10-K

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

      For the Fiscal Year Ended December 31, 2004 Commission File Number 0-13071

INTERPHASE CORPORATION

(Exact name of registrant as specified in its charter)

Texas (State or other jurisdiction of	75-1549797 (I.R.S. Employer
incorporation or organization)	Identification No.)

2901 North Dallas Parkway, Suite 200
Plano, Texas 75093
(Address of principal executive offices and zip code)
Registrant’s telephone number, including area code: (214) 654-5000
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.10 par value
Title of Class

Indicate by check mark whether the registrant (1) has filed all reports required 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.

Yes þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

                     Yes o No þ

The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2004 was approximately $56,046,615.

As of March 11, 2005, the registrant had 5,750,824 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Parts of the following document is incorporated by reference into this annual report on Form 10-K: Portions of the Definitive Proxy Statement for Annual Meeting of Shareholders to be held on May 4, 2005 (Part III).

TABLE OF CONTENTS

PART I
	ITEM 1. BUSINESS
	ITEM 2. PROPERTIES
	ITEM 3. LEGAL PROCEEDINGS
	ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
PART II
	ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
	ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
	ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
	ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
	ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
	ITEM 9A. CONTROLS AND PROCEDURES
	ITEM 9B. OTHER INFORMATION
PART III
	ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
	ITEM 11. EXECUTIVE COMPENSATION
	ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
	ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
	ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
	ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
SIGNATURES
INDEX TO EXHIBITS
Note and Credit Agreement
Consent of Independent Registered Public Accounting Firm
Consent of Independent Registered Public Accounting Firm
Rule 13a-14(a)/15d-14(a) Certification
Rule 13a-14(a)/15d-14(a) Certification
Section 1350 Certification
Section 1350 Certification

PART I

ITEM 1. BUSINESS

Introduction

Interphase Corporation and subsidiaries (“Interphase” or the “Company”) enables rapid platform design and integration for the global voice, video, and data communications markets through custom and off-the-shelf communications equipment, embedded software development suites, and systems integration and professional services for carrier and private networks. The Company’s products provide communications computing and connectivity of telecommunications and enterprise computer systems to Wide Area Networks (WANs), Local Area Networks (LANs), and Storage Area Networks (SANs) using Asynchronous Transfer Mode (ATM), Ethernet, Internet Protocol (IP), Point-to-Point Protocol (PPP), Q.SAAL, Internet Protocol Security (IPSec), and protocol interworking technologies.

The Company maintains a website on the Internet with the address of www.interphase.com. Copies of this Annual Report on Form 10-K for the year ended December 31, 2004 and copies of the Company’s Quarterly Reports on Form 10-Q for 2003 and 2004 and any Current Reports on Form 8-K for 2003 and 2004, and any amendments thereto, are or will be available free of charge as soon as reasonably practical after they are filed with Securities and Exchange Commission (“SEC”) at such website. The general public may obtain any materials the Company files with the SEC at 1-800-SEC-0330, or since the Company is an electronic filer, the SEC maintains an Internet website at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.

Key Terms and Definitions

Interphase is a technology company and 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.

Adapter - Also called a host bus adapter (HBA) or network interface card (NIC). An adapter is a device that connects a computer server to one or more peripheral devices (such as switches, hubs, storage devices, etc.) or other computers. An adapter card typically plugs into the expansion bus of a system and communicates with the operating system controlling the system via the use of specific device drivers. Adapters generally refer to passive (non-intelligent) printed circuit boards used for interfacing to a network.

AdvancedTCA or ATCA (Advanced Telecom Computing Architecture) — The next generation of system architecture beyond CompactPCI. It affords greater bandwidth, processing and board density, cooling abilities, and memory to meet the growing needs of next generation applications.

ATM (Asynchronous Transfer Mode) — A network technology used in WANs that supports real time voice, real time video, and data. The topology uses switches that establish a logical circuit from end to end, which guarantees a quality of service for that transmission. However, unlike telephone switches that dedicate circuits end to end, unused bandwidth in ATM circuits can be appropriated whenever available. For example, idle bandwidth in a videoconference circuit can be used to transfer data. ATM is also highly

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scalable and supports transmission speeds of 1.5, 25, 100, 155, 622 and 2488 Megabits per second (Mbps).

Backplane - The interconnect mechanism that links all printed circuit boards within a system such that various boards can communicate and work together for a common purpose as a system. The backplane extends perpendicularly across all boards in a system and offers sockets for boards to be plugged into.

Blade - A subsystem within a system contained within a single system slot. A blade can operate as a single board in a slot or with a multitude of boards, including mezzanine cards to a carrier card.

Broadband - A transmission facility (communications link) that has bandwidth (capacity) greater than a traditional voice grade line.

CDMA2000/1xRTT (Code Division Multiple Access 2000/one times Radio Transmission Technologies) — A third generation wireless system, which is based on earlier versions of CDMA and used in certain phone systems and Wireless Local Area Networks. CDMA2000 runs in the 800 MHz and 1.8-2.0 GHz spectrum.

Communications Controller - Communications controller modules (similar to a network interface card) are designed specifically for carrier-grade computer systems that often support signaling, switching and routing networks. Communication controllers must conform to specifications that maintain overall system compliance to the rigorous performance and reliability standards that apply to telecom service provider equipment into which they are integrated. Controllers are essentially intelligent network interface cards.

CompactPCI® - An industrial grade variation of the PCI bus standard that utilizes the Eurocard (VME) form factor. CompactPCI has been widely adopted by telecom equipment suppliers because of its high-density connectors, support for front or rear I/O access and hot-swap capabilities important for “Five 9’s” (99.999%) reliability. Often referred to as CPCI or 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.

CompactPCI Packet Switching Backplane (CPSB) - The newest generation of the CompactPCI standard that enables an Ethernet-based interconnection fabric across a system backplane in lieu of the H.110 PCI bus. This backplane technology served as the foundation for the new AdvancedTCA standard architecture from PICMG.

CPU (Central Processing Unit) — The part of a computer that performs the logic, computational and decision-making functions. Telephone systems typically have one CPU, which takes the form of a chip that controls the various functions in a telephone.

Ethernet — A Local Area Network standard used for connecting computers, printers, workstations, and servers. It operates over twisted wire and coaxial cable at speeds beginning at 10 Mbps.

Fast Ethernet - A variation of the Ethernet standard (10Base-T) that provides 100 Mbps transmission bandwidth, and up to 200 Mbps total I/O throughput with full duplex operation. Also known as 100Base-T Often 10/100Base-T is used to describe a link with the capability to support both Ethernet (10 Mbps) and Fast Ethernet (100 Mbps).

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Frame Relay - A high-speed packet switching protocol used in wide area networks (WANs). Providing a granular service of up to DS3 speed (45 Mbps), it has become very popular for LAN-to-LAN connections across remote distances. All the major telecommunications carriers offer frame relay services. Frame relay is much faster than X.25 networks, the first packet-switching WAN standard, because frame relay was designed for today’s reliable circuits and performs less rigorous error detection.

Gbps (Gigabits per second) — One thousand million bits per second.

Gigabit Ethernet - An Ethernet technology that raises transmission speed to one Gigabit per second (Gbps) and is used primarily for backbone networks and high-speed server-to-server connectivity. Also known as 1000BaseT or 10/100/1000BaseT where line rates are negotiated to regular Ethernet, Fast Ethernet, or Gigabit Ethernet speeds.

IETF (Internet Engineering Task Force) — Formed in 1986, the IETF sets technical standards that run the Internet such as routing, transport and security.

I/O (Input/output) — The transfer of data or voice traffic into and out of a computing device. The main function of an adapter, communications controller, or network interface card is to regulate or control communications I/O.

IP (Internet Protocol) — The standard method or protocol by which data is sent from one computer to another on the Internet.

IPSec (IP Security) — A security protocol from the Internet Engineering Task Force (IETF) that provides authentication and encryption over the Internet.

LAN (Local Area Network) — A short-distanced data communications network that is contained within a building or complex. Its primary use is to link computers and peripheral devices (such as printers) and to provide individuals with access to databases and applications running on servers attached to the network. Anyone connected to the LAN can send messages to and work jointly with others on the network.

Media Gateway — A networking device that converts data from the format required for one type of network to the format required for another. The media gateway is controlled by the media gateway controller. Both are a component of softswitch.

Mbps (Megabits per second) — One million bits per second, when used as a measurement for the speed of telecommunications, networking or local area networking.

NEP (Network Equipment Provider) - A company which designs, builds and markets telecommunications infrastructure platforms.

OC-3/STM-1 — The American and European standards (respectively) for ATM optical interconnect 3 traffic, which is a digital transmission link with capacity of 155 Mbps. This line speed is very common in telecommunications access networks.

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Operating System - The master control program that runs the computer. It is the first program loaded when the computer is turned on, and its main part, called the kernel, resides in memory at all times. It may be developed by the vendor of the computer it is running in or by a third party. It is an important component of the computer system because it sets the operational guidelines for all application programs that run on the system. All programs must “talk to” the operating system. Popular network operating systems today include Windows NT, XP and 2000, VxWorks, Solaris and Linux.

OEM (Original Equipment Manufacturer) — A manufacturer who resells other company’s products under their own name.

PCI (Peripheral Components Interconnect) — A printed circuit board bus standard that is currently the main general-purpose bus in many desktop computers and a majority of enterprise servers throughout the world. Telecom servers generally use the newer generation of the PCI architecture — CompactPCI.

PICMG (PCI Industrial Computer Manufacturers Group) - The technical standards governing body responsible for specifying technical requirements of specific systems architectures, including PCI, CompactPCI, CPSB, and AdvancedTCA. Standardized architectures are intended to provide a common set of rules and parameters for creating a system. The resulting benefit of such specifications is interoperability among multiple vendors for complementary system components and marketplace of cooperation and fair competition provided by commercial off the shelf (COTS) products, thereby providing alternatives to the market monopolies created by proprietary system architectures.

PMC (PCI Mezzanine Card) — a low profile mezzanine card that is electronically equivalent to the Peripheral Component Interconnect (PCI) specification. PMC cards are used as a quick and cost-effective method to add modular I/O to other card formats such as VME and CompactPCI, thus expanding the processing or I/O density of a single system slot.

PPP (Point-to-Point Protocol) — Provides router-to-router and host-to-network connections over synchronous and asynchronous circuits.

Protocol - The special set of common rules that end points in a telecommunication connection use when they communicate. A protocol could be described as a common language for communication across a network.

Protocol Interworking — A mechanism for protocol conversion or bridging in cases where computers or networks lack a common communications medium. Could be considered a protocol ‘language’ translation mechanism so that disparate technologies can interconnect.

PTMC (PCI Telecom Mezzanine Card) — A mezzanine card with connectors specific to telecom applications, based on the industry standard PICMG 2.15.

Q.SAAL — A communications protocol used for signaling applications where the SS7 protocol runs over ATM links.

SAN (Storage Area Network) — Servers providing high speed data storage and retrieval in enterprise environments.

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SCSI (Small Computer System Interface) — Pronounced “skuzzy,” SCSI is a widely used communications technology for connecting computer servers to storage devices.

Server - A computer in a network shared by multiple users. These are typically more powerful than computers used by individuals (often referred to as “desktops”) and require advanced I/O connectivity.

Softswitch (Software Switch) — A generic term for an open application program interface software used to bridge a public switched telephone network and the Internet Protocol by separating the call control functions of a phone call from the media gateway (transport layer).

SS7 (Signaling System 7) — The protocols used in the U.S. telephone system for setting up calls and providing modern transaction services such as caller ID, automatic recall and call forwarding. When you dial “1” in front of a number, SS7 routes the call to your long distance carrier and it also routes local calls based on the first three digits of the phone number.

System - A collection of elements or components that are organized for a common purpose. A computer system consists of hardware components that have been carefully chosen so that they work well together and software components or programs that run in the computer.

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.

T3/E3 - A digital transmission link equivalent to 28 T1 lines. Providing a capacity of 45 Mbps, a T3 link is capable of handling 672 voice conversations. E3 is the European equivalent and J3 is the Japanese equivalent to T3.

VME (VersModule-Eurocard) - A mechanical and electrical bus standard developed in the late 70’s, with a backplane that runs at 80 Mbps and is most commonly used in commercial, military and industrial applications.

WAN (Wide Area Network) — A communications network that covers a wide geographic area, such as a state or country. A WAN typically extends a LAN outside the building, over telephone common carrier lines to link to other LANs in remote locations, such as branch offices or at-home workers and telecommuters. WANs typically run over leased phone lines, but are increasingly also employing the Internet for VPN (virtual private network) connectivity.

6U — A standard size and design of printed circuit boards and the chassis that holds them.

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Mission

The Company’s mission is to provide innovative, high-performance connectivity solutions for the telecommunications and enterprise embedded system markets. To achieve this, Interphase pursues several key initiatives that include:

Providing an advanced line of communication for next-generation telecom systems

The Company offers original equipment manufacturers (OEMs) in the communications sector an advanced, high quality, high performing, feature-rich, and broad portfolio of communications boards and subsystems at competitive prices. The Company therefore maintains a value strategy while maintaining the utmost commitment to customer service and flexibility to customer needs.

OEMs, due to significant workforce reductions in recent years, have been outsourcing a greater portion of the equipment that they traditionally made in-house. To capitalize on this trend, Interphase offers a comprehensive line of standards-based, carrier-class communications controllers and network interface solutions for:

•   2.5 and 3G Wireless Networks - controllers that provide enhanced mobile services and integration with other networks.

•   Broadband Network Telephony/Video Access - controllers that enable high-speed network connectivity, i.e. Internet access through ADSL, cable and fixed wireless providers.

•   Intelligent (SS7) and Converging Networks - controllers that help service providers migrate their intelligent network facilities to more scalable and cost-effective architectures and provide new platforms for softswitch and media gateway convergence of voice and data networks.

To further assist telecommunication server providers, Interphase offers professional services for customizing software and third party applications to customer-specific designs. With high-performance communication controllers, software development tools, protocol support, experience with third party protocols and professional services, Interphase products and services help decrease costs and improve time-to-market of OEMs building next-generation telecom equipment.

A comprehensive line of private network I/O adapters and modules

In order to provide Interphase customers with effective storage networking solutions, Interphase offers a comprehensive line of networking adapters and security acceleration modules specifically designed for use in demanding, enterprise class applications such as:

•   Private Networking/Enterprise Networking — mission critical backbone and Internet servers served with unique, slot-saving designs.

•   Network Security — Enterprise devices, such as virtual private networks (VPNs), which provide encryption and decryption of data traffic for preventing security breaches. Interphase serves this segment with network security co-processor modules.

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•   Storage Area Networks — servers providing high speed data storage and retrieval in enterprise environments. Interphase serves this segment with a legacy portfolio of fibre channel host bus adapters.

Currently, the Company is developing primarily specialized enterprise equipment due to the rapid commoditization of unspecialized (or “standardized”) equipment in this segment.

Delivering superior customer service

Over the past 28 years, Interphase has established strong relationships with key Fortune 500 suppliers of enterprise computer and telecommunication servers. Much of this success has been due to the superior pre-sale and post-sale service the Company delivers to customers. With a vertically integrated account perspective, Interphase provides flexibility, timely response and other customized account service features. Further, the Company’s technical support is staffed by experts for both Telecom and Enterprise products, allowing Interphase to specifically focus its support efforts for the different needs and requirements of its customers in these differing market segments.

Developing strategic partnerships

Interphase designs and tests products for multi-vendor interoperability. The Company leverages these efforts towards building more effective strategic partnerships. Through its partner program, Interphase builds synergistic marketing and technical relationships with other key suppliers in its respective markets. Rigorous product testing and early access to new partner product releases allows tighter product integration and helps assure compatibility for end-users of the Company’s products. Also, Interphase’s joint software development, particularly with third party protocol vendors, decreases the integration time for customers by offering a pre-integrated solution.

Products

Interphase offers an advanced line of telecom communication controllers, a comprehensive portfolio of specialized enterprise connectivity and storage adapters, and resource modules for security acceleration.

Telecom Products

Interphase products designed for use in next-generation broadband telecommunication networks include:

•   iNAV® 9200 Multiprotocol Gateway Appliance - designed to meet the needs of both connection-oriented and connectionless packet switched networks, the new iNav®9200 series of specialized appliances is by far the industry’s most advanced, price/performance-maximized solution for applications requiring multiprotocol interworking, IP routing and classification and ATM SARing such as converging networks with those with dissimilar network protocols.

