ITEM 1. BUSINESS
Introduction
Interphase Corporation and subsidiaries ("Interphase" or the "Company") designs, develops, manufactures, markets and supports high-performance connectivity products utilizing advanced technologies being used in next- generation telecommunication networks and enterprise data/storage networks. Interphase's products include telecom server communication controllers, server-based adapter cards, network operating system device drivers, software development tools and management software applications.
Key Terms and Definitions
Interphase is a technology company and many terms used by the Company may be unfamiliar to those outside the industry. Following are some key terms that may be useful in helping the reader understand the products, technologies and markets relevant for the Company.
Adapter - Also called a host bus adapter (HBA) or network interface card (NIC). An adapter is a device that connects a computer server to one or more peripheral devices (such as switches, hubs, storage devices, etc.) or other computers. An adapter card typically plugs into the expansion bus on the motherboard of the computer and communicates with the operating system controlling the system via the use of specific device drivers.
AIN - (Advanced Intelligent Network) The primary architecture of the public switched telephone system (PSTN) in the 1990s, which provides enhanced voice, video and data services and dynamic routing capabilities. It uses digital switches known as Signal Switching Points (SSPs) that query databases in computer systems known as Service Control Points (SCPs).
ATM - (Asynchronous Transfer Mode) A network technology for both LANs and WANs that supports real time voice and video as well as data. The topology uses switches that establish a logical circuit from end to end, which guarantees a quality of service (QoS) for that transmission. However, unlike telephone switches that dedicate circuits end to end, unused bandwidth in ATM circuits can be appropriated whenever available. For example, idle bandwidth in a videoconference circuit can be used to transfer data. ATM is also highly scalable and supports transmission speeds of 1.5, 25, 100, 155, 622 and 2488 Mbps.
Broadband - A transmission facility (communications link) that has bandwidth (capacity) greater than a voice grade line.
Communications Controller - Communications I/O adapter (similar to a network interface card) designed specifically for carrier-grade computer systems that often support signaling, switching and routing networks. Communication controllers must conform to specifications that maintain overall system compliance to the rigorous performance and reliability standards that apply to telecom service provider equipment into which they are integrated.
CompactPCI - An industrial grade variation of the PCI bus standard that utilizes the Eurocard (VME) form factor. CompactPCI has been widely adopted by telecom equipment suppliers because of its high-density connectors, support for front or rear I/O access and hot-swap capabilities important for "Five 9's" (99.999%) reliability.
Device Drivers - A program routine that links an adapter card (or other device) to the operating system. It is written by software engineers who understand the detailed knowledge of the adapter's command language and characteristics and contains the precise machine language necessary to perform the functions requested by the application. When a new adapter is added to the computer, its driver must be installed in order to run it. The operating system calls the driver, and the driver "drives" the adapter. Routines that perform internal functions, such as memory managers and disk caches, are also called drivers.
DSL - A relatively new broadband technology that carries data signals up to 20 times faster than 56K dial-up modems on the high-frequency portions of phone lines that also transmit voice. Unlike with dial-up services, DSL users don't dial a phone number to log on to the Internet. Like cable-modem service, a DSL line is continuously open. DSL requires two modems, one at the customer end and one at the phone company end (called a DSLAN), which communicate constantly with each other. DSL providers don't usually sell their services directly to consumers - they typically resell them through Internet service providers such as America Online and Mindspring.
Broadband telecom controllers System - As related to Interphase, an Broadband telecom controllers system is a highly specialized computer server that resides in an "industrial" environment requiring high-availability and maximized "up-time." Typical uses for this type of server include military applications such as on-board ship communications or avionics, or next- generation telecommunication applications such as intelligent call routing, call number portability or base station communications control for wireless service.
Fast Ethernet - A variation of the Ethernet standard (10Base-T) that provides 100 Mbps transmission bandwidth, and up to 200 Mbps total I/O throughput with full duplex operation.
Fibre Channel - A high-speed transmission technology that can be used as a front-end communications network, a back-end storage network, or both at the same time. With Fibre Channel, servers can not only talk to the storage system via SCSI (storage protocol, see below), but the hosts can talk to each other via IP (Internet Protocol) over the same network. Fibre Channel supports existing peripheral interfaces and communications protocols. Its name is somewhat misleading, as Fibre Channel supports coaxial cable and twisted pair copper wiring as well as single mode and multimode fiber connections.
Frame Relay - A high-speed packet switching protocol used in wide area networks (WANs). Providing a granular service of up to DS3 speed (45 Mbps), it has become very popular for LAN-to-LAN connections across remote distances. All the major telecommunications carriers offer frame relay services. Frame relay is much faster than X.25 networks, the first packet- switching WAN standard, because frame relay was designed for today's reliable circuits and performs less rigorous error detection.
Gigabit Ethernet - An Ethernet technology that raises transmission speed to one Gbps and is used primarily for backbone networks and high-speed server- to-server connectivity.
ISDN - A system of digital connections that has been available for over a decade and has gained increased use in the last few years for high-speed data and video transmission.
LAN - (Local Area Network) A short distanced data communications network that is contained within a building or complex. Its primary use is to link computers and peripheral devices (such as printers) and to provide individuals with access to databases and applications running on servers attached to the network. Anyone connected to the LAN can send messages to and work jointly with others on the network.
NAS - (Network Attached Storage) A network topology that provides a common pool of storage that can be shared by multiple servers and clients, regardless of their file system or operating system. Network Attached Storage servers are self-contained, intelligent devices that attach directly to an existing LAN. A file system is located and managed on the NAS server and data is transferred to network clients over industry standard network protocols such as IP (Ethernet).
Operating System - The master control program that runs the computer. It is the first program loaded when the computer is turned on, and its main part, called the kernel, resides in memory at all times. It may be developed by the vendor of the computer it's running in or by a third party. It is an important component of the computer system because it sets the operational guidelines for all application programs that run on the system. All programs must "talk to" the operating system. Popular network operating systems today include Windows NT and 2000, HP-UX, AIX and Linux.
PCI - A bus standard (Peripheral Components Interconnect) that is currently the main general-purpose bus in virtually every desktop computer and a majority of servers throughout the world.
PCI-X - A high-performance extension to the PCI Local Bus that is designed to meet the increased I/O demands of technologies such as Fibre Channel, Gigabit Ethernet, and Ultra3 SCSI.
PMC - (PCI Mezzanine Card) a low profile mezzanine card that is electronically equivalent to the Peripheral Component Interconnect (PCI) specification. PMC cards are used as a quick and cost-effective method to add modular I/O to other card formats such as VME and CompactPCI.
Remote Access Server - A remote access server is a computer that provides access to remote users (such as telecommuters, road warriors and branch office locations) via analog or digital modems and ISDN connections.
SAN - (Storage Area Network) A flexible "any-to-any" networking infrastructure linking multiple servers to multiple storage devices. Based on Fibre Channel technology, SANs have recently emerged as the highest performance data communications environment available today to interconnect servers and storage. Running at Gigabit speeds, SANs offer better scalability, fault recovery and general manageability than current client- server LAN-based approaches for real-time and data intensive applications. Storage Area Networks are being widely deployed for video editing, prepress and data mining applications throughout the general IT marketplace.
