10-Q/A 1 e10-qa.txt FORM 10-Q/A 1 U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q/A (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 0-10902 INTERFACE SYSTEMS, INC. (Exact name of registrant as specified in its charter) MICHIGAN 38-1857379 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 5855 INTERFACE DRIVE, ANN ARBOR, MICHIGAN 48103 (Address of principal executive offices) (734) 769-5900 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [ X ] Yes [ ] No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: Common Stock, no par value, 4,721,175 shares as of July 31, 2000. 1 2 INTERFACE SYSTEMS, INC. FORM 10-Q INDEX

2 3 PART 1 - FINANCIAL INFORMATION Item 1. Financial Statements INTERFACE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these consolidated financial statements. 3 4 INTERFACE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of these consolidated financial statements. 4 5 INTERFACE SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these consolidated financial statements. 5 6 INTERFACE SYSTEMS, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation The interim consolidated financial statements of Interface Systems, Inc. have been prepared by the Company without audit pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The information included in this report should be read in conjunction with the financial statements for the year ended September 30, 1999 and notes thereto included in the Company's Annual Report on Form 10-K. In the opinion of management, the accompanying interim consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the Company's financial position, results of operations and cash flows for the periods presented. The results for the quarter ended June 30, 2000 may not be indicative of the results to be expected for future quarters or the fiscal year ending September 30, 2000. For comparative purposes, certain amounts reported in prior years' financial statements have been reclassified to conform to current year presentations. 2. Line-of-Credit In May 2000, the Company and its bank entered into a commitment for a new credit facility expanding borrowing capability from $3.5 to $5.0 million. On August 14, 2000, the Company and its bank executed a credit agreement dated as of June 1, 2000. As of June 30, 2000, there was $1.1 million outstanding under its facility. Advances bear interest at the bank's prime rate (9.5% at June 30, 2000) plus 1%, are payable on demand and are collateralized by substantially all of the Company's assets. The amount available for borrowing at any time is based on borrowing base formulae relating to levels of accounts receivable, the value of the Company's real property and improvements located in Ann Arbor, Michigan and other bank covenants. Under such formulae in the new agreement, $2.1 million would have been available to the Company at June 30, 2000. Under the terms of the credit agreement, the Company is required to maintain certain minimum working capital, net worth, and other specific financial ratios. In addition, the credit agreement prohibits the payment of cash dividends and contains certain restrictions on the Company's ability to borrow money or purchase assets or interests in other entities without the prior written consent of the bank. On July 7, 2000, the Company repaid all indebtedness under the credit facility (see Note 6). In connection with the new facility, the Company issued to the bank warrants to purchase 20,000 shares of common stock at $13.44 per share. The warrants will be fully exercisable and expire three years from the date of issuance. 6 7 3. Impact of Recently Issued Accounting Standards Various accounting pronouncements have been issued but which are not yet effective including, but not limited to, Statement of Financial Accounting Standards Nos. 133 and 138, "Accounting for Derivative Instruments and Hedging Activities," which is effective for fiscal years beginning after June 15, 2000; Securities and Exchange Commission Staff Accounting Bulletin No. 101, "Revenue Recognition," which the Company must adopt no later than the fourth quarter of fiscal 2001; and Financial Accounting Standards Board Interpretation No. 44, "Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25," which generally is effective for all periods after July 1, 2000, but certain conclusions in this Interpretation cover specific events that occur after either December 15, 1998, or January 12, 2000. Management expects that adoption of these pronouncements will have little, if any, impact on the Company's consolidated financial position or results of operations. 4. Comprehensive Income SFAS No. 130, "Reporting Comprehensive Income", establishes standards for reporting and display of comprehensive income and its components in a full set of financial statements. Comprehensive income is the total of net income and all other non-owner changes in equity. The components of comprehensive income, are as follows:

5. Sale of Wholly Owned Subsidiary On December 22, 1999, the Company sold its subsidiary, I.G.K. Industries, Inc. ("IGK") for $1,450,000, which resulted in a $37,000 gain. The purchaser acquired all assets and assumed all current liabilities of IGK. Also included in the sale was the building that housed IGK's operations, which was owned by the Company and leased by IGK. 6. Merger Agreement On June 28, 2000, the Company entered into a merger agreement with Tumbleweed Communications Corp. ("Tumbleweed") whereby the Company agreed to merge with a newly formed subsidiary of Tumbleweed. The Company's stockholders are expected to receive 0.264 shares of Tumbleweed common stock for each share of the Company's common stock. In addition, outstanding options and warrants will be converted into options or warrants to purchase 0.264 shares of Tumbleweed common stock with an appropriate adjustment to the exercise price to reflect the exchange ratio. In connection with the merger, the Company granted Tumbleweed an option to purchase 19.9% of the total number of shares of the Company issued and outstanding at June 28, 2000 if an event occurs which would entitle Tumbleweed to terminate the merger agreement and which would entitle Tumbleweed to receive a termination fee. In connection with the merger, Tumbleweed also agreed to purchase $3,000,000 of convertible subordinate promissory notes of the Company and, on July 7, 2000, purchased $2,000,000 of such notes. 