•   iNAV 4000 CompactPCI Network Processor Blade - a protocol interworking, network protocol processing board with on-board intelligence suited to broadband convergence applications such as wireless gateways and media gateways.

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•   iSPAN® 1635 CompactPCI Packet Switched Backplane T1/E1/J1 Communications Controller - a 6U CompactPCI communications controller, based on the PICMG 2.16 Ethernet backplane standard, with an advanced architecture featuring the Motorola MPC8264 RISC CPU that offers superior performance over T1/E1/J1 communication links. The 1635 also offers dual Ethernet interfaces to 2.16 backplanes, and is capable of supporting a variety of network protocols including ATM, Frame Relay, SS7, Q.SAAL, PPP, Ethernet, and HDLC.

•   iSPAN 4531 PMC ATM over T3/E3 Communications Controller - a PCI Mezzanine Card that provides reliable, high performance ATM communications over T3/E3 connections for applications such as aggregating Internet traffic for transport over the public ATM backbone network.

•   iSPAN 4532 PMC OC-3/STM-1 Communications Controller — an intelligent, high-performance, PCI Mezzanine Card that provides direct access to SONET networks and software selectable access to an OC-3/STM-1 ATM network, as well as a 10/100 Ethernet interface. The 4532 is ideally suited for 3G networks that define ATM as the interconnect between radio network controllers and cell sites, for example. It also targets broadband access networks and gateways that require on-board ATM to Ethernet interworking. The 4532 has been recently leveraged to target a growing market niche, supporting the Q.SAAL protocol for SS7 over ATM traffic processing.

•   iSPAN 4532P PMC ATM over OC-3/STM-1 Communications Interface Card — A passive interface module providing 155 Mbps connectivity for use with the iNAV 4000.

•   iSPAN 4534 PMC Quad-port Serial Communications Controller - a PCI Mezzanine Card that provides reliable, high performance serial communications for multiple telecommunication protocols including ATM, ISDN, Frame Relay, X.25 and PPP.

•   iSPAN 4535 PMC Multiprotocol T1/E1 Communications Controller - a cost-effective PCI Mezzanine Card that provides two high-speed serial communication links to provide connection to the Public Switch Telephone Network to support advanced SS7 or converged network applications.

•   iSPAN 4538 PMC T1/E1/J1 Communications Controller - a PCI Mezzanine Card with 2 software selectable T1/E1/J1 interfaces on the front faceplate plus a 10/100 Ethernet port. It is targeted for signaling and control plane applications in wireless and “converged” voice and data telecom networks. With its on-board SS7 protocol processing, excellent SS7 performance, and its Ethernet access, it is a modular solution for signaling platforms and signaling gateway applications.

•   iSPAN 4539/4539F PMC T1/E1/J1 Communications Controller - a PCI Mezzanine Card targeted for signaling/control plane and broadband/user plane telecom networks. The 4539 offers four software selectable T1/E1/J1 interfaces via front or rear access, and a 10/100 Ethernet interface on the front with an on-board CPU to offload host processors. The 4539/4539F supports multiple protocols on board, including ATM, and it can serve both narrowband and broadband networks in one solution.

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•   iSPAN 4575 PMC ATM Communications Interface Card — a PCI Mezzanine Card that provides cost-effective, reliable, high performance ATM over OC-3/STM-1 155 Mbps connectivity.

•   iSPAN 4576 PMC ATM Communications Interface Card — the next generation of the 4575 product.

•   iSPAN 5539F PCI T1/E1/J1 Communications Controller - a PCI version of the 4539 for use in traditional PCI-based systems.

•   iSPAN 5575 PCI ATM Communications Interface Card - a PCI adapter card that provides full duplex ATM connectivity for systems running Windows NT, Novell NetWare, UnixWare, Solaris and AIX.

•   iSPAN 5576 PCI ATM Communications Interface Card — the next generation of the 5575 product.

•   iSPAN 6535 CompactPCI T1/E1/J1 Communications Controller - a 6U CompactPCI communications controller with an advanced architecture featuring the Motorola MPC8264 RISC CPU that offers superior multiprotocol processing performance over T1/E1/J1 communication links.

•   iSPAN 6575 CompactPCI ATM Communications Controller — a 3U or 6U CompactPCI adapter that provides full duplex ATM connectivity at OC-3/STM-1 data rates for industrial and telecommunication systems.

•   iWARE® — a software development suite that complements the intelligent communications controllers. It offers an application programming interface for developers to develop applications on the Interphase communications controllers and provides software for various protocols to be run on the Interphase controllers.

Enterprise Network Products

Interphase enterprise products targeted for use in enterprise applications include the following:

•   454E SlotOptimizer™ (Combo) PMC Fast Ethernet Interface Card - a quad-port 10/100 Ethernet card enables slot conservation where high density Ethernet connectivity is required.

•   4526T PowerSAN™ PCI Fibre Channel Adapter - a 33Mhz PMC adapter which provides single port 1-Gbps Fibre Channel connectivity.

•   552C SlotOptimizer (Combo) PCI Storage Networking Adapter - a 64-bit PCI multifunction adapter card combining dual channel Ultra2 SCSI connectivity with two 10/100 Ethernet ports.

•   551E SlotOptimizer (Combo) Single-port Fast Ethernet Adapter — a 64-bit PCI adapter card with a Fast Ethernet interface.

•   554E SlotOptimizer (Combo) Quad-port Fast Ethernet Adapter — a 64-bit PCI adapter card that provides four independent full-duplex Fast Ethernet ports.

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•   45NS PMC Network Security Acceleration Adapter — a PCI mezzanine card designed for IPSec processing acceleration for use in encryption and decryption of security protocols.

•   55NS PCI Network Security Acceleration Adapter - a PCI card designed for IPSec processing acceleration for use in encryption and decryption of security protocols.

New Product Development

As stated previously, the primary target markets for the Company’s products are characterized by those areas of a telecom network that can reduce cost for service providers (carriers), decrease their time to market for deployment of new and existing services and finally, preserve carriers’ prior network equipment investment. The economic downturn in the telecom business sector has motivated telecom service providers and network equipment providers (“NEPs”), to reexamine their areas of competitive value add and streamline their business operations. In particular, NEPs, and carriers as well, have been consolidating their product development and manufacturing groups, actions which generally lead to an increase in the use of off-the-shelf products, such as the products sold by Interphase. Consequently, the Company’s new product development is driven by a focus on providing NEPs with “off the shelf” designs built from emerging standards that improve the performance and reliability of standard designs, while continuing to offer greater speed to market. See the research and development discussion in the Results of Operations section of Item 7. (Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Enterprise/Private Network Initiatives

In the enterprise network segment, Interphase will invest product development resources into product additions to the existing security acceleration product line. These security modules are designed to work as co-processor resources for servers required to perform compute-intensive security encryption and decryption functions. Use of these security modules offloads host Central Processing Units (CPUs) of encryption/decryption processing burdens and therefore improves overall system performance. Based upon interest from customers in the currently-available 45NS and 55NS security products, new additions to this line are expected to offer customers even greater throughput by way of a newer, more powerful co-processor chipset. New generations of these products will be announced in early 2005.

Additionally, Interphase has enhanced its SlotOptimizer™ product line, a portfolio of products that enable maximized port density, enabling OEMs and enterprises alike to consolidate multiple network interfaces on to a single slot. The end result is conservative usage of system slots for network I/O and real estate preservation within the server chassis. The SlotOptimizer line will be expanded to include PMC architectures. With the addition of a variety of new PMC-based designs in 2004 and early 2005, maximized slot density solutions were brought to market for use with a broader set of system architectures, including CompactPCI, VersaModule-Eurocard (VME), and proprietary systems. This move is intended to broaden the list of suitable applications for the SlotOptimizer line to include carrier-grade and military uses in addition to a wide variety of enterprise networking applications.

Telecom Segment Initiatives

Interphase continues to build on its existing portfolio of telecom solutions by diversifying into an even broader set of capabilities. The Company continues to target three main carrier segments (via OEM

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channels) with the greatest opportunity for intelligent communications solutions including wireless, convergence/next generation public network equipment, and broadband network/telephony access. Expansion of the iSPAN and iNAV lines will continue in several ways, described below.

Migration to Pre-integrated Frameworks. Interphase has evolved from offering passive line interface modules to intelligent communications controllers in the last few years. In keeping with the same initiative, Interphase has made several pre-integrated frameworks available to customers. These solutions are generally a combination of multiple hardware and software modules which enable customers to spend less time and development resources for integrating their blade-level subsystems. This affords OEMs a better focus on their true core competencies (i.e. applications development), faster time to market, and a reduction in development costs. More of these frameworks, using a combination of Interphase products and partner components, are expected to become available in the coming year.

AdvancedTCA. The widely accepted telecom platform form factor, CompactPCI, is beginning to reach a performance peak, and NEPs and carriers alike are developing applications that are expected to outgrow the architecture. Vendors seeking to provide solutions with greater bandwidth, processing and board density, cooling abilities, and memory to meet the needs of next generation applications have initiated a new technology standard. Governed by the PICMG standards body, the PICMG 3.0 subcommittee has standardized the Advanced Telecom Computing Architecture (“AdvancedTCA” or “ATCA”) specification. Interphase is an active participant in this standards group, and it has developed two AdvancedTCA products to date with numerous products in development. In keeping with the blade-mezzanine solution strategy, Interphase is additionally developing ATCA-compliant PTMC Cards as well as a new generation of ATCA-specific mezzanine cards known as AdvancedMCs or AMCs. This new architecture has already begun acceptance by network OEMs, and full production units are expected to slowly replace CompactPCI systems in the next two to three years.

Appliances. Interphase has maintained a specialty in interworking multiple protocols and gateway-on-a-card technologies for several years and has begun to expand its product line upon this concept. The Company’s interworking solutions based on a single card (as opposed to previous methods requiring the use of multiple boards) have paved the way for compact, specialized appliances for bridging multiple protocols and routing communications traffic. The first product in this line of appliances, the iNAV 9200 Multiprotocol Gateway Appliance, is designed for bridging ATM and Ethernet protocols. Based on network processors, the 9200 offers numerous advantages to the network equipment OEMs and carriers alike, including improved performance, a hardware-based architecture (a substantial improvement in reliability and development time over software-based alternatives), reduced footprint, and significantly reduced cycles for applications development due to the pre-development of protocol software. Protocol interworking is a widespread practice throughout the public network, because it enables carriers to migrate existing infrastructures to next generation technologies without forklift upgrades. Convergence of voice and video is a common theme today and Interphase appliances provide a higher performing, more cost effective solution in specific convergence applications requiring simple protocol conversions. Building on this gateway solution, Interphase is developing enhanced specialty appliances for IP routing in broadband access environments where video services are being deployed to the end user. 2005 could be an exciting year for Interphase appliances as the telecom carrier video market is in its infancy and projected to be very large.

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Industry Standards Participation

The Company has been engaged in the development of new products and the refinement of its existing products since its inception. Throughout its history, Interphase has been active in the formulation of industry standards sanctioned by groups such as PICMG and the AdvancedTCA subcommittee in particular, IEEE, ANSI, VME International Trade Association (VITA), Fast Ethernet Alliance, SCSI Committee, the LADDIS Group, ONC/NFS Consortium, and Storage Networking Interoperability Association (SNIA), and FC-Open (Fibre Channel) Consortium. Throughout 2004 and into 2005, Interphase has been and continues to be a very active member of the PICMG standards body particularly for AdvancedTCA. Additionally, the AMC mezzanine subcommittee will be hosting a variety of industry interoperability “plugfests” that Interphase will be heavily engaged in.

Marketing and Customers

The Company’s products are sold to network equipment OEMs for inclusion in embedded systems designed for use in carrier networks and enterprise data networks. These purchasers incorporate the Company’s products into proprietary or standards-based systems for resale to either telecom carriers directly, or in cases of enterprise equipment, to distributors, system integrators or Value Added Resellers (“VARs”), (which may add specially designed software) prior to resale to the enterprise end-users. Also, the Company sells products directly to sophisticated end-users such as the military.

During 2004, sales to Lucent Technologies and Hewlett Packard accounted for $12.6 million or 36% and $9.6 million or 27% of the Company’s consolidated revenues, respectively. During 2003, sales to Lucent Technologies and Hewlett Packard accounted for $13.5 million or 42% and $9.7 million or 30% of the Company’s consolidated revenues, respectively. During 2002, sales to Hewlett Packard and Lucent Technologies accounted for $8.7 million or 35% and $7.2 million or 29% of the Company’s consolidated revenues, respectively. No other customers accounted for more than 10% of the Company’s consolidated revenues in the periods presented.

The Company markets its products through its direct sales force, manufacturers’ representatives and value-added distribution partners. In addition to the Company’s headquarters in Plano, Texas; the Company has sales offices located in or near Boca Raton, Florida; Santa Clara, California; Minneapolis, Minnesota; Newark, New Jersey; Munich, Germany; Helsinki, Finland; Sydney, Australia; and Paris, France. The Company’s direct sales force markets products directly to key customers and support manufacturer’s representatives and the distribution channel. In addition, the Company has entered into distribution agreements with key national and international distribution partners located in countries in North America, Asia and Europe. 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 currently conducted at the Company’s manufacturing facility located in Carrollton, Texas. The Company’s products consist primarily of various integrated circuits, other electronic components and firmware assembled onto an internally designed printed circuit board.

The Company uses internally designed applications or specific integrated circuits (ASIC), some of which are sole-sourced, on some of its products, as well as standard off-the shelf items presently available from

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two or more suppliers. Historically, the Company has not experienced any significant problems in maintaining an adequate supply of these parts sufficient to satisfy customer demand. The Company believes that it has good relations with its vendors.

The Company generally does not manufacture products to stock finished goods inventory, as substantially all of the Company’s production is dedicated to specific customer purchase orders. As a result, the Company has limited requirements to maintain significant finished goods inventories.

Intellectual Property and Patents

While the Company believes that its success is ultimately dependent upon the innovative skills of its personnel and its ability to anticipate technological changes, its ability to compete successfully will depend, in part, upon its ability to protect proprietary technology contained in its products. The Company does not currently hold any patents relative to its current product lines. Instead, the Company relies upon a combination of trade secret, copyright and trademark laws and contractual restrictions to establish and protect proprietary rights in its products. The development of alternative, proprietary and other technologies by third parties could adversely affect the competitiveness of the Company’s products. Further, the laws of some countries do not provide the same degree of protection of the Company’s proprietary information, as do the laws of the United States. Finally, the Company’s adherence to industry-wide technical standards and specifications may limit the Company’s opportunities to provide proprietary product features capable of protection.

The Company is also subject to the risk of litigation alleging infringement of third party intellectual property rights. Infringement claims could require the Company to expend significant time and money in litigation, pay damages, develop noninfringing technology or acquire licenses to the technology, which is the subject of asserted infringement.

The Company has entered into several nonexclusive software licensing agreements that allow the Company to incorporate third-party software into its product line thereby increasing its functionality, performance and interoperability.

Employees

At December 31, 2004, the Company had 159 full-time employees, of which 40 were engaged in manufacturing and quality assurance, 60 in research and development, 34 in sales, sales support, customer service and marketing and 25 in general management and administration.

The Company’s success to date has been significantly dependent on the contributions of a number of its key technical and management employees. The loss of the services of one or more of these key employees could have a material adverse effect on the Company. In addition, the Company believes that its future success will depend in a large part upon its ability to attract and retain highly skilled and motivated technical, managerial, sales and marketing personnel. Competition for such personnel is intense.

None of the Company’s employees are covered by a collective bargaining agreement and there have been no work stoppages. The Company considers its relationship with its employees to be good.

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Competition

The Company’s competition includes vendors specifically dedicated to the enterprise I/O and telecommunication product markets. Most of the Company’s major OEM 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 off the shelf products for their product design. Increased competition and commoditization of network interface technologies could result in price reductions, reduced margins and loss of market share.