SCSI - (Small Computer System Interface) Pronounced "skuzzy," SCSI is a widely used communications technology for connecting computer servers to storage devices. The technology is especially popular in applications where network servers are attached to numerous SCSI drives and configured as fault-tolerant RAID clusters. In the event one drive fails, the system is still operational. SCSI-based RAID is widely used in file servers, database servers and other network servers. Interphase products utilize Ultra2 SCSI, which provides up to 80 Mbps data throughput and Ultra3 SCSI, which doubles the throughput to 160 Mbps.
Server - A computer in a network shared by multiple users. These are typically more powerful than computers used by individuals (often referred to as "desktops") and require advanced I/O connectivity. In enterprise network environments, some computers may be dedicated to a single task. For instance, an Internet server is a computer that provides World Wide Web services on the Internet. If the Web server is used internally and not by the public, it may be known as an "intranet server."
SS7 - (Signaling System 7) The protocols used in the U.S. telephone system for setting up calls and providing modern transaction services such as caller ID, automatic recall and call forwarding. When you dial "1" in front of a number, SS7 routes the call to your long distance carrier. It also routes local calls based on the first three digits of the phone number.
T1 - A digital transmission link with a capacity of 1.544 Mbps (1,544,000 bits per second). T1 links normally handle 24 voice conversations, but with digital encoding can handle many more voice channels. T1 lines are also used to connect networks across remote distances. The European equivalent (E1) handles 30 voice channels.
T3 - A digital transmission link equivalent to 28 T1 lines. Providing a capacity of 45 Mbps, a T3 link is capable of handling 672 voice conversations.
WAN - (Wide Area Network) A communications network that covers a wide geographic area, such as state or country. A WAN typically extends a LAN (Local Area Network, see above) outside the building, over telephone common carrier lines to link to other LANs in remote locations, such as branch offices or at-home workers and telecommuters. WANs typically run over leased phone lines, but are increasingly also employing the Internet for VPN (virtual private network) connectivity.
Strategy
The Company's strategy is to provide innovative, high-performance connectivity solutions for the telecommunications and enterprise server markets. To achieve this strategy, Interphase pursues several key initiatives that include:
Providing an advanced line of communication controllers for next-generation telecom servers.
To capitalize on the trend towards the acquisition of I/O connectivity from third party vendors by telecommunication server providers, Interphase offers a comprehensive line of carrier-class communications controllers for:
* 2.5 and 3G Wireless - controllers that provide enhanced mobile services and integration with the Internet
* Fast Internet Access - controllers that enable broadband Internet connectivity and high-speed wireless Internet access
* Intelligent Network Migration - controllers that help service providers migrate their AIN facilities to more scalable and versatile network architectures
Beginning in 2001, the Interphase telecommunication solutions offering also includes a Professional Services organization responsible for customizing software and third party applications to customer specific designs. With high-performance communication controllers, software development tools, the industry's broadest protocol support, and complementary professional services, Interphase helps decrease costs and improve time-to-market for service providers building next-generation telecom networks.
Offering a comprehensive server I/O adapter product portfolio.
In order to provide Interphase customers with effective storage networking solutions, Interphase offers a comprehensive line of storage networking adapters specifically designed for use in demanding, enterprise class applications such as:
* Enterprise Connectivity - mission critical backbone and Internet servers
* Server-attached Storage - high-throughput direct-attached storage servers
* Storage Area Networks - servers providing connectivity for SAN and NAS applications
Delivering superior customer service.
Over the past 25 years, Interphase has established strong relationships with key suppliers of enterprise computer and telecommunication servers. Much of this success has been due to the superior pre- and post-sale service the Company delivers to customers. With a vertically integrated account perspective, Interphase provides flexibility, timely response and other customized account service features. Further, the Company's technical support is divided into functional groups supporting either server I/O or telecommunication product offerings, allowing Interphase to specifically focus its support efforts for the different needs and requirements of its customers in these differing market segments.
Expanding the company's base of quality channel partners.
In keeping with its efforts to expand the total available market for its product offerings, Interphase continues to build a broad base of distribution channel partners that provide cost-effective penetration into the enterprise IT segment. Through its Gold Rush Partners Program, the Company recruits high-end resellers (VARs) and systems integrators that are building storage-centric solutions for their enterprise customers.
Developing strategic partnerships.
Interphase is an acknowledged leader in multi-vendor interoperability. The Company leverages this leadership position into strategic partnerships with its Diamond Developer Partners Program. Through this program, Interphase builds synergistic marketing and technical relationships with other key suppliers in its respective markets. Rigorous product testing and early access to new partner product releases allows tighter product integration and helps assure compatibility for the Company's end-user customers.
Products
Interphase offers an advanced line of telecom communication controllers, a comprehensive portfolio of Fibre Channel SAN adapters (including HBA SAN management software) and adapters for remote access and WAN communications.
Telecom Communication Controllers
Interphase products designed for use in next-generation Broadband telecom controllers telecommunication servers include:
* 4531 PMC ATM over T3/E3 Communications Controller - a PCI Mezzanine Card that provides reliable, high performance ATM communications over T3/E3 connections for applications such as aggregating Internet traffic for transport over the public ATM backbone network.
* 4534 PMC Quad-port Serial Communications Controller - a PCI Mezzanine Card that provides reliable, high performance serial communications for multiple telecommunication protocols including ATM, ISDN, Frame Relay, X.25 and PPP.
* 4535 PMC Multiprotocol Communications Controller - a PCI Mezzanine Card that provides four high-speed serial communication links to provide connection to the Public Switch Telephone Network to support advanced SS7 or AIN applications.
* 4537 PMC Multiprotocol Communications Controller - a PCI Mezzanine Card targeted specifically for telecommunication applications that require multiple T1/E1 interfaces. The 4537 supports multiple frame-based protocols, such as ATM and SS7, provides options for front or rear I/O access, and includes an integrated Channel Service Unit.
* 4575 PMC ATM Communications Controller - a PCI Mezzanine Card that provides reliable, high performance ATM SONET OC-3 155 Mbps connectivity.
* 5575 PCI ATM Adapter - a PCI adapter card that provides full duplex ATM connectivity for systems running Windows NT, Novell NetWare, UnixWare, Solaris and AIX.
* 6535 CompactPCI T1/E1/J1 Communications Controller - a 6U CompactPCI communications controller with an advanced architecture featuring the Motorola MPC8260 RISC CPU that offers superior performance over T1/E1/J1 communication links.
* 6575 CompactPCI ATM Communications Controller - a 3U or 6U CompactPCI adapter that provides full duplex ATM connectivity at OC-3 data rates for industrial and telecommunication server computers.
Server I/O Products
Interphase server I/O products targeted for use in enterprise applications include the following:
* 5526 PowerSAN PCI Fibre Channel Adapter - a 33Mhz PCI bus adapter which provides single port 100 MBps Fibre Channel connectivity.
* 5527 PowerSAN PCI Fibre Channel Adapter - a 66Mhz PCI bus adapter which provides single port 100 MBps Fibre Channel connectivity.
* 5540 PowerSAN PCI Fibre Channel Adapter - a 66Mhz PCI bus adapter which provides price-effective 1-Gbps storage connectivity for basic Fibre Channel SAN connectivity.
* 5541 PowerSAN PCI Fibre Channel Adapter - a low profile version of the 5540 that is only half of the height of normal PCI cards, allowing use in the new smaller profile (1U) servers being increasingly used in Internet server and e-commerce applications.
