Item 1. Business.
Company Background
Interphase Corporation (“Interphase” or the “Company”) is a diversified information and communications technology company, committed to innovation through the process of identifying, developing and introducing new products and services. The Company provides its customers solutions for connectivity, interworking and packet processing. Clients of the Company’s communications networking products include Alcatel-Lucent, Fujitsu Ltd., Genband, Hewlett Packard, Nokia Solutions and Networks (formerly Nokia Siemens Networks), and Samsung.
The Company also offers engineering design and manufacturing services to customers from a wide variety of industries within the electronics market.
Interphase recently expanded its business to include penveu®, a handheld device that adds interactivity to the installed base of projectors and large screen displays, making any flat surface, from pull down screens to HDTVs, an interactive display system. penveu is an affordable and portable solution that targets the education and enterprise markets.
The Company, founded in 1974, is headquartered in Carrollton, Texas, with sales offices in the United States and Europe.
Key Terms and Definitions
Because Interphase is a technology company, many terms used by the Company may be unfamiliar to those outside the industry. The following are some key terms that may be useful in helping the reader understand the products, technologies, and markets relevant for the Company:
AdvancedMC™ or AMC (Advanced Mezzanine Card) - Specifications that define the mezzanine card form factor for use with Advanced Telecommunications Computing Architecture (ATCA) or MicroTCA platforms. AdvancedMC enhances ATCA flexibility by extending its high-bandwidth, multi-protocol interface to individual hot-swappable modules, which are optimized for packet-based telecom applications. Together, ATCA blades equipped with AdvancedMC modules give telecom equipment manufacturers (or TEMs) a versatile platform for quickly building modular telecom systems that could be designed, manufactured, scaled, upgraded and serviced at a much lower cost. AdvancedMC is a trademark of PCI Industrial Computer Manufacturers Group (PICMG).
Broadband - A transmission facility (communications link) that has bandwidth (capacity) greater than a traditional voice-grade line.
Building Blocks - The basic board-level products used in a system. These products are combined with other hardware and software building blocks to build a network element, system and/or application.
CompactPCI (CPCI) - An industrial-grade variation of the PCI bus standard that utilizes the Versa Module Eurocard (VME) form factor. CompactPCI was 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 9s” (i.e., 99.999%) reliability. Often referred to as cPCI, it is a standardized architecture for printed circuit boards (governed by PICMG) used in the embedded systems industry, particularly in carrier communications and industrial computing market segments.
Gateway Appliances - Network elements that provide translation functions between multiple protocols used for transfer of data and to control information across networks.
Gigabit Ethernet (GigE) - A family of frame-based computer networking technologies for local area networks (LANs). Ethernet operates over twisted wire, coaxial cable and fiber optic cables at speeds starting at 10 Mbps. The original 10 Mbps specification was extended to a speed of 100 Mbps transmission bandwidth with Fast Ethernet and to 1 Gbps with Gigabit Ethernet. GigE is now the most popular variant being deployed. Ethernet itself has evolved to the next 10 Gbps transmission bandwidth capability. As network bandwidth usage continues to rapidly expand world-wide, 10 Gbps is becoming a commonplace offering in enterprise and service provider networks.
Interworking - The ability to seamlessly communicate between devices supporting dissimilar protocols, such as frame relay and Asynchronous Transfer Mode (ATM), by translating between the protocols, not through encapsulation.
Internet Protocol (IP) - The standard method or protocol by which data is sent from one computer to another on the Internet.
OC-3/STM-1 - The American and the European standards (respectively) for optical connections at 155.52 Mbps. This line speed is very common in telecommunications access networks.
Packet Processing - Real-time wire-speed analysis and processing of packets in an IP network.
PCI Mezzanine Card (PMC) - 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, thus expanding the processing or I/O density of a single system slot.
SS7 (Signaling System 7) - The protocols used in the public switch telephone network (PSTN) 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, and it also routes local calls based on the first three digits of the phone number.
T1/E1 - A digital transmission link with a capacity of 1.544 Mbps (1,544,000 bits per second) or 2.048 Mbps for the European E1 standard. 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.
Time-division multiplexing (TDM) - A type of digital or analog multiplexing in which two or more signals, or bit streams, are transferred apparently simultaneously as sub-channels in one communication channel, but physically are taking turns on the channel.
Business Strategy
The Company’s business strategy leverages nearly forty years of development and manufacturing expertise; this experience, coupled with a process for identifying innovative product and solution ideas, is aimed not only at developing its core business, but also at identifying and launching into new high-growth businesses which will continue to help the Company to diversify its products and services into a variety of potential new markets. The Company’s core business has long been providing networking input/output (I/O) devices that serve as building blocks within a telecommunications or enterprise network infrastructure. The Company is now primarily focused upon a strategy to expand its reach into innovative and sometimes disruptive technologies and services where the Company believes it has the technology and process excellence to be successful. The Company’s goals are increasing the value of its product line, strengthening its portfolio with new solutions and diversifying into attractive new markets. Thus far, the Company is focusing its efforts in three main areas.
Telecommunications and Enterprise Products
The market for the Company’s network connectivity products has declined as native IP-based networks continue to proliferate. However, the Company believes its products in this area should remain viable in networks for several more years, although in shrinking numbers. The Company has expanded its market reach and revenue opportunities from its telecommunications product portfolio through its interworking product line, which include the iSPAN 3632 AMC, and the 92XX Gateway family of products. All of these products provide the necessary protocol interworking between the TDM networks and IP-based networks, at various levels of channelization, and typically offer customers a significant cost reduction from alternative approaches to accomplish the interworking function. The Company’s packet processing products utilize Cavium’s OCTEON multi-core processor product line. The Company relies on its custom design services as well as its experience in thermal analysis and design to differentiate itself from other suppliers of such products. Given the challenging thermal demands of these multi-core processors, these capabilities are critical to the Company’s customers’ success in their system design efforts and are key factors to Interphase’s success in this product area.
Embedded Computer Vision
In 2010 the Company selected embedded computer vision technology as a new strategic area of business, and has identified the market for interactive displays and interactive whiteboards as a target market that the Company could disrupt with this technology. In early 2010, the Company began the development of penveu, an innovative interactive display product the Company believes will be disruptive to this market. The Company began hiring key talent in the area of embedded computer vision, digital signal processing, and embedded microcontroller systems. Due to the disruptive nature of the product on its intended market, the development was kept confidential until the announcement of the product in April 2012. The general availability of penveu is May 2014. The Company protects its intellectual property rights incorporated in penveu through the filing of patents (provisional, utility, and design) and trademarks. The Company anticipates that penveu is the first of many products that the Company will continue to identify, invent, develop, and market that will use its acquired skills in the embedded computer vision technology.
Engineering Design and Manufacturing Services
Electronic Engineering Design Services
The Company’s offered engineering design services now reach beyond traditional telecommunications and enterprise network technologies into new areas such as location-based mobile services offerings and high efficiency enterprise computing solutions among others. These engagements are expected to be not only revenue generators for Interphase in the near term but also, in many cases, to provide additional opportunities for future growth.
Electronic Manufacturing Services
This service is offered to clients in need of high-quality and highly responsive electronic product manufacturing. Interphase differentiates itself on the basis of customer responsiveness, high quality, local presence, and low total cost of engagement. The Company has positioned its manufacturing services to offer high-quality manufacturing services to those under-served by the top-tier contract manufacturers. With its unique breadth of experience, the Company is further able to differentiate itself by providing additional services to customers who are in need of converting an engineering design to a manufacturing-ready product. The Company has recently experienced strong growth in this area of the business and anticipates this growth to accelerate as new customers complete their qualification process and existing customers increase their production orders. This service offering makes Interphase’s manufacturing capability more financially efficient while expanding the markets from which the Company generates revenues.
Product and Service Overview
Telecommunications and Enterprise Products
The Company offers innovative, high-performance solutions to the converging voice, data, and video communication segments of the telecommunications market while also offering high-value solutions addressing the enterprise computing market. Interphase offers solutions primarily in the following three categories, supporting various form factors such as AMC, PCI-X, PCIe, CPCI, and PMC as well as related software applications:
Network Connectivity
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T1/E1 communication controllers that primarily support SS7 signaling
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OC-3/STM-1 ATM network interface cards (NICs)
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Ethernet NICs
Interworking
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OC-3/STM-1 interworking modules
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Gateway appliances (broadband access gateway and media converter)
Multi-core Packet Processors
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GigE packet processors
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10 GigE packet processors
penveu
penveu is a handheld device that replaces the need for interactive whiteboards, interactive projectors and expensive large touch screen displays. penveu addresses many of the shortcomings of alternate interactive technologies, because it can be installed in as little as 30 seconds, and it can be added to projectors and large screen displays that are already installed. penveu is aimed at the education market, with more than 30 million classrooms worldwide, and it can also be used effectively in the corporate training market as well as the enterprise market. The benefits of penveu include:
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Easy and quick to install: No software installation is required, and penveu does not have to be installed on the wall like interactive whiteboard and touch displays.
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Accurate: Due to a unique and patent-protected technology which embeds invisible targets in the display stream, the pen can calculate its position accurately and requires no calibration.
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Flexibility: penveu can operate while touching the screen or display, and up to 40 feet away from it, giving the teacher (or presenter) the flexibility to move around the classroom (or other room) without losing the ability to continue to interact with the content.
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Easy to use: penveu is a self contained interactive display system that creates its own digital ink on any projected media. There is no need for any additional applications or features to be enabled; a user can just plug it in and begin writing.
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Portability: Due to the small size of the overall product, it can be carried by traveling presenters and installed in new locations very quickly.
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Price: While providing all the functionality of an interactive whiteboard and much more, penveu will cost less than one-quarter of the average price of a typical installed interactive whiteboard. For the education market, after the educator discount, the 8GB product price will be $499.
Services
Interphase has been designing and manufacturing products for the electronics industry for nearly 40 years and offers this expertise and capability to customers as a separate service. Since Interphase has honed its processes of design for manufacture, and can supplement these services with engineering design services, Interphase believes it can improve its customers’ ability to meet their outsourcing needs by using Interphase as a qualified “one-stop shop” supplier.
Interphase offers services in two basic categories:
Engineering Design Services
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Specifications gathering
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Program management
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Detailed electrical, mechanical and thermal design (high performance/cost optimized)
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Wireless services design for cellular, WiFi, Bluetooth, and other services
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Full mechanical enclosure design
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Plastics designs for consumer products
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Metal enclosures for Enterprise and Telecommunication application
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Software design for drivers and applications
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Application software porting and integration
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Rapid prototyping
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Transition of design to manufacturing (productization), including design for manufacturability and testability, product design verification testing, product certification and production test development
Electronics Manufacturing Services
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Supply chain management
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Custom branding and control
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Production assembly
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System integration
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Testing and delivery
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Inventory management and logistics
Marketing and Customers
The Company’s network connectivity, interworking and multi-core packet processor products are sold to Telecommunications Equipment Manufacturers (TEMs) for inclusion into telecommunications and networking infrastructure solutions designed for use in wireless carrier networks. Enterprise products are delivered to server manufacturers for integration into server platforms for delivery of high-performance application platforms for enterprise networking. penveu is aimed mainly at the education market, but will also be marketed to corporate and training users as well. The Company’s engineering design and electronics manufacturing services customers are from a variety of different markets within the electronics industry.
During 2013, sales to Nokia Solutions and Networks (formerly Nokia Siemens Networks) and Alcatel-Lucent were $3.5 million (or 23%) and $3.3 million (or 21%), respectively, of the Company’s consolidated revenues. During 2012, sales to Alcatel-Lucent and Nokia Siemens Networks were $3.8 million (or 27%) and $1.9 million (or 13%), respectively, of the Company’s consolidated revenues. During 2011, sales to Nokia Siemens Networks and Alcatel-Lucent were $6.7 million (or 31%) and $4.6 million (or 21%), respectively, of the Company’s consolidated revenues. No other customers individually accounted for more than 10% of the Company’s consolidated revenues in any of those years.
The Company markets its products through its direct sales force, manufacturers’ representatives, value-added distributors, and web and social media tools. In addition to the Company's headquarters in Carrollton, Texas, the Company has sales offices located in or near Seattle, Washington; Amsterdam, Holland; and Helsinki, Finland. The Company's direct sales force sells products directly to key customers and supports manufacturers’ representatives and the distribution channel. See Note 13 of the accompanying notes to the consolidated financial statements for information regarding the Company’s geographic assets and revenues.
Manufacturing and Supplies
Manufacturing operations are conducted at the Company's facility located in Carrollton, Texas. The Company's products consist primarily of various integrated circuits, other electronic components and firmware assembled onto both internally-designed and customer-designed printed circuit boards, and in some cases, assembled with plastic components to create a device for consumer use.
The Company uses sole-sourced components on some of its products, as well as standard off-the-shelf items. Historically, the Company has not experienced significant long-term problems in maintaining an adequate supply of these parts sufficient to satisfy customer demand. The Company believes it has good relationships with its vendors.
The Company generally does not manufacture products to stock its finished goods inventory. Instead, substantially all of the Company's production is dedicated to specific customer purchase orders. As a result, the Company has had limited requirements to maintain significant finished goods inventories. However, the Company’s requirements to maintain its finished goods inventory may increase in the future with the market release of penveu.
Patents, Copyrights, Trademarks, Licenses and Intellectual Property
While the Company believes its success is ultimately dependent upon the innovative skills of its personnel and its ability to anticipate and adapt to technology changes, its success also depends, in part, upon its ability to protect proprietary technology contained in its products. The Company is building a patent portfolio related to its embedded computer vision technology, specifically penveu. Since the Company began filing patents for penveu, U.S. patent 8,127,997 has been issued (on July 10, 2012) and U.S. Patent No. 8,446,364 has issued (on May 21, 2013). International patent applications based on these and other pending U.S. applications have been filed, including those published as PCT International Patent Application Publications WO/2011/115764 (published September 22, 2011) and WO/2012/121969 (published on September 13, 2012). Additional utility patent applications and a design patent application have been filed by the Company in the U.S., and a design patent has been registered in some countries outside of the U.S.