Risk Factors

Potential Fluctuations in Period-to-Period Results

Interphase has experienced fluctuations in its period-to-period revenue and operating results in the past and may experience fluctuations in the future. The Company’s sales on both an annual and a quarterly basis can fluctuate as a result of a variety of factors, many of which are beyond its control. The Company may have difficulty predicting the volume and timing of orders for products, and delays in closing orders can cause the Company’s operating results to fall short of anticipated levels for any period. Delays by Interphase’s OEM customers in producing products that incorporate the Company’s products could also cause operating results to fall short of anticipated levels. Other factors that may particularly contribute to fluctuations in the Company’s revenue and operating results include success in achieving design wins, the market acceptance of the OEM products that incorporate the Company’s products, the rate of adoption of new products, competition from new technologies and other companies, and the variability of the life cycles of Interphase’s customers’ products.

Because fluctuations can happen, Interphase believes that comparisons of the results of its operations for preceding quarters are not necessarily predictive of future quarters and that investors should not rely on the results for any one quarter as an indication of how Interphase will perform in the future. Investors should also understand that, if the Company’s revenue or operating results for any quarter are less than the level expected by securities analysts or the market in general, the market price for the Company’s common stock could immediately and significantly decline.

Technological Change and New Product Introductions

The market for the Company’s products is characterized by rapid technological change and frequent introduction of products based on new technologies. As these products are introduced, the industry standards change. Additionally, 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. The Company’s future revenue will depend upon the Company’s ability to anticipate technological change and to develop and introduce enhanced products of its 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 in of one of our products to actual production is 12 to 24 months. The inability to develop and manufacture

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new products in a timely manner, the existence of reliability, quality or availability problems in its products or their component parts, or the failure to achieve market acceptance for its products could have a material adverse effect on the Company’s operating results, financial condition and cash flows.

Competition

The telecommunications, signaling and networking business is extremely competitive, and the Company faces competition from a number of established and emerging start-up companies both public and private. Many of the Company’s principal competitors have established brand name recognition and market positions and have substantially greater financial resources to deploy on promotion, advertising and research and product development than the Company. In addition, as the Company broadens its product offerings, it may face competition from new competitors. Companies in related markets could offer products with functionality similar or superior to that offered by the Company’s products. Increased competition could result in significant pricing pressures. These pricing pressures could result in significantly lower average selling prices for the Company’s products. The Company may not be able to offset the effects of any price reductions with an increase in the number of customers, cost reductions or otherwise. The Company expects that competition will increase as a result of industry consolidations and alliances, as well as the emergence of new competitors. There can be no assurance that the Company will be able to compete successfully with its existing or new competitors or that competitive pressures faced by the Company will not have a material adverse effect on the Company’s operating results, financial condition and cash flows.

Dependence on Key Customers

While the Company enjoys a very good relationship with its customers, there can be no assurance that the Company’s principal customers will continue to purchase products from the Company at 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 the Company, and customers have certain rights to extend or delay the shipment of their orders. The loss of one or more of the Company’s major customers, or the reduction, delay or cancellation of orders or a delay in shipment of the Company’s products to such customers could have a material adverse effect on the Company’s operating results, financial condition and cash flows.

Design Wins

A design win occurs when a customer or prospective customer notifies the Company that its 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 12 to 24 months after the design win occurs. A variety of risks such as schedule delays, 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 their product to the production phase could have an adverse effect on the Company’s operating results, financial condition and cash flows.

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Product Liability

If the Company delivers products with errors, defects or problems, its credibility and the market acceptance and sales of its products could be harmed. Further, if Interphase’s products contain errors, defects and problems, then the Company may be required to expend significant capital and resources to alleviate such problems. Defects could also lead to product liability as a result of product liability lawsuits against Interphase or against its customers. Interphase has agreed to indemnify its customers in some circumstances against liability from defects in its 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 Interphase, 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 the Company’s license agreements. A successful product liability claim could seriously harm the Company’s business, financial condition and results of operations.

Interphase maintains insurance coverage for product liability claims. Although management believes this coverage is adequate, it is not assured that coverage under insurance policies will be adequate to cover product liability claims against the Company. 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 the Company.

Dependence on Third-Party Suppliers

Certain components used in the Company’s products are currently available to the Company from one or a limited number of sources. There can be no assurance that future supplies will be adequate for the Company’s needs or will be available on prices and terms acceptable to the Company. The Company’s 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 the Company’s gross margins, either of which could have a material adverse effect on the Company’s operating results, financial condition and cash flows.

Dependence on Internal Manufacturing

The Company manufactures its products at its Carrollton, Texas facility, and is currently in negotiations to establish alternative manufacturing capabilities through a third party in the event of a disaster in its current facility. If the Company is successful in establishing an alternative third-party contract manufacturer, there can be no assurance that the Company would be able to retain their services at the same costs that the Company currently enjoys. In the event of an interruption in production, the Company may not be able to deliver products on a timely basis, which could have a material adverse effect on the Company’s revenue and operating results. Although the Company currently has business interruption insurance and a disaster recovery plan to minimize the effect of the interruption, no assurances can be given that such insurance or recovery plan will adequately cover the Company’s lost business as a result of such an interruption.

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Dependence on Proprietary Technology

The Company’s success depends partly upon certain proprietary technologies developed in its software. To date, the Company has relied principally upon trademark, copyright and trade secret laws to protect its proprietary technologies. The Company generally enters into confidentiality or license agreements with its customers, distributors and potential customers and limits access to and distribution of the source code to its software and other proprietary information. The Company’s employees are subject to the Company’s employment policy regarding confidentiality. There can be no assurance that the steps taken by the Company in this regard will be adequate to prevent misappropriation of its technologies or to provide an effective remedy in the event of a misappropriation by others.

Although management believes that the Company’s 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 the Company may not ultimately prevail. Adverse determinations in such litigation could result in the loss of the Company’s proprietary rights, subject the Company to significant liabilities, require that the Company seek licenses from third parties or prevent the Company from manufacturing or selling its products, any of which could have a material adverse effect on the Company’s operating results, financial condition and cash flows.

It may be necessary for the Company to obtain technology licenses from others due to the large number of patents in the computer networking industry 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 to the Company 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 the Company’s operating results, financial condition and cash flows.

Dependence on Employees

The Company’s success depends on the continued contributions of its personnel and on its ability to attract and retain skilled employees. Changes in personnel could adversely affect the Company’s operating results, financial condition and cash flows.

Foreign Currency

The Company is exposed to adverse movements in foreign currency exchange rates because it conducts business on a global basis and in some cases in foreign currencies. The Company’s operations in France are measured in the local currency and converted into U.S. Dollars based on published exchange rates for the periods reported and are therefore subject to risk of exchange rate fluctuations (See Item 7A – Foreign Currency Risk).

The Company has Incurred Significant Losses in the Past

Although the Company posted net income of approximately $1.7 million for the year ended December 31, 2004, the Company has incurred net losses of approximately $769,000 for the year ended December 31, 2003, $8.4 million for the year ended December 31, 2002, and $9.6 million for the year ended December

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31, 2001. As part of a broader strategic refocusing, the Company developed a strategy to end-of-life many of its legacy products in an effort to focus its resources on its new product lines. This strategy resulted in increased sales of legacy products in 2000, however legacy product revenues have consistently declined since. Management does not expect significant revenues from its legacy product lines in future periods. In order to sustain its profitability, the Company will need to generate higher revenues while containing costs and operating expenses. Management cannot be certain that the Company’s revenues will continue to grow or that the Company will achieve sufficient revenues to maintain profitability on a long-term, sustained basis.

The Company May Need More Working Capital to Fund Operations and Expand the Business

Management believes the Company’s current financial resources will be sufficient to meet the present working capital and capital expenditure requirements for the next twelve months. However, the Company may need to raise additional capital before this period ends to further:

•   fund research and development of new products beyond what is expected in 2005;

•   expand the Company’s product and service offerings beyond what is contemplated in 2005 if unforeseen opportunities arise;

•   respond to unforeseen competitive pressures.

The Company’s 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. If current cash, marketable securities, lines of credit and cash generated from operations are insufficient to satisfy the liquidity requirements, the Company may seek to sell additional equity securities, issue debt securities or increase the Company’s working capital line of credit. The sale of additional equity securities could result in additional dilution to the Company’s shareholders. From time to time, management expects to evaluate the acquisition of, or investment in businesses and technologies that complement the Company. Acquisitions or investments might impact the Company’s liquidity requirements or cause the Company to sell additional equity securities or issue debt securities. There can be no assurance that financing will be available in amounts or on terms acceptable to the Company, if at all. If adequate funds were not available on acceptable terms, the Company’s 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 the results of operations, financial condition and cash flows of the Company.

The Market Price of the Company’s Common Stock is Likely to Continue to be Volatile

The trading price of the Company’s common stock is subject to wide fluctuations in response to quarter-to-quarter fluctuations in operating results, general conditions in the computer and communications industries 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 the Company’s common stock. The Company’s common stock has historically had relatively

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small trading volumes. As a result, small transactions in the Company’s common stock can have a disproportionately large impact on the quoted price of the Company’s common stock.

2006 will be the First Year That the Company’s Internal Controls Over Financial Reporting Will be Audited by Our Independent Registered Public Accounting Firm in Accordance with Section 404 of the Sarbanes-Oxley Act of 2002 unless the Company becomes an accelerated filer in 2005.

The year ending December 31, 2006 will be the first year that the Company’s internal controls over financial reporting will be audited by the Company’s independent registered public accounting firm in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”). However, if the Company becomes an accelerated filer in 2005 then the year ending December 31, 2005 will be the first year that the Company’s internal controls over financial reporting will be audited in accordance with Section 404. As a result of the ongoing interpretation of new guidance issued by the standards-setting community and the audit testing yet to be completed, the Company’s internal controls over financial reporting may include an unidentified material weakness which would result in receiving an adverse opinion on the Company’s internal controls over financial reporting from the Company’s independent registered public accounting firm. This could result in significant additional expenditures responding to the Section 404 internal control audit, heightened regulatory scrutiny and potentially an adverse effect to the price of the Company’s stock.

ITEM 2. PROPERTIES

The Company’s executive offices are located in a 22,000-square foot leased facility located in Plano, Texas. The executive offices serve as the primary location for the Company’s administrative, engineering and marketing functions. The Company’s manufacturing and operations center is located in a 24,000-square foot leased facility in Carrollton, Texas. The executive offices lease extends through the end of 2008 and the manufacturing and operations center lease extends through the end of 2005. The Company also leases a 3,000-square foot facility in Lisle, Illinois that supports an engineering laboratory. The Lisle, Illinois lease extends through October 2006. In addition, the Company leases a 9,000-square foot facility in Chaville, France (near Paris) that primarily supports an engineering team. The Chaville, France lease which the Company is in the process of renewing, expires in June 2005. The Company believes that its facilities and equipment are in good operating condition and are adequate for its operations. The Company owns most of the equipment used in its operations. Such equipment consists primarily of engineering equipment, manufacturing and test equipment and fixtures.

ITEM 3. LEGAL PROCEEDINGS

None

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable

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PART II

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 National Market, or its predecessors, under the symbol INPH. The following table summarizes its high and low closing price for each quarter during 2004 and 2003 as reported by Nasdaq.

2004	High		Low
First Quarter		19.17		11.30
Second Quarter		12.67		8.36
Third Quarter		12.65		9.21
Fourth Quarter		10.22		6.70

2003	High		Low
First Quarter		4.25		3.17
Second Quarter		7.69		3.97
Third Quarter		10.58		6.50
Fourth Quarter		18.05		8.77

On March 10, 2005 there were approximately 56 shareholders of record of the Company’s common stock.

The Company has not paid dividends on its common stock since its inception. The Board of Directors does not anticipate payment of any dividends in the foreseeable future and intends to continue its present policy of retaining earnings for reinvestment in the operations of the Company.

The Board of Directors has adopted a Shareholder Rights Plan whereby each holder of record as of December 29, 2000 received a right to purchase from the Company one share of common stock of the Company at a price of $93 per share for each share held. These rights can only be exercised after certain events occur, such as if a person or entity acquires, or makes a tender or exchange offer to acquire 15% or more of the Company’s common stock and the rights expire ten years from the record date. Upon acquisition of 15% or more of the Company’s common stock, each right not owned by the acquiring person or group will be adjusted to allow the purchase for $93 of a number of shares having a then market value of $186. These rights are intended to provide the Company certain anti-takeover protections. The Board of Directors may terminate the Rights Plan, or redeem the rights for $0.01 per right, at any time until the tenth business day following a public announcement of a 15% or more stock acquisition. The Company has reserved 7,000,000 shares of common stock for this plan. The rights were distributed to shareholders as of the record date as a nontaxable dividend. The rights are attached to and trade with Interphase common stock until the occurrence of one of the triggering events, at which time the rights would become detached from the common stock.

In November 2001, the Board of Directors authorized the repurchase of up to $5 million of the Company’s common stock. Purchases were authorized to be made from time to time during a twenty-four

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month period, ending in November 2003, in the open market or in privately negotiated transactions depending on market conditions. The Company canceled all shares that it repurchased.

See Note 8 of the accompanying notes to the consolidated financial statements for information regarding the Company’s shareholder approved stock incentive plans.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The selected consolidated 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 statements of operations for the years ended December 31, 2004, 2003, 2002, 2001 and 2000, and the notes thereto appearing elsewhere herein, as applicable.

It is important that you also read “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements, including the notes, for the years ended December 31, 2004, 2003, and 2002.

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Statement of Operations Data:
(In thousands, except per share data)

	Year ended December 31
	2004			2003			2002			2001			2000
Revenue	$	35,015		$	32,490		$	25,123		$	28,732		$	55,697
Gross margin		19,171			16,909			9,792			9,004			29,688
Research and development		8,033			7,719			7,005			7,757			10,359
Sales and marketing		6,107			6,929			5,991			6,812			10,731
General and administrative		3,675			3,547			3,285			3,759			4,824
Restructuring costs and other special charges		—			—			—			2,091			—
Goodwill impairment charge		—			—			—			2,350			—
Income (loss) from operations		1,356			(1,286	)		(6,489	)		(13,765	)		3,774
Other, net		240			305			611			(20	)		333
Income (loss) from continuing operations before income taxes		1,596			(981	)		(5,878	)		(13,785	)		4,107
Income tax (benefit) provision		(122	)		(212	)		2,523			(4,213	)		1,707
Income (loss) from continuing operations		1,718			(769	)		(8,401	)		(9,572	)		2,400
Discontinued operations, net		—			—			—			—			571
Net income (loss)	$	1,718		$	(769	)	$	(8,401	)	$	(9,572	)	$	2,971
Income (loss) from continuing operations per share
Basic EPS	$	0.30		$	(0.14	)	$	(1.51	)	$	(1.68	)	$	0.41
Diluted EPS	$	0.27		$	(0.14	)	$	(1.51	)	$	(1.68	)	$	0.38
Net income (loss) income per share
Basic EPS	$	0.30		$	(0.14	)	$	(1.51	)	$	(1.68	)	$	0.51
Diluted EPS	$	0.27		$	(0.14	)	$	(1.51	)	$	(1.68	)	$	0.48
Weighted average common shares		5,719			5,544			5,551			5,705			5,805
Weighted average common and dilutive shares		6,312			5,544			5,551			5,705			6,237

Balance Sheet Data:
(In thousands)

	December 31,
	2004		2003		2002		2001		2000
Working capital	$	26,450	$	24,255	$	24,254	$	31,601	$	37,502
Total assets		32,098		30,743		30,749		39,243		54,473
Total liabilities		7,310		7,930		7,931		7,323		12,534
Redeemable common stock		—		—		—		762		1,780
Shareholders’ equity		24,788		22,813		22,818		31,158		40,159

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ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This report contains forward-looking statements about the business, financial condition and prospects of the Company. These statements are made under the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. The actual results of the Company could differ materially from those indicated by the forward-looking statements because of various risks and uncertainties, including without limitation, our reliance on a limited number of customers, failure to see spending improvements in the telecommunications and computer networking industries, significant changes in product demand, the availability of products, changes in competition, various inventory risks due to changes in market conditions and other risks and uncertainties indicated in the Company’s filings and reports with the Securities and Exchange Commission. All the foregoing risks and uncertainties are beyond the ability of the Company to control, and in many cases, the Company cannot predict the risks and uncertainties that could cause its actual results to differ materially from those indicated by the forward-looking statements. When used in this report, the words “believes,” “plans,” “expects,” “intends,” and “anticipates” and similar expressions as they relate to the Company or its management are intended to identify forward-looking statements.

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 some of the more critical judgment areas in the application of the Company’s accounting policies that affect the Company’s financial condition and results of operations. Management has discussed the application of these critical accounting policies with the Board of Directors and Audit Committee.