* 5550 PowerSAN PCI Fibre Channel Adapter - a 66Mhz PCI bus adapter which provides two independent 1-Gbps Fibre Channel connections for high- reliability SAN applications.
* 5560 PowerSAN PCI Fibre Channel Adapter - a 66Mhz PCI bus adapter which provides 2-Gbps Fibre Channel connectivity for applications requiring maximized data throughput.
* FibreView Enterprise - a JAVA-based management utility which allows enterprise IT managers to control Fibre Channel server connections from anywhere within the network via the Internet.
* 5570 SlotOptimizer PCI Storage Networking Adapter - a 64-bit PCI multifunction adapter card providing full duplex Gigabit Fibre Channel and high-performance Gigabit Ethernet connectivity.
* 552C SlotOptimizer PCI Storage Networking Adapter - a 64-bit PCI multifunction adapter card combining dual channel Ultra2 SCSI connectivity with two 10/100 Ethernet ports.
* 553C SlotOptimizer PCI Storage Networking Adapter - a 64-bit PCI multifunction adapter card combining dual channel Ultra3 SCSI connectivity with two 10/100 Ethernet ports.
* 554E SlotOptimizer Quad-port Fast Ethernet Adapter - a 64-bit PCI adapter card that provides four independent full-duplex Fast Ethernet ports.
Remote Access and WAN Communications Adapters
Interphase also offers communication adapters that enable remote access server communications in enterprise WAN environments. Flagship Interphase products for remote access and WAN connectivity include:
* 5535 ENTIA ATM over T1 Communications Controller - an PCI WAN controller that uses an on-board CPU and memory to locally execute all communications protocols. Providing either single or dual port PRI or T1/E1 connectivity, this controller is a cost-effective connectivity solution for small and medium size enterprise networking environments.
* 5536 ENTIA V.90 Digital Modem Controller - a PCI WAN controller that uses an on-board CPU and memory to locally process all communications protocols. Offering up to 60 digital modems and simultaneous processing of both ISDN and analog (V.34 and V.90) call traffic, this adapter is a cost-effective solution for remote users requiring access to enterprise network applications.
New Product Development
The markets for the Company's products are characterized by rapid technological development, evolving industry standards, frequent new product introductions and relatively short product life cycles. The Company's success is substantially dependent upon its ability to anticipate and react to these changes, maintain its technological expertise, expand and enhance its product offerings in existing technologies, and develop, in a timely manner, new products in emerging technologies that achieve market acceptance. The Company believes it must offer products to the market that not only meet ever-increasing performance and quality standards, but also provide compatibility and interoperability with products and architectures offered by various computer and network systems vendors. The continued utility of the Company's products can be adversely affected by products or technologies developed by others.
The Company has been engaged in the development of new products and the refinement of its existing products since its inception. Interphase has been active in the formulation of industry standards sanctioned by groups such as the IEEE, ANSI, VME International Trade Association (VITA), Fibre Channel Industry Association (FCIA), Infiniband Trade Association (ITA), PCI Industrial Manufacturers Group (PICMG), Project UDI, Fast Ethernet Alliance, SCSI Committee, the LADDIS Group, ONC/NFS Consortium, University of New Hampshire FDDI Interoperability Lab, FC-Open (Fibre Channel) Consortium, and ANTC Consortium for FDDI interoperability testing.
Marketing and Customers
The Company's standard products are sold to OEM's for inclusion in scientific, industrial, medical, engineering workstations, printing, mini- supercomputer, graphics and other computer applications. These purchasers incorporate the Company's products in proprietary systems for resale to distributors, system integrators and VAR's (which may add specially designed software) prior to resale to end-users. Also, the Company sells products directly to sophisticated end-users such as large corporations, universities and scientific research organizations. During 2000, sales to Hewlett Packard and Terayon Communication Systems accounted for $10 million or 18% and $5.9 million or 11% of consolidated revenues, respectively, and were the only customers accounting for more than 10% of consolidated revenues. During 1999, sales to Hewlett Packard accounted for $36.9 million or 50% of consolidated revenues, and was the only customer accounting for more than 10% of consolidated revenues. During 1998, sales to Hewlett Packard accounted for $28.3 million or 41% of consolidated revenues, and was the only customer accounting for more than 10% of consolidated revenues.
The Company markets its products through its own sales organization and, to a lesser extent, through a network of independent sales representatives. In addition to the Company's headquarters in Dallas, Texas, the Company has sales offices located in or near Santa Clara, California; Boston, Massachusetts; Minneapolis, Minnesota; Paris, France and Bangkok, Thailand. The Company's sales personnel market products directly to key customers as well as support the sales representative network. In addition, the Company has entered into distribution agreements with key national and international distribution partners, including Ingram Micro, Tech Data, Fuji-Xerox, Gates/Arrow and Macnica.
Interphase emphasizes its extensive product support, training and field support to its customers. The Company's products are generally sold with a one to three-year warranty covering components and labor. After the expiration of the warranty period, the Company generally provides support services for a stated flat fee.
The Company and its customers generally enter into written agreements specifying, among other items standard in commercial agreements, product specifications, failure rates, shipping requirements, shipment rescheduling terms, price/volume schedules and manufacturer warranties. Substantially all of these agreements do not contain determinable purchase commitments of the customers, providing instead that actual purchase and shipments of products be made by specific purchase order. Accordingly, any shipment dates stated in such contracts are subject to rescheduling and/or cancellation, and therefore are not indicative of the future purchase orders to be submitted by such customer. In addition, the actual terms of the contracts tend to be modified in the ordinary course of business by means of subsequent purchase order terms and by course of dealing.
The Company does not believe that the level of backlog of orders is either material or indicative of future results, since its contracts are subject to revision through subsequent purchase orders and its customers are generally permitted to cancel purchase orders, within certain parameters, prior to shipment without penalty.
The majority of the Company's sales are to OEMs with payment terms typically being net 30-45 days from the date of invoice.
Manufacturing and Supplies
Manufacturing operations are currently conducted at the Company's headquarters in Dallas, Texas. The Company's products consist primarily of various integrated circuits, other electronic components and firmware assembled onto an internally designed printed circuit board.
The Company uses internally designed applications specific integrated circuits ("ASIC"), some of which are sole-sourced, on some of its products as well as standard off-the shelf items presently available from two or more suppliers. Historically, the Company has not experienced any significant problems in maintaining an adequate supply of these parts sufficient to satisfy customer demand. The Company believes that it has good relations with its vendors.
The Company generally does not manufacture products to stock in finished goods inventory, as substantially all of the Company's production is dedicated to specific customer purchase orders. As a result, the Company does not have any material requirements to maintain significant finished goods inventories.
Intellectual Property and Patents
While the Company believes that its success is ultimately dependent upon the innovative skills of its personnel and its ability to anticipate technological changes, its ability to compete successfully will depend, in part, upon its ability to protect proprietary technology contained in its products. The Company does not currently hold any patents relative to its current product lines. Instead, the Company relies upon a combination of trade secret, copyright and trademark laws and contractual restrictions to establish and protect proprietary rights in its products. The development of alternative, proprietary and other technologies by third parties could adversely affect the competitiveness of the Company's products. Further, the laws of some countries do not provide the same degree of protection of the Company's proprietary information, as do the laws of the United States. Finally, the Company's adherence to industry-wide technical standards and specifications may limit the Company's opportunities to provide proprietary product features capable of protection.