7 8 7. Litigation On July 7, 2000, several parties, including Congressional Securities, Inc. and David H. Zimmer, filed complaints against the Company, its President and Chief Executive Officer and certain other third parties. The complaints generally allege that the Company and its officers intentionally made statements containing material omissions or misrepresentations in an effort to induce plaintiffs to purchase stock in the Company. The complaints allege violations of the federal securities laws and other complaints allege fraudulent and negligent misrepresentations, defamation and tortious interference with business relations. The complaints seek compensatory and punitive damages allegedly incurred as a result of the decline in the market price of shares of the Company's common stock after a dramatic stock market correction that occurred in April 2000. On July 17, 2000, at least one of the complaints was amended. These actions are in a preliminary stage and the Company and its named officer have just recently been served process in these actions. However, the Company believes that these actions are without merit, and the Company and its named officer intend to vigorously defend these claims. Although the final resolution of this litigation cannot be presently determined, management of the Company does not believe it will have material adverse effect on the Company's business, or the future consolidated financial statements, although such adverse effects could be possible. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OPERATIONS The Company is currently completing a transition plan that is focused on the movement from the manufacturing of hardware (printers, circuit boards and peripheral equipment) to the development and marketing of higher margin and higher growth software solutions. The progress related to the plan is evidenced by the current structure of the Company. Currently, the Company is organized around two software solutions groups: L2i(TM) (Legacy-to-Internet) and Cleo. On June 28, 2000, the Company entered into an Agreement and Plan of Merger with Tumbleweed Communications Corp., a Delaware corporation ("Tumbleweed"), and Maize Acquisition Sub, Inc. ("Maize"), a Delaware corporation and a direct wholly-owned subsidiary of Tumbleweed (the "Merger Agreement"). Pursuant to the Merger Agreement, Maize will merge with and into the Company and the Company will become a wholly-owned subsidiary of Tumbleweed. Under the terms of the agreement, the Company's shareholders will receive a fixed exchange ratio of 0.264 Tumbleweed common shares for each share of the Company's common stock and each outstanding option to purchase shares of the Company's common stock under the Company's employee stock option plans will be assumed by Tumbleweed. The boards of directors of both companies have approved the transaction. The completion of the transaction is subject to certain closing conditions, including the approval of the Company's shareholders. In connection with the acquisition, the companies announced their intent to divest the Cleo solutions group. RESULTS OF OPERATIONS Net Revenues. Revenues for the third quarter ended June 30, 2000 were $2.7 million, a decrease of 47.8% over revenues of $5.2 million for the third quarter of fiscal 1999. Revenues for the first nine months of fiscal 2000 were $9.1 million, a decrease of 40.4% over revenues of $15.3 million for the same period of fiscal 1999. The decrease for the quarter and the nine-month period was primarily due to the curtailment of the printer business, the sale of IGK that occurred at the end of the first quarter, and decreased sales of the Cleo solutions group. The above declines were partially offset by the increased sales of the L2i solutions, MyCopy(TM), e-Bill Bridge(TM), Document Server and related professional services. Cost of Revenues. Cost of revenues were $937,000 and $2.0 million or 34.5% and 38.4% of net revenues for the quarters ended June 30, 2000 and 1999, respectively; and $3.4 million and $6.2 8 9 million, or 36.8% and 40.4% of net revenues for the nine months of fiscal 2000 and 1999, respectively. The decrease for the quarter and the nine-month period resulted from a decline in overall sales as well as a change in the sales mix from lower margin hardware products to the more profitable L2i software solutions and consulting services. Product Development Costs. Product development costs were $1.0 million and $489,000, or 37.1% and 9.4% of net revenues for the quarters ended June 30, 2000 and 1999, respectively; and $2.4 million and $1.3 million, or 26.8% and 8.5% of net revenues for the first nine months of fiscal 2000 and 1999, respectively. The increase for the quarter and nine month periods was primarily due to the investment the Company is making with respect to enhancements of its L2i software solutions. Selling, General, and Administrative Expenses. Selling, general, and administrative expenses were $3.2 million and $2.4 million, or 119.1% and 47.1% of net revenues for the quarters ended June 30, 2000 and 1999, respectively; and $9.1 million and $7.9 million, or 99.6% and 51.8% of net revenues for the first nine moths of fiscal 2000 and 1999, respectively. The increase was primarily due to the addition of sales and marketing staff located at the Company's headquarters facility and the East Coast and professional fees related to the implementation of our growth plan. Interest and Other Income. Interest and other income for the first nine months of fiscal 2000 was primarily composed of the $37,000 gain on the sale of IGK. LIQUIDITY AND CAPITAL RESOURCES At June 30, 2000, the Company's primary sources of liquidity included cash and cash equivalents of $231,000, a short-term credit facility with a bank providing for a $3.5 million line of credit prior to the renewal discussed below and a note purchase agreement with Tumbleweed. In May 2000, the Company and its bank entered into a commitment for a new credit facility expanding borrowing capability from $3.5 to $5.0 million. On August 14, 2000, the Company and its bank executed a credit agreement dated as of June 1, 2000. Advances