Revenue Recognition: Revenues consist of product and service revenues and are recognized in accordance with SEC Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition.” Product revenues are recognized upon shipment, provided fees are fixed and determinable, a customer purchase order is obtained (when applicable), and collection is probable. Revenues from reseller agreements are recognized when the product is sold through to the end customer unless an established return history supports recognizing revenue upon shipment, less a provision for estimated sales returns. Deferred revenue consists primarily of revenue from reseller arrangements, service revenue and certain arrangements with extended payment terms. Revenue from extended payment terms is recognized in the period the payment becomes due if all other revenue recognition criteria have been met. Service revenue is recognized as the services are performed.

Revenue derived from the development and installation of highly customized software packages under a professional services contract is recognized on a percentage of completion basis measured by the relationship of hours worked to total estimated contract hours and the costs incurred as of the date of measurement. The Company follows this method since reasonably dependable estimates of the revenue and contract hours applicable to various elements of a contract can be made. Since the financial reporting of these contracts depends upon estimates, which are assessed continually during the term of these contracts, recognized revenue and profit are subject to revisions as the contract progresses to completion.

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Revisions in profit estimates are reflected in the period in which the facts that give rise to the revisions become known. Accordingly, favorable changes in estimates result in additional revenue recognition and net income, and unfavorable changes in estimates result in a reduction of recognized revenue and net income. If estimates were to indicate that a loss would be incurred on a contract upon completion, a provision for the expected loss would be recorded in the period in which the loss became evident.

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.

Allowance for Doubtful Accounts: Management is required to estimate the collectibility 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 and reevaluated and adjusted as additional information is received. The reserves also are determined by using percentages applied to certain aged receivable categories based on historical results.

Allowance for Returns: The Company estimates its allowance for returns based upon expected return rates. The estimates of expected return rates are generally a factor of historical returns. 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 inventories 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 our 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 requirements decrease 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 as well as declining market conditions. It is possible that significant changes in this estimate may continue to occur in the future as market conditions change.

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. Such determination is made in accordance with the applicable Generally Accepted Accounting Principles (“GAAP”) requirements associated with the long-lived asset, and is based upon, among other things, estimates of the amount of future net cash flows to be generated by the long-lived asset and estimates of the current fair value of the asset. Adverse changes in such estimates could result in an inability to recover the carrying value of the long-lived asset, thereby possibly requiring an impairment charge to be recognized in the future. All impairments are recognized in operating results when a permanent reduction in value occurs.

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Tax Assessments: The Company is periodically engaged in various tax audits by federal and state governmental authorities incidental to its business activities. The Company records reserves for its estimated probable losses of these proceedings, if applicable.

Deferred Taxes: The Company records a valuation allowance to reduce its deferred income tax assets to the amount that is believed to be realizable under the guidance of Statement of Financial Accounting Standards No. 109 “Accounting for Income Taxes.” 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 required to make a continuous assessment as to the realizability of the deferred tax assets.

CONSOLIDATED STATEMENT OF OPERATIONS AS A PERCENTAGE OF REVENUE

	Year ended December 31,
	2004			2003			2002
Revenue		100.0	%		100.0	%		100.0	%
Cost of sales		45.2	%		48.0	%		61.0	%
Gross margin		54.8	%		52.0	%		39.0	%
Research and development		22.9	%		23.8	%		27.9	%
Sales and marketing		17.5	%		21.3	%		23.8	%
General and administrative		10.5	%		10.9	%		13.1	%
Income (loss) from operations		3.9	%		(4.0	)%		(25.8	)%
Interest income, net		0.7	%		0.7	%		2.0	%
Other income, net		0.0	%		0.3	%		0.4	%
Income (loss) before income taxes		4.6	%		(3.0	)%		(23.4	)%
Income tax (benefit) provision		(0.3	)%		(0.6	)%		10.0	%
Net income (loss)		4.9	%		(2.4	)%		(33.4	)%

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OVERVIEW

During 2004, we recorded our second consecutive year of revenue growth and our first full year of profitable operations since 2000. As we continue to add value to our product offerings, through innovative new technologies, we have been able to improve our gross margin three consecutive years due to lower excess and obsolete inventory charges, improved product mix, improved manufacturing efficiencies and achieved reductions in material costs of certain product lines due to increased production volumes. Total operating expenses decreased slightly in 2004 compared to 2003 as we continued to manage resources very judiciously throughout the year.

The Company continues to enjoy a strong and extremely liquid balance sheet. Cash and securities increased to their highest year-end level in the Company’s history. Total liabilities decreased to their lowest levels since 1995 and working capital reached its highest level since 2001.

RESULTS OF OPERATIONS

Revenue: Total revenue for the years ended December 31, 2004, 2003 and 2002 were $35 million, $32.5 million and $25.1 million, respectively.

Revenue increased 8% in 2004 compared to 2003. This increase was primarily attributable to broadband telecom product revenue. Broadband telecom revenue increased approximately 13% to $20.2 million for the year ended December 31, 2004 compared to $17.8 million for the year ended December 31, 2003. This increase was partially offset by SlotOptimizer revenue which declined approximately 6% to $10.7 million for the year ended December 31, 2004 compared to $11.4 million for the year ended December 31, 2003. The Company anticipates that SlotOptimizer revenue will continue to decline as the product line ages. All other revenue, composed primarily of security, professional services and legacy networking and storage product lines, increased approximately 26% for the year ended December 31, 2004 to $4.1 million compared to $3.3 million for the year ended December 31, 2003. One of the Company’s major challenges in 2005 will be to replace the revenue impacted by our largest telecom customer migrating to a more cost effective Interphase controller board for their application. This migration makes for a more competitive solution offering which our customer will be selling in very price sensitive markets. Although we anticipate some volume growth due to this migration, we do not anticipate that growth to be sufficient enough to replace the revenue impacted by the transition. However, the company anticipates that revenue levels for 2005 will be comparable or higher as certain design wins from prior periods move into production and that customers will increase the part of product rollout.

Revenue increased 29% in 2003 compared to 2002. The increase was primarily attributable to broadband telecom and SlotOptimizer product revenue. Broadband telecom revenue increased approximately 51% to $17.8 million for the year ended December 31, 2003 compared to $11.8 million for the year ended December 31, 2002. In addition, SlotOptimizer revenue increased approximately 33% to $11.4 million for the year ended December 31, 2003 compared to $8.6 million for the year ended December 31, 2002. The increase in revenue related to these product lines was partially offset by the continued decrease in revenue related to legacy networking and storage product lines, which decreased approximately 72% to $1.0 million for the year ended December 31, 2003, compared to $3.7 million for the year ended December 31, 2002.

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Gross Margin: Gross margin as a percentage of sales for the years ended December 31, 2004, 2003 and 2002 was 55%, 52% and 39%, respectively. The increase in the gross margin percentage in 2004 compared to 2003 is partially due to a continued shift toward more complex, and thus, higher margin products. In addition, the Company’s excess and obsolete inventory charges decreased to $300,000 for the year ended December 31, 2004, compared to $700,000 for the year ended December 31, 2003. The Company also improved manufacturing efficiencies and achieved reductions in material costs for certain product lines due to increased production volumes. The Company believes that pricing pressures in the industry may dampen gross margins in future periods and it may become increasingly challenging to offset these pressures with incremental supplier cost reductions and factory productivity improvements.

The increase in the gross margin percentage in 2003 compared to 2002 is partially due to a continued shift in product mix toward more complex, and thus, higher margin products. In addition, the Company’s excess and obsolete inventory charges decreased to $700,000 for the year ended December 31, 2003, compared to $1.8 million for the year ended December 31, 2002.

Research and Development: The Company’s investment in the development of new products through research and development was $8.0 million, $7.7 million and $7.0 million in 2004, 2003 and 2002, respectively. As a percentage of revenue, research and development expenses were 23%, 24% and 28% for 2004, 2003 and 2002, respectively. The Company anticipates that spending on research and development will remain steady in 2005, except for fluctuations in currency exchange rates because much of the Company’s development expenses are associated with is engineering lab in France (see Item 7A – Foreign Currency Risk), as the Company continues to invest in development of our current and future products, however, the Company will continue to monitor the level of its investments concurrently with actual revenue results.

Research and development expenses increased $314,000 in 2004 compared to 2003. The increase in research and development expense primarily is due to foreign currency changes as the dollar dropped significantly in value relative to the Euro (see Item 7A – Foreign Currency Risk) partially offset by reduced general overhead spending as the Company continues to work toward keeping break even levels as low as possible. The decrease in research and development costs as a percentage of total revenue is due to revenue increasing at a higher rate than research and development costs for the year.

Research and development expenses increased $714,000 in 2003 compared to 2002. Approximately 78% of the increase in research and development expenses year over year is due to foreign currency changes as the dollar dropped significantly in value relative to the Euro (see Item 7A – Foreign Currency Risk). The remaining portion of the increase is primarily due to an increase in the development of new Broadband telecom products. The decrease in research and development costs as a percentage of total revenue is due to revenue increasing at a higher rate than research and development costs for the year.

Sales and Marketing: Sales and marketing expenses were $6.1 million, $6.9 million and $6.0 million in 2004, 2003 and 2002, respectively. As a percentage of revenue, sales and marketing expenses were 18%, 21% and 24% for 2004, 2003 and 2002, respectively.

Sales and marketing expense decreased $822,000 in 2004 compared to 2003. Approximately 82% of the decrease in sales and marketing expenses for the twelve months ended December 31, 2004 compared to the twelve months ended December 31, 2003 related to a reduction in sales and marketing headcount related expenses, including contract labor and sales commissions. The remaining portion of the decrease

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primarily relates to reductions in advertising and promotional activities. The decrease in sales and marketing expense as a percentage of total revenue is due to revenue increasing while sales and marketing expenses decreased.

Sales and marketing expense increased $938,000 in 2003 compared to 2002. Approximately 66% of the increase in sales and marketing year over year is due to higher sales commissions and bonuses due to higher revenue levels and other headcount related expenses in the sales organization. Additionally, approximately 23% of the increase in sales and marketing expense relates to higher marketing expenditures, including headcount. The remaining portion of the increase is due to increased travel and related expenses. The decrease in sales and marketing expense as a percentage of total revenue is due to revenue increasing at a higher rate than sales and marketing expense for the year.

General and Administrative: General and administrative expenses were $3.7 million, $3.5 million and $3.3 million in 2004, 2003 and 2002, respectively. As a percentage of revenue, general and administrative expenses were 11%, 11% and 13% for 2004, 2003 and 2002, respectively.

General and administrative expenses increased $128,000 in 2004 compared to 2003. The increase in general and administrative expenses primarily relates to increased employee compensation including bonuses tied to increased revenues and profits.

General and administrative expenses increased $262,000 in 2003 compared to 2002. Approximately 84% of the increase in general and administrative expenses year over year is due to an increase in insurance premiums and other legal and accounting related expenses. The remaining portion of the increase is due to headcount related expenses partially offset by reductions in corporate spending related to the change in facilities in November of 2002. The decrease as a percentage of total revenue is due to revenue for the period increasing at a higher rate than general and administrative expenses.

Interest, Net: Interest income, net of interest expense, was $232,000, $226,000 and $517,000 in 2004, 2003 and 2002, respectively.

The decrease in interest income, net of interest expense in 2003 compared to 2002 is primarily due to lower cash levels during 2003 as well as lower investment rates of return.

Other Income, Net: Other income, net, was $8,000, $79,000 and $94,000 in 2004, 2003 and 2002, respectively.

Income Taxes: The Company’s effective income tax rates were (8%) in 2004, (22%) in 2003 and 43% in 2002.

The effective tax rates for the periods presented differ from the U.S. statutory rate as the Company continues to provide a full valuation allowance for its net deferred tax assets at December 31, 2004, 2003 and 2002.

During the first quarter of 2004, after conducting a thorough review of the Company’s Internal revenue Service (“IRS”) transcripts, the Company discovered that the IRS had not paid allowable interest on the refund from the IRS audit described below. As a result, the Company recognized a tax benefit of approximately $100,000 in 2004.

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During the third quarter 2003, the IRS concluded a federal income tax audit of the Company related to the tax years 1996 through 2001. In addition, the French tax administration also concluded a tax audit of the Company’s French subsidiary covering the same periods resulting in a finding of no tax due. Due to the finalization of both tax audits, the Company recognized a benefit of approximately $245,000 during the year ended December 31, 2003. This benefit was partially offset by taxes on foreign income.

The effective tax provision rate for 2002 was significantly more than the U.S. statutory rate due to a non-cash charge of approximately $4.9 million to provide a full valuation allowance for the net deferred tax assets at December 31, 2002. The effective tax benefit rate excluding this charge would have been (40%), which differed from the U.S. statutory rate primarily due to the benefit of a foreign tax loss carry forward. The foreign tax loss carry forward expired at December 31, 2002.

Net Income (Loss): The Company reported net income of $1.7 million for the twelve months ended December 31, 2004. The Company reported a net loss of $769,000 in 2003 and $8.4 million in 2002.

LIQUIDITY AND CAPITAL RESOURCES

Consolidated Cash Flows

During 2004 the Company purchased approximately $14.0 million in marketable securities, which decreased cash and cash equivalents by $9.3 million for the year ended December 31, 2004. Cash and cash equivalents increased $4.3 million for the year ended December 31, 2003 and decreased $558,000 for the year ended December 31, 2002. Cash flows are impacted by operating, investing and financing activities.

Operating Activities: Trends in cash flows from operating activities for 2004, 2003 and 2002, are generally similar to the trends in the Company’s earnings except for noncash realized holding period loss on marketable securities, provision for uncollectible accounts and returns, provision for excess and obsolete inventory, depreciation and amortization and deferred income taxes. Cash provided by operating activities totaled $1.5 million, $385,000 and $1.9 million for the years ended December 31, 2004, 2003 and 2002, respectively, compared to net income of $1.7 million, a net loss of $769,000 and a net loss of $8.4 million in 2004, 2003 and 2002, respectively. The Company incurred noncash realized holding period losses on marketable securities in 2002 related to the other than temporary impairment of certain marketable securities received in the sale of the Company’s Voice Over Internet Protocol (“VOIP”) business. Provisions for uncollectible accounts and returns decreased during all three years due to the reduction in accounts receivable, an increased focus on credit evaluation and improved returns experience. Provision for excess and obsolete inventories has decreased in 2004 and 2003. Depreciation and amortization decreased slightly in 2004. Deferred income taxes decreased in 2002, due to the establishment of a full valuation allowance for the Company’s domestic deferred tax assets (See Note 5 to the consolidated financial statements).

Changes in assets and liabilities result primarily from the timing of production, sales and purchases. 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: The Company’s investing activities resulted in a net cash use of $11.3 million, $484,000 and $1.8 million in 2004, 2003 and 2002, respectively. Cash used in investing activities in each

29

of the three years related principally to additions to property and equipment, capitalized software and the Company’s investments in marketable securities. Additions to property and equipment and capitalized software in each of the three years focused on the manufacturing, sales and engineering functions of the Company. The expenditures in 2004 were focused on software and equipment purchases for the sales, engineering and information technology functions of the Company. The expenditures in 2003 related primarily to manufacturing equipment and capitalized software used in the engineering and sales functions. Expenditures in 2002 related primarily to leasehold improvements made to the Company’s new corporate offices and manufacturing facility and to the purchase of new manufacturing equipment which utilizes new technologies and increases automation of the manufacturing process to provide improved productivity and efficiency. Purchases of marketable securities significantly increased to $14.0 million in 2004 compared to $1.7 million in 2003 as the Company adjusted its investment strategy in 2004. Proceeds from the sale of marketable securities increased slightly and was $3.3 million in 2004 compared to $2.1 million in 2003.

Financing Activities: Net cash provided by financing activities totaled $422,000 for the year ended December 31, 2004 and $4.4 million for the year ended December 31, 2003. Net cash used by financing activities totaled $783,000 for the year ended December 31, 2002. Cash provided by financing activities in 2004 is comprised of $422,000 in proceeds from the exercise of stock options. Cash provided by financing activities in 2003 includes the removal of $3.5 million of restrictions on cash in 2003 and $931,000 in proceeds from the exercise of stock options due to the increase in stock option exercises as a result of the Company’s increased stock price during the second half of 2003. Cash used from financing activities in 2002 includes the purchase of redeemable common stock of $762,000 and the purchase of common stock of $21,000.