The Company is also subject to the risk of litigation alleging infringement of third party intellectual property rights. Infringement claims could require the Company to expend significant time and money in litigation, pay damages, develop noninfringing technology or acquire licenses to the technology, which is the subject of asserted infringement.
The Company has entered into several nonexclusive software licensing agreements that allow the Company to incorporate software into its product line thereby increasing its functionality, performance and interoperability.
Employees
At December 31, 2000, the Company had 197 full-time employees, of which 70 were engaged in manufacturing and quality assurance, 71 in research and development, 31 in sales, sales support, service and marketing and 25 in general management and administration.
The Company's success to date has been significantly dependent on the contributions of a number of its key technical and management employees. The loss of the services of one or more of these key employees could have a material adverse effect on the Company. In addition, the Company believes that its future success will depend in large part upon its ability to attract and retain highly skilled and motivated technical, managerial, sales and marketing personnel. Competition for such personnel is intense.
None of the Company's employees are covered by a collective bargaining agreement and there have been no work stoppages. Additionally, the Company considers its relationship with its employees to be good.
Competition
The computer network industry is intensely competitive and is significantly affected by product introductions and market activities of industry participants. The Company expects substantial competition to continue. The Company's competition includes vendors specifically dedicated to the storage I/O and telecommunication product markets. Traditionally the Company's major OEM customers have chosen not to manufacture adapters for their products or do not manufacture sufficient quantities or types of controllers to meet their needs. Increased competition could result in price reductions, reduced margins and loss of market share.
ITEM 2.
ITEM 2. PROPERTIES.
The Company leases a 96,000-square foot facility located in Farmers Branch, Texas, a suburb of Dallas. The facility includes approximately $2.9 million in leasehold improvements that were made by the Company. The lease, inclusive of renewal options, extends through 2002. In addition, the Company leases a facility in Chaville, France (near Paris) that supports the European markets. The Company believes that its facilities and equipment are in good operating condition and are adequate for its operations. The Company owns most of the equipment used in its operations. Such equipment consists primarily of engineering equipment, manufacturing and test equipment and fixtures.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
None
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS.
The Company had approximately 4,800 beneficial owners of its common stock, of which 64 are of record as of March 1, 2001.
The Company has not paid dividends on its common stock since its inception. The Board of Directors does not anticipate payment of any dividends in the foreseeable future and intends to continue its present policy of retaining earnings for reinvestment in the operations of the Company.
The Board of Directors has adopted a Shareholder Rights Plan whereby each holder of record as of December 29, 2000 received a right to purchase from the Company one share of common stock of the Company at a price of $93 per share for each share held. These rights can only be exercised after certain events occur, such as if a person or entity acquires, or makes a tender or exchange offer to acquire 15% or more of the Company's common stock and the rights expire ten years from the record date. Upon acquisition of 15% or more of the Company's common stock, each right not owned by the acquiring person or group will be adjusted to allow the purchase for $93 of a number of shares having a then market value of $186. These rights are intended to provide the Company certain antitakeover protections. The Board of Directors may terminate the Rights Plan, or redeem the rights for $0.01 per right, at any time until the tenth business day following a public announcement of a 15% or more stock acquisition. The Company has reserved 7,000,000 shares of common stock for this plan.
The rights were distributed to shareholders as of the record date as a non- taxable dividend. The rights are attached to and trade with Interphase common stock until the occurrence of one of the triggering events, at which time the rights would become detached from the common stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This report contains forward-looking statements with respect to financial results and certain other matters. These statements are made under the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 and involve a number of risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Such risks and uncertainties include, without limitation, fluctuations in demand, the quality and price of similar or comparable networking products, access to sources of capital, general economic conditions in the Company's market areas and that future sales and growth rates for the industry and the Company could be lower than anticipated.
RESULTS OF OPERATIONS
In September 1999, the Company completed the sale of its Voice Over Internet Protocol ("VOIP") business. Accordingly, the Company's consolidated financial statements and notes included herein, for all periods presented reflect the VOIP business as a discontinued operation in accordance with Accounting Principles Board Opinion No. 30.
Revenues consist of product revenues and are recognized in accordance with SEC Staff Accounting Bulletin (SAB) 101, "Revenue Recognition." Product revenues are recognized upon shipment, provided fees are fixed and determinable, a customer order is obtained, and collection is probable. Revenues from reseller agreements are typically recognized when the product is sold through to the end customer. Deferred revenue consists of revenue from reseller arrangements and certain arrangements with extended payment terms.
Revenues: Total revenues for the years ended December 31, 2000, 1999 and 1998 were $55.7 million, $73.5 million and $68.7 million, respectively.
Revenues decreased 24% in 2000 compared to 1999. The decrease in revenue was primarily attributable to the effects of the transitional period where the Company is refocusing its efforts on its new Fibre Channel and Telecom Communication Controller products. During this period, several of the new Fibre Channel products experienced delays in the engineering phase. Due to the intense competition in the industry, these delays had a significant impact on sales during 2000. Additionally, 30% of the revenues in 1999 were attributable to Hewlett Packard's purchases of a Fibre Channel product, which ceased in the first quarter of 2000. The decrease in revenues during 2000 was partially offset by sales of products through an end-of-life program instituted in 2000 for many of the Company's legacy products. The Company began this program in an effort to focus its resources on its new product lines.
The growth in revenues from 1998 to 1999 was 7%. The increase in revenue was attributable to growth in the Company's Storage and Broadband telecom controller product lines, partially offset by a decline in LAN and WAN products. In 1999, Storage revenues, which consist of Fibre Channel and SCSI technologies, accounted for approximately 48% of total revenues, LAN revenues which consist of FDDI, Fast Ethernet, ATM and Ethernet, accounted for 36% of total revenues, WAN accounted for 7% of total revenues and Broadband telecom controllers accounted for 9% of total revenues. North American revenues grew 14%, Pacific Rim revenues grew 78%, and European revenues declined 26% compared to 1998. In 1999, sales to one OEM customer accounted for approximately 50% of the Company's revenue.
Gross Profit: Gross profit as a percentage of sales was 53% for the year ended December 31, 2000, 47% for the year ended December 31, 1999 and 49% for the year ended December 31, 1998. The increase in the gross profit rate is primarily the result of a change in product mix and product cost improvements that began in late 1999, whereby the Company improved its purchasing and production processes.
Research and Development: The Company's investment in the development of new products through research and development was $10.4 million, $10.6 million and $10.8 million in 2000, 1999, and 1998, respectively. As a percentage of revenue, research and development expenses were 19%, 14% and 16% for 2000, 1999 and 1998, respectively. Research and development costs decreased slightly in 2000, primarily due to a reduction in variable spending in response to decreased revenues for the year. However, the research and development investment in 2000 resulted in new products that will provide the foundation for the Company's product lines in 2001 and beyond.
Sales and Marketing: Sales and marketing expenses were $10.7 million, $11 million, and $10.1 million in 2000, 1999 and 1998, respectively. As a percentage of revenue, sales and marketing expenses were 19%, 15% and 15% for 2000, 1999 and 1998, respectively. The decrease in sales and marketing expenses in 2000 is primarily the result of decreased revenues, which resulted in reduced sales commissions and bonuses for the year, partially offset by increased marketing activity used to position the Company for future product releases.