Interphase does not hold any patents relative to its telecommunications and enterprise product lines already deployed or released to the market. Instead, as it relates to product lines already deployed or released to the market, the Company relies upon a combination of trade secrets, 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. Furthermore, 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 suitable for intellectual rights protection.
Interphase, the Interphase logo, penveu, the penveu logo, iWARE, iSPAN, iNAV, and SlotOptimizer are trademarks or registered trademarks of Interphase Corporation.
Many of the Company’s products are designed to include intellectual property obtained from third parties. The Company has entered into several licensing agreements that allow the Company to incorporate third-party intellectual property into its product line, thereby increasing its functionality, performance and interoperability.
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, paying damages, developing non-infringing technology or acquiring licenses to the technology which is the subject of asserted infringement.
Employees
At December 31, 2013, the Company had 67 regular full-time employees, of which 26 were engaged in manufacturing and quality assurance, 16 in research and development, 12 in sales, sales support, customer service and marketing and 13 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 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 significant.
None of the Company’s employees are covered by a collective bargaining agreement, and there have been no work stoppages. The Company considers its relationship with its employees to be good.
Competition
The Company’s primary competition for its telecommunications and enterprise products currently includes embedded computing vendors specifically dedicated to telecommunication and enterprise I/O market segments. In the case of specific product offerings, Interphase may also face competition from TEMs’ in-house design teams. Increased competition and commoditization of network interface technologies could result in price reductions, reduced margins and loss of market share. The Company’s products and services compete on the basis of the following key characteristics: performance, functionality, reliability, pricing, quality, customer support skills, ease of integration, time-to-market delivery capabilities, flexibility and compliance with industry standards. Most of the Company’s major TEM customers have chosen to outsource the design, manufacture and software integration of certain communications controllers and protocol processing, and the recent market conditions and reduction in resources have forced some network equipment providers to utilize additional off-the-shelf products for their product design.
The Company’s primary competition for its engineering design and manufacturing services includes small and mid-tier domestic engineering design and manufacturing services providers which offer full life-cycle services to take new or existing product design ideas from concept into manufactured products. These companies are usually regionally based and are of comparable size. The Company also faces competition, from time to time, from companies that offer only manufacturing services or only design services, and from companies that offer similar services from offshore centers. Other than price, the Company competes for its engineering design and manufacturing services on the basis of experience, process and product quality and speed of delivery.
The Company’s primary competition for its penveu product includes manufacturers of large interactive whiteboards, manufacturers of interactive projectors, and manufacturers of after-market pen tracking products. Interactive whiteboards limit users to the screen, operate only with projectors, are difficult and expensive to install, once mounted on the wall are not portable at all, and require constant calibration. While interactive projectors offer the flexibility of on-board and remote operation, they still require professional installation, are not portable, and are expensive. After-market pen tracking products restrict the users to at-board operation, require professional installation, and constant calibration. penveu, on the other hand, operates at the board and up to 40 feet away from it; is portable and can be carried by a traveling salesperson; can be installed by a user with no professional help in less than a minute; requires no software installation; works with any Microsoft or Apple product; requires no calibration to maintain its accuracy. In addition, penveu addresses the market of already-installed projectors and displays, requiring no new display technology installation and is only a fraction of the cost of an interactive whiteboard or interactive projector.
Available Information
The Company maintains a website at www.interphase.com. Copies of this Annual Report on Form 10-K and copies of the Company’s Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments thereto are or will be available free of charge at the Company’s website as soon as reasonably practical after they are filed with the Securities and Exchange Commission (“SEC”). The public may read and copy any materials the Company files with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The general public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains a website at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC.
Item 1A.
Item 1A. Risk Factors.
The continued issues in global credit and financial markets and adverse global economic conditions could materially and adversely affect our business and results of operations.
The global credit and financial markets have been experiencing significant disruptions for several years, including diminished liquidity and credit availability. There can be no assurance that there will not be continuing, or even further, deterioration in credit and financial markets. These economic uncertainties affect businesses such as ours in a number of ways, making it difficult to accurately forecast and plan our future business activities. The continued tightening of credit in financial markets may lead consumers and businesses to postpone spending, which may cause our customers to decrease or delay their existing and future orders with us. In addition, financial difficulties experienced by our suppliers, distributors, or customers could result in product delays, increased accounts receivable defaults and inventory challenges.
We are unable to predict the likely duration and severity of the current and potential future disruptions in the credit and financial markets and adverse global economic conditions. There can be no assurance that if the current uncertain economic conditions continue, it will not have a material adverse effect on our operating results, financial condition and cash flows.
The marketing and sale of our products involve lengthy sales cycles. This and other factors make business forecasting extremely difficult and can lead to significant fluctuations in period-to-period results.
We have experienced fluctuations in our period-to-period revenue and operating results in the past and may experience similar fluctuations in the future. Our sales, on both an annual and a quarterly basis, can fluctuate as a result of a variety of factors, many of which are beyond our control. We may have difficulty predicting the volume and timing of orders for products, and delays in closing orders can cause our operating results to fall short of anticipated levels for any period. Delays by our OEM customers in producing products that incorporate our products could also cause operating results to fall short of anticipated levels. Other factors that may particularly contribute to fluctuations in our revenue and operating results include success in achieving design wins, the market acceptance of the OEM products that incorporate our products, the rate of adoption of new products, competition from new technologies and other companies, and the variability of the life cycles of our customers’ products.
Because fluctuations can happen, we believe that comparisons of the results of our operations for preceding quarters are not necessarily predictive of future quarters and that investors should not rely on the results of any one quarter as an indication of how we will perform in the future. Investors should also understand that, if the revenue or operating results for any quarter are less than the level expected by securities analysts or the market in general, the market price of our common stock could immediately and significantly decline.
The telecommunications signaling and networking business is characterized by rapid technological change and frequent introduction of new products.
The market for our telecommunications products is characterized by rapid technological change and the frequent introduction of products based on new technologies. The overall telecommunications and networking industry is volatile, as the effects of new technologies, new standards, new products and short life cycles contribute to changes in the industry and the performance of industry participants. Future revenue will depend upon our ability to anticipate technological change and to develop and introduce enhanced products of our own on a timely basis that comply with new industry standards. New product introductions, or the delays thereof, could contribute to quarterly fluctuations in operating results as orders for new products commence and orders for existing products decline. Moreover, significant delays can occur between a product introduction and commencement of volume production. A typical time period from design-win of one of our telecommunications products to actual production is 18 to 30 months. This timing has varied significantly during times of mergers, economic instability, and technology changes affecting platform architectures. Our inability to develop and manufacture new products in a timely manner, the existence of reliability, quality or availability problems in our products or their component parts, or the failure to achieve market acceptance for our products could have a material adverse effect on our operating results, financial condition and cash flows.
We must successfully manage new product and service introductions and the entry into new markets.
As described under Item 1. “Business - Business Strategy” above, we are focused upon a strategy to expand our reach into innovative and sometimes market-disruptive technologies and services where we believe we have the technology and process excellence to be successful. As a result we intend to introduce new products, services and technologies, enhance existing products and services, and effectively stimulate customer demand for new and upgraded products. We expect that these new product and service introductions will lead us into markets where we have not previously competed. The success of new product and service introductions will depend on a number of factors including, but not limited to, timely and successful development of products or services, market acceptance, our ability to manage the risks associated with new products and production ramp issues, the effective management of purchase commitments and inventory levels in line with anticipated product demand, the availability of products in appropriate quantities and costs to meet anticipated demand, the risk that new products may have quality or other defects in the early stages of introduction, and the availability of qualified persons to perform new services. Accordingly, we cannot determine in advance the ultimate effect that new product and service introductions and the entry into new markets will have on our operating results, financial condition and cash flows.
Litigation against us could require significant time of our management, be costly to defend against and/or negatively impact our operating results.
As noted under Item 3. “Legal Proceedings” below, twenty-five former employees (“Plaintiffs”) of Interphase SAS, a France domiciled subsidiary of Interphase Corporation, brought suit in France against Interphase SAS alleging various causes of action and rights to damages relating to claims of wrongful dismissal of employment, specific French employment indemnities, general economic losses, and contractual claims relating specifically to their employment relationship and contracts entered into between the individual and Interphase SAS. The lawsuits were filed between November 2010 and April 2011 in the Labor Court of Boulogne-Billancourt, France and the Administrative Court of Cergy-Pontoise, France. The various claims and assertions arose from, and related to, the Plaintiffs’ release from employment as part of the restructuring actions taken during the third quarter of 2010. See Note 6 in the notes to the consolidated financial statements for more information regarding the 2010 restructuring plan. The updated statement of claim is for an aggregate payment of approximately €2.1 million, which translated to approximately $2.9 million at December 31, 2013, related to these claims. We have been successful in defending most, though not all, of these claims in the two courts. The Labor Court entered an adverse judgment as to claims totaling approximately €265,000, which translated to approximately $365,000 at December 31, 2013, most of which has been paid. Two of the claims remaining pending in the courts, and a number of the Plaintiffs have filed appeals of the Labor Court’s dismissals of their claims. We believe that the Plaintiffs’ remaining and appellate claims are without merit and plan to continue to vigorously defend ourselves against them.
Although we do not believe that the Plaintiffs’ remaining and appellate claims have merit, litigation (particularly outside of the United States) is inherently unpredictable, and it is possible that we would be required to pay an additional amount to the Plaintiffs. If the potential required amount is significant, the payment could have a material adverse effect on our financial condition. Further, if this litigation were to continue for an extended time, our defense of the Plaintiffs’ claims, even if successful, could require us to pay significant costs (including fees of counsel) and require time and energy of management that could otherwise be spent on our business, all of which could negatively affect our financial condition and operations.
We operate in an intensely competitive marketplace and many of our competitors have greater resources than we do.
We face competition from a number of established and emerging companies, both public and private, in the markets we serve. Our principal competitors generally have established brand name recognition and market positions, and have substantially greater financial resources to deploy on promotion, advertising, research and product development. In addition, as we broaden our product and service offerings, we may face competition from new competitors. Companies in related markets could offer products with functionality similar or superior to our product offerings. Increased competition could result in significant pricing pressures, which could result in significantly lower average selling prices for our products and services. We may not be able to offset the effects of any price reductions with an increase in sales volumes, cost reductions or otherwise. We expect competition to increase as a result of industry consolidations and alliances, as well as the potential emergence of new competitors. There can be no assurance that we will be able to compete successfully with existing or new competitors or that competitive pressures will not have a material adverse effect on our operating results, financial condition and cash flows.
The loss of one or more key customers, or reduced spending by customers, could significantly impact our operating results, financial condition and cash flows.
While we enjoy very good relationships with our customers, there can be no assurance that our customers will continue to purchase products from us at the current levels. Orders from our customers are affected by factors such as new product introductions, product life cycles, inventory levels, manufacturing strategies, contract awards, competitive conditions and general economic conditions. Customers typically do not enter into long-term volume purchase contracts with us, and they have certain rights to extend or delay the shipment of their orders. The loss of one or more of our major customers, or the reduction, delay or cancellation of orders or a delay in shipment of products to such customers, could have a material adverse effect on our operating results, financial condition and cash flows.
Schedule delays, cancellations of programs and changes in customer markets can delay or prevent a design-win from reaching the production phase, which could negatively impact our operating results, financial condition and cash flows.
In the telecommunications industry, a design-win occurs when a customer or prospective customer notifies us that our product has been selected to be integrated with their product. Ordinarily, there are a number of steps between the design-win and when customers initiate production shipments. Design-wins reach production volumes at varying rates, typically beginning approximately 18 to 30 months after the design-win occurs. A variety of risks, such as schedule delays, customer consolidations, cancellations of programs and changes in customer markets, can delay or prevent the design-win from reaching the production phase. The customer's failure to bring its product (into which our product is designed) to the production phase could have an adverse effect on our operating results, financial condition and cash flows.
Design defects, errors or problems in our products or services could harm our reputation, revenue and profitability.
If we deliver products or services with errors, defects or problems, our credibility, market acceptance and sales of our products and services could be harmed. Further, if our products or services contain errors, defects or problems, we may be required to expend significant capital and resources to alleviate such problems. Defects could also lead to product liability lawsuits against us or our customers, tort or warranty claims, increased insurance costs or increased service and warranty costs, any of which could harm our business. We have agreed to indemnify our customers in some circumstances against liability from defects in our products. While no such litigation currently exists, product liability litigation arising from errors, defects or problems, even if it resulted in an outcome favorable to us, would be time consuming and costly to defend. Existing or future laws, or unfavorable judicial decisions, could negate any limitation-of-liability provisions that are included in our license agreements. A product liability claim, whether or not successful, could seriously harm our business, financial condition and results of operations.
We maintain insurance coverage for product liability claims. Although we believe this coverage is adequate, there can be no assurance that coverage under insurance policies will be adequate to cover specific product liability claims made against us. In addition, product liability insurance could become more expensive and difficult to maintain and may not be available in the future on commercially reasonable terms or at all. The amount and scope of any insurance coverage may be inadequate if a product liability claim is successfully asserted against us.
If our third party suppliers fail to produce quality products or parts in a timely manner, we may not be able to meet our customers’ demands.
Certain components used in our products are currently available from one or only a limited number of sources. There can be no assurance that future supplies will be adequate for our needs or will be available with acceptable prices and terms. Inability in the future to obtain sufficient limited-source components, or to develop alternative sources, could result in delays in product introduction or shipments, and increased component prices could negatively affect gross margins, either of which could have a material adverse effect on our operating results, financial condition and cash flows.
Regulations related to conflict minerals could adversely impact our business.