Commitments

At December 31, 2004, the Company had no material commitments to purchase capital assets, however, planned capital expenditures for 2005 are estimated at approximately $1.0 million, the majority of which relate to the Company’s engineering tools and general office equipment. The Company’s significant long-term obligations are its operating leases on its facilities and future debt payments. The Company has not paid any dividends since its inception and does not anticipate paying any dividends in 2005.

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The following table summarizes the Company’s future contractual obligations and payment commitments as of December 31, 2004.

Contractual Obligation	2005		2006		2007		2008		Total
Operating leases (1)	$	604	$	410	$	403	$	411	$	1,828
Long-term debt (2,3)	$	123	$	123	$	3,571		—	$	3,817
Total	$	727	$	533	$	3,974	$	411	$	5,645

(1)	The Company leases its facilities under non-cancelable operating leases with the longest terms extending to December 2008.
(2)	At December 31, 2004, the Company had borrowings of $3.5 million under a $5 million revolving credit facility with a bank. The revolving credit facility matures on July 31, 2007 and is secured throughout the term of the credit facility by marketable securities.
(3)	The Company incurs interest expense on the borrowings from the revolving credit facility at a rate of LIBOR + 1% (3.5% at December 31, 2004). The Company used the 3.5% rate to estimate interest expense for 2005 through July 2007. The interest expense estimate is $123,000, $123,000 and $71,000 for years 2005, 2006 and 2007, respectively.

Contingencies

The Company has agreed to perform a minor repair, at no cost to a customer, of approximately 1,800 units that were shipped between December 2003 and April 2004. The actual cost to repair the units is insignificant. However, the Company has estimated that other costs including shipping related charges and installation related charges could be more significant. The Company has estimated that the range of the potential liability is between approximately $225,000 and $650,000 but cannot determine an amount within that range which is more likely than another. Therefore, in accordance with Financial Accounting Standards Board Interpretation No. 14 “Reasonable Estimation of the Amount of a Loss — an Interpretation of FASB Statement No. 5”, the Company has recorded, in accrued liabilities, the minimum liability amount of approximately $225,000 at December 31, 2004.

Other

Management believes that cash generated from operations and borrowing availability under the revolving credit facility, together with cash on hand, will be sufficient to meet the Company’s liquidity needs for working capital, capital expenditures and debt services. To the extent that the Company’s actual operating results or other developments differ from the Company’s expectations, Interphase’s liquidity could be adversely affected.

The Company periodically evaluates its liquidity requirements, alternative uses of capital, capital needs and available resources in view of, among other things, its capital expenditure requirements, and estimated future operating cash flows. As a result of this process, the Company has in the past and may in the future seek to raise additional capital, refinance or restructure indebtedness, issue additional securities, repurchase shares of its common stock or take a combination of such steps to manage its liquidity and capital resources. In the normal course of business, the Company may review opportunities for acquisitions, joint ventures or other business combinations in the component products industry. In the event of any such transaction, the Company may consider using available cash, issuing additional equity securities or increasing the indebtedness of the Company or its subsidiaries.

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Recently Issued Accounting Pronouncements

In October 2004, the American Jobs Creation Act of 2004 was enacted into law. The new law provides for a special 85% deduction for certain dividends received in 2005 from controlled foreign corporations. Because certain details in the new law lack clarification, and the impact of the special dividend received deduction to the Company is dependent, in part, on the Company’s 2005 foreign and domestic taxable income, the Company has not yet determined whether it will benefit from the new law. In 2005, the Company plans to evaluate both clarifying guidance on the new law from the Internal Revenue Service and its year-to-date taxable income activity to determine the level of benefit, if any, the Company will derive from the special dividend received deduction.

Beginning in 2005, the new law also provides for a special deduction from U.S. taxable income equal to a stipulated percentage of a U.S. company’s qualified income from domestic manufacturing activities (as defined). Although the Company believes that the majority of its operations meet the definition of qualified domestic manufacturing activities, the Company does not expect to benefit from the special manufacturing deduction in 2005, primarily because the Company projects its U.S. taxable income in 2005 will be fully offset by its existing U.S. NOL carryforwards.

In December 2004, the FASB issued SFAS No. 123(R), “Share Based Payments”, which replaces SFAS No. 123, “Accounting for Stock-Based Compensation”, and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” and amends SFAS No. 95, “Statement of Cash Flows”. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. As such, pro forma disclosure in lieu of expensing is no longer an alternative. The new standard is effective in the first interim or annual reporting period beginning after June 15, 2005. The Company is currently assessing the impact that the statement may have on its financial statements.

In December 2004, the FASB issued SFAS No. 151 “Inventory Costs, an Amendment of ARB No. 43, Chapter 4”. SFAS No. 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material and requires that these items be recognized as current period charges. SFAS No. 151 applies only to inventory costs incurred during periods beginning after the effective date and also requires that the allocation of fixed production overhead to conversion costs be based on the normal capacity of the production facilities. SFAS No. 151 is effective for the Company’s fiscal year beginning January 1, 2006. The Company is currently assessing the impact, if any, of the adoption of the provisions of SFAS No. 151.

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets”, which amends APB Opinion No. 29. The guidance in APB No. 29, “Accounting for Nonmonetary Transactions”, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The amendment made by SFAS No. 153 eliminates the exception for exchanges of similar productive assets and replaces it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. The provisions of the statement are effective for exchanges taking place in fiscal periods beginning after June 15, 2005. The Company does not believe the adoption of this statement will have a material impact on our financial statements.

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ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Foreign Currency Risk

The Company is exposed to adverse movements in foreign currency exchange rates because it conducts business on a global basis and in some cases in foreign currencies. The Company’s operations in France are measured in the local currency and converted into U.S. Dollars based on published exchange rates for the periods reported and are therefore subject to risk of exchange rate fluctuations. The Euro to U.S. Dollar translation accounted for a charge of approximately $1.1 million and $595,000 for the years ended December 31, 2004 and 2003, respectively. The Euro to U.S. Dollar translation accounted for a benefit of $255,000 for the year ended December 31, 2002.

Market Price Risk

In 2002 the Company maintained a minority equity investment in a publicly traded company and recorded a net after tax loss on this investment of $20,000 thus eliminating the Company’s investment. The Company has no equity hedge contracts outstanding as of December 31, 2004 or December 31, 2003.

Interest Rate Risk

The Company’s investments are subject to interest rate risk. Interest rate risk is the risk that the Company’s financial condition and results of operations could be adversely affected due to movements in interest rates. The Company invests its cash in a variety of interest-earning financial instruments, including bank time deposits, money market funds, and variable rate and fixed rate obligations of corporations and national governmental entities and agencies. Due to the demand nature of the Company’s money market funds and the short-term nature of the Company’s time deposits and debt securities portfolio, these assets are particularly sensitive to changes in interest rates. The Company manages this risk through investments with shorter-term maturities and varying maturity dates.

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, 2004. This potential change is based on sensitivity analyses performed on our marketable securities at December 31, 2004. 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, 2003.

The Company’s credit facility, bears interest at a variable rate tied to the London Interbank Offered Rate (LIBOR). In an effort to mitigate interest rate fluxations the Company typically locks in the rate under one year agreements. The current agreement which expires in October 2005 is at 3.5% (LIBOR + 1%). A hypothetical 100 basis point increase in LIBOR would increase annual interest expense on this credit facility by approximately $32,000.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     See Item 15 (a) below.

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ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

     None.

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 effective.

Changes in Internal Controls

The Company maintains a system of internal controls that are designed to provide reasonable assurance that its books and records accurately reflect, in all material respects, the transactions of the Company and that its established policies and procedures are adhered to. There were no changes to the Company’s internal controls or in other factors that could significantly affect the Company’s internal controls subsequent to the date of the evaluation by the Company’s CEO and CFO, including any corrective actions with regard to significant deficiencies and material weaknesses.

ITEM 9B.  OTHER INFORMATION

     None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Directors

See information regarding the directors and nominees for director under the heading “Election of Directors” of the Proxy Statement for the Annual Meeting of Shareholders to be held May 4, 2005, which is incorporated herein by reference.

Executive Officers

See information regarding the executive officers under the heading “Executive Officers” of the Proxy Statement for the Annual Meeting of Shareholders to be held May 4, 2005, which is incorporated herein by reference.

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Code of Ethics

The Company has adopted a Code of Business Conduct, which applies to all of its employees, including its Chairman and Chief Executive Officer, its Chief Financial Officer and its 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 Stock Market, by filing a Current Report on Form 8-K with the Securities and Exchange Commission disclosing such information.

ITEM 11. EXECUTIVE COMPENSATION

See information regarding executive compensation under the heading “Executive Compensation” of the Proxy Statement for the Annual Meeting of Shareholders to be held May 4, 2005, which is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

See information regarding security ownership of certain beneficial owners and management under the headings “Principal Shareholders” and “Executive Compensation” of the Proxy Statement for the Annual Meeting of Shareholders to be held May 4, 2005, which is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

See information regarding certain relationships and related transactions under the headings “Principal Shareholders” and “Certain Related Transactions” of the Proxy Statement for the Annual Meeting of Shareholders to be held May 4, 2005, which is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

See information regarding principal accountant fees and services under the heading “Relationship with Independent Public Accountants” of the Proxy Statement for the Annual Meeting of Shareholders to be held May 4, 2005, which is incorporated herein by reference.

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)   (1) and (2) Financial Statements and Schedules.

Reference is made to the listing on page F-1 of all financial statements and schedules filed as a part of this report.

     (3) Exhibits.

Reference is made to the Index to Exhibits on page E-1 for a list of all exhibits filed during the period covered by this report.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	INTERPHASE CORPORATION
Date: March 18, 2005	By:	/s/ Gregory B. Kalush
		Gregory B. Kalush
		Chairman of the Board, Chief Executive Officer and President

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 18, 2005.

Name	Title
/s/ Gregory B. Kalush Gregory B. Kalush	Chairman of the Board, Chief Executive Officer and President (Principal executive officer)
/s/ Steven P. Kovac Steven P. Kovac	Chief Financial Officer, Treasurer and Vice President of Finance (Principal financial officer)
/s/ Paul N. Hug Paul N. Hug	Director
/s/ Randall D. Ledford Randall D. Ledford	Director
/s/ Michael J. Myers Michael J. Myers	Director
/s/ Kenneth V. Spenser Kenneth V. Spenser	Director
/s/ S. Thomas Thawley S. Thomas Thawley	Vice Chairman, Director and Secretary

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INDEX TO FINANCIAL STATEMENTS

Report of Grant Thornton LLP	F-2
Report of PricewaterhouseCoopers LLP	F-3
Consolidated Balance Sheets – As of December 31, 2004 and 2003	F-4
Consolidated Statements of Operations — Years Ended December 31, 2004, 2003 and 2002	F-5
Consolidated Statements of Shareholders’ Equity — Years Ended December 31, 2004, 2003 and 2002	F-6
Consolidated Statements of Cash Flows — Years Ended December 31, 2004, 2003 and 2002	F-7
Notes to Consolidated Financial Statements	F-8 to F-23

* All schedules are omitted because they are not applicable or the required information is presented in the consolidated financial statements or notes thereto.

F-1

Report of Independent Registered Public Accounting Firm

The Board of Directors
Interphase Corporation

We have audited the accompanying consolidated balance sheet of Interphase Corporation and subsidiaries (the Company) as of December 31, 2004 and the related consolidated statement of operations, shareholders’ equity, and cash flows for the year then ended. 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 audit.

We conducted our audit 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. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit 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 audit provides 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, 2004, and the results of their operations and cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

/s/ Grant Thornton LLP

Dallas, Texas
March 7, 2005

F-2

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Interphase Corporation:

In our opinion, the accompanying consolidated balance sheets as of December 31, 2003 and 2002 and the related consolidated statements of operations, of shareholders’ equity, and of cash flows present fairly, in all material respects, the financial position of Interphase Corporation and its subsidiaries (the Company) at December 31, 2003 and 2002, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. 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 of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP

Dallas, Texas
March 5, 2004

F-3

INTERPHASE CORPORATION
CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

	December 31,
	2004			2003
ASSETS
Cash and cash equivalents	$	4,928		$	14,204
Marketable securities		15,585			5,047
Trade accounts receivable, less allowances of $141 and $194, respectively		4,976			5,634
Inventories		3,509			2,961
Prepaid expenses and other current assets		956			751
Income taxes receivable		246			—
Total current assets		30,200			28,597
Machinery and equipment		6,170			5,626
Leasehold improvements		377			392
Furniture and fixtures		572			560
		7,119			6,578
Less-accumulated depreciation and amortization		(5,729	)		(5,018	)
Total property and equipment, net		1,390			1,560
Capitalized software, net		310			355
Other assets		198			231
Total assets	$	32,098		$	30,743
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Accounts payable	$	529		$	1,106
Deferred revenue		244			373
Accrued liabilities		1,423			1,684
Accrued compensation		1,554			1,179
Total current liabilities		3,750			4,342
Deferred lease obligations		60			88
Long term debt		3,500			3,500
Total liabilities		7,310			7,930
Commitments and contingencies
Shareholders’ Equity
Common stock, $.10 par value; 100,000,000 shares authorized; 5,750,824 and 5,680,179 shares issued and outstanding, respectively		575			568
Additional paid in capital		38,633			38,218
Retained deficit		(13,846	)		(15,564	)
Cumulative other comprehensive loss		(574	)		(409	)
Total shareholders’ equity		24,788			22,813
Total liabilities and shareholders’ equity	$	32,098		$	30,743

The accompanying notes are an integral part of these consolidated financial statements.

F-4

INTERPHASE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

	Years ended December 31,
	2004			2003			2002
Revenues	$	35,015		$	32,490		$	25,123
Cost of sales		15,844			15,581			15,331
Gross margin		19,171			16,909			9,792
Research and development		8,033			7,719			7,005
Sales and marketing		6,107			6,929			5,991
General and administrative		3,675			3,547			3,285
Total operating expenses		17,815			18,195			16,281
Income (loss) from operations		1,356			(1,286	)		(6,489	)
Interest income, net		232			226			517
Other income, net		8			79			94
Income (loss) before income tax		1,596			(981	)		(5,878	)
Income tax (benefit) provision		(122	)		(212	)		2,523
Net income (loss)	$	1,718		$	(769	)	$	(8,401	)
Net income (loss) per share:
Basic EPS	$	0.30		$	(0.14	)	$	(1.51	)
Diluted EPS	$	0.27		$	(0.14	)	$	(1.51	)
Weighted average common shares		5,719			5,544			5,551
Weighted average common and dilutive shares		6,312			5,544			5,551

The accompanying notes are an integral part of these consolidated financial statements.

F-5

INTERPHASE CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(in thousands)

													Cumulative
							Additional			Retained			Other
	Common Stock						Paid in			Earnings			Comprehensive						Comprehensive
	Shares			Amount			Capital			(Deficit)			Income (Loss)			Total			Income (Loss)
Balance at December 31, 2001		5,518		$	552		$	37,324		$	(6,394	)	$	(324	)	$	31,158
Stock repurchase		(4	)		(1	)		(20	)		—			—			(21	)
Comprehensive income:
Foreign currency translation		—			—			—			—			32			32			32
Unrealized holding period gain		—			—			—			—			50			50			50
Net loss		—			—			—			(8,401	)		—			(8,401	)		(8,401	)
Total comprehensive loss		—			—			—			—			—			—		$	(8,319	)
Balance at December 31, 2002		5,514		$	551		$	37,304		$	(14,795	)	$	(242	)	$	22,818
Option exercises		166			17			914			—			—			931
Comprehensive loss:
Foreign currency translation		—			—			—			—			(46	)		(46	)		(46	)
Unrealized holding period loss		—			—			—			—			(121	)		(121	)		(121	)
Net loss		—			—			—			(769	)		—			(769	)		(769	)
Total comprehensive loss		—			—			—			—			—			—		$	(936	)
Balance at December 31, 2003		5,680		$	568		$	38,218		$	(15,564	)	$	(409	)	$	22,813
Option exercises		71			7			415			—			—			422
Comprehensive income (loss):
Foreign currency translation		—			—			—			—			21			21			21
Unrealized holding period loss		—			—			—			—			(186	)		(186	)		(186	)
Net income		—			—			—			1,718						1,718			1,718
Total comprehensive income		—			—			—			—			—			—		$	1,553
Balance at December 31, 2004		5,751		$	575		$	38,633		$	(13,846	)	$	(574	)	$	24,788

The accompanying notes are an integral part of these consolidated financial statements.

