective for annual reporting periods
beginning after June 15, 2005. Therefore, the Company will be required to adopt the provisions of
SFAS 123(R) as of January 1, 2006. The Company is currently assessing the impact that the
statement may have on its financial statements. In December 2004, the FASB issued SFAS No. 151 Inventory Costs, an Amendment of ARB No. 43,
Chapter 4. SFAS No. 151 clarifies the accounting for abnormal amounts of idle facility expense,
freight, handling costs and wasted material and requires that these items be recognized as current
period charges. SFAS No. 151 applies only to inventory costs incurred during periods beginning
after the effective date and also requires that the allocation of fixed production overhead to
conversion costs be based on the normal capacity of the production facilities. SFAS No. 151 is
effective for the Companys fiscal year beginning January 1, 2006. The Company is currently
assessing the impact, if any, of the adoption of the provisions of SFAS No. 151. In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, which amends APB
Opinion No. 29. The guidance in APB No. 29, Accounting for Nonmonetary Transactions, is based on
the principle that exchanges of nonmonetary assets should be measured based on the fair value of
the assets exchanged. The amendment made by SFAS No. 153 eliminates the exception for exchanges of
similar productive assets and replaces it with a broader exception for exchanges of nonmonetary
assets that do not have commercial substance. The provisions of the statement are effective for
exchanges taking place in fiscal periods beginning after June 15, 2005. The Company does not
believe the adoption of this statement will have a material impact on our financial statements. 
 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 $389,000 and $290,000 for the three
months ended March 31, 2005 and 2004, respectively. Market Price Risk The Company had no equity hedge contracts outstanding as of March 31, 2005 or December 31, 2004. 15




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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. A hypothetical 50 basis point increase in interest rates would be expected to result in an
approximate decrease of less than 1% in the fair value of our available-for-sale securities at
March 31, 2005. This potential change is based on sensitivity analyses performed on our marketable
securities at March 31, 2005. Actual results may differ materially. We estimate that the same
hypothetical 50 basis point increase in interest rates would have resulted in an approximate
decrease of less than 1% in the fair value of our available-for-sale securities at March 31, 2004. The Companys credit facility bears interest at a variable rate tied to the London Interbank
Offered Rate (LIBOR). In an effort to mitigate interest rate fluctuations, the Company typically
locks in the rate under one year agreements. The current agreement which expires in October 2005
is at 3.5% (LIBOR + 1%). A hypothetical 100 basis point increase in LIBOR would increase annual
interest expense on this credit facility by approximately $35,000. 
 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 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. 
 PART II
OTHER INFORMATION 
 Item 1. LEGAL PROCEEDINGS None. 
 Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None. 
 Item 3. DEFAULTS UPON SENIOR SECURITIES None. 16




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Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 
 Item 5. OTHER INFORMATION None. 
 Item 6. EXHIBITS Exhibits 2 (a)
    
    Stock Purchase Agreement, dated as of 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). (7)3 (a)
    
    Certificate of Incorporation of the registrant. (1)3 (b)
    
    Amendment to Articles of Incorporation of the registrant. (10)3 (c)
    
    Amended and Restated Bylaws of the registrant adopted on December 5, 1995 and
amended on January 19, 1999. (12)4 (a)
    
    Rights Agreement dated as of December 7, 2000 by and between the Company and
Computershare Investor Services, LLC as Rights Agent. (11)10 (a)
    
    Registrants Amended and Restated Stock Option Plan and Amendment No. 1 and 2 thereto. (9)10 (b)
    
    Registrants Amended and Restated Stock Option Plan Amendment No. 4. (10)10 (c)
    
    Registrants United Kingdom Incentive Stock Option Sub-Plan. (3)10 (d)
    
    Stock Purchase Warrant issued to Motorola, Inc. (4)10 (e)
    
    Lease on Dallas facility. (5)10 (f)
    
    Directors Stock Option Plan and Amendment No. 1 thereto. (6)10 (g)
    
    Directors Stock Option Plan Amendment No. 2. (10)10 (h)
    
    Loan Agreement between Interphase Corporation and BankOne Texas, N.A. (8)10 (i)
    
    Purchase Agreement between Interphase Corporation and Cisco Systems Inc. (9)10(j)
    
    Motorola Stock Repurchase Agreement. (2)10 (k)
    
    Registrants France Incentive Stock Option Sub-Plan. (12)10 (l)
    
    Sublease on Plano facility. (12)10 (m)
    
    Credit Agreement between Interphase Corporation and Bank One, NA. (12)10 (n)
    
    Lease on Facility at Parkway Center, Phase I, Plano, Texas. (13)10 (o)
    
    Lease on Facility at 2105 Luna Road, Carrolton, Texas. (13)10 (p)
    
    Note and Credit Agreement between Interphase Corporation and Comerica Bank, including
Amendment dated November 5, 2004. (14)10 (q)
    
    Interphase Corporation 2004 Long-Term Stock Incentive Plan (14)31 (a)
    
    Rule 13a-14(a)/15d-14(a) Certification. (15)31 (b)
    
    Rule 13a-14(a)/15d-14(a) Certification. (15)32 (a)
    
    Section 1350 Certification. (15)32 (b)
    
    Section 1350 Certification. (15)
 17




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(1)
    
    Filed as an exhibit to Registration Statement No. 2-86523 on Form S-1 and incorporated herein
by reference.(2)
    
    Filed as an exhibit to Report on Form 8-K on October 15, 1998, and incorporated
herein by reference.(3)
    
    Filed as an exhibit to Report on Form 10-K for the year ended October 31, 1988, and
incorporated herein by reference.(4)
    
    Filed as an exhibit to Report on Form 10-Q for the quarter ended April 30, 1989, and
incorporated herein by reference.(5)
    
    Filed as an exhibit to Report on Form 10-K for the year ended October 31, 1994, and
incorporated herein by reference.(6)
    
    Filed as an exhibit to Report on Form 10-K for the year ended October 31, 1995, and
incorporated herein by reference.  (7)
    
    Filed as an exhibit to Report on Form 8-K on August 6, 1996, and incorporated herein by
reference.(8)
    
    Filed as an exhibit to Report on Form 8-K on October 4, 1996, and incorporated herein by
reference.(9)
    
    Filed as an exhibit to Report on Form 10-K for the year ended December 31, 1996, and
incorporated herein by reference.(10)
    
    Filed as an exhibit to Report on Form 10-K for the year ended December 31, 1999, and
incorporated herein by reference.(11)
    
    Filed as an exhibit to Form 8-K on January 9, 2001, and incorporated herein by reference.(12)
    
    Filed as an exhibit to Report on Form 10-K for the year ended December 31, 2001, and
incorporated herein by reference.(13)
    
    Filed as an exhibit to Report on Form 10-Q for the quarter ended September 30, 2002, and
incorporated herein by reference.(14)
    
    Filed as an exhibit to Def 14A on March 31, 2004, and incorporated herein by reference.(15)
    
    Filed herein. 
 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 and
Treasurer
(Principal Financial and Accounting Officer) Plano, Texas
May 11, 2005
 18