The Dodd-Frank Wall Street Reform and Consumer Protection Act contains provisions to improve transparency and accountability concerning the supply of certain minerals (gold, tin, tungsten and tantalum), known as conflict minerals, originating from the Democratic Republic of Congo and adjoining countries that are believed to be benefitting armed groups. As a result, the SEC has adopted due diligence, disclosure and reporting requirements for companies which manufacture products that include components containing such minerals. Since we manufacture products which may use one or more of such minerals, we will be required to comply with the new SEC rules, with our first required report due in May 2014, covering our activities in 2013. We have spent, and expect to continue to spend, money and time of key personnel to comply with these disclosure requirements, including diligence to determine the sources of minerals used in our products and other potential changes to products, processes or sources of supply as a consequence of such verification activities. Compliance with the SEC rules could adversely affect the sourcing, supply and pricing of materials used in our products. Because there may be only a limited number of suppliers offering “conflict free” minerals, we cannot be sure that we will be able to obtain necessary minerals from such suppliers in sufficient quantities or at competitive prices. In addition, our supply chain is complex and we may not be able to easily verify the origins for all minerals used in our products. We may face reputational challenges with our customers and other stakeholders if our products contain minerals not determined to be conflict free or if we are unable to sufficiently verify the origins of minerals contained in the components included in our products through the due diligence procedures that we implement.
Although we expect to be able to file our first required report in May 2014, our ability to do so depends on our implementation of new processes and procedures and on information supplied by numerous suppliers of products or components to us that contain, or potentially contain, conflict minerals. To the extent that the information that we receive from our suppliers is inadequate or inaccurate, or our procedures to obtain the information do not fulfill the SEC’s requirements, we could face both reputational and SEC-enforcement risks.
We are dependent on one manufacturing facility, and if there is an interruption in production we may not be able to deliver products on a timely basis.
We manufacture our products at our Carrollton, Texas facility, and have established alternative manufacturing capabilities through a third party in the event of a disaster in the current facility. Even though we have been successful in establishing an alternative third-party contract manufacturer, there can be no assurance that we would be able to retain its services at the same costs we currently enjoy. In the event of an interruption in production, we may not be able to deliver products on a timely basis, which could have a material adverse effect on our revenue and operating results. Although we currently have business interruption insurance and a disaster recovery plan to mitigate the effect of an interruption, no assurances can be given that such insurance or recovery plan will adequately cover lost business as a result of such an interruption.
Because business forecasting is difficult and involves uncertainty, we may fail to accurately forecast demand for our products which may expose us to risk associated with inventory.
We must identify the right product mix and maintain sufficient raw materials inventory on hand to meet customer orders. Failure to do so could adversely affect our sales and earnings. However, if circumstances change, there could be a material impact on the net realizable value of our inventory, which could adversely affect our results.
We may be unable to effectively protect our proprietary technology, which would negatively affect our ability to compete. Also, if our products are alleged to violate the proprietary rights of others, our ability to compete would be negatively impacted.
Our success depends partly upon certain proprietary technologies developed within our products. Historically, we have relied principally upon trademark, copyright and trade secret laws to protect our proprietary technologies. Over the last few years, we also filed a number of patents and trademarks with the United States Patent and Trademark Office and internationally. In addition, we generally enter into confidentiality or license agreements with our customers, distributors and potential customers, which limit access to, and distribution of, the source code to our software and other proprietary information. Our employees are subject to our strict employment policy regarding confidentiality. There can be no assurance that the steps taken by us in this regard will be adequate to prevent misappropriation of our technologies or to provide an effective remedy in the event of a misappropriation by others.
Although we believe our products do not infringe on the proprietary rights of third parties, there can be no assurance that infringement claims will not be asserted, possibly resulting in costly litigation in which we may not ultimately prevail. Adverse determinations in such litigation could result in the loss of proprietary rights, subject us to significant liabilities, require that we seek licenses from third parties or prevent us from manufacturing or selling our products, any of which could have a material adverse effect on our operating results, financial condition and cash flows.
It may be necessary to obtain technology licenses from others due to the large number of patents in the markets we serve and the rapid rate of issuance of new patents and new standards or to obtain important new technology. There can be no assurance that these third party technology licenses will be available on commercially reasonable terms. The loss of, or inability to, obtain any of these technology licenses could result in delays or reductions in product shipments. Such delays or reductions in product shipments could have a material adverse effect on our operating results, financial condition and cash flows.
We depend on key personnel to manage our business effectively.
Our success and the pursuit of our business strategy depend on the continued contributions of our personnel and on our ability to attract and retain skilled employees for our current and future business. Changes in personnel could adversely affect our operating results, financial condition and cash flows.
We derive a substantial portion of our revenues from outside of North America, which exposes us to additional business risks, including political, economic and currency risks.
In 2013, we derived approximately 47% of our revenues from sales outside of North America. Economic and political conditions in some of these markets, as well as different legal, tax, accounting and other regulatory requirements, may adversely affect our operating results, financial condition and cash flows. We are exposed to adverse movements in foreign currency exchange rates because we conduct business on a global basis and in some cases in foreign currencies. Our former operations in France were transacted in the local currency and converted into U.S. Dollars based on published exchange rates for the periods reported and were therefore subject to risk of exchange rate fluctuations (See Item 7A. “Quantitative and Qualitative Disclosures about Market Risk - Foreign Currency Risk” below).
We may require additional working capital to fund operations and expand our business.
We believe our current financial resources will be sufficient to meet our present working capital and capital expenditure requirements for the next twelve months.
However, we may need to raise additional capital before this period ends to:
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fund research and development of new products beyond what is expected in 2014;
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expand product and service offerings beyond what is contemplated in 2014 if unforeseen opportunities arise;
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fund activities related to the introduction of new products and services or the entry into new markets beyond what is anticipated in 2014;
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respond to a rapid increase in demand for our products;
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take advantage of potential acquisition opportunities in the current economic environment;
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invest in businesses and technologies that complement our current operations; or
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respond to unforeseen competitive pressures.
Our future liquidity and capital requirements will depend upon numerous factors, including the success of the existing and new product and service offerings and potentially competing technological and market developments. However, any projections of future cash flows are subject to substantial uncertainty. From time to time, we expect to evaluate the acquisition of, or investment in, businesses and technologies that complement our current operations. If current cash, marketable securities, lines of credit and cash generated from operations are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity securities, issue debt securities or increase our working capital line of credit. The sale of additional equity securities could result in additional dilution to shareholders. There can be no assurance that financing will be available in amounts or on terms acceptable, if at all. If adequate funds are not available on acceptable terms, our ability to develop or enhance products and services, take advantage of future opportunities or respond to competitive pressures would be limited. This limitation could negatively impact our results of operations, financial condition and cash flows.
We have incurred significant losses, which may result in volatility in our stock price.
We reported net losses of $2.7 million, $3.8 million and $505,000 for the years ended December 31, 2013, 2012 and 2011, respectively. In order to achieve consistent profitability, we will need to generate higher revenues while containing costs and operating expenses. We cannot be certain that our revenues will grow or that we will generate sufficient revenues to achieve and maintain profitability on a long-term, sustained basis. If we fail to achieve and maintain profitability, the market price of our common stock will likely be negatively impacted.
We may experience significant period-to-period quarterly and annual fluctuations in our revenue and operating results, which may result in volatility in our stock price.
The trading price of our common stock is subject to wide fluctuations in response to quarter-to-quarter fluctuations in operating results, general conditions in the telecommunications and networking industry and other events or factors. In addition, stock markets have experienced extreme price and trading volume volatility in recent years. This volatility has had a substantial effect on the market price of the securities of many high-technology companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of our common stock, which has historically had relatively small trading volumes. As a result, small transactions in our common stock can have a disproportionately large impact on its price.
If our stock does not continue to be traded on an established exchange, an active trading market may not exist and the trading price of our stock may decline.
Our common stock is currently listed on the NASDAQ Capital Market. The NASDAQ Capital Market’s continued listing standards for our common stock require, among other things, that (i) the closing bid price for our common stock not fall below $1.00; (ii) we have at least 300 beneficial holders and/or holders of record of our common stock; (iii) our stockholders’ equity not fall below $2.5 million; (iv) we have more than 500,000 shares held by the public (excluding officers, directors, and beneficial holders of 10% or more) with a market value of at least $1.0 million; and (v) we have at least two registered and active dealers meeting the requirements set forth in the standards. If our common stock was threatened with delisting from the NASDAQ Capital Market, we may, depending on the circumstances, seek to extend the period for regaining compliance with NASDAQ listing requirements or we may pursue other strategic alternatives to meet the continuing listing standards.
In addition, we may choose to voluntarily delist from NASDAQ, or even deregister from the reporting requirements with the SEC (i.e., “go dark”), in the event we believe we may be subject to a delisting proceeding, or for any other reason our Board of Directors determines it to be in the best interest of our stockholders.
If our common stock is delisted by, or we voluntarily delist from, the NASDAQ Capital Market, our common stock may be eligible to be traded on the OTC Bulletin Board or the Pink OTC Markets. In such an event, it could become more difficult to dispose of, or obtain accurate quotations for the price of, our common stock, and there also would likely be a reduction in our coverage by security analysts and the news media, which could cause the price of our common stock to decline further.
Certain provisions of Texas law and our shareholder rights plan may make it more difficult to acquire us, even if such acquisition may be beneficial to our shareholders.
Certain provisions of the Texas corporate statute, to which we are subject, limits business combinations with any “affiliated shareholder,” which is generally any person or group of persons that is, or has been during the preceding three years, the beneficial owner of 20% or more of our outstanding voting shares. Also, we have in place a shareholder rights plan, commonly referred to as a “poison pill” (see Note 8 in the notes to the consolidated financial statements). The statutory provisions and the rights plan may discourage, delay or prevent a third party from acquiring us or acquiring a large portion of our shares (including by initiating a tender offer), even if our shareholders might receive for their shares in any such acquisition a premium over the then current market price of the shares.
The cost of compliance or failure to comply with the Sarbanes-Oxley Act of 2002 may adversely affect our business.
As a smaller reporting company, we are not subject to the provisions of the Sarbanes-Oxley Act of 2002 that require an attestation report from our independent registered public accounting firm regarding our internal controls over financial reporting. If we cease to qualify as a smaller reporting company or as a non-accelerated filer, we would become subject to this requirement, which could cause us to incur substantial additional costs and may adversely affect our financial results. The failure of our independent registered public accounting firm to concur with management’s assessment of the effectiveness of our internal controls over financial reporting may result in investors losing confidence in the reliability of our financial statements, which may result in a decrease in the trading price of our common stock. It may also prevent us from providing the required financial information in a timely manner which could materially and adversely impact our business, our financial condition and the trading price of our common stock, and it may prevent us from otherwise complying with the standards applicable to us as a public company and subject us to additional regulatory consequences.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties.
The Company’s operations are conducted in a 43,000-square-foot leased facility located in Carrollton, Texas. The lease extends through February 2025. The Company believes that its facilities and equipment are in good operating condition and are adequate for its operations. The Company owns a large portion of the equipment used in its operations. Such equipment consists primarily of engineering equipment, manufacturing and test equipment, computer equipment and fixtures. In order to provide additional capacity, the Company also leases certain manufacturing equipment.
Item 3.
Item 3. Legal Proceedings.
Twenty-five former employees (“Plaintiffs”) of Interphase SAS, a France domiciled subsidiary of Interphase Corporation, brought suit in France against Interphase SAS alleging various causes of action and rights to damages relating to claims of wrongful dismissal of employment, specific French employment indemnities, general economic losses, and contractual claims relating specifically to their employment relationship and contracts entered into between the individual and Interphase SAS. The lawsuits were filed between November 2010 and April 2011 in the Labor Court of Boulogne-Billancourt, France and the Administrative Court of Cergy-Pontoise, France. The various claims and assertions arose from, and related to, the Plaintiffs’ release from employment as part of the restructuring actions taken during the third quarter of 2010. See Note 6 in the notes to the consolidated financial statements for more information regarding the 2010 restructuring plan. The updated statement of claim is for an aggregate payment of approximately €2.1 million, which translated to approximately $2.9 million at December 31, 2013. The Company believes that the Plaintiffs’ claims were without merit and has vigorously defended itself in these lawsuits.
On March 22, 2012, a hearing was conducted before the Labor Court of Boulogne-Billancourt, France related to the claims of twenty-three of the twenty-five former employees. On May 31, 2012, the Court reported that the four judges’ votes were split; therefore, another hearing before the Labor Court took place on January 25, 2013. The same four judges heard the case again, along with a professional judge from another court to ensure that a majority decision would be reached.
The decision of the Labor Court regarding the claims of twenty-two former employees was rendered on March 22, 2013. All of those claims were rejected, because the Labor Court ruled that the redundancy procedure was regular and that redundancies were based on valid reasons, except claims from four Plaintiffs based on non-competition indemnity (amounting in total to approximately €265,000, which translated to approximately $340,000 at March 31, 2013). During the three months ended March 31, 2013 and the three months ended December 31, 2013, the Company recorded a charge of approximately $340,000 and $115,000 (to reflect payroll taxes corresponding to the allowed claims), respectively, classified as other loss on its condensed consolidated statements of operations and as a current liability on its condensed consolidated balance sheets in connection with the non-competition indemnity. Regarding the claims of the four Plaintiffs based on non-competition indemnity, one of these Plaintiffs has filed an appeal of the Labor Court’s decision (the part of the judgment dismissing his claims based on the redundancy procedures; the economic and financial justification for the redundancy); therefore, related to this Plaintiff, the Company is currently evaluating its appeal options. No payment to this Plaintiff is to be made until the appeal process is resolved. The Company is not filing an appeal related to the other three Plaintiffs’ claims based on non-competition indemnity. For these three Plaintiffs, the Company must pay approximately €238,000, which translated to approximately $305,000 at March 31, 2013. Approximately $275,000 was paid during the three months ended December 31, 2013. Fourteen other former employees also filed an appeal. The date of the hearing before the Court of Appeals of Versailles is on October 8, 2014. The Company intends to vigorously defend itself against these appeals.