F-6

INTERPHASE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

	Years ended December 31,
	2004			2003			2002
Cash flows from operating activities:
Net income (loss)	$	1,718		$	(769	)	$	(8,401	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Non-cash realized holding period loss on marketable securities		—			—			20
Provision for uncollectible accounts and returns		(3	)		(42	)		(77	)
Provision for excess and obsolete inventories		300			700			1,849
Depreciation and amortization		788			902			845
Deferred income taxes		—			—			4,009
Change in assets and liabilities:
Trade accounts receivable		661			91			(558	)
Inventories		(848	)		(540	)		1,685
Prepaid expenses and other current assets		(187	)		(62	)		(185	)
Income taxes receivable		(246	)		247			2,229
Other assets		44			1			(25	)
Accounts payable, deferred revenue and accrued liabilities		(976	)		(183	)		638
Accrued compensation		309			37			(252	)
Deferred lease obligations		(28	)		3			85
Net adjustments		(186	)		1,154			10,263
Net cash provided by operating activities		1,532			385			1,862
Cash flows from investing activities:
Purchase of property and equipment		(454	)		(504	)		(1,448	)
Purchase of capitalized software		(86	)		(329	)		(34	)
Proceeds from the sale of marketable securities		3,322			2,068			2,219
Purchases of marketable securities, net of unrealized holding period gain or loss		(14,047	)		(1,719	)		(2,491	)
Net cash used in investing activities		(11,265	)		(484	)		(1,754	)
Cash flows from financing activities:
Decrease in restricted cash		—			3,500			—
Purchase of redeemable common stock		—			—			(762	)
Purchase of common stock		—			—			(21	)
Proceeds from the excerise of stock options		422			931			—
Repayment of long-term debt		—			(3,500	)		—
Borrowings under new revolving credit facility		—			3,500			—
Net cash provided by (used in) financing activities		422			4,431			(783	)
Effect of exchange rate changes on cash and cash equivalents		35			15			117
Net (decrease) increase in cash and cash equivalents		(9,276	)		4,347			(558	)
Cash and cash equivalents at beginning of year		14,204			9,857			10,415
Cash and cash equivalents at end of year	$	4,928		$	14,204		$	9,857
Supplemental Disclosure of Cash Flow Information:
Income taxes paid	$	—		$	—		$	22
Interest paid	$	111		$	72		$	88

The accompanying notes are an integral part of these consolidated financial statements.

F-7

INTERPHASE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of the Business: Interphase Corporation and subsidiaries (“Interphase” or the “Company”) enables rapid platform design and integration for the global voice, video, and data communications markets through custom and off-the-shelf communications equipment, embedded software development suites, and systems integration and consulting services for carrier and private networks. The Company’s products provide communications computing and connectivity of telecommunications and computer systems to Wide Area Networks (WANs), Local Area Networks (LANS), and Storage Area Networks (SANs) using Asynchronous Transfer Mode (ATM), Ethernet, Signaling System 7 (SS7), IP, Fibre Channel, HDLC, Frame Relay and multi-protocol interworking technologies. See Note 13 for information regarding the Company’s revenues related to North America and foreign countries.

Principles of Consolidation and Basis of Presentation: The accompanying consolidated financial statements include the accounts of Interphase Corporation and its wholly owned subsidiaries. Significant intercompany accounts and transactions have been eliminated. The Company has no involvement with any variable interest entity covered by the scope of FASB Interpretation (“FIN”) No. 46R, Consolidation of Variable Interest Entities.

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.

Marketable Securities: Investments in debt and equity securities are classified as available for sale with unrealized holding gains and losses reported in other comprehensive income. Gains and losses from securities are calculated using the specific identification method. Management determines the appropriate classification of securities at the time of purchase. Earnings from debt securities are calculated on a yield to maturity basis and recorded in the results of operation.

Allowance for Doubtful Accounts: Management is required to estimate the collectibility 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 and reevaluated and adjusted as additional information is received. The reserves also are determined by using percentages applied to certain aged receivable categories based on historical results. The activity in this account was as follows (in thousands):

	Balance at					Write-offs,			Balance
	Beginning		Charged to			Net of			at End
Year Ended:	of Period		(Income) Expense			Recoveries			of Period
December 31, 2004	$	89	$	9		$	(62	)	$	36
December 31, 2003		30		53			6			89
December 31, 2002		170		(77	)		(63	)		30

F-8

Allowance for Returns: The Company maintains an allowance for returns based upon expected return rates. The estimates of expected return rates are generally a factor of historical returns experience. Changes in return rates could impact allowance for return estimates. As of December 31, 2004, 2003 and 2002, the allowance for returns was $105,000, $105,000, and $200,000 respectively maintained 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):

	Years ended December 31,
	2004		2003
Raw Materials	$	1,818	$	1,907
Work-in-Process		747		745
Finished Goods		944		309
Total	$	3,509	$	2,961

Valuing inventory at the lower of cost or market involves an inherent level of risk and uncertainty due to technology trends in the industry and customer demand for the Company’s products. Future events may cause significant fluctuations in the Company’s operating results.

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):

Year ended December 31:	Depreciation Expense
2004	$	656
2003	$	721
2002	$	671

The depreciable lives of property and equipment are as follows:

Machinery and equipment	3-5years
Leasehold improvements	Term of the respective leases (up to 3 years)
Furniture and fixtures	3-10years

F-9

Capitalized Software: Capitalized software represents various software licenses purchased by the Company and utilized in connection with the Company’s network and mass storage products as well as the general operations of the Company. Capitalized software is amortized over three to five years utilizing the straight-line method. Related amortization expense and accumulated amortization were as follows (in thousands):

Year ended December 31:	Amortization expense		Accumulated Amortization
2004	$	132	$	2,429
2003	$	181	$	2,268
2002	$	174	$	2,190

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.

Revenue Recognition: Revenues consist of product and service revenues and are recognized in accordance with SEC Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition.” Product revenues are recognized upon shipment, provided fees are fixed and determinable, a customer purchase order is obtained (when applicable), and collection is probable. Revenues from reseller agreements are recognized when the product is sold through to the end customer unless an established return history supports recognizing revenue upon shipment, less a provision for estimated sales returns. Deferred revenue consists primarily of revenue from reseller arrangements, service revenue and certain arrangements with extended payment terms. Revenue from extended payment terms is recognized in the period the payment becomes due if all other revenue recognition criteria have been met. Service revenue is recognized as the services are performed.

Revenue derived from the development and installation of highly customized software packages under a professional services contract is recognized on a percentage of completion basis measured by the relationship of hours worked to total estimated contract hours and the costs incurred as of the date of measurement. The Company follows this method since reasonably dependable estimates of the revenue and contract hours applicable to various elements of a contract can be made. Since the financial reporting of these contracts depends upon estimates, which are assessed continually during the term of these contacts, recognized revenue and profit are subject to revisions as the contract progresses to completion. Revisions in profit estimates are reflected in the period in which the facts that give rise to the revisions become known. Accordingly, favorable changes in estimates result in additional revenue recognition and net income, and unfavorable changes in estimates result in a reduction of recognized revenue and net income. If estimates were to indicate that a loss would be incurred on a contract upon completion, a provision for the expected loss would be recorded in the period in which the loss became evident.

At December 31, 2004, the Company had recognized revenue of approximately $549,000 and had deferred revenue of $51,000 related to a fixed price contract to provide services at a price of approximately $800,000.

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

F-10

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.

Concentration of Credit Risks: Financial instruments which potentially expose the Company to concentrations of credit risk consist primarily of trade accounts receivable. The majority of the Company’s sales have been to original equipment manufacturers of computer systems or telecommunication networks. The Company conducts credit evaluations of its customers’ financial condition and limits the amount of trade credit extended when necessary.

Research and Development: Research and development costs are charged to expense as incurred.

Advertising Expense: Advertising costs are charged to expense as incurred. Advertising expense was approximately $14,000, $156,000 and $102,000 during the years ended December 31, 2004, 2003 and 2002, 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. Foreign currency transaction gains and losses are recognized in income as incurred.

The Company accounts for unrealized gains or losses on its foreign currency translation adjustments in accordance with Statement of Financial Accounting Standards No. 130, “Reporting Comprehensive Income,” which requires the adjustments be accumulated in shareholders’ equity as part of other comprehensive income.

Income Taxes: The Company determines its deferred taxes using the liability method. Deferred tax assets and liabilities are based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of enacted tax law. The Company’s consolidated financial statements include deferred income taxes arising from the recognition of revenues and expenses in different periods for income tax and financial reporting purposes.

The Company records a valuation allowance to reduce its deferred income tax assets to the amount that is believed to be realizable under the guidance of Statement of Financial Accounting Standards No. 109 “Accounting for Income Taxes.” 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 required to make a continuous assessment as to the realizability of the deferred tax assets.

Other Comprehensive Income (Loss): Other comprehensive income (loss) is recorded directly to a separate section of shareholders’ equity in cumulative other comprehensive loss and includes 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.

F-11

Stock-Based Compensation: The Company has elected to follow Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”) and related interpretations in accounting for its employee stock options. Under APB 25, compensation expense is recorded when the exercise price of employee stock options is less than the fair value of the underlying stock on the date of grant. The Company has implemented the disclosure-only provisions of Statement of Financial Accounting Standards Board No. (“SFAS”) 123, “Accounting for Stock-Based Compensation,” and SFAS 148, “Accounting for Stock-Based Compensation Transition and Disclosure.” Had the Company elected to adopt the expense recognition provisions of SFAS 123, the pro forma impact on net income and earnings per share would have been as follows (in thousands, except per share data):

	Years ended December 31,
	2004			2003			2002
Net income (loss) as reported		1,718			(769	)		(8,401	)
Add: APB 25 expense		—			—			—
Less: Total stock based employee compensation expense determined under fair value methods for all awards		(1,863	)		(2,084	)		(4,192	)
Pro forma net (loss)		(145	)		(2,853	)		(12,593	)
Income (loss) per common share:
As reported — basic	$	0.30		$	(0.14	)	$	(1.51	)
Pro forma — basic	$	(0.03	)	$	(0.53	)	$	(2.88	)
As reported — diluted	$	0.27		$	(0.14	)	$	(1.51	)
Pro forma — diluted	$	(0.03	)	$	(0.53	)	$	(2.88	)

Certain Reclassifications: Certain reclassifications have been made for consistent presentation among periods presented.

Use of Estimates: The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America, requires Company management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Areas involving estimates are the allowance for doubtful accounts and returns, warranty and inventory reserves and income tax accounts.

2. MARKETABLE SECURITIES

Marketable securities primarily consist of investments in debt securities. As of December 31, 2004 the fair market value of marketable securities was $15.6 million, of which $9.3 million matures in one year or less, $6.3 million matures in one to five years. As of December 31, 2003 the fair market value of marketable securities was $5.0 million, of which $1.2 million matures in one year or less, $3.8 million matures in one to five years. The Company recorded charges due to the other than temporary impairment of certain marketable securities received in the sale of the Company’s VOIP business of $20,000 in 2002. Gains and losses on marketable securities sold are recognized on a specific identification basis. The Company recorded an unrealized loss with respect to certain available-for-

F-12

sale securities of $186,000 and $121,000 in 2004 and 2003 respectively and an unrealized gain of $50,000 in 2002.

3. ACCRUED LIABILITIES

Accrued liabilities consisted of the following (in thousands):

	2004		2003
Accrued audit fees	$	170	$	125
Loss contingency		225		—
Accrued outside commissions		15		191
Accrued property tax		56		185
Accrued other		957		1,183
	$	1,423	$	1,684

4. CREDIT FACILITY

The Company maintains a $5.0 million revolving bank credit facility with a maturity date of July 31, 2007 and interest rate of LIBOR plus 1.0% (3.5% at December 31, 2004). All borrowings under this facility are secured by marketable securities. The borrowings of $3.5 million are classified as long-term debt on the accompanying balance sheet.

5. INCOME TAXES

The provision for income taxes applicable to continuing operations for each period presented was as follows (in thousands):

	Year ended December 31,
	2004			2003			2002
Current benefit	$	(122	)	$	(212	)	$	(1,486	)
Deferred provision		—			—			4,009
Income tax (benefit) expense	$	(122	)	$	(212	)	$	2,523

F-13

Tax effect of temporary differences that give rise to significant components of the deferred tax assets as of December 31, 2004 and 2003, are presented as follows (in thousands):

	Year ended December 31,
	2004			2003
Current deferred tax assets:
Inventory	$	1,249		$	1,278
Accounts receivable		14			34
Deferred revenue		34			46
Other accruals		610			510
Total current deferred tax assets	$	1,907		$	1,868
Noncurrent deferred tax assets, net:
Assets:
Depreciation	$	4		$	191
Amortization		433			496
Net operating loss		4,169			3,844
Total noncurrent deferred tax assets, net	$	4,606		$	4,531
Valuation allowance for deferred tax assets		(6,513	)		(6,399	)
Deferred tax assets, net of valuation allowance	$	-		$	—

SFAS 109, “Accounting for Income Taxes,” requires that a valuation allowance be established when it is “more likely than not” that all or a portion of a deferred tax asset will not be realized. A review of all available positive and negative evidence needs to be considered, including a company’s current and past performance, the market environment in which the company operates, the utilization of past tax credits, length of carry back and carry forward periods, existing contracts or sales backlog that will result in future profits, as well as other factors.

Forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years. Cumulative losses weigh heavily in the overall assessment. As a result of a review undertaken at December 31, 2002, the Company concluded that it was appropriate to establish a full valuation allowance for its net deferred tax assets. The Company continues to maintain a valuation allowance on all of the net deferred tax assets. Until an appropriate level of profitability is sustained, the Company expects to continue to maintain a valuation allowance on substantially all of the future tax benefits and does not expect to recognize any significant tax benefits in future results of operations. At December 31, 2004, the amount of valuation allowance is approximately $6.5 million. Approximately $500,000 of this total, if reversed, would be allocated directly to additional paid-in capital as it relates to non-qualified stock option deductions.

During the first quarter of 2004, after conducting a thorough review of the Company’s IRS transcripts, the Company discovered that the IRS had not paid allowable interest on the refund from the IRS audit described below. As a result, the Company recognized a tax benefit of approximately $100,000 in 2004.

During the third quarter of 2003, the Internal Revenue Service concluded a federal income tax audit of the Company related to the tax years 1996 through 2001. In addition, the French tax administration also concluded a tax audit of the Company’s French subsidiary covering the same periods resulting in a finding of no tax due. Due to the finalization of both tax audits, the Company recognized a tax benefit of approximately $245,000. This benefit was partially offset by taxes on foreign income.

F-14

The differences between the provision for income taxes computed on income before income taxes at the U.S. federal statutory income tax rate (34%) and the amount shown in the Consolidated Statements of Operations are presented below (in thousands):

	Year ended December 31,
	2004			2003			2002
Income taxes at statutory rate	$	543		$	(334	)	$	(1,999	)
Benefit of foreign tax loss carry-forward		—			—			(383	)
Benefit for French research and development tax credit		(144	)		—			—
Benefit recorded for favorable outcome of tax audits		(102	)		(245	)		—
French permanent items		(133	)		(292	)		—
Extraterritorial income exclusion benefit		(389	)		(386	)
Other		(11	)		—			39
Change in valuation allowance		114			1,045			4,866
(Benefit) provision for income taxes	$	(122	)	$	(212	)	$	2,523

At December 31, 2004, the Company had net operating loss carryforwards for federal income tax purposes of approximately $11.7 million, $1.6 million of which are related to non-qualified stock option deductions. These net operating loss carryforwards will begin to expire in 2022. A valuation allowance against the entire net operating loss carryforward has been established as the realizability of this asset is uncertain.

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 payable to foreign countries.