bear interest at the bank's prime rate (9.5% at June 30, 2000) plus 1%, are payable on demand and are collateralized by substantially all of the Company's assets. The amount available for borrowing at any time is based on borrowing base formulae relating to levels of accounts receivable, the value of the Company's real property and improvements located in Ann Arbor, Michigan and other bank covenants. Under such formulae in the new agreement, $2.1 million would have been available to the Company at June 30, 2000. Under the terms of the credit agreement, the Company is required to maintain certain minimum working capital, net worth, and other specific financial ratios. In addition, the credit agreement prohibits the payment of cash dividends and contains certain restrictions on the Company's ability to borrow money or purchase assets or interests in other entities without the prior written consent of the bank. On July 7, 2000, the Company repaid all indebtedness under the credit facility with proceeds from the issuance of $2,000,000 of convertible subordinated promissory notes to Tumbleweed. In connection with the transactions contemplated by the Merger Agreement described above, Tumbleweed agreed to purchase an aggregate of $3,000,000 of Convertible Subordinated Promissory Notes of the Company (the "Notes") pursuant to a Convertible Subordinated Note Purchase Agreement, dated as of June 28, 2000, by and between the Company and Tumbleweed (the "Note Purchase Agreement"). At Tumbleweed's option, or upon the occurrence of certain specified events, the Notes are convertible into shares of the Company's common stock. At June 30, 2000, no Notes had been issued pursuant to the Note Purchase Agreement. On July 7, 2000, Tumbleweed purchased $2,000,000 of such Notes. Cash provided by investing activities was $805,000 in the first nine months of fiscal 2000 primarily due to the proceeds received from the sale of IGK. Cash provided by financing activities was $1.7 million in the first nine months of fiscal 2000 and was primarily composed of the borrowings under the credit facility and proceeds from the issuance of stock. 9 10 or purchase assets or interests in other entities without the prior written consent of the bank. On July 7, 2000, the Company repaid all indebtedness under the credit facility with proceeds from the issuance of $2,000,000 of convertible subordinated promissory notes to Tumbleweed. The Company believes that its existing cash balances, available credit facility and future operating cash flows will be sufficient for near term operating needs. The foregoing statements are "forward looking statements" within the meaning of the Securities Exchange Act of 1934. The extent to which such sources will be sufficient to meet the Company's anticipated cash requirements is subject to a number of uncertainties including the ability of the Company's operations to generate sufficient cash to support operations, and other uncertainties described in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Uncertainties Relating to Forward-Looking Statements." UNCERTAINTIES RELATING TO FORWARD-LOOKING STATEMENTS "Management's Discussion and Analysis of Results of Operations" contain "forward-looking statements" within the meaning of the Securities Exchange Act of 1934, as amended, based on current management expectations. Actual results could differ materially from those in the forward-looking statements due to a number of uncertainties, including, but not limited to, those discussed in this section. Factors that could cause future results to differ from these expectations include general economic conditions particularly related to demand for the Company's products and services; changes in Company strategy; product life cycles; competitive factors (including the introduction or enhancement of competitive products); pricing pressures; the Company's success in and expense associated with developing, introducing and shipping new products; software defects and latent technological deficiencies in new products; changes in operating expenses; inability to attract or retain consulting, sales and/or engineering talent; changes in customer requirements; and evolving industry standards; and the inability to close the merger with Tumbleweed. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company has no material market risk exposure. PART II - OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS: On June 28, 2000, in order to facilitate the acquisition of the Company pursuant to the Merger Agreement, the Company and Tumbleweed entered into a Stock Option Agreement (the "Stock Option Agreement") pursuant to which the Company granted Tumbleweed an option to purchase 939,215 shares of the Company's common stock, subject to adjustment, at $13.33 per share. The option is exercisable if an event occurs which would entitle Tumbleweed to terminate the Merger Agreement and which would entitle Tumbleweed to receive a termination fee. The Company granted the option to Tumbleweed without registration under the Securities Act of 1933, as amended (the "Act"), in reliance upon Section 4(2) of the Act and Regulation D promulgated thereunder. The Company relied upon this exemption based upon the limited number of purchasers, the provision to Tumbleweed of financial and other information concerning the Company, investment representations made by Tumbleweed in the Stock Option Agreement, the lack of general solicitation, and actions taken by the Company to restrict resale without registration of the securities to be acquired upon exercise of the option, including the requirement that each certificate representing shares acquired upon exercise of the option bear a restrictive legend. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 4.1 Credit Agreement between the Company and Bank One, Michigan, dated as of June 1, 2000 (To be filed by amendment) 27 Financial Data Schedule (b) No reports on Form 8-K have been filed during the quarter for which this report is filed. 10 11 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. INTERFACE SYSTEMS, INC. Date: August 24, 2000 /S/ Brian D. Brooks ------------------- Brian D. Brooks Vice President and Chief Financial Officer 11 12 Exhibit Index -------------

INTERFACE SYSTEMS INC 10-Q/A