On May 22, 2012, a hearing was conducted before the Labor Court of Boulogne-Billancourt, France related to the claims of one of the twenty-five former employees with non-executive status. On July 31, 2012, the Court reported that the four judges’ votes were split; therefore, the Labor Court decided to join this case to the cases of the other twenty-three former employees described above in order to be heard again at the same hearing. Therefore, this case was heard again at the hearing on January 25, 2013 before the Labor Court. On March 22, 2013, the Labor Court rejected this former employee's claims. This former employee is one of the fourteen other former employees that filed an appeal, as described in the preceding paragraph.
Among the twenty-five cases described above, two former employees were made redundant related to a decision of the Labor Inspector to authorize their redundancy. Because of their protected status as employee representatives, their redundancy required the prior authorization of the French administration. Each of those former employees also filed a claim before the Administrative Tribunal in order to challenge the decision of the Labor Inspector which authorized their redundancy. Although each such claim or action is directed against the State, Interphase is also a party to these proceedings. The decision of the Administrative Tribunal regarding these two cases was rendered on February 3, 2014. The Administrative Tribunal dismissed these two former employees’ claims challenging the administrative decision authorizing their redundancy. Each former employee will have two months to file an appeal from the receipt of official notice of the dismissal of his claim.
For one of the twenty-five former employees, who was an employee representative, the Labor Court granted the Company’s motion at the January 25, 2013 hearing; the Labor Court rejected the Plaintiff’s claim to hear the case on the merits, regarding the alleged irregularity of the information and consultation procedure, and postponed this case in deference to the pending case before the Administrative Tribunal as described above. This case was heard again on September 27, 2013, and the Labor Court rendered the same decision (to postpone the case to a hearing on September 5, 2014). On September 5, 2014, the case will not be heard on the merits if the Plaintiff files an appeal against the Administrative Tribunal’s judgment before the Administrative Court of Appeal.
On June 12, 2012, a hearing was conducted with the Labor Court of Boulogne-Billancourt, France related to the claims of one of the twenty-five former employees, who was also an employee representative. The Labor Court granted the Company’s motion and rejected the Plaintiff’s claim to hear the case on the merits, regarding the alleged irregularity of the information and consultation procedure, and decided to postpone this case in deference to the pending case before the Administrative Tribunal as described above. This case was heard again on May 28, 2013. The Labor Court rendered the same decision and again postponed the hearing until the Administrative Tribunal makes its decision; therefore, this case will be heard again on June 17, 2014. On June 17, 2014, the case will not be heard on the merits if the Plaintiff files an appeal against the Administrative Tribunal’s judgment before the Administrative Court of Appeal.
Item 4.
Item 4. Mine Safety Disclosures.
None.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Since January 1984, shares of the Company's common stock have been traded on the NASDAQ Capital Market, the NASDAQ Global Market, or their predecessors, under the symbol INPH. The following table summarizes its high and low closing price for each quarter during 2012 and 2013 as reported by the NASDAQ Global Market or the NASDAQ Capital Market, as applicable.
The Company had approximately 1,200 beneficial owners of its common stock, of which 48 were of record, as of March 19, 2014.
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.
Stock Performance Graph
The following chart compares the cumulative total shareholder return of Interphase common stock during the years ended December 31, 2013, 2012, 2011, 2010 and 2009 with the cumulative total return of the NASDAQ composite index and the Dow Jones US Telecommunications Equipment TSM Index. The Company relied upon information provided by another firm with respect to the stock performance graph. The Company did not attempt to validate the information supplied to it other than review it for reasonableness. The comparison assumes $100 was invested on December 31, 2008 in the common stock of the Company and in each of the two indices, and assumes reinvestment of dividends.
Item 6.
Item 6. Selected Financial Data.
The selected financial data presented below under the captions "Statement of Operations Data" and "Balance Sheet Data" have been derived from the consolidated balance sheets and the related consolidated statements of operations at or for the years ended December 31, 2013, 2012, 2011, 2010 and 2009, and the notes thereto appearing elsewhere herein, as applicable.
It is important that you also read "Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Application of Critical Accounting Policies
The Company’s consolidated financial statements are based on the selection and application of significant accounting policies, which require management to make significant 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. Management believes the following are the more critical judgment areas in the application of the Company’s accounting policies that affect the Company’s financial condition, results of operations, and cash flows. Management has reviewed these critical accounting policies and related disclosures with the Audit Committee of the Board of Directors.
Revenue Recognition: Revenues consist of product and service revenues and are recognized in accordance with ASC Topic 605, “Revenue Recognition.” Product revenues and electronic manufacturing services revenues are recognized upon shipment, provided fees are fixed and determinable, a customer purchase order is obtained (when applicable), and collection is probable. Sales tax collected from customers and remitted to the applicable taxing authorities is accounted for on a net basis, with no impact to revenues. Service revenue, other than electronic manufacturing services revenue, is recognized as the services are performed. Deferred revenue consists primarily of advance payments for electronic manufacturing services where the goods have not yet shipped.
The Company’s engineering design services are typically provided on a fixed-fee basis. The revenues for such longer duration projects that require significant customization and integration are recognized using the percentage-of-completion method. In using the percentage-of-completion method, revenues are generally recorded based on the percentage of effort incurred to date on a contract relative to the estimated total expected contract effort. Significant judgment is required when estimating total contract effort and progress to completion on the arrangements as well as whether a loss is expected to be incurred on the contract. Management uses historical experience, project plans and an assessment of the risks and uncertainties inherent in the arrangement to establish these estimates. Uncertainties include implementation delays or performance issues that may or may not be within the Company’s control. Changes in these estimates could result in a material impact on revenues and net earnings (loss). If the Company is unable to develop reasonably dependable cost or revenue estimates, the completed contract method is applied under which all revenues and related costs are deferred until the contract is completed.
Warranty Reserve: The Company offers to its customers a limited warranty that its products will be free from defect in the materials and workmanship for a specified period. The Company has established a warranty reserve, as a component of accrued liabilities, for any potential claims. The Company estimates its warranty reserve based upon an analysis of all identified or expected claims and an estimate of the cost to resolve those claims. Changes in claim rates and differences between actual and expected warranty costs could impact the warranty reserve estimates.
Accounts Receivable and Allowance for Doubtful Accounts: The Company records accounts receivable at their net realizable value, which requires management to estimate the collectability of the Company’s trade receivables. A considerable amount of judgment is required in assessing the realization of these receivables, including the current creditworthiness of each customer and related aging of the past due balances. Management evaluates all accounts periodically and a reserve is established based on the best facts available to management. This reserve is also partially determined by using percentages applied to certain aged receivable categories based on historical results and is reevaluated and adjusted as additional information is received. After all attempts to collect a receivable have failed, the receivable is written off against the allowance for doubtful accounts.
Allowance for Returns: The Company maintains an allowance for returns, based upon expected return rates, when such return rates are estimable. The estimates of expected return rates are generally a factor of historical returns experience. Changes in return rates could impact allowance for return estimates.
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. 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. In assessing the ultimate realization of inventories, management is required to make judgments as to future demand requirements and compare that with the current or committed inventory levels. Reserve requirements generally increase as projected demand decreases due to market conditions, technological and product life cycle changes as well as longer than previously expected usage periods. The Company has experienced significant changes in required reserves in the past due to changes in strategic direction, such as discontinuances of product lines and declining market conditions. It is possible that significant changes in this estimate may occur in the future as market conditions change.
Stock-Based Compensation: Management estimates are necessary in determining compensation expense for both restricted stock and stock options with performance-based vesting criteria. Compensation expense for this type of stock-based award is recognized over the period from the date the performance condition is determined to be probable of being achieved through the date the applicable condition is expected to be achieved. If the performance condition is not considered probable of being achieved, no expense is recognized until such time as the performance condition is considered probable of being achieved, if ever. Management evaluates whether performance conditions are probable of being achieved on a quarterly basis.
Income Taxes: The Company determines its deferred taxes using the asset and liability method. Deferred tax assets and liabilities are based on the estimated future tax effects of differences between the financial statement basis 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.
The Company records a valuation allowance to reduce its deferred income tax assets to the amount that is believed to be realizable. The Company considers recent historical losses, future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. Management is continuously assessing the realizability of deferred tax assets.
The Company recognizes the impact of uncertain tax positions taken or expected to be taken on an income tax return in the financial statements at the amount that is more likely than not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized in the financial statements unless it is more likely than not of being sustained.
The Company is periodically engaged in various tax audits by federal, state and foreign governmental authorities incidental to its business activities. The Company records reserves for its estimated probable losses of these proceedings, if applicable. The Company is currently undergoing a tax audit in France.
Consolidated Statement of Operations as a Percentage of Revenue
Overview
During 2013 we continued to diversify our company into new markets while leveraging our core telecommunication products to generate meaningful revenues and gross margin. Revenue grew by 13% in 2013, including a 33% increase in services revenues and a 10% increase in our telecommunications product revenues. In addition, we continued to diligently manage our expenses and successfully reduced our operating expenses by 14%. Despite these accomplishments, we were unable to achieve the profitable year we desired in 2013, primarily due to the delay in bringing penveu to market.
Although we were excited for penveu to enter the beta phase of testing during 2013, we experienced some unexpected challenges related to the positioning system and certain areas of the user experience. However, we believe these technical issues have been resolved, and we expect to begin shipping penveu in May 2014.
In preparation of our anticipated growth, we moved into a new facility in Carrollton, Texas in the first quarter of 2014. This move was strategically important for several reasons. Our new space has enabled us to expand our current production capability and provides us additional room for future growth. At the same time, we have reduced our facility expenses. Furthermore, we have gained operational efficiencies since our company functions are now contiguous.
Results of Operations
Revenues: Total revenues for the years ended December 31, 2013, 2012 and 2011 were $15.6 million, $13.9 million and $22.0 million, respectively. Revenues increased by 13% in 2013 compared to 2012. This increase was primarily attributable to our services revenues, which increased approximately 33% to $4.3 million in 2013 compared to approximately $3.2 million in 2012. This increase was primarily related to increased electronic contract manufacturing services revenue of approximately $1.8 million, partially offset by decreased electronic engineering design services revenue of approximately $850,000. Additionally, our telecommunications product revenues increased approximately 10% to $11.1 million in 2013 compared to $10.1 million in 2012. Approximately 60% of this increase was due to revenue from a product purchased by two telecommunications equipment manufacturers. However, in October 2013, we were notified by one of these customers that it has cancelled the project that was using our product. As a result, we expect that future revenue from that product will be impacted to some degree. Nevertheless, our other, larger customer has expansion plans for its media gateway that uses our product; so some of this revenue may be restored for us. In addition, approximately 40% of this increase was due to revenue from a product purchased by a telecommunications equipment manufacturer who experienced a design win in China. These design wins typically are unpredictable in timing and not long in duration. This increased revenue was partially offset by a decrease of two telecommunications products that are end-of-life, which led to reduced revenue from these products in 2013. Our enterprise product revenues decreased approximately 94% to $23,000 in 2013 compared to $393,000 in 2012. All other revenues increased slightly to $156,000 in 2013 compared to $134,000 in 2012.
Revenues decreased by 37% in 2012 compared to 2011. This decrease was primarily attributable to our telecommunications product revenues, which decreased by approximately 43% to $10.1 million in 2012 compared to $17.8 million in 2011. This decrease reflects a general slowdown in telecommunications spending worldwide. This slowdown, coupled with the shift in subscriber growth toward emerging countries, where our customers have not been able to secure dominate market share, and the shift from circuit-switched network architectures toward packet-based IP network architectures resulted in a significant reduction in revenues from our telecommunications products. Additionally, our enterprise product revenues decreased approximately 75% to $393,000 in 2012 compared to $1.6 million in 2011 because the major customer roll-out driving this product line has been completed. Our services revenues increased approximately 31% to $3.2 million in 2012 compared to approximately $2.5 million in 2011. All other revenues decreased slightly to $134,000 in 2012 compared to $162,000 in 2011.
Gross Margin: Gross margin as a percentage of revenue for the years ended December 31, 2013, 2012 and 2011 was 40%, 44% and 48%, respectively. The decrease in gross margin percentage in 2013 compared to 2012 was primarily due to a shift in product mix toward lower margin products and services, partially offset by increased utilization of our manufacturing facility. We expect this trend to stabilize in future periods.
The decrease in gross margin percentage in 2012 compared to 2011 was primarily due to decreased utilization of our manufacturing facility.
Research and Development: Our investment in the development of new products through research and development was $3.0 million, $3.3 million and $3.8 million in 2013, 2012 and 2011, respectively. As a percentage of revenue, research and development expenses were 19%, 24% and 17% for 2013, 2012 and 2011, respectively. Research and development expenses decreased in 2013 compared to 2012 by $298,000. This decrease in research and development expense was made up of several items. A decrease in personnel-related expenses, as a result of the 2012 restructuring plan, represents approximately 56% of the decrease and a decrease in other personnel-related expenses, not associated with the 2012 restructuring plan, represents approximately 13% of the decrease. See Note 6 in the notes to the consolidated financial statements for more information regarding the 2012 restructuring plan. In addition, variable project-related expenses decreased approximately 28% during the period. These decreases in research and development expense were partially offset by a decrease in professional services activities. Engineering costs associated with these professional services activities generate revenue; therefore, the related expenses are recorded as cost of sales rather than research and development operating expenses. The decrease in professional services activities resulted in an increase in research and development expenses during the period of approximately $500,000. The decrease in research and development expense as a percentage of total revenue is due to revenue increasing while research and development expense decreased as described above. We will continue to monitor the level of our investments in research and development concurrently with actual revenue results.