General and Administrative: General and administrative expenses were $4.8 million, $5.4 million, and $5.4 million in 2000, 1999 and 1998, respectively. As a percentage of revenue, general and administrative expenses were 9%, 7% and 8% for 2000, 1999 and 1998, respectively. General and administrative costs have been relatively consistent in recent years. However, the decrease in 2000 costs, relative to 1999, is primarily due to lower headcount related expenses, as the number of employees in the general and administrative function decreased from 33 as of December 31, 1999 to 25 as of December 31, 2000.
Interest Income: Interest income was $1.2 million, $481,000 and $338,000 in 2000, 1999 and 1998, respectively. The increase in interest income from year to year is a reflection of the increase in the funds available for investment.
Interest Expense: Interest expense was $587,000, $694,000 and $1 million in 2000, 1999 and 1998, respectively. The decrease in interest expense is due to the reduction of the Company's credit facility.
Other Expense, Net: Other expense, net, was $266,000, $817,000 and $896,000 in 2000, 1999 and 1998, respectively. Other expense primarily reflects the amortization of goodwill and acquired developed technologies related to a 1996 acquisition of Synaptel. However, the net decrease in 2000 is primarily due to the increase in other income generated by hedging transactions on certain marketable securities received in the sale of the Company's VOIP business. For the year ended December 31, 2000, these hedging transactions resulted in a gain of approximately $689,000.
Provision for Income Taxes: The Company's provision for taxes was $1.7 million, $2.4 million and $2.2 million in 2000, 1999 and 1998, respectively.
The effective income tax rates were 42% in 2000, 36% in 1999 and 39% in 1998. The Company's effective tax rate is greater than the statutory rate primarily due to nondeductible goodwill amortization. The increase in the Company's effective income tax rate, from 1999 to 2000, is primarily due to the decrease in foreign earnings, which are offset by foreign loss carry forwards.
Discontinued Operations: In 1999, the Company sold its VOIP business for $2.4 million. However, due to the uncertainty of payment on the proceeds that remained unpaid as of December 31, 1999, the Company recognized income upon payment. In 2000, the remaining $830,000 due for the technology license fee was collected and recorded as a gain on disposal of discontinued operations. Additionally, in 2000, the Company sold its 20% interest in Quescom for $400,000, resulting in a gain of $91,000. The total gain in 2000 was $571,000 net of $350,000 tax. There were no operating activities during 2000 related to the VOIP business. Gain on disposal of assets was $326,000, net of tax, in 1999. Operating losses, net of tax, for the VOIP business were $1.2 million and $829,000 for 1999 and 1998, respectively.
Net Income (Loss): The Company reported net income of $3 million in 2000, $3.4 million in 1999 and $2.7 million in 1998.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash, cash equivalents and marketable securities aggregated $17.5 million and $16.3 million at December 31, 2000 and 1999. The growth in cash, cash equivalents and marketable securities from 1999 to 2000 is primarily attributable to cash generated by the Company's operations, proceeds received from the exercise of stock options and cash received in connection with the sale of its VOIP business.
Expenditures for equipment and purchased software were $1.1 million, $2 million and $2.9 million in 2000, 1999 and 1998, respectively. At December 31, 2000, the Company had no material commitments to purchase capital assets. The Company's significant long-term obligations are its operating lease on its Dallas facility, future debt payments and repurchase of Interphase common stock from Motorola (described below).
The Company has a $16 million credit facility with a financial institution. This credit facility includes an $8.5 million term loan, a $2.5 million equipment loan and a $5 million revolving credit facility. The term and equipment loans are due in quarterly installments, and expire in November 2001. The revolving credit facility expires in June 2002. In 2001, maturities of this credit facility will be approximately $1.7 million. The Company has not paid any dividends since its inception and does not anticipate paying any dividends in 2001.
Effective October 1998, the Company approved a stock repurchase agreement with Motorola, Inc. to purchase ratably from October 1998 to July 2002, all of the shares owned by Motorola for $4.1 million at $6.25 per share. Under the terms of the agreement, Motorola retains the right as an equity owner and has assigned its voting rights to the Company. The Company cancels the stock upon each repurchase. Prior to the repurchase agreement, Motorola owned approximately 12% of the Company's outstanding common stock. The future scheduled payments are classified as redeemable common stock in the accompanying consolidated balance sheets. As of December 31, 2000, 375,336 shares have been repurchased for $2.3 million and retired; 284,664 shares remain to be repurchased.
The Company expects that its cash, cash equivalents, marketable securities and proceeds from its credit facility will be adequate to meet foreseeable needs for at least the next 12 months.
Recently Issued Accounting Pronouncements
On January 1, 2001, the Company adopted SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS 137 and SFAS 138. SFAS 133 requires all derivatives to be recorded at fair value. Changes in the fair values of derivatives are recorded in either the statement of operations or as a component of comprehensive income, depending on whether the derivative qualifies as a hedge, and depending on the type of hedging relationship that exists. Adoption of this standard did not have a material effect on the Company's financial statements.""
ITEM 7a.
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Foreign currency risk - Revenues originating outside of the United States totaled 15%, 17% and 22% of total revenues in 2000, 1999, and 1998. Due to the fact that the Company conducts business on a global basis in various foreign currencies, it is exposed to adverse movements in foreign currency exchange rates. During the periods presented, the Company entered into certain foreign currency forward exchange contracts to reduce the risk of foreign exchange exposure. Neither the foreign currency transaction gains and losses nor the gains and losses on the forward contracts were significant. The Company has not used, nor do they expect to use, forward contracts for trading purposes.
Interest Rate Risk - The Company is exposed to interest rate risk under its Credit Facility, which currently bears interest at 8.5%. The Company does not enter into hedging arrangements to mitigate this risk.
Market Price Risk - The Company maintains a minority equity investment in a publicly traded Company and recorded a $925,000 net after tax unrealized loss during 2000 on this investment. The Company's ability to sell certain equity positions is restricted under contractual arrangements. During 2000 the Company entered into a hedge on a portion of this equity investment, realizing a gain of $689,000 on the transaction. The Company has no equity hedge contracts outstanding as of December 31, 2000.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See Item 14 (a) below.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not applicable
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Directors
See information regarding the directors and nominees for director under the heading "Election of Directors" of the Proxy Statement for the Annual Meeting of Shareholders to be held May 2, 2001, which is incorporated herein by reference.
Executive Officers
As of March 1, 2001, the executive officers of the Company, their respective ages, positions held and tenure as officers are listed below:
Executive Officers of the Company Name Age Position(s) Held with the Company Since ----------------- --- ---------------------------------- ----------- Gregory B. Kalush 44 Chairman of the Board, Chief 1998 Executive Officer and President
Steven P. Kovac 45 Chief Financial Officer, Treasurer 1999 and Vice President of Finance
Gregory B. Kalush joined the Company in February 1998, as Chief Financial Officer, Vice President of Finance and Treasurer. Mr. Kalush was appointed the Chief Executive Officer, President and Director of the Company in March 1999 and was elected Chairman of the Board in May 2000. Mr. Kalush is also the sole member of the New Employee and Retention Stock Option Committee of the Board of Directors. Prior to joining Interphase, Mr. Kalush was with DSC Communications Corporation from 1995 to 1997. While at DSC, he served as Vice President Transmission Data Services, Vice President of Operations, International Access Products and Group Vice President of Finance, Transport Systems Group. Prior to DSC, Mr. Kalush was with IBM Corporation from 1978 to 1994. During that time his positions included Chief Financial Officer and Operations Executive for the Skill Dynamics Business Unit, Director of Finance, Planning and Administration for the Southwest area, and Division Director of Finance and Operations for the Data Systems division.