F-15

6. EXIT ACTIVITIES

During the second quarter of 2003, the Company committed to an exit plan regarding one of its leased facilities, the lease was scheduled to expire during the first quarter of 2005. The Company had previously held this facility open for storage, overflow use, and anticipated growth. However, it was determined that the facility would not be needed for such uses and the Company began pursuing subleasing opportunities. As a result of this exit plan, the Company recorded a charge of approximately $109,000 during the second quarter of 2003, classified as operating expenses, related to net termination costs associated with the lease of the facility. In May 2004, the Company entered into a sublease termination agreement with the landlord of the leased facility resulting in an additional charge of approximately $42,000. A reconciliation showing the changes to the liability account during 2004 is as follows (in thousands):

Liability at December 31, 2002	$	—
Exit plan net termination costs		109
Rent payments		(78	)
Cost of not subleasing		45
Liability at December 31, 2003	$	76
Exit plan net termination costs		(178	)
Rent payments		60
Cost of not subleasing		42
Liability at December 31, 2004	$	—
Total costs to date	$	256

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):

	Years ended December 31,
	2004		2003			2002
Basic income (loss) per share:
Net income (loss)	$	1,718	$	(769	)	$	(8,401	)
Weighted average common shares outstanding		5,719		5,544			5,551
Basic income (loss) per share	$	0.30	$	(0.14	)	$	(1.51	)
Diluted income (loss) per share:
Net income (loss)	$	1,718	$	(769	)	$	(8,401	)
Weighted average common shares outstanding		5,719		5,544			5,551
Dilutive stock options		593		—			—
Weighted average common shares outstanding – assuming dilution		6,312		5,544			5,551
Diluted income (loss) per share	$	0.27	$	(0.14	)	$	(1.51	)
Outstanding stock options that were not included in the diluted calculation because their effect would be anti-dilutive		808		1,199			2,091

F-16

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 have been 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 shall be 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 shall be 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 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.

Amended and Restated Stock Option Plan: The exercise price of the incentive stock options must be at least equal to the fair market value of the Company’s common stock on the date of the grant, while the exercise price of nonqualified stock options may be less than fair market value on the date of grant, as determined by the Board 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 granted prior to January 1, 1999 generally vest ratably over a five-year period from the date of grant. Options granted since January 1, 1999 generally vest ratably over a three-year period from the date of grant. The term of option grants may be up to ten years. Options are canceled upon the lapse of three months following termination of employment except in the event of death or disability, as defined.

France Stock Option Sub-Plan: This plan was adopted in 2000 for the benefit of the Company’s employees located in France. This plan authorizes the issuance of options to purchase common stock of the Company at prices at least equal to the fair market value of the common stock on the date of the grant. Unless otherwise decided at the sole discretion of the Board, the options vest (i) 75% after the expiration of a two-year period from the date of grant and (ii) 25% after the expiration of a three-year period from the date of grant. Except for the events provided under the French tax code, the shares cannot be sold or otherwise disposed of for a period of four years from the date of grant. The term of option grants may be up to ten years. Options are canceled upon the lapse of three months following termination of employment except in the event of death or disability, as defined.

Amended and Restated Director Stock Option Plan: Stock option grants pursuant to the directors’ plan will vest in one year 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.

F-17

The following table summarizes the combined transactions under the all of the plans (in thousands, except option prices):

	Number of			Weighted Average
	Options			Option Price
Balance, December 31, 2001		2,095		$	10.38
Granted		402			4.71
Exercised		—			—
Canceled		(82	)		8.78
Balance, December 31, 2002		2,415			9.49
Granted		413			6.25
Exercised		(166	)		5.61
Canceled		(84	)		10.66
Balance, December 31, 2003		2,578			9.18
Granted		226			10.84
Exercised		(71	)		5.97
Canceled		(79	)		10.92
Balance, December 31, 2004		2,654			9.35
Exercisable at December 31, 2004		2,095		$	9.75

The following table summarizes information about options granted under the plans that were outstanding at December 31, 2004 (in thousands, except option prices):

	Options Outstanding				Options Exercisable
			Weighted-
			Average
	Number		Remaining		Weighted		Number		Weighted
Range of	Outstanding at		Contractual Life		Average Exercise		Exercisable at		Average Exercise
Exercise Prices	12/31/04		(years)		Price		12/31/04		Price
$3.09-$4.60		323		6.94	$	4.21		304	$	4.24
$4.65-$6.50		718		7.17		5.59		421		5.57
$7.20-$10.63		786		5.42		8.19		739		8.18
$11.25-$16.44		498		6.97		12.86		303		13.69
$17.25-$24.06		318		4.96		19.75		317		19.76
$25.88-$31.00		11		4.93		30.53		11		30.53
Total		2,654		6.31	$	9.35		2,095	$	9.75

Rights Agreement: The Board of Directors has adopted a Shareholder Rights Plan whereby each holder of record as of December 29, 2000 received a right to purchase from the Company one share of common stock of the Company at a price of $93 per share for each share held. These rights can only be exercised after certain events occur, such as if a person or entity acquires, or makes a tender or exchange offer to acquire, 15% or more of the Company’s common stock and the rights expire ten years from the record date. Upon acquisition of 15% or more of the Company’s common stock, each

F-18

right not owned by the acquiring person or group will be adjusted to allow the purchase for $93 of a number of shares having a then market value of $186. These rights are intended to provide the Company certain antitakeover protections. The Board of Directors may terminate the Rights Plan, or redeem the rights for $0.01 per right, at any time until the tenth business day following a public announcement of a 15% or more stock acquisition. The Company had reserved 7,000,000 shares of common stock for this plan.

The rights were distributed to shareholders as of the record date as a nontaxable dividend. The rights are attached to and trade with Interphase common stock until the occurrence of one of the triggering events, at which time the rights would become detached from the Company’s common stock.

Pro Forma Net Income (Loss): The Black-Scholes model was not developed for use in valuing employee stock options, but was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, it requires the use of subjective assumptions including expectations of future dividends and stock price volatility. Such assumptions are only used for making the required fair value estimate and should not be considered as indicators of future dividend policy or stock price appreciation. Because changes in the subjective assumptions can materially affect the fair value estimate, and because employee stock options have characteristics significantly different from those of traded options, the use of the Black-Scholes option-pricing model may not provide a reliable estimate of the fair value of employee stock options.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for options granted in 2004, 2003 and 2002:

	2004			2003			2002
Weighted average risk free interest rates		2.39	%		2.36	%		3.51	%
Weighted average life (in years)		4.10			3.87			6.81
Volatility		88	%		130	%		160	%
Expected dividend yield		—			—			—
Weighted average grant-date fair value per share of options granted	$	6.99		$	5.02		$	4.54

9. RELATED PARTY TRANSACTIONS

The Company paid approximately $104,000, $68,000 and $146,000 for the years ended December 31, 2004, 2003 and 2002, respectively to certain outside directors of the Company or their firms for professional services. The Company believes the terms were equivalent to those of unrelated parties.

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 the Company matches 50% of the first 6% of the employee’s contributions up to a maximum of $6,150 per employee for the year ended December 31, 2004. The total expense under this plan was $295,000, $270,000 and $261,000 for the years ended December 31, 2004, 2003 and 2002, respectively. The Company offers no post-retirement or post-employment benefits.

F-19

11. OTHER FINANCIAL INFORMATION

Major Customers: During 2004, sales to Lucent Technologies and Hewlett Packard accounted for $12.6 million or 36% and $9.6 million or 27% of the Company’s consolidated revenues, respectively. During 2003, sales to Lucent Technologies and Hewlett Packard accounted for $13.5 million or 42% and $9.7 million or 30% of the Company’s consolidated revenues, respectively. During 2002, sales to Hewlett Packard and Lucent Technologies accounted for $8.7 million or 35% and $7.2 million or 29% of the Company’s consolidated revenues, respectively. No other customers accounted for more than 10% of the Company’s consolidated revenues in the periods presented.

Included in accounts receivable at December 31, 2004, was approximately $1.4 million due from Hewlett Packard, approximately $710,000 due from Lucent Technologies and approximately $660,000 due from Macnica Networks Corporation. Included in accounts receivable at December 31, 2003, was approximately $2.5 million due from Lucent Technologies and approximately $1.2 million due from Hewlett Packard. No other customers accounted for more than 10% of the Company’s accounts receivable at the balance sheet dates presented.

Commitments: The Company leases its facilities under noncancelable operating leases with the longest terms extending to December of 2008. Rent expense related to these leases is recorded on a straight-line basis. As of December 31, 2004, operating lease commitments having noncancelable terms of more than one year are as follows (in thousands):

Commitments

Year ending December 31:
2005	$	604
2006	$	410
2007	$	403
2008	$	411

Total rent expense for operating leases was as follows (in thousands):

Year ending December 31:
2004	$	791
2003	$	932
2002	$	1,336

Contingencies: The Company has agreed to perform a minor repair, at no cost to a customer, of approximately 1,800 units that were shipped between December 2003 and April 2004. The actual cost to repair the units is insignificant. However, the Company has estimated that other costs including shipping related charges and installation related charges could be more significant. The Company has estimated that the range of the potential liability is between approximately $225,000 and $650,000 but cannot determine an amount within that range which is more likely than another. Therefore, in accordance with Financial Accounting Standards Board Interpretation No. 14 “Reasonable Estimation of the Amount of a Loss — an Interpretation of FASB Statement No. 5”, the Company has recorded, in accrued liabilities, the minimum liability amount of approximately $225,000 at December 31, 2004.

F-20

The Company is involved in various legal actions and claims arising in the ordinary course of business. Management believes that such litigation and claims will be resolved without material effect on the Company’s financial position or results of operations.

12. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In October 2004, the American Jobs Creation Act of 2004 was enacted into law. The new law provides for a special 85% deduction for certain dividends received in 2005 from controlled foreign corporations. Because certain details in the new law lack clarification, and the impact of the special dividend received deduction to the Company is dependent, in part, on the Company’s 2005 foreign and domestic taxable income, the Company has not yet determined whether it will benefit from the new law. In 2005, the Company plans to evaluate both clarifying guidance on the new law from the Internal Revenue Service and its year-to-date taxable income activity to determine the level of benefit, if any, the Company will derive from the special dividend received deduction.

Beginning in 2005, the new law also provides for a special deduction from U.S. taxable income equal to a stipulated percentage of a U.S. company’s qualified income from domestic manufacturing activities (as defined). Although the Company believes that the majority of its operations meet the definition of qualified domestic manufacturing activities, the Company does not expect to benefit from the special manufacturing deduction in 2005, primarily because the Company projects its U.S. taxable income in 2005 will be fully offset by its existing U.S. NOL carryforwards.

In December 2004, the FASB issued SFAS No. 123(R), “Share Based Payments”, which replaces SFAS No. 123, “Accounting for Stock-Based Compensation”, and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” and amends SFAS No. 95, “Statement of Cash Flows”. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. As such, pro forma disclosure in lieu of expensing is no longer an alternative. The new standard is effective in the first interim or annual reporting period beginning after June 15, 2005. The Company is currently assessing the impact that the statement may have on its financial statements.

In December 2004, the FASB issued SFAS No. 151 “Inventory Costs, an Amendment of ARB No. 43, Chapter 4”. SFAS No. 151 clarifies the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material and requires that these items be recognized as current period charges. SFAS No. 151 applies only to inventory costs incurred during periods beginning after the effective date and also requires that the allocation of fixed production overhead to conversion costs be based on the normal capacity of the production facilities. SFAS No. 151 is effective for the Company’s fiscal year beginning January 1, 2006. The Company is currently assessing the impact, if any, of the adoption of the provisions of SFAS No. 151.

In December 2004, the FASB issued SFAS 153, Exchanges of Nonmonetary Assets, which amends APB Opinion No. 29. The guidance in APB 29, Accounting for Nonmonetary Transactions, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The amendment made by SFAS 153 eliminates the exception for exchanges of similar productive assets and replaces it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. The provisions of the statement are effective for exchanges taking place in fiscal periods beginning after June 15, 2005. The Company does not believe the adoption of this statement will have a material impact on our financial statements.

F-21

13. SEGMENT DATA

The Company is principally engaged in the design, development, and manufacturing of high-performance connectivity products utilizing advanced technologies being used in next generation telecommunication networks and enterprise data/storage networks. Except for revenue performance, which is monitored by product line, the chief operating decision-makers review financial information presented on a consolidated basis for purposes of making operating decisions and assessing financial performance. Accordingly, the Company considers itself to be in a single industry segment.

Geographic long lived assets and revenue related to North America and foreign countries as of December 31, 2004 and 2003 and for the years ended December 31, 2004, 2003 and 2002 is as follows
(in thousands):

Long Lived Assets	2004		2003
North America	$	1,321	$	1,639
Europe		379		276
Total	$	1,700	$	1,915

Revenues	2004		2003		2002
North America	$	21,049	$	23,037	$	18,525
Europe		8,528		4,312		4,011
Pacific Rim		5,438		5,141		2,587
Total	$	35,015	$	32,490	$	25,123

Additional information regarding revenue by product-line is as follows (in thousands):

Product Revenue	2004		2003		2002
Broadband telecom	$	20,151	$	17,773	$	11,767
SlotOptimizer		10,713		11,422		8,589
LAN		1,088		1,368		2,027
Storage		814		522		1,505
WAN		188		152		167
Other		2,061		1,253		1,068
Total	$	35,015	$	32,490	$	25,123

F-22

14. QUARTERLY FINANCIAL DATA (Unaudited)

Quarterly results of operations for 2004 (unaudited)
(In thousands, except per share amounts)

	Quarter Ended
	March 31		June 30		September 30		December 31
Revenues	$	9,198	$	10,129	$	8,294	$	7,394
Gross margin		4,903		5,613		4,666		3,989
Income (loss) before income taxes		218		1,134		525		(281	)
Net income (loss)		275		1,095		500		(152	)
Earnings per share: (loss)
Basic EPS	$	0.05	$	0.19	$	0.09	$	(0.03	)
Diluted EPS	$	0.04	$	0.18	$	0.08	$	(0.03	)

Quarterly results of operations for 2003 (unaudited)
(In thousands, except per share amounts)

	Quarter Ended
	March 31			June 30			September 30		December 31
Revenues	$	7,513		$	7,357		$	8,571	$	9,049
Gross margin		3,791			3,696			4,479		4,943
(Loss) income before income taxes		(769	)		(578	)		146		220
Net (loss) income		(826	)		(521	)		366		212
Earnings per share: (loss)
Basic EPS	$	(0.15	)	$	(0.09	)	$	0.07	$	0.04
Diluted EPS	$	(0.15	)	$	(0.09	)	$	0.06	$	0.03

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 earnings (loss) per common share for the applicable year.

F-23

INDEX TO EXHIBITS

Exhibits

2 (a)	Stock Purchase Agreement, dated as of June 29, 1996, among Interphase Corporation, Synaptel and Philippe Oros, Xavier Sutter, Francois Lecerf, Schroder Ventures French Enterprise Fund LPI (USA), Schroder ventures French Enterprise Fund UKLP (UK) and Schroder Ventures Holding Limited (UK). (7)
3 (a)	Certificate of Incorporation of the registrant. (1)
3 (b)	Amendment to Articles of Incorporation of the registrant. (10)
3 (c)	Amended and Restated Bylaws of the registrant adopted on December 5, 1995 and amended on January 19, 1999. (12)
4 (a)	Rights Agreement dated as of December 7, 2000 by and between the Company and Computershare Investor Services, LLC as Rights Agent. (11)
10 (a)	Registrant’s Amended and Restated Stock Option Plan and Amendment No. 1 and 2 thereto. (9)
10 (b)	Registrant’s Amended and Restated Stock Option Plan Amendment No. 4. (10)
10 (c)	Registrant’s United Kingdom Incentive Stock Option Sub-Plan. (3)
10 (d)	Stock Purchase Warrant issued to Motorola, Inc. (4)
10 (e)	Lease on Dallas facility. (5)
10 (f)	Directors Stock Option Plan and Amendment No. 1 thereto. (6)
10 (g)	Directors Stock Option Plan Amendment No. 2. (10)
10 (h )	Loan Agreement between Interphase Corporation and BankOne Texas, N.A. (8)
10 (i)	Purchase Agreement between Interphase Corporation and Cisco Systems Inc. (9)
10 (j)	Motorola Stock Repurchase Agreement. (2)
10 (k)	Registrant’s France Incentive Stock Option Sub-Plan. (12)
10 (l)	Sublease on Plano facility. (12)
10 (m)	Credit Agreement between Interphase Corporation and Bank One, NA. (12)
10 (n)	Lease on Facility at Parkway Center, Phase I, Plano, Texas. (13)
10 (o)	Lease on Facility at 2105 Luna Road, Carrolton, Texas. (13)
10 (p)	Note and Credit Agreement between Interphase Corporation and Comerica Bank, including Amendment dated November 5, 2004. (16)
16 (a)	Letter regarding change in certifying accountant. (15)
21 (a)	Subsidiaries of the Registrant. (14)
23 (a)	Consent of Independent Registered Public Accounting Firm. (16)
23 (b)	Consent of Independent Registered Public Accounting Firm. (16)
31 (a)	Rule 13a-14(a)/15d-14(a) Certification. (16)
31 (b)	Rule 13a-14(a)/15d-14(a) Certification. (16)
32 (a)	Section 1350 Certification. (16)
32 (b)	Section 1350 Certification. (16)

E-1

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

E-2

EX-10.(P)

                                                                               .
                                                                               .
                                                                               .