Research and development expenses decreased in 2012 compared to 2011 by $524,000. During 2012, there was an increase in professional services activities, which resulted in an increase in services revenues. Engineering costs associated with these activities generate revenue; therefore, the related expenses are recorded as cost of sales rather than research and development operating expenses, resulting in a decrease of approximately 32% in research and development expenses in 2012 compared to 2011. In addition, there was a decrease in personnel and related expenses of approximately 31%, primarily as a result of the 2012 restructuring plan. See Note 6 in the notes to the consolidated financial statements for more information regarding the 2012 restructuring plan. Furthermore, variable research and development project-related expenses decreased approximately 19% during the year. The increase in research and development expense as a percentage of total revenue is due to revenue decreasing at a higher rate than research and development expense as described above.
Sales and Marketing: Sales and marketing expenses were $2.6 million, $3.4 million and $3.5 million in 2013, 2012 and 2011, respectively. As a percentage of revenue, sales and marketing expenses were 17%, 24% and 16% for 2013, 2012 and 2011, respectively. Sales and marketing expenses decreased by $733,000 in 2013 compared to 2012. Approximately 65% of the decrease in sales and marketing expense was due to a decrease in personnel-related expenses. The remaining decrease in sales and marketing expense was due to a decrease in marketing and tradeshow related expenses. The decrease in sales and marketing expense as a percentage of total revenue was due to revenue increasing while sales and marketing expense decreased as described above. We will continue to monitor the level of our investments in sales and marketing concurrently with actual revenue results.
Sales and marketing expenses decreased by $140,000 in 2012 compared to 2011. The increase in sales and marketing expense as a percentage of total revenue was due to revenue decreasing at a higher rate than sales and marketing expense.
General and Administrative: General and administrative expenses were $2.9 million, $3.0 million and $3.5 million in 2013, 2012 and 2011, respectively. As a percentage of revenue, general and administrative expenses were 19%, 22% and 16% in the years ended December 31, 2013, 2012 and 2011, respectively. General and administrative expenses decreased by $88,000 in 2013 compared to 2012. The decrease in general and administrative expense was primarily due to a decrease in depreciation and amortization expense of our Enterprise Performance Management software. The decrease in general and administrative expense as a percentage of total revenue was due to revenue increasing while general and administrative expense decreased as described above.
General and administrative expenses decreased by $495,000 in 2012 compared to 2011. Approximately 31% of the decrease in general and administrative expenses was due to a decrease in legal services expense. Additionally, there was a decrease in variable compensation expense of approximately 22% and a decrease in depreciation and amortization expense of approximately 20%. See Note 11 in the notes to the consolidated financial statements for more information regarding legal proceedings. The increase in general and administrative expense as a percentage of total revenue was due to revenue decreasing at a higher rate than general and administrative expense as described above.
Restructuring Charge: On October 19, 2012, we committed to a plan intended to improve the balance between our telecommunications product expenses with the reduced revenue levels of this product line. Under the 2012 restructuring plan, we reduced our workforce by 10 regular full-time positions. As a result of the 2012 restructuring plan, we recorded a restructuring charge of $253,000, classified as an operating expense, in the fourth quarter of 2012 related to future cash expenditures to cover employee severance and benefits. During the three months ended March 31, 2013, we reduced our restructuring charge by $67,000 related to reduced future cash expenditures related to severance and benefits for a former employee. The former employee’s accepting other employment in April 2013 reduced the amount of severance and benefit payouts by us. See Note 6 in the notes to the consolidated financial statements for more information regarding the 2012 restructuring plan.
On September 30, 2010, we initiated a restructuring plan to mitigate gross margin erosion by reducing manufacturing and procurement costs, streamline research and development expense and focus remaining resources on key strategic growth areas, and reduce selling and administrative expenses through product rationalization and consolidation of support functions. Under the 2010 restructuring plan, we reduced our worldwide work force by 39 regular full-time positions, including the closure of our European engineering and support center located in Chaville, France. As a result of the 2010 restructuring plan, we recorded a restructuring charge of approximately $3.3 million, classified as an operating expense, in the third quarter of 2010 related to future cash expenditures to cover employee severance and benefits and other related costs. See Note 6 in the notes to the consolidated financial statements for more information regarding the 2010 restructuring plan.
Interest Income, Net: Interest income earned on marketable securities, net of interest expense on long-term debt, was $7,000, $25,000 and $22,000 in 2013, 2012 and 2011, respectively.
Other Loss, Net: Other loss, net was $477,000 in 2013, $12,000 in 2012 and zero in 2011. Approximately 97% of other loss, net in 2013 was related to the adverse decision of the Labor Court of Boulogne-Billancourt, France on March 22, 2013 related to specific French employment indemnity claims and related payroll taxes of four former employees of our France domiciled subsidiary. See Note 11 in the notes to the consolidated financial statements for more information.
Income Taxes: The effective income tax rates for the periods presented differ from the U.S. statutory rate as we continue to provide a full valuation allowance for our net deferred tax assets at December 31, 2013, 2012 and 2011. Approximately 65% of the income tax expense for 2013 was due to tax in foreign jurisdictions and approximately 35% due to tax in domestic jurisdictions. The income tax expense for 2012 was nearly equally due to tax in domestic and foreign jurisdictions. The income tax expense for 2011 was primarily due to tax in a foreign jurisdiction.
Net Loss: We reported a net loss of approximately $2.7 million, $3.8 million and $505,000 for the twelve months ended December 31, 2013, 2012 and 2011, respectively.
New Product: On April 18, 2012 we announced the debut of penveu, a handheld device that adds interactivity to the installed base of projectors and large screen displays; making any flat surface, from pull down screens to HDTVs, an interactive display system. Using embedded computer vision technology, penveu works with any device with a VGA connection and requires no software or driver installation, no particular operating system, and no periodic calibration. penveu is targeted at the education market, and it can be used effectively in the corporate training market as well as the enterprise market. An independent source estimates the new interactive whiteboard installations market to grow to approximately $1.85 billion in revenue by 2017. However, penveu also has the unique ability to turn the estimated over 50 million projectors and 7 million large screen displays that are currently installed worldwide into interactive display devices. The retail price of penveu is less than 25% of the average price of a typical installed interactive whiteboard, and unlike an interactive whiteboard, penveu does not require the time and expense of installation. penveu will be offered and sold through our website, other online distributors, resellers, retailers and catalogs. Although we were excited for penveu to enter the beta phase of testing during 2013, we experienced some unexpected challenges related to the positioning system and certain areas of the user experience. However, we believe these technical issues have been resolved, and we expect to begin shipping penveu in May 2014.
Liquidity and Capital Resources
Consolidated Cash Flows
Cash and cash equivalents decreased by $2.5 million and $3.5 million for the year ended December 31, 2013 and 2012, respectively. Cash and cash equivalents increased by $2.7 million for the year ended December 31, 2011. Cash flows are impacted by operating, investing and financing activities.
Operating Activities: Trends in cash flows from operating activities for 2013, 2012 and 2011 are generally similar to the trends in our earnings adjusted by the provision for/(recovery of) uncollectible accounts and returns, provision for excess and obsolete inventories, depreciation and amortization and amortization of stock-based compensation. Cash used in operating activities totaled $2.1 million compared to a net loss of $2.7 million for the year ended December 31, 2013. Cash used in operating activities totaled $3.6 million compared to a net loss of $3.8 million for the year ended December 31, 2012. Cash provided by operating activities totaled $771,000 compared to a net loss of $505,000 for the year ended December 31, 2011. Allowances for doubtful accounts and returns increased during 2013 as we experienced a shift in our customers’ risk profiles and payment trends. We recovered $4,000 during 2012 in uncollectible accounts and returns due to improved collection activities throughout the year. Writedowns of excess and obsolete inventories increased by $63,000 and decreased by $3,000 in 2013 and 2012, respectively. Depreciation and amortization decreased by $156,000 and $188,000 in 2013 and 2012, respectively. Approximately 60% of the decrease in depreciation and amortization in 2013 related to our Enterprise Performance Management software and approximately 30% of the decrease in depreciation and amortization in 2013 related to our manufacturing equipment. The decrease in depreciation and amortization in 2012 was primarily due to our Enterprise Performance Management software. Amortization of stock-based compensation increased by $12,000 and $316,000 in 2013 and 2012, respectively. The increase in amortization of stock-based compensation in 2012 was primarily due to the issuance of stock options. See Note 8 in the notes to the consolidated financial statements for more information on stock-based compensation.
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: Net cash used in investing activities totaled $402,000 and $790,000 for the year ended December 31, 2013 and 2012, respectively. Net cash provided by investing activities totaled $1.3 million for the year ended December 31, 2011. Cash used in or provided by investing activities in each of the three years presented related principally to our investments in marketable securities, additions to property and equipment and capitalized software purchases. Additions to property and equipment during 2013 primarily related to leasehold improvements made to the Company’s new corporate office and manufacturing facility and software and equipment purchases for penveu and for our manufacturing operations. Additions to property and equipment during 2012 primarily related to software and equipment purchases for penveu and for our manufacturing function. Additions to property and equipment during 2011 primarily related to software and equipment purchases for our engineering, manufacturing and administrative functions. Purchases of marketable securities increased by approximately $4.2 million for 2013 compared to 2012. Purchases of marketable securities increased by approximately $4.5 million for 2012 compared to 2011. Proceeds from the sale of marketable securities increased by approximately $4.4 million for 2013 compared to 2012. Proceeds from the sale of marketable securities increased by approximately $2.4 million for 2012 compared to 2011.
Financing Activities: Net cash provided by financing activities totaled $26,000, $835,000 and $527,000 for the years ended December 31, 2013, 2012 and 2011, respectively, related to proceeds from the exercise of stock options.
Commitments
At December 31, 2013, we had no material commitments to purchase capital assets; however, planned capital expenditures for 2014 are estimated at approximately $1 million, approximately 75% of which relates to enhancements to our manufacturing equipment through a capital lease entered into in the first quarter of 2014. Our significant long-term obligations are operating leases on facilities and phone systems and future debt payments. In addition, at December 31, 2013, we had approximately $230,000 of non-cancelable purchase commitments for inventory as part of the normal course of business. We have not paid any dividends since our inception and do not anticipate paying any dividends in 2014.
The following table summarizes our future contractual obligations and payment commitments as of December 31, 2013 (in thousands):
(1)
At December 31, 2013, we had borrowings of $3.5 million under a $5.0 million revolving credit facility with a bank. The revolving credit facility matures on December 19, 2015 and is secured throughout the term of the credit facility by marketable securities.
(2)
We incur interest expense on the borrowings from the revolving credit facility at a rate of London Interbank Offered Rate (“LIBOR”) plus 1.0% to 1.5% applicable margin rate based on certain factors included in our credit agreement. At December 31, 2013, our interest rate on the borrowings from the revolving credit facility was 1.7%. We used the 1.7% rate to estimate interest expense for 2014 through December 2015. The interest expense estimate is $59,500 annually for the years 2014 through December 2015.
(3)
We lease our facilities under non-cancelable operating leases with the longest terms extending to February 2025.
(4)
Our operating lease at our former Plano headquarters location included a $70,000 letter of credit issued to our landlord which could only be used in the case of bankruptcy, insolvency, or the uncured non-payment of monetary obligations of such lease. The letter of credit, if accessed, would be funded by our existing revolving credit facility.
(5)
We lease our phone system under a non-cancelable operating lease extending to October 2014.
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 our liquidity needs for working capital, capital expenditures and debt service for the next twelve months. To the extent our actual operating results or other developments, including the anticipated financial impact of the second quarter of 2014 release of penveu, differ from our expectations, our liquidity could be adversely affected.
We periodically evaluate our liquidity requirements, alternative uses of capital, capital needs and available resources in view of, among other things, our capital expenditure requirements and estimated future operating cash flows. As a result of this process, we have in the past sought, and may in the future seek, to raise additional capital, refinance or restructure indebtedness, issue additional securities, repurchase shares of our common stock or take a combination of such steps to manage our liquidity and capital resources. In the normal course of business, we may review opportunities for acquisitions, joint ventures or other business combinations. In the event of any such transaction, we may consider using available cash, issuing additional equity securities or increasing the indebtedness of the Company or its subsidiaries.
Recently Issued Accounting Pronouncements
See Note 12 in the notes to the consolidated financial statements for more information regarding recently issued accounting pronouncements, including the expected dates of adoption and estimated effects on our consolidated financial statements.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk.
Foreign Currency Risk
We are exposed to adverse movements in foreign currency exchange rates because we conduct business on a global basis and, in some cases, in foreign currencies. The Company’s operations in France were transacted in the local currency and converted into U.S. Dollars based on published exchange rates for the periods reported and were therefore subject to risk of exchange rate fluctuations. The Euro to U.S. Dollar translation accounted for charges of approximately $4,000, $14,000 and $27,000 for the years ended December 31, 2013, 2012 and 2011, respectively.
Market Price Risk
We had no equity hedge contracts outstanding as of December 31, 2013 or 2012.
Interest Rate Risk
Our investments are subject to interest rate risk. Interest rate risk is the risk that our financial condition and results of operations could be adversely affected due to movements in interest rates. We invest our 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 our money market funds and the short-term nature of our time deposits and debt securities portfolio, these assets are particularly sensitive to changes in interest rates. We manage this risk through investments with shorter-term maturities and varying maturity dates.
A hypothetical 50 basis point increase in interest rates would result in an approximate decrease of less than 1% in the fair value of our available-for-sale securities at December 31, 2013. This potential change is based on sensitivity analyses performed on our marketable securities at December 31, 2013. Actual results may differ materially. 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 December 31, 2012.
We maintain a $5.0 million revolving bank credit facility maturing December 19, 2015 with an applicable interest rate on any outstanding balances under the credit facility based on London Interbank Offered Rate (“LIBOR”) plus a 1.0% to 1.5% applicable margin rate based on certain factors included in our credit agreement. The interest rate on the borrowings under the revolving credit facility was 1.7% and 1.2% at December 31, 2013 and 2012, respectively. The unused portion of the credit facility is subject to an unused facility fee ranging from .25% to .75% depending on total deposits with the creditor. A hypothetical 50 basis point increase in LIBOR would increase annual interest expense on this credit facility by approximately $17,500. All borrowings under this facility are secured by marketable securities. Subsequent to December 31, 2013 and prior to the Company’s filing of the consolidated financial statements, the outstanding balance on the credit facility was repaid.