Steven P. Kovac joined the Company in May 1999 as Chief Financial Officer, Vice President of Finance and Treasurer. Prior to Interphase, from 1997 to 1999 Mr. Kovac served as Chief Operating Officer and Chief Financial Officer for TPN Inc., a satellite television network. From 1989 to 1997 Mr. Kovac was the Regional Vice President of Finance and Chief Financial Officer for AT&T Wireless Services, McCaw Cellular Communications and LIN Cellular Communications. From 1988 to 1989, Mr. Kovac was Vice President of Finance and Administration for BBL Industries, a manufacturer of paging terminals and voice messaging equipment. Mr. Kovac is a member of the Board of Directors for Integrated Systems Corporation, a reseller of DSL and satellite ISP, located in Denver, Colorado.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this Item will be included in the Proxy Statement for the Annual Meeting of Shareholders to be held on May 2, 2001, which is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item will be included in the Proxy Statement for the Annual Meeting of Shareholders to be held on May 2, 2001, which is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item will be included in the Proxy Statement for the Annual Meeting of Shareholders to be held on May 2, 2001, which is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) (i) and (ii) Financial Statements and Schedules.
Reference is made to the listing on page of all financial statements and schedules filed as a part of this report.
(iii) Exhibits.
Reference is made to the Index to Exhibits on page E-1 for a list of all exhibits filed during the period covered by this report.
(b) Reports on Form 8-K.
The Registrant has filed no Reports on Form 8-K during the quarter ended December 31, 2000.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
INTERPHASE CORPORATION
Date: March 26, 2001 By: /s/ Gregory B. Kalush ----------------------- Gregory B. Kalush Chairman of the Board, Chief Executive Officer and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 26, 2001.
Name Title --------------------------- ---------------------------
/s/ Gregory B. Kalush Chairman of the Board, --------------------------- Chief Executive Officer and President Gregory B. Kalush (Principal executive officer)
/s/ Steven P. Kovac Chief Financial Officer, Treasurer --------------------------- and Vice President of Finance Steven P. Kovac (Principal financial officer)
/s/ James F. Halpin Director --------------------------- James F. Halpin
/s/ Paul N. Hug Director --------------------------- Paul N. Hug
/s/ David H. Segrest Director --------------------------- David H. Segrest
/s/ S. Thomas Thawley Vice Chairman, Director --------------------------- and Secretary S. Thomas Thawley
/s/ William R. Voss Director --------------------------- William R. Voss
INDEX TO EXHIBITS
Exhibits -------- 2 (a) Stock Purchase Agreement, dated as of June 29, 1996, among 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. (6) 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 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) Rights Agreement dated as of December 7, 2000 by and between the Company and Computershare Investor Services, LLC as Rights Agent. (11) 23 (a) Consent of Independent Public Accountants. (12) _____________________ (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-KA 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 herein.
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
Management's Report on Financial Responsibility
Report of Independent Public Accountants - Arthur Andersen LLP
Consolidated Balance Sheets - As of December 31, 2000 and 1999
Consolidated Statements of Operations - Years Ended December 31, 2000, 1999 and 1998
Consolidated Statements of Shareholders' Equity - Years Ended December 31, 2000, 1999 and 1998
Consolidated Statements of Cash Flows - Years Ended December 31, 2000, 1999 and 1998
Notes to Consolidated Financial Statements to
MANAGEMENT'S REPORT ON FINANCIAL RESPONSIBILITY
Management is responsible for the preparation and fairness of the consolidated financial statements of Interphase Corporation and all other information contained in this annual report. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States and reflect informed judgments and estimates, which management believes to be reasonable.
The Company maintains an effective system of internal accounting controls, which are modified periodically as the Company's operations change. Additionally, the Company is receptive to suggestions made by Arthur Andersen LLP, its independent public accountants, regarding enhancements and changes to the Company's existing internal accounting controls. Overall, management believes that its system of internal accounting controls is adequate to provide reasonable assurance as to the integrity and reliability of its financial statements, and the safeguarding of assets.
The Board of Directors, acting through its Audit Committee, monitors the accounting affairs of the Company and has approved the accompanying consolidated financial statements. The Audit Committee, consisting of three directors, reviews the results of the annual financial statement audit, and the actions taken by management in discharging its responsibilities for accounting and financial reporting. The Audit Committee meets periodically and privately with management and the independent public accountants to assure that each is carrying out its responsibilities.
Gregory B. Kalush Chairman of the Board, Chief Executive Officer and President
February 6, 2001
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of Interphase Corporation:
We have audited the accompanying consolidated balance sheets of Interphase Corporation (a Texas corporation) and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Interphase Corporation and subsidiaries as of December 31, 2000 and 1999, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States.
ARTHUR ANDERSEN LLP Dallas, Texas February 6, 2001
INTERPHASE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Basis of Presentation: The consolidated financial statements include the financial statements of Interphase Corporation (the "Company") and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
In September 1999, the Company completed the sale of its VOIP business. Accordingly, the Company's consolidated financial statements and notes included herein, for all periods presented reflect the VOIP business as a discontinued operation in accordance with Accounting Principles Board Opinion No. 30. See further discussion of the sale in Note 7.
Cash and Cash Equivalents: The Company considers cash and temporary investments with original maturities of less than three months, as well as interest bearing money market accounts, to be cash equivalents.
Investments - Investments in debt and equity securities are classified as available for sale with unrealized holding gains and losses reported in other comprehensive income. Management determines the appropriate classification of securities at the time of purchase. Earnings from debt securities are calculated on a yield to maturity basis and recorded in the results of operations.
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):
Years ended December 31, 2000 1999 ------------------------- Raw Materials $ 9,439 $ 8,044 Work-in-process 3,280 3,352 Finished Goods 474 282 ------- ------- Total $ 13,193 $ 11,678 ======= =======
Property and Equipment: Property and equipment are recorded at cost. Depreciation and amortization are provided over the estimated useful lives of depreciable assets using the straight-line method. When property and equipment are sold or otherwise retired, the cost and accumulated depreciation applicable to such assets are eliminated from the accounts, and any resulting gain or loss is reflected in current operations. Related depreciation expense and accumulated depreciation were as follows (in thousands):
Year ended Depreciation Accumulated December 31: Expense Depreciation ------------ ------- ------------ 2000 $ 1,370 $ 9,755 1999 2,035 10,334 1998 2,436 10,339
The depreciable lives of property and equipment are as follows:
Machinery and equipment 3-5 years Leasehold improvements 3-10 years Furniture and fixtures 5-7 years
Capitalized Software: Capitalized software represents various software licenses purchased by the Company and utilized in connection with the Company's network and mass storage products as well as the general operations of the Company. Capitalized software is amortized over 3-5 years utilizing the straight-line method. Related amortization expense and accumulated amortization were as follows (in thousands):
Year ended Amortization Accumulated December 31: Expense Amortization ------------ ------- ------------ 2000 $ 345 $ 2,139 1999 280 1,875 1998 302 1,656
Research and Development Subsidy: Included in other assets at December 31, 2000 and 1999, is a receivable for a subsidy of $72,000 and $529,000, respectively, due from the French government related to the research and development activities of the Company's Paris based operation.
Long-Lived Assets: Intangibles and other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Any impairment would be recognized in operating results if a permanent reduction in value were to occur.
Revenue Recognition: Revenues consist of product revenues and are recognized in accordance with SEC Staff Accounting Bulletin (SAB) 101, "Revenue Recognition." Product revenues are recognized upon shipment, provided fees are fixed and determinable, a customer order is obtained, and collection is probable. Revenues from reseller agreements are typically recognized when the product is sold through to the end customer. Deferred revenue consists of revenue from reseller arrangements and certain arrangements with extended payment terms.
Concentration of Credit Risk: Financial instruments which potentially expose the Company to concentrations of credit risk consist primarily of trade accounts receivable. The majority of the Company's sales have been to original equipment manufacturers of computer systems.
The Company conducts credit evaluations of its customers' financial condition and limits the amount of trade credit extended when necessary. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information.
Research and Development: Research and development costs are charged to expense as incurred.
Foreign Currency Translation: Assets and liabilities of certain non-U.S. subsidiaries are translated at current exchange rates, and related revenues and expenses are translated at average exchange rates in effect during the period. Resulting translation adjustments are reflected in shareholders' equity as a component of comprehensive income (loss).
Income Taxes: The Company determines its deferred taxes using the liability method. Deferred tax assets and liabilities are based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of enacted tax law. The Company's consolidated financial statements include deferred income taxes arising from the recognition of revenues and expenses in different periods for income tax and financial reporting purposes.
Certain Reclassifications: Certain prior year amounts have been reclassified to conform with the 2000 presentation.
Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires Company management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
2. ACQUISITION
As a result of the acquisition of Synaptel, S.A. ("Synaptel") and certain product rights acquired from Cisco Systems, Inc. ("Cisco"), the Company acquired intangible assets related to developed technologies, assembled workforce and goodwill. Developed technology and assembled workforce are amortized on a straight-line basis over a 7-year period. Goodwill is amortized on a straight-line basis over a 15-year period. Acquired product rights from Cisco are amortized ratably over the anticipated revenue stream of such products sold. The December 31, 2000 intangible balances at historical cost and related amortization expense and accumulated amortization were as follows (in thousands):
3. MARKETABLE SECURITIES
Marketable securities consist of investments in equity and debt securities. As of December 31, 2000 and 1999, the fair market value of marketable securities was $6.9 million and $5.3 million, respectively. During 2000, the Company realized a gain of $689,000 from the sale of securities. The Company had an unrealized loss of $887,000 (net of taxes) in 2000, and an unrealized gain of $692,000 (net of taxes) in 1999, with respect to certain available-for-sale securities.
4. DERIVATIVES AND HEDGINGS
The Company addresses certain financial exposures through a controlled program of risk management that includes the use of derivative financial instruments on a minimal basis. The Company does not utilize or expect to utilize derivative financial instruments for trading or speculative purposes.
During the periods presented, the Company entered into certain foreign currency forward exchange contracts to reduce the risk of foreign exchange exposure. Neither the foreign currency transaction gains and losses nor the gains and losses on the forward contracts were significant. Additionally, the Company entered into a hedge on a portion of an equity investment realizing a gain of $689,000 on the transaction. The Company has no equity hedge contracts outstanding as of December 31, 2000.
On January 1, 2001, the Company adopted SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS 137 and SFAS 138. SFAS 133 requires all derivatives to be recorded at fair value. Changes in the fair values of derivatives are recorded in either the statement of operations or as a component of comprehensive income, depending on whether the derivative qualifies as a hedge, and depending on the type of hedging relationship that exists. Adoption of this standard did not have a material effect on the Company's financial statements.
5. ACCRUED LIABILITIES
Accrued liabilities consisted of the following (in thousands):
Years ended December 31, 2000 1999 ----------------------- Accrued outside commissions $ 300 $ 362 Accrued property tax 281 147 Accrued other 2,235 1,077 ------ ------ $ 2,816 $ 1,586 ====== ======
6. CREDIT FACILITY
The Company maintains a credit facility with a bank. The credit facility consists of an $8.5 million acquisition term loan, a $2.5 million equipment financing facility and a $5 million revolving credit facility. The revolving credit facility matures June 30, 2002, and bears interest at the bank's base rate (currently 8.5%). The term loan and equipment loan are payable in equal quarterly installments totaling $548,000 plus accrued interest with final payment due November 30, 2001. The Company has the ability to satisfy the quarterly payments on the term notes through borrowing under the revolving credit component of the credit facility. The credit facility is collateralized by marketable securities, accounts receivable and equipment. The credit facility includes certain restrictive financial covenants including, among others, tangible net worth, total liabilities to tangible net worth, interest coverage, quick ratio, debt service coverage, and is subject to a borrowing base calculation. At December 31, 2000, the Company was in compliance with all covenants. At December 31, 2000, total availability under the revolving credit facility was $1.5 million.
The total scheduled debt principal payments are $1.7 million in 2001, $3.5 million in 2002 and zero thereafter.
7. DISPOSITION OF ASSETS
In June 1999, the Company sold an 80% interest in part of its VOIP business, Quescom, for $1,172,000 to the former owner of Interphase's Paris Operation. The sales proceeds consisted of $300,000 due at closing with a $830,000 technology license fee. In 2000, the remaining $830,000 due for the technology license fee was collected and recorded as a gain on disposal of discontinued operations. Additionally, in 2000, the Company sold its 20% interest in Quescom for $400,000, resulting in a gain of $91,000. The total gain in 2000 was $571,000 net of $350,000 tax.
In September 1999, the Company sold its other VOIP business, Zirca Corporation ("Zirca"), along with the technologies developed by Zirca for $300,000 cash and stock valued at $517,680 on the date of disposition, to UniView Technologies, resulting in a gain of $140,000, net of $86,000 tax. The UniView securities received as part of the agreement are included on the Balance Sheet in Marketable Securities, and accounted for as available-for- sale securities.
8. INCOME TAXES
The Company has not recorded a valuation allowance with respect to the various domestic deferred tax assets, as management believes it is more likely than not that these assets will be realized. Management periodically reviews the realizability of the Company's deferred tax assets, as appropriate, when existing conditions change the probability of realization. The differences between the provision for income taxes computed on income before income taxes at the U.S. federal statutory income tax rate (34%) and the amount shown in the Consolidated Statements of Operations are presented below (in thousands):
9. NET INCOME PER COMMON AND COMMON EQUIVALENT SHARE
Anti-dilutive options of 348,000, 117,000 and 944,000 were excluded from the dilutive calculation in 2000, 1999 and 1998, respectively.