Item 8.
Item 8. Financial Statements and Supplementary Data.
See Item 15(a). “Exhibits and Financial Statement Schedules” below.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
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 annual report. Based on that evaluation, the CEO and CFO concluded that the Company’s disclosure controls and procedures are designed, and are effective, to give reasonable assurance that the information required to be disclosed by the Company in reports that it files under the Securities Exchange Act of 1934 is accumulated and communicated to management, including the CEO and CFO, to allow timely decisions regarding disclosure and that information is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.
Changes in Internal Controls
The Company maintains a system of internal controls that is 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. From time to time the Company may experience changes to its internal controls due, for example, to employee turnover, re-balancing of workloads, extended absences and promotions of employees. However, there were no changes in our internal controls over financial reporting during the fourth quarter of the year ended December 31, 2013 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s board of directors, management and other associates, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
(1)
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;
(2)
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
(3)
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2013. In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission, known as COSO, in “Internal Control - Integrated Framework (1992).” Based on the results of its evaluation, the Company’s management has concluded that the internal control over financial reporting was effective as of December 31, 2013. This annual report does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. As we are a smaller reporting company, internal control over financial reporting is not subject to attestation by our registered public accounting firm pursuant to Section 404(c) of the Sarbanes-Oxley Act of 2002 that permits us to provide only management's report in this annual report.
Item 9B.
Item 9B. Other Information.
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
Directors
See information regarding the directors and nominees for director under the heading “Election of Directors” in the Proxy Statement for the Annual Meeting of Shareholders to be held May 7, 2014, which is incorporated herein by reference.
Executive Officers
See information regarding the executive officers under the heading “Executive Officers” in the Proxy Statement for the Annual Meeting of Shareholders to be held May 7, 2014, which is incorporated herein by reference.
Code of Ethics
The Company has adopted a Code of Business Conduct, which applies to all members of the board of directors and employees, including its Chairman and Chief Executive Officer, its Chief Financial Officer and its Corporate Controller. The Code of Ethics is available on the Company’s website at www.interphase.com. The Company intends to satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding an amendment to, or waiver from, a provision of this Code of Ethics by posting such information on its website, at the address specified above, and, to the extent required by the listing standards of the NASDAQ Capital Market, by filing a Current Report on Form 8-K with the Securities and Exchange Commission disclosing such information.
Item 11.
Item 11. Executive Compensation.
See information regarding executive compensation under the heading “Executive Compensation” in the Proxy Statement for the Annual Meeting of Shareholders to be held May 7, 2014, which is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
See information regarding security ownership of certain beneficial owners and management under the headings “Principal Shareholders” and “Executive Compensation” in the Proxy Statement for the Annual Meeting of Shareholders to be held May 7, 2014, which is incorporated herein by reference.
The following table sets forth information as of December 31, 2013 regarding the Company’s equity compensation plans:
See Note 8 of the accompanying notes to the consolidated financial statements for information regarding the Company’s shareholder-approved stock incentive plans.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
See information regarding certain relationships, related transactions and director independence under the headings “Election of Directors,” “Audit Committee,” “Nominating and Governance Committee,” “Executive Compensation,” and “Certain Related Transactions” in the Proxy Statement for the Annual Meeting of Shareholders to be held May 7, 2014, which is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services.
See information regarding principal accountant fees and services under the heading “Ratification of Appointment of Independent Registered Public Accounting Firm for the Year Ending December 31, 2014” in the Proxy Statement for the Annual Meeting of Shareholders to be held May 7, 2014, which is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
(a)
(1)
Financial Statements.
Reference is made to the listing on page of all financial statements filed as a part of this report.
(2)
Financial Statement Schedules.
All schedules are omitted because they are not applicable or the required information is presented in the consolidated financial statements or notes thereto.
(3)
Exhibits.
Reference is made to the Index to Exhibits on page E-1 for a list of all exhibits filed with this report.
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.
INTERPINTERPHASE CORPORATION
By: /s/ Gregory B. Kalush
Date: March 27, 2014
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 27, 2014.
Name
Title
/s/ Gregory B. Kalush
Chairman of the Board,
Gregory B. Kalush
Chief Executive Officer and President
(Principal executive officer)
/s/ Thomas N. Tipton, Jr.
Chief Financial Officer, Secretary,
Thomas N. Tipton, Jr.
Vice President of Finance and Treasurer
(Principal financial and accounting officer)
/s/ Mark D. Kemp
Director
Mark D. Kemp
/s/ Michael J. Myers
Director
Michael J. Myers
/s/ Kenneth V. Spenser
Director
Kenneth V. SpenseR
/s/ Christopher B. Strunk
Director
Christopher B. Strunk
* All schedules are omitted because they are not applicable or the required information is presented in the consolidated financial statements or notes thereto.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
Interphase Corporation
We have audited the accompanying consolidated balance sheets of Interphase Corporation (a Texas corporation) and subsidiaries (the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive loss, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2013. 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 the standards of the Public Company Accounting Oversight Board (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. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Interphase Corporation and subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America.
/s/ GRANT THORNTON LLP
Dallas, Texas
March 27, 2014
INTERPHASE CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
INTERPHASE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
The accompanying notes are an integral part of these consolidated financial statements.
INTERPHASE CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
INTERPHASE CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
INTERPHASE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
INTERPHASE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of the Business: Interphase Corporation (“Interphase” or the “Company”) is a diversified information and communications technology company, committed to innovation through the process of identifying, developing and introducing new products and services. The Company provides its customers solutions for connectivity, interworking and packet processing. Clients of the Company’s communications networking products include Alcatel-Lucent, Fujitsu Ltd., Genband, Hewlett Packard, Nokia Solutions and Networks (formerly Nokia Siemens Networks), and Samsung.
The Company also offers engineering design and manufacturing services to customers from a wide variety of industries within the electronics market.
Interphase recently expanded its business to include penveu®, a handheld device that adds interactivity to the installed base of projectors and large screen displays, making any flat surface, from pull down screens to HDTVs, an interactive display system. penveu is an affordable and portable solution that targets the education and enterprise markets.
The Company, founded in 1974, is headquartered in Carrollton, Texas, with sales offices in the United States and Europe. See Note 13 for information regarding the Company’s revenues related to North America and foreign regions.
Principles of Consolidation and Basis of Presentation: The accompanying consolidated financial statements include the accounts of Interphase Corporation and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated. In the opinion of the Company, all material adjustments and disclosures necessary to fairly present the results of such periods have been made. All such adjustments are of a normal, recurring nature.
Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“US GAAP”) requires management to make estimates and assumptions that affect the reported amounts and disclosures. Actual results could differ from those estimates. Areas involving estimates include the allowance for doubtful accounts and returns, warranties, inventory impairment charges, accrued liabilities, income tax accounts and revenues.
Fair Value of Financial Instruments: Fair value is the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company classifies the levels used to measure fair value into the following hierarchy:
1.
Level 1 - Valuations based on quoted prices in active markets for identical assets and liabilities that the reporting entity has the ability to obtain at the measurement date. This level provides the most reliable evidence of fair value.
2. Level 2 - Valuations based on observable inputs other than Level 1, such as: quoted prices for similar assets or liabilities in active markets; quoted prices in markets that are not active; or inputs that are derived principally from or corroborated by observable market data by correlation or other means. Valuations in the category are inherently less reliable than Level 1 due to the degree of subjectivity involved in determining appropriate methodologies and the applicable observable market underlying assumptions.
3. Level 3 - Valuations based on inputs that are unobservable, supported by little or no market activity, and significant to the overall fair value measurement.
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. The Company maintains cash balances at various financial institutions with high credit ratings. From time to time, the Company has had cash in financial institutions in excess of federally insured limits or in interest bearing accounts.
Marketable Securities: The Company’s investments in marketable securities primarily consist of investments in debt securities, which are classified as available-for-sale and presented as current assets on the balance sheet. Earnings from debt securities are calculated on a yield to maturity basis and recorded in the results of operations. Unrealized gains or losses for the periods presented are included in other comprehensive loss. Realized gains and losses are computed based on the specific identification method and were not material for the periods presented. Marketable securities are used to secure the Company’s credit facility.
The fair values of marketable securities were estimated using the market approach using prices and other relevant information generated by market transactions involving identical or comparable assets. The Company uses quoted market prices in active markets or quoted market prices in markets that are not active to measure fair value. When developing fair value estimates, the Company maximizes the use of observable inputs and minimizes the use of unobservable inputs. As of December 31, 2013, the fair market value of marketable securities was approximately $5.1 million, of which approximately $4.6 million matures in one year or less, and approximately $500,000 matures after one year, but less than five years. As of December 31, 2012, the fair market value of marketable securities was approximately $4.9 million, of which approximately $4.7 million matures in one year or less, and approximately $200,000 matures after one year, but less than five years. The Company recorded an unrealized loss with respect to certain available-for-sale securities in 2013 of $3,000. The Company recorded an unrealized gain with respect to certain available-for-sale securities in 2012 of $1,000.
Financial assets, measured at fair value, by level within the fair value hierarchy were as follows (in thousands):
Accounts Receivable and Allowance for Doubtful Accounts: The Company records accounts receivable at their net realizable value, which requires management to estimate the collectability of the Company’s trade receivables. A considerable amount of judgment is required in assessing the realization of these receivables, including the current creditworthiness of each customer and related aging of the past due balances. Management evaluates all accounts periodically and a reserve is established based on the best facts available to management. This reserve is also partially determined by using percentages applied to certain aged receivable categories based on historical results and is reevaluated and adjusted as additional information is received. After all attempts to collect a receivable have failed, the receivable is written off against the allowance for doubtful accounts.
The activity in this account was as follows (in thousands):
Allowance for Returns: The Company maintains an allowance for returns, based upon expected return rates, when such return rates are estimable. The estimates of expected return rates are generally based upon historical returns experience. Changes in return rates could impact allowance for return estimates. As of December 31, 2013, 2012 and 2011, the allowance for returns was $28,000, $22,000 and $25,000, respectively, and presented as a reduction to accounts receivable.
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):
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. Inventories are written down when needed to ensure the Company carries inventory at the lower of cost or market. Writedowns in 2013, 2012 and 2011 were $120,000, $57,000 and $60,000, respectively.
Property and Equipment: Property and equipment are recorded at cost. Depreciation is 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 was as follows (in thousands):
The depreciable lives of property and equipment are as follows:
Capitalized Software: Capitalized software represents various software licenses purchased by the Company and utilized in connection with the Company’s products as well as the general operations of the Company. In addition, the Company capitalizes certain external direct costs incurred to create internal use software, principally related to applications, infrastructure and the development of its websites. Capitalized software is amortized over three to five years utilizing the straight-line method. Related amortization expense and accumulated amortization were as follows (in thousands):
Long-Lived Assets: Property and equipment and other long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. All impairments are recognized in operating results when a permanent reduction in value occurs. There was no such writedown during 2013, 2012 or 2011.
Revenue Recognition: Product revenues and electronic manufacturing services revenues are recognized in accordance with shipping terms, which is typically upon shipment, provided fees are fixed and determinable, a customer purchase order is obtained (when applicable), and collection is probable. Sales tax collected from customers and remitted to the applicable taxing authorities is accounted for on a net basis, with no impact to revenues. Service revenue, other than electronic manufacturing services revenue, is recognized as the services are performed. Deferred revenue consists primarily of advance payments for electronic manufacturing services where the goods have not yet shipped.
The Company’s engineering design services are typically provided on a fixed-fee basis. The revenues for such longer duration projects that require significant customization and integration are recognized using the percentage-of-completion method. In using the percentage-of-completion method, revenues are generally recorded based on the percentage of effort incurred to date on a contract relative to the estimated total expected contract effort. Significant judgment is required when estimating total contract effort and progress to completion on the arrangements as well as whether a loss is expected to be incurred on the contract. Management uses historical experience, project plans and an assessment of the risks and uncertainties inherent in the arrangement to establish these estimates. Uncertainties include implementation delays or performance issues that may or may not be within the Company’s control. Changes in these estimates could result in a material impact on revenues and net earnings (loss). If the Company is unable to develop reasonably dependable cost or revenue estimates, the completed contract method is applied under which all revenues and related costs are deferred until the contract is completed. The Company had unbilled receivables of $46,000 and $77,000 included in trade accounts receivable on the Company’s balance sheet at December 31, 2013 and 2012, respectively.
Warranty Reserve: The Company offers to its customers a limited warranty that its products will be free from defect in the materials and workmanship for a specified period. The Company has established a warranty reserve of $20,000 and $15,000 at December 31, 2013 and 2012, respectively, as a component of accrued liabilities, for any potential claims. The Company estimates its warranty reserve based upon an analysis of all identified or expected claims and an estimate of the cost to resolve those claims.
Research and Development: Research and development costs are charged to expense as incurred.
Interest Income, Net: Interest income from investments in securities and cash balances was $12,000, $34,000 and $46,000 for the years ended December 31, 2013, 2012 and 2011, respectively. Interest expense related to the Company’s credit facility was $5,000, $9,000 and $24,000 for the years ended December 31, 2013, 2012 and 2011, respectively.
Advertising Expense: Advertising costs are charged to expense as incurred. Advertising expense was $1,000, $9,000 and $6,000 for the years ended December 31, 2013, 2012 and 2011, respectively.
Foreign Currency Translation: Assets and liabilities of the Company’s French subsidiary, whose functional currency is other than the U.S. Dollar, are translated at year-end rates of exchange, and revenues and expenses are translated at average exchange rates prevailing during the year. Realized foreign currency transaction gains and losses are recognized in the Consolidated Statements of Operations as incurred. Unrealized gains or losses are accumulated in shareholders’ equity as a component of other comprehensive income.
Income Taxes: The Company determines its deferred taxes using the asset and liability method. Deferred tax assets and liabilities are based on the estimated future tax effects of differences between the financial statement basis 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.
The Company records a valuation allowance to reduce its deferred income tax assets to the amount that are more likely than not to be realizable. The Company considers all available evidence, both positive and negative, such as future reversals of deferred tax assets and liabilities, cumulative losses in recent years, projected future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. In making such judgments, significant weight is given to evidence that can be objectively verified. Management is continuously assessing the realizability of deferred tax assets.
The Company recognizes the impact of uncertain tax positions taken or expected to be taken on an income tax return in the financial statements at the amount that is more likely than not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position, interest, and penalties will not be recognized in the financial statements unless it is more likely than not of being sustained.
Other Comprehensive Loss: Other comprehensive loss is presented on the Consolidated Statements of Comprehensive Loss and is comprised of unrealized gains and losses excluded from the Consolidated Statements of Operations. These unrealized gains and losses consist of holding period gains and losses related to marketable securities, net of income taxes, and foreign currency translation, which are not adjusted for income taxes since they relate to indefinite investments in a non-U.S. subsidiary.
2. PREPAID EXPENSES AND OTHER CURRENT ASSETS
Prepaid expenses and other current assets consisted of the following (in thousands):
3. ACCRUED LIABILITIES
Accrued liabilities consisted of the following (in thousands):
4. CREDIT FACILITY
The Company maintains a $5.0 million revolving bank credit facility maturing December 19, 2015. The applicable interest rate on outstanding balances is LIBOR plus 1.0% to 1.5% based on certain factors included in the credit agreement. At December 31, 2013 and December 31, 2012, the Company’s interest rate on the $3.5 million outstanding balance was 1.7% and 1.2%, respectively. The unused portion of the credit facility is subject to an unused facility fee ranging from .25% to .75% depending on total deposits with the creditor. All borrowings under this facility are secured by marketable securities. The outstanding balance of $3.5 million as of December 31, 2013 and 2012 was classified as long-term debt on the Company’s consolidated balance sheets. Subsequent to December 31, 2013 and prior to the Company’s filing of the consolidated financial statements, the outstanding balance on the credit facility was repaid.
5. INCOME TAXES
The provision for income taxes applicable to operations for each period presented was as follows (in thousands):
The tax effect of temporary differences that give rise to significant components of the deferred tax assets as of December 31, 2013 and 2012, are presented as follows (in thousands):
A valuation allowance is 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 is considered, including 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 and other factors.
Concluding that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years. Cumulative losses in recent years is significant negative evidence in considering whether deferred tax assets are realizable and also restricts the reliance on projections of future taxable income to support the recovery of deferred tax assets. The Company continues to maintain a valuation allowance on all of the net deferred tax assets at December 31, 2013 because management believes, after considering all available objective evidence, that the realization of the assets is not reasonably assured. Until an appropriate level of profitability is sustained, the Company expects to record a full valuation allowance on future tax benefits, except for those that may be generated in foreign jurisdictions.
The differences between the actual income tax provision and the amount computed by applying the statutory federal tax rate to the loss before income tax shown in the Consolidated Statements of Operations are as follows (in thousands):
At December 31, 2013, the Company had approximately $47.9 million of federal net operating loss carryforwards, the earliest of which does not expire until 2022. The federal net operating loss includes $3.6 million related to non-qualified stock option deductions. The Company also had state net operating losses of $4.2 million. The valuation allowance recorded on the portion of net operating losses related to stock options will reverse as a credit to shareholders’ equity once management believes that these losses are more likely than not to be realized. At December 31, 2013, the Company’s French subsidiary has a net research and development tax credit, generated in 2010, of $381,000, classified as a current asset on the Company’s consolidated balance sheet. The Company expects to receive the refund for the research and development tax credit generated for the year ended December 31, 2010 in 2014 or to utilize it to offset future tax payments in advance of the refund. The Company no longer generates tax credits from French research and development activities as a result of the closure of its French operations at the end of 2010.
The earnings of the Company’s foreign subsidiary are considered to be indefinitely reinvested and, accordingly, no provision for U.S. federal and state income taxes have been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income taxes (subject to foreign tax credits) and withholding taxes, if applicable, payable to foreign countries.
At both December 31, 2013 and 2012, the Company had an uncertain U.S. tax position of approximately $80,000 related to foreign operations. Due to the net operating loss position in the U.S., the Company would not incur tax, interest or penalty currently or in the near future. As such, no expense was recorded on the income statement and there is no impact on the Company’s effective tax rate. The Company does not anticipate any event in the next twelve months that would cause a change to this position. The Company will recognize any penalties and interest when necessary as tax expense. The U.S. federal returns for the years ending December 31, 2010 and after are open for IRS examination. The Company’s operations during the year ended December 31, 2002 generated a loss and the 2002 net operating loss (“NOL”) is still being used by the Company. The IRS may audit up to the NOL amount generated during the year ended December 31, 2002 until the statute of limitations expiration on open tax years.
The Company is also subject to income tax in France. At December 31, 2013, the Company had an uncertain tax position of $885,000, of which $756,000 is related to a potential liability, $102,000 is related to possible interest, and $27,000 is related to a potential penalty. At December 31, 2012, the Company had an uncertain tax position of $820,000, of which $722,000 is related to a potential liability, $72,000 is related to possible interest, and $26,000 is related to a potential penalty. The uncertain tax position in France is expected to have a favorable impact in the amount of $885,000, resulting in a favorable impact on the effective tax rate. The Company is under a tax audit in France related to the years ended December 31, 2009, 2010, and 2011; however, it does not anticipate any event, other than the results of this tax audit, in the next twelve months that would cause a change to this position. As a result of the tax audit, the French income tax returns for the years ended December 31, 2009 and subsequent remain open for examination.
A reconciliation of the beginning and ending amount of unrecognized tax benefit is as follows (in thousands):
6. RESTRUCTURING CHARGE
On October 19, 2012, the Company committed to a plan intended to improve the balance between the Company’s telecommunications product expenses with the reduced revenue levels of this product line. Under the 2012 restructuring plan, the Company reduced its workforce by 10 regular full-time positions. As a result of the 2012 restructuring plan, the Company recorded a restructuring charge of $253,000, classified as an operating expense, in the fourth quarter of 2012 related to future cash expenditures to cover employee severance and benefits. During the three months ended March 31, 2013, the Company reduced its restructuring charge by $67,000 related to reduced future cash expenditures related to severance and benefits for a former employee. The former employee’s accepting other employment in April 2013 reduced the amount of severance and benefit payouts by the Company. These amounts were paid out under the restructuring plan by the end of 2013.
On September 30, 2010, the Company initiated a restructuring plan to mitigate gross margin erosion by reducing manufacturing and procurement costs, streamline research and development expense and focus remaining resources on key strategic growth areas, and reduce selling and administrative expenses through product rationalization and consolidation of support functions. Under the 2010 restructuring plan, the Company reduced its worldwide workforce by 39 regular full-time positions, including the closure of its European engineering and support center located in Chaville, France. As a result of the 2010 restructuring plan, the Company recorded a restructuring charge of approximately $3.3 million, classified as an operating expense, in the third quarter of 2010 related to future cash expenditures to cover employee severance and benefits and other related costs. These amounts were paid out under the restructuring plan by the end of 2011.
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):
8. COMMON STOCK
2004 Long-Term Stock Incentive Plan: The Interphase Corporation Amended and Restated Stock Option Plan and the Interphase Corporation Directors Stock Option Plan were collectively amended and restated as the “Interphase Corporation 2004 Long-Term Stock Incentive Plan,” effective May 5, 2004. Options granted under the separate plans prior to the effective date of the amended and restated plan are subject to the terms and conditions of the separate plans in effect with respect to such options prior to the effective date, and awards granted after the effective date are subject to the terms and conditions of the 2004 Long-Term Stock Incentive Plan. Awards granted under this plan may be (a) incentive stock options, (b) non-qualified stock options, (c) bonus stock awards, (d) stock appreciation rights, (e) performance share awards and performance unit awards, (f) phantom stock awards, and (g) any other type of award established by the Compensation Committee which is consistent with the Plan’s purposes, as designated at the time of grant. The total amount of Common Stock with respect to which awards may be granted under the Plan is 5,250,000 shares. The Company issues new shares upon exercise of stock options.
Amended and Restated Stock Option Plan: The exercise price of 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 of Directors. The Board of Directors may provide for the exercise of options in installments and upon such terms, conditions and restrictions as it may determine. Options generally vest ratably over a three-year or four-year period from the date of grant or upon the achievement of certain performance conditions. The term of option grants may be up to ten years. Options are canceled upon the lapse of three months, in most cases, following termination of employment except in the event of death or disability, as defined.
Amended and Restated Director Stock Option Plan: Stock option grants pursuant to the directors’ plan vest over a period of one to three years and have a term of ten years. The exercise prices related to these options are equal to the market value of the Company’s stock on the date of grant.
Stock Options: During 2013, the Company issued 49,000 stock options that vest over a four year period and expire ten years from date of grant. The weighted average exercise price of these stock options is $4.33. During 2012, the Company issued 194,500 stock options that vest over a one to four year period and expire ten years from date of grant. The weighted average exercise price of these stock options is $4.56. During 2011, the Company issued 219,500 stock options that vest over a one to four year period and expire ten years from date of grant. The weighted average exercise price of these stock options is $2.05. Compensation expense related to these stock options was $344,000, $392,000 and $162,000 for the years ended December 31, 2013, 2012 and 2011, respectively.
During 2013, the Company also issued 542,500 stock options with performance-based vesting conditions for the years ending December 31, 2014, 2015, 2016, and 2017, the achievement of which would result in pro rata vesting per year in February 2015, 2016, 2017, and 2018, respectively. The weighted average exercise price of these stock options is $4.67. During 2012, the Company issued 900,500 stock options with performance-based vesting conditions for the years ending December 31, 2012, 2013, 2014, 2015, and 2016, the achievement of which would result in pro rata vesting per year in February 2013, 2014, 2015, 2016, and 2017, respectively. The weighted average exercise price of these stock options is $3.80. During 2011, the Company issued 150,500 stock options with performance-based conditions through the year ended December 31, 2015, the achievement of which would result in vesting in February 2016. The weighted average exercise price of these stock options is $4.32. All stock options with performance-based conditions expire ten years from the date of grant. Of the stock options outstanding at December 31, 2013, approximately 1,375,000 are subject to the achievement of certain performance conditions. The performance conditions related to approximately 91,000 of these stock options were deemed probable as of December 31, 2013. Compensation expense related to performance-based stock options, for which vesting was deemed probable, was $239,000, $147,000 and $9,000 for the years ended December 31, 2013, 2012 and 2011, respectively. The performance conditions related to the remaining stock options were not deemed probable; therefore, no compensation expense related to these options has been recorded.
As of December 31, 2013, there were 1,586,076 unvested options expected to vest over a weighted-average period of 8.9 years. As of December 31, 2012, there were 1,508,910 unvested options expected to vest over a weighted-average period of 9.1 years.
The following table summarizes the combined stock option activity under all of the plans (in thousands, except option prices):
The following table summarizes information about options granted under the plans that were outstanding at December 31, 2013 (in thousands, except option prices):
Option Valuation: The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with weighted-average assumptions based on the grant date.
Restricted Stock: The Interphase Corporation 2004 Long-Term Stock Incentive Plan provides for grants of bonus stock awards (“restricted stock”) to its directors and certain employees at no cost to the recipient. Holders of restricted stock are entitled to cash dividends, if any, and to vote their respective shares. Restrictions limit the sale or transfer of these shares during a predefined vesting period, currently ranging from three to six years, and in some cases vesting is subject to the achievement of certain performance conditions. During 2013, the Company issued no restricted stock shares. During 2012, the Company issued 9,000 restricted stock shares at a market price of $5.72. During 2011, the Company issued 72,000 restricted stock shares at a market price of $4.41. Upon issuance of restricted stock under the plan, unearned compensation equivalent to the market value at the date of grant is recorded as a reduction to shareholders’ equity and subsequently amortized to expense over the respective restriction periods. Compensation expense related to restricted stock was $103,000, $135,000 and $188,000 for the years ended December 31, 2013, 2012 and 2011, respectively. As of December 31, 2013, there was $124,000 of total unamortized compensation cost related to unvested restricted stock remaining to be recognized. The expense is expected to be recognized over a weighted-average period of 1.2 years. As of December 31, 2012, there was $261,000 of total unamortized compensation cost related to unvested restricted stock remaining to be recognized. The expense is expected to be recognized over a weighted-average period of 2.1 years.
The following summarizes the restricted stock activity for 2013 and 2012 (in thousands, except weighted average grant date value):
Shareholder Rights Plan: The Board of Directors adopted a Shareholder Rights Plan (the “Plan”) and, under the Plan, declared a non-taxable dividend, paid at the close of business on August 9, 2011 (the “Record Date”), of one common share purchase right (a “Right”) for each outstanding share of Common Stock. From the Record Date until the Rights become exercisable, the Rights will be attached to all outstanding shares of Common Stock and, therefore, will be represented by the certificates evidencing the shares of Common Stock and transferrable only with the shares of Common Stock. A Right will be exercisable, upon certain conditions, to purchase one share of Common Stock from the Company at a price of $39, subject to adjustment. The Rights will become exercisable, and separate from the shares of Common Stock, upon the earlier of:
(1)
ten business days following the date of the first public announcement (the “Stock Acquisition Date”) that a person or a group of affiliated or associated persons has acquired, or obtained the right to acquire, beneficial ownership of 15% or more of the outstanding shares of Common Stock (an “Acquiring Person”), or
(2)
ten business days (or such later date as the Board of Directors may determine) following the commencement of a tender or exchange offer that, if consummated, would result in a person or group of persons becoming an Acquiring Person.