10. COMMON STOCK
Amended and Restated Stock Option Plan: In 2000, the Company amended and restated its Stock Option Plan which, as amended, authorizes the issuance to employees of up to 3,500,000 shares of common stock in incentive stock options (as defined in section 422 of the Internal Revenue Code of 1986, as amended) and nonqualified stock options. The exercise price of the incentive stock options must be at least equal to the fair market value of the Company's common stock on the date of the grant, while the exercise price of nonqualified stock options may be less than fair market value on the date of grant, as determined by the Board. The Board may provide for the exercise of options in installments and upon such terms, conditions and restrictions as it may determine. Options granted prior to January 1, 1999 generally vest ratably over a 5-year period from the date of grant. Options granted since January 1, 1999 generally vest ratably over a 3-year period from the date of grant. The term of option grants may be up to 10 years. Options are canceled upon the lapse of three months following termination of employment except in the event of death or disability, as defined.
United Kingdom Stock Option Sub-Plan: This plan was adopted in 1988 for the benefit of the Company's employees located in the United Kingdom. This plan authorizes the issuance of options to purchase common stock of the Company at prices at least equal to the fair market value of the common stock on the date of the grant. The Board may provide for the exercise of options in installments and upon such terms, conditions and restrictions as it may determine. Options granted prior to January 1, 1999 generally vest ratably over a 5-year period from the date of grant. Options granted since January 1, 1999 generally vest ratably over a 3-year period from the date of grant. The term of option grants may be up to 10 years. The options are canceled upon termination of employment, except in the event of death, retirement or injury, as defined.
France Stock Option Sub-Plan: This plan was adopted in 2000 for the benefit of the Company's employees located in France. This plan authorizes the issuance of options to purchase common stock of the Company at prices at least equal to the fair market value of the common stock on the date of the grant. Unless otherwise decided by at the sole discretion of the Board, the options vest (i) 75% after the expiration of a two-year period from the date of grant and (ii) 25% after the expiration of a three-year period from the date of grant. Except for the events provided under the French tax code, the shares cannot be sold or otherwise disposed of for a period of five years from the date of grant. The term of option grants may be up to 10 years. Options are canceled upon the lapse of three months following termination of employment except in the event of death or disability, as defined.
Amended and Restated Director Stock Option Plan: In 2000, the Company amended and restated its Director Stock Option Plan, which, as amended, authorizes the issuance to directors of up to 750,000 shares of common stock. Stock option grants pursuant to the directors' plan will vest in one year and have a term of 10 years. The exercise prices related to these options are equal to the market value of the Company's stock on the date of grant. The following table summarizes the transactions under the Director Stock Option Plan (in thousands, except option prices):
Rights Agreement: The Board of Directors has adopted a Shareholder Rights Plan whereby each holder of record as of December 29, 2000 received a right to purchase from the Company one share of common stock of the Company at a price of $93 per share for each share held. These rights can only be exercised after certain events occur, such as if a person or entity acquires, or makes a tender or exchange offer to acquire, 15% or more of the Company's common stock and the rights expire ten years from the record date. Upon acquisition of 15% or more of the Company's common stock, each right not owned by the acquiring person or group will be adjusted to allow the purchase for $93 of a number of shares having a then market value of $186. These rights are intended to provide the Company certain antitakeover protections. The Board of Directors may terminate the Rights Plan, or redeem the rights for $0.01 per right, at any time until the tenth business day following a public announcement of a 15% or more stock acquisition. The Company had reserved 7,000,000 shares of common stock for this plan.
The rights were distributed to shareholders as of the record date as a non- taxable dividend. The rights are attached to and trade with Interphase common stock until the occurrence of one of the triggering events, at which time the rights would become detached from the Company's common stock.
Pro-Forma Net Income (Loss): The Company's pro forma net income (loss) for 2000, 1999 and 1998 would have been $ (2.2 million), $1.5 million and $1.6 million respectively, resulting in diluted earnings per share of $(0.36), $0.24 and $0.29, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for options granted in 2000, 1999 and 1998: risk-free interest rate of 6% for each year 2000, 1999 and 1998, expected dividend yield of zero in each year, expected term of 3.88 in 2000, 4.83 years in 1999 and 4.41 years in 1998, and expected volatility of 140% in 2000, 140.29% in 1999 and 117.31% in 1998. The weighted average fair valuation per share was $12.63 in 2000, $14.25 in 1999 and $5.42 in 1998.
Because the SFAS No. 123 method of accounting has not been applied to options granted prior to January 1, 1995, the resulting pro-forma compensation cost may not be representative of that to be expected in future years.
11. RELATED-PARTY TRANSACTIONS
The Company paid approximately $253,000, $366,000 and $425,000 for the years ended December 31, 2000, 1999 and 1998, respectively, to certain outside directors of the Company or their firms for professional services. The Company believes the terms were equivalent to those of unrelated parties.
12. STOCK REPURCHASE
Effective October 1998, the Company approved a stock repurchase agreement with Motorola, Inc. to purchase all of the shares owned by Motorola for $4.1 million or $6.25 per share, ratably from October 1998 to July 2002. Under the terms of the agreement, Motorola retains the right as an equity owner and has assigned its voting rights to the Company. The Company cancels the stock upon each purchase. The future scheduled payments are classified as redeemable common stock in the accompanying consolidated Balance Sheet. As of December 31, 2000, 375,336 shares have been purchased for $2.3 million and retired.
13. EMPLOYEE BENEFIT PLAN
The Company maintains a defined contribution plan for those employees who meet the plan's length of service requirements. Under the defined contribution plan, employees may make voluntary contributions to the plan, subject to certain limitations, and the Company matches employee's contributions up to 3% of the employees' annual salary. The total expense under this plan was $256,000, $232,000 and $240,000 for the years ended December 31, 2000, 1999 and 1998 respectively. The Company offers no post- retirement or post-employment benefits.
14. OTHER FINANCIAL INFORMATION
Major Customers: During 2000, sales to Hewlett Packard and Terayon Communication Systems accounted for $10 million or 18% and $5.9 million or 11% of consolidated revenues, respectively, and were the only customers accounting for more than 10% of consolidated revenues. During 1999, sales to Hewlett Packard accounted for $36.9 million or 50% of consolidated revenues, and was the only customer accounting for more than 10% of consolidated revenues. During 1998, sales to Hewlett Packard accounted for $28.3 million or 41% of consolidated revenues, and was the only customer accounting for more than 10% of consolidated revenues.
Commitments: The Company leases its office, research and development and manufacturing facility and certain manufacturing equipment under noncancelable operating leases to 2005. Rent expense related to these leases is recorded on a straight-line basis. As of December 31, 2000, operating lease commitments having noncancelable terms of more than one year are as follows (in thousands):
Year ending December 31: ------------------------ 2001 $ 985 2002 878 2003 262 2004 182 2005 84 Thereafter -
Total rent expense for operating leases was approximately as follows (in thousands):
Year Total Rent Expense ---- ------------------ 2000 $1,120 1999 1,231 1998 1,089
Contingencies: The Company is involved in various legal actions and claims arising in the ordinary course of business. Management believes that such litigation and claims will be resolved without material effect on the Company's financial position or results of operations.
15. SEGMENT DATA
The Company is principally engaged in the design, development and manufacturing of advanced technologies for enterprise networks and storage environments. The chief operating decision-makers review financial information presented on a consolidated basis, accompanied by information by geographic region for purposes of making operating decisions and assessing financial performance. Accordingly, the Company considers itself to be in a single industry segment.
16. QUARTERLY FINANCIAL DATA (Unaudited)