Upon a Stock Acquisition Date, each holder of a Right (other than an Acquiring Person) will be entitled to receive, upon exercise of the Right, shares of Common Stock at a 50% discount. Also, if, at any time following a Stock Acquisition Date, the Company is acquired in a merger or business combination and its Common Stock is exchanged or converted, or if 50% or more of the Company’s assets, cash flow or earning power is sold or transferred, then each holder of a Right (other than an Acquiring Person) will be entitled to receive, upon exercise of the Right, shares of the acquirer’s common stock at a 50% discount. Further, at any time after a person or group of persons becomes an Acquiring Person, but before any person or group of persons becomes the beneficial owner of 50% or more of the outstanding shares of Common Stock, the Company may cause each exercisable Right to be exchanged for one share of Common Stock. The Rights will expire at the close of business on July 29, 2021, or such other date as the Board of Directors may determine under certain circumstances. The Board of Directors may terminate the Plan or cause the Company to redeem the Rights, at a price of $0.001 per Right, at any time before the earlier of a Stock Acquisition Date or the expiration of the Rights. The Company has reserved 90,315,210 shares of Common Stock for possible issuance upon exercise of Rights under the Plan.
9. RELATED PARTY TRANSACTIONS
During the years ended December 31, 2013, 2012 and 2011, the Company had no related party transactions.
10. 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, through July 6, 2012, the Company matched 50% up to 6% of the employee’s contributions, up to a maximum of $7,500 per employee for the year ended December 31, 2012. Subsequent to July 6, 2012, the Company suspended its match of the United States employee’s contributions. The total expense under this plan was $43,000, $130,000 and $208,000 for the years ended December 31, 2013, 2012 and 2011, respectively. The Company offers no post-retirement or post-employment benefits to its employees generally.
11. OTHER FINANCIAL INFORMATION
Major Customers: During 2013, sales to Nokia Solutions and Networks (formerly Nokia Siemens Networks) and Alcatel-Lucent were $3.5 million (or 23%) and $3.3 million (or 21%), respectively, of the Company’s consolidated revenues. During 2012, sales to Alcatel-Lucent and Nokia Siemens Networks were $3.8 million (or 27%) and $1.9 million (or 13%), respectively, of the Company’s consolidated revenues. During 2011, sales to Nokia Siemens Networks and Alcatel-Lucent were $6.7 million (or 31%) and $4.6 million (or 21%), respectively, of the Company’s consolidated revenues. No other customers individually accounted for more than 10% of the Company’s consolidated revenues in the periods presented.
Included in accounts receivable at December 31, 2013, was $809,000, $491,000, and $404,000 due from Alcatel-Lucent, E4D Technologies LLC, and Nokia Solutions and Networks (formerly Nokia Siemens Networks), respectively. Included in accounts receivable at December 31, 2012, was $721,000, $401,000, $387,000, and $312,000 due from Nokia Siemens Networks, Networks Engines, Alcatel-Lucent, and Genband, respectively. No other customers individually accounted for more than 10% of the Company’s accounts receivable at the balance sheet dates presented.
Commitments: The Company leases its facilities under non-cancelable operating leases with the longest terms extending to February 2025. The Company leases its phone system under a non-cancelable operating lease extending to October 2014. Certain of the leases contain escalation clauses over their respective terms. Rent expense related to these leases is recorded on a straight-line basis with the difference between rent expense recognized and cash payments made recorded as deferred rent, a component of accrued liabilities in the accompanying consolidated balance sheets.
As of December 31, 2013, operating lease commitments having non-cancelable terms of more than one year are as follows (in thousands):
Total rent expense for operating leases was as follows (in thousands):
As of December 31, 2013, the Company had approximately $230,000 of non-cancelable purchase commitments for inventory as part of the normal course of business.
Contingencies: Twenty-five former employees (“Plaintiffs”) of Interphase SAS, a France domiciled subsidiary of Interphase Corporation, brought suit in France against Interphase SAS alleging various causes of action and rights to damages relating to claims of wrongful dismissal of employment, specific French employment indemnities, general economic losses, and contractual claims relating specifically to their employment relationship and contracts entered into between the individual and Interphase SAS. The lawsuits were filed between November 2010 and April 2011 in the Labor Court of Boulogne-Billancourt, France and the Administrative Court of Cergy-Pontoise, France. The various claims and assertions arose from, and related to, the Plaintiffs’ release from employment as part of the restructuring actions taken during the third quarter of 2010. The updated statement of claim is for an aggregate payment of approximately €2.1 million, which translated to approximately $2.9 million at December 31, 2013. The Company believes that the Plaintiffs’ claims were without merit and has vigorously defended itself in these lawsuits.
On March 22, 2012, a hearing was conducted before the Labor Court of Boulogne-Billancourt, France related to the claims of twenty-three of the twenty-five former employees. On May 31, 2012, the Court reported that the four judges’ votes were split; therefore, another hearing before the Labor Court took place on January 25, 2013. The same four judges heard the case again, along with a professional judge from another court to ensure that a majority decision would be reached.
The decision of the Labor Court regarding the claims of twenty-two former employees was rendered on March 22, 2013. All of those claims were rejected, because the Labor Court ruled that the redundancy procedure was regular and that redundancies were based on valid reasons, except claims from four Plaintiffs based on non-competition indemnity (amounting in total to approximately €265,000, which translated to approximately $340,000 at March 31, 2013). During the three months ended March 31, 2013 and the three months ended December 31, 2013, the Company recorded a charge of approximately $340,000 and $115,000 (to reflect payroll taxes corresponding to the allowed claims), respectively, classified as other loss on its condensed consolidated statements of operations and as a current liability on its condensed consolidated balance sheets in connection with the non-competition indemnity. Regarding the claims of the four Plaintiffs based on non-competition indemnity, one of these Plaintiffs has filed an appeal of the Labor Court’s decision (the part of the judgment dismissing his claims based on the redundancy procedures; the economic and financial justification for the redundancy); therefore, related to this Plaintiff, the Company is currently evaluating its appeal options. No payment to this Plaintiff is to be made until the appeal process is resolved. The Company is not filing an appeal related to the other three Plaintiffs’ claims based on non-competition indemnity. For these three Plaintiffs, the Company must pay approximately €238,000, which translated to approximately $305,000 at March 31, 2013. Approximately $275,000 was paid during the three months ended December 31, 2013. Fourteen other former employees also filed an appeal. The date of the hearing before the Court of Appeals of Versailles is on October 8, 2014. The Company intends to vigorously defend itself against these appeals.
On May 22, 2012, a hearing was conducted before the Labor Court of Boulogne-Billancourt, France related to the claims of one of the twenty-five former employees with non-executive status. On July 31, 2012, the Court reported that the four judges’ votes were split; therefore, the Labor Court decided to join this case to the cases of the other twenty-three former employees described above in order to be heard again at the same hearing. Therefore, this case was heard again at the hearing on January 25, 2013 before the Labor Court. On March 22, 2013, the Labor Court rejected this former employee's claims. This former employee is one of the fourteen other former employees that filed an appeal, as described in the preceding paragraph.
Among the twenty-five cases described above, two former employees were made redundant related to a decision of the Labor Inspector to authorize their redundancy. Because of their protected status as employee representatives, their redundancy required the prior authorization of the French administration. Each of those former employees also filed a claim before the Administrative Tribunal in order to challenge the decision of the Labor Inspector which authorized their redundancy. Although each such claim or action is directed against the State, Interphase is also a party to these proceedings. The decision of the Administrative Tribunal regarding these two cases was rendered on February 3, 2014. The Administrative Tribunal dismissed these two former employees’ claims challenging the administrative decision authorizing their redundancy. Each former employee will have two months to file an appeal from the receipt of official notice of the dismissal of his claim.
For one of the twenty-five former employees, who was an employee representative, the Labor Court granted the Company’s motion at the January 25, 2013 hearing; the Labor Court rejected the Plaintiff’s claim to hear the case on the merits, regarding the alleged irregularity of the information and consultation procedure, and postponed this case in deference to the pending case before the Administrative Tribunal as described above. This case was heard again on September 27, 2013, and the Labor Court rendered the same decision (to postpone the case to a hearing on September 5, 2014). On September 5, 2014, the case will not be heard on the merits if the Plaintiff files an appeal against the Administrative Tribunal’s judgment before the Administrative Court of Appeal.
On June 12, 2012, a hearing was conducted with the Labor Court of Boulogne-Billancourt, France related to the claims of one of the twenty-five former employees, who was also an employee representative. The Labor Court granted the Company’s motion and rejected the Plaintiff’s claim to hear the case on the merits, regarding the alleged irregularity of the information and consultation procedure, and decided to postpone this case in deference to the pending case before the Administrative Tribunal as described above. This case was heard again on May 28, 2013. The Labor Court rendered the same decision and again postponed the hearing until the Administrative Tribunal makes its decision; therefore, this case will be heard again on June 17, 2014. On June 17, 2014, the case will not be heard on the merits if the Plaintiff files an appeal against the Administrative Tribunal’s judgment before the Administrative Court of Appeal.
12. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This ASU addresses the diversity in practice regarding financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The guidance requires an unrecognized tax benefit, or a portion of it, to be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward. To the extent the deferred tax asset is not available at the reporting date to settle any additional income taxes that would result from the disallowance of a tax position, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with the deferred tax asset. The amendments to this standard are effective for reporting periods beginning after December 15, 2013, with early adoption permitted. The adoption of this update did not have a material impact on the consolidated financial statements, as it is consistent with the Company’s present practice.
In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income. This ASU was effective prospectively for interim and annual periods beginning after December 15, 2012. The Company’s adoption of this update did not have a material impact on the consolidated financial statements.
In December 2011, the Financial Accounting Standards Board (“FASB”) issued ASU 2011-12, Comprehensive Income (Topic 220), Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. This ASU deferred the ASU 2011-05 requirement that companies present reclassification adjustments for each component of accumulated other comprehensive income (“AOCI”) in both net income and other comprehensive income on the face of the financial statements. Companies are still required to present reclassifications out of AOCI on the face of the financial statements or disclose those amounts in the notes to the financial statements. This ASU also defers the requirement to report reclassification adjustments in interim periods. This ASU is effective for interim and annual periods beginning after December 15, 2011 and is to be applied retrospectively. The Company’s adoption of this update did not have a material impact on the consolidated financial statements.
In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This update requires that all nonowner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. This ASU is effective for interim and annual periods beginning after December 15, 2011 and is to be applied retrospectively. The Company’s adoption of this update did not have a material impact on the consolidated financial statements.
In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this ASU generally represent clarification of Topic 820, but also include instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. This update results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) and International Financial Reporting Standards (“IFRS”). The amendments are effective for interim and annual periods beginning after December 15, 2011 and are to be applied prospectively. Early application is not permitted. The Company’s adoption of this update did not have a material impact on the consolidated financial statements.
13. SEGMENT DATA
Interphase is a diversified information and communications technology company, committed to innovation through the process of identifying, developing and introducing new products and services. The Company provides its customers solutions for connectivity, interworking and packet processing. The Company also offers engineering design and manufacturing services to customers from a wide variety of industries within the electronics market. Interphase recently expanded its business to include penveu®, a handheld device that adds interactivity to the installed base of projectors and large screen displays, making any flat surface, from pull down screens to HDTVs, an interactive display system. Except for revenues, which are 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 have only a single reporting segment.
Geographic long lived assets, determined by physical location, are all located in North America as of December 31, 2013 and 2012. Revenue, determined by location of the customer, related to North America and foreign regions for the years ended December 31, 2013, 2012 and 2011 is as follows (in thousands):
Additional information regarding revenues by product-line is as follows (in thousands):
14. QUARTERLY FINANCIAL DATA (Unaudited)
Quarterly results of operations for 2013 (unaudited)
(In thousands, except per share amounts)
Quarterly results of operations for 2012 (unaudited)
(In thousands, except per share amounts)
Due to changes in the weighted average common shares outstanding per quarter, the sum of basic and diluted earnings per common share per quarter may not equal the basic and diluted income (loss) per common share for the applicable year.
INDEX TO EXHIBITS
E-1
(1) Filed as an exhibit to Form 8-K on July 31, 2007, and incorporated herein by reference.
(2) Filed as an exhibit to Quarterly Report on Form 10-Q for the quarter ended September 30, 2002, and incorporated herein by reference.
(3)
Filed as an exhibit to Annual Report on Form 10-K for the year ended December 31, 2008, and incorporated herein by reference.
(4) Filed as an exhibit to Form 8-K on December 10, 2008, and incorporated herein by reference.
(5) Filed as an exhibit to Form 8-K on December 24, 2008, and incorporated herein by reference.
(6) Filed as an exhibit to Quarterly Report on Form 10-Q for the quarter ended March 31, 2009, and incorporated herein by reference.
(7) Filed as an exhibit to Form 8-K on December 31, 2008, and incorporated herein by reference.
(8) Filed as an exhibit to Form 8-K on November 17, 2008, and incorporated herein by reference.
(9) Filed as an exhibit to Schedule 14A on March 31, 2004 and incorporated herein by reference.
(10) Filed as an exhibit to Annual Report on Form 10-K for the year ended December 31, 2010, and incorporated herein by reference.
(11) Filed as an exhibit to Form 8-K on August 2, 2011, and incorporated herein by reference.
(12) Filed as an exhibit to Form 8-K on November 1, 2011, and incorporated herein by reference.
(13) Filed as an exhibit to Annual Report on Form 10-K for the year ended December 31, 2012, and incorporated herein by reference
(14) Filed as an exhibit to Form 8-K on September 6, 2013, and incorporated herein by reference.
(15) Filed herewith.
(16) Furnished electronically herewith, but (in accordance with Rule 406T of Regulation S-T) not deemed “filed”.
* Management contract or compensatory plan or arrangement.
E-2