[COMERICA - BANK LOGO]  MASTER REVOLVING NOTE
                        LIBOR Rate-Maturity Date-Optional Advances (Business and
                         Commercial Loans Only)


AMOUNT            NOTE DATE        MATURITY DATE     TAX IDENTIFICATION NUMBER
                                            
$5,000,000.00     July 25, 2003    July 30, 2005     75-1549797

ON THE MATURITY DATE, as stated above, for value received, the undersigned
promise(s) to pay to the order of Comerica Bank-Texas ("Bank") at any office of
the Bank in the State of Texas, FIVE MILLION AND NO/100 DOLLARS (U.S.) (or that
portion of it advanced by the Bank and not repaid as later provided) with
interest until maturity, whether by acceleration or otherwise, or until Default,
as later defined, at a per annum rate equal to the lesser of (a) the Maximum
Rate, as later defined, or (b) the Stated Rate, as later defined, and after that
at a rate equal to the rate of interest otherwise prevailing under this Note
plus three percent (3%) per annum (but in no event in excess of the Maximum
Rate.) If on any day the Stated Rate shall exceed the Maximum Rate for that day,
the rate of interest applicable to this Note shall be fixed at the Maximum Rate
on that day and on each day thereafter until the total amount of interest
accrued on the unpaid principal balance of this Note equals the total amount of
interest which would have accrued if there had been no Maximum Rate. Interest
rate changes will be effective for interest computation purposes as and when the
Maximum Rate or the Stated Rate, as later defined, as applicable, changes.
Subject to the limitations hereinbelow set forth, interest shall be calculated
on the basis of a 360-day year for the actual number of days the principal is
outstanding. Accrued interest on this Note shall be payable on the first LIBOR
Business Day, as later defined, of each calendar month, commencing with the
first LIBOR Business Day of the calendar month following the date of this Note
and with respect to interest accrued on any LIBOR Balance, as later defined, on
the last day of the applicable LIBOR Interest Period, as later defined, until
the Maturity Date (set forth above) when all amounts outstanding under this Note
shall be due and payable in full. If any payment of principal or interest under
this Note shall be payable on a day other than a day on which the Bank is open
for business, this payment shall be extended to the next succeeding business day
and interest shall be payable at the rate specified in this Note during this
extension. A late payment charge equal to a reasonable amount not to exceed five
percent (5%) of each late payment may be charged on any payment not received by
the Bank within ten (10) calendar days after the payment due date, but
acceptance of payment of this charge shall not waive any Default under this
Note.

Subject to the provisions hereof, the undersigned shall have the option (an
"Interest Option") exercisable from time to time to designate a portion of the
unpaid principal balance of this Note to bear interest at a rate determined with
respect to the Prime Rate (such portion being herein referred to as the "Prime
Rate Balance") and to designate one or more portions of the unpaid principal
balance of this Note to bear interest at a rate determined with respect to a
LIBOR Based Rate (each such portion being herein referred to as a "LIBOR
Balance").

The term "Maximum Rate" as used herein, shall mean at the particular time in
question the maximum nonusurious rate of interest which, under applicable law,
may then be charged on this Note. If such maximum rate of interest changes after
the date hereof, the Maximum Rate shall be automatically increased or decreased,
as the case may be, without notice to the undersigned from time to time as of
the effective date of each change in such maximum rate. For purposes of
determining the Maximum Rate under the law of the State of Texas, the applicable
interest rate ceiling shall be the "weekly ceiling" from time to time in effect
under Chapter 303 of the Texas Finance Code, as amended.

The term "Stated Rate," as used in this Note, shall mean (a) with respect to the
Prime Rate Balance outstanding from time to time, a fluctuating per annum rate
of interest equal to the Prime Rate plus the Applicable Margin and (b) with
respect to each LIBOR Balance, a per annum rate of interest equal to the LIBOR
Based Rate for the LIBOR Interest Period then in effect with respect to such
LIBOR Balance plus the Applicable Margin.

The term "Prime Rate," as used herein, shall mean that annual rate of interest
which is equal to the greater of the annual rate of interest designated by the
Bank as its Prime Rate which is changed by the Bank from time to time or a
variable per annum rate of interest determined from day to day which equals the
sum of 1% plus the average per annum rate of interest on overnight Federal
funds transactions with members of Federal Reserve System arranged by Federal
funds brokers ("Overnight Transactions") transacted on the immediately preceding
Business Day, as published by the Federal Reserve Bank of New York, or, if such
interest rate is not so published for any Business Day, the average of the per
annum interest rate quotations for Overnight Transactions received by the Bank
(or, at its option, the Reference Bank) for such Business Day from 3 Federal
funds brokers of recognized standing selected by the Bank (or, at its option,
the Reference Bank). The Bank's Prime Rate is a reference rate and does not
necessarily represent the lowest or best rate actually charged by the Bank to
any of its customers. The Bank may make commercial loans at rates of interest
at, above or below its Prime Rate.

The term "Reference Bank" means Comerica Bank, a Michigan banking corporation,
its successors and assigns.

The term "LIBOR-Based Rate", as used herein, shall mean, with respect to the
applicable LIBOR Interest Period and applicable LIBOR Balance (as defined
above), the quotient of the following (rounded upwards, if necessary, to the
nearest 1/16 of 1%): (a) the LIBOR Rate (as defined below); divided by (b) a
percentage (expressed as a decimal) equal to 1.00 minus the maximum rate during
such interest period at which Bank or the Reference Bank (or, if applicable, the
Reference Bank's designated eurodollar lending office) is required to maintain
reserves on "Eurocurrency Liabilities" as defined in and pursuant to Regulation
D of the Board of Governors of the Federal Reserve System or, if such regulation
or designation is modified, and as long as Bank or the Reference Bank (or, if
applicable, the Reference Bank's designated eurodollar lending office) is
required to maintain reserves against a category of liabilities which includes
eurodollar deposits or includes a category of assets which includes eurodollar
loans, the rate at which such reserves are required to be maintained on such
category.

The term "LIBOR Rate", as used herein, shall mean the per annum rate of interest
determined on the basis of the rate for deposits in United States Dollars for a
period equal to the relevant LIBOR Interest Period for such LIBOR Balance,
commencing on the first day of such LIBOR Interest Period, appearing on Page
BBAM of the Bloomberg Financial Markets Information Service as of 10:00 a.m.
(Dallas, Texas time) (or soon thereafter as practical), two (2) LIBOR Business
Days prior to the first day of such LIBOR Interest Period. In the event that
such rate does not appear on Page BBAM of the Bloomberg Financial Markets
Information Service (or otherwise on such Service), the LIBOR Rate shall be
determined by reference to such other publicly available service for displaying
eurodollar rates as may be agreed upon by Bank and the undersigned, or, in the
absence of such agreement, the LIBOR Rate shall, instead, be the per annum rate
equal to the average (rounded upward, if necessary, to the nearest one-sixteenth
of one percent (1/16%)) of the rate at which Bank is offered dollar deposits at
or about 10:00 a.m. (Dallas, Texas time) (or soon thereafter as practical), two
(2) LIBOR Business Days prior to the first day of such LIBOR Interest Period in
the interbank eurodollar market in an amount comparable to the principal amount
of the respective LIBOR Balance which is to bear interest at such LIBOR Rate and
for a period equal to the relevant LIBOR Interest Period.

The term "LIBOR Interest Period", as used herein, shall mean, with respect to
the applicable LIBOR Balance, a period commencing on the date (which must be a
LIBOR Business Day) upon which, pursuant to an Interest Notice, as later
defined, the principal amount of such LIBOR Balance begins to accrue interest at
the applicable LIBOR-based Rate plus, if applicable, the Applicable Margin (or,
in the case of a rollover to a successive LIBOR Interest Period, the last day of
the immediately preceding LIBOR Interest Period) and ending 30, 60, 90,180 or
360 days after the commencement date (as designated in the Interest Notice);
provided, that: (i) any LIBOR Interest Period which would otherwise end on a day
which is not a LIBOR Business Day shall be extended to the next succeeding LIBOR
Business Day (unless such LIBOR Business Day falls in another calendar month, in
which case, such LIBOR Interest Period shall end on the next preceding LIBOR
Business Day); and (ii) any LIBOR Interest Period which begins on a day for
which there is no numerically corresponding day in the calendar month at the end
of such LIBOR Interest Period shall end on the last LIBOR Business Day of such
last calendar month; and (iii) no LIBOR Interest Period shall extend beyond the
Maturity Date.

The term "LIBOR Business Day," as used herein, shall mean any day other than a
Saturday, Sunday or holiday on which Bank is open for all or substantially all
of its domestic and international commercial banking business (including
dealings in foreign exchange) in Dallas, Texas, and, if the applicable day
relates to the LIBOR-based Rate, any LIBOR Interest Period, or any notice with
respect to the LIBOR-based Rate

                                       1


or any LIBOR Interest Period, also a day on which dealings in dollar deposits
are also carried on in the London interbank market and on which banks are open
for business in London.

The term "Applicable Margin," as used herein, shall mean 0% for the Prime Rate
Balance and two percent (2%) for each LIBOR Balance.

The term "Business Day" as used herein, shall mean any day other than a
Saturday, Sunday or holiday, on which the Bank and the Reference Bank (and, if
applicable, the Reference Bank's designated eurodollar lending office) are open
to carry on all or substantially all of their normal commercial lending
business.

The Interest Option shall be exercisable by the undersigned subject to the other
limitations in this Note on the undersigned's option to designate a portion of
the unpaid principal balance hereof as a LIBOR Balance and only in the manner
provided below:

      (i) Before 12:00 noon at least 3 Business Days prior to the date the
undersigned has requested the Bank to make an advance upon this Note, the
undersigned shall have given the Bank written notice (any such notice, an
"Interest Notice") each in form and content satisfactory to Bank specifying the
initial Interest Option(s) and the respective initial amounts of the Prime Rate
Balance and LIBOR Balance designated by the undersigned for such advance. If the
required Interest Notice shall not have been timely received by the Bank or
fails to designate all or any portion of the unpaid principal amount of the
advance as either a Prime Rate Balance or a LIBOR Balance in accordance with the
terms and provisions of this Note, the undersigned shall be deemed conclusively
to have designated such amounts to be a Prime Rate Balance and to have given the
Bank notice of such designation.

      (ii) At least three (3) LIBOR Business Days prior to the termination of
any LIBOR Interest Period for a LIBOR Balance, the undersigned shall give the
Bank an Interest Notice specifying the Interest Option which is to be applicable
to such LIBOR Balance upon the expiration of such LIBOR Interest Period. If the
required Interest Notice shall not have been timely received by the Bank, the
undersigned shall be deemed conclusively to have designated such amount as a
Prime Rate Balance immediately upon the expiration of such LIBOR Interest Period
and to have given the Bank notice of such designation.

      (iii) The undersigned shall have the right, exercisable on any Business
Day subject to the terms of this Note, to convert an eligible portion of the
Prime Rate Balance to a LIBOR Balance by giving the Bank an Interest Notice of
such designation at least three (3) LIBOR Business Days prior to the effective
date of such exercise. Additionally, upon termination of any LIBOR Interest
Period, the undersigned shall have the right, on any Business Day, to convert
all or a portion of such principal amount from the LIBOR Balance to a Prime Rate
Balance by giving Bank an Interest Notice of such selection at least three (3)
LIBOR Business Days prior to effective date of such exercise.

      (iv) There may be no more than four (4) LIBOR Balances in effect at any
time.

      (v) Each LIBOR Balance must be, as of the first day of the applicable
LIBOR Interest Period, at least $100,000.00.

      (vi) No Default, or condition or event which, with the giving of notice or
the lapse of time, or both, would constitute a Default, shall have occurred and
be continuing or exist.

      (vii) Each exercise of an Interest Option to designate a LIBOR Balance to
bear interest at a Stated Rate which is based on the LIBOR Based Rate shall not
be revocable.

Changes in the Stated Rate applicable to a Prime Rate Balance or a LIBOR Balance
shall become effective without prior notice to the undersigned automatically as
of the opening of business on the date of each change in the Prime Rate or the
LIBOR Based Rate, as the case may be.

If the Bank or Reference Bank (or, if applicable, the Reference Bank's
designated eurodollar lending office) determines that deposits in U.S. dollars
(in the applicable amounts) are not being offered to prime banks in the
interbank eurodollar market selected by the Bank or Reference Bank (or, if
applicable, the Reference Bank's designated eurodollar lending office) for the
applicable LIBOR Interest Period, or that the rate at which such dollar deposits
are being offered will not adequately and fairly reflect the cost to the Bank or
Reference Bank (or, if applicable, the Reference Bank's designated eurodollar
lending office) of making or maintaining a LIBOR Balance for the applicable
LIBOR Interest Period, the Bank shall forthwith give notice thereof to the
undersigned, whereupon, until the Bank notifies the undersigned that such
circumstances no longer exist, the right of the undersigned to select an
Interest Option based upon a LIBOR Based Rate shall be suspended, and the
undersigned may only select Interest Options based on the Prime Rate.

If the adoption of any applicable law, rule or regulation, or any change
therein, or any change in the interpretation or administration thereof by any
governmental authority, central bank or comparable agency charged with the
interpretation or administration thereof, or compliance by the Bank or Reference
Bank (or, if applicable, its designated eurodollar lending office) with any
request or directive (whether or not having the force of law) of any such
authority, central bank or comparable agency shall make it unlawful or
impractical for the Bank or Reference Bank (or, if applicable, its designated
eurodollar lending office) to make or maintain a LIBOR Balance, the Bank shall
so notify the undersigned and any then-existing LIBOR Balance shall
automatically convert to a Prime Rate Balance either (i) on the last day of the
then-current LIBOR Interest Period applicable to such LIBOR Balance, if the Bank
and Reference Bank (and, if applicable, its designated eurodollar lending
office) may lawfully continue to maintain and fund such LIBOR Balance to such
day, or (ii) immediately, if the Bank or Reference Bank (or, if applicable, its
designated eurodollar lending office) may not lawfully continue to maintain such
LIBOR Balance to such day. Further, until the Bank notices the undersigned that
such conditions or circumstances no longer exist, the right of the undersigned
to select an Interest Option based on a LIBOR Based Rate shall be suspended, and
the undersigned may only select Interest Options based on the Prime Rate.

If either (i) the adoption of any applicable law, rule or regulation, or any
change therein, or any change in the interpretation or administration thereof by
any governmental authority, central bank or comparable agency charged with the
interpretation or administration thereof, or compliance by the Bank or Reference
Bank (or, if applicable, its designated eurodollar lending office) with any
request or directive (whether or not having the force of law) of any such
authority, central bank or comparable agency shall subject the Bank or Reference
Bank (or, if applicable, its designated eurodollar lending office) to any tax
(including without limitation any United States interest equalization or similar
tax, however named), duty or other charge with respect to any LIBOR Balance,
this Note or the Bank's or the Reference Bank's (or, if applicable, its
designated eurodollar lending office's) obligation to compute interest on the
principal balance of this Note at a rate based upon a LIBOR Based Rate, or shall
change the basis of taxation of payments to the Bank or the Reference Bank (or,
if applicable, its designated eurodollar lending office) of the principal of or
interest on any LIBOR Balance or any other amounts due under this Note in
respect of any LIBOR Balance or the Bank's or Reference Bank's (or, if
applicable, its designated eurodollar lending office's) obligation to compute
the interest on the balance of this Note at a rate based upon a LIBOR Based
Rate, or (ii) any governmental authority, central bank or other comparable
authority shall at any time impose, modify or deem applicable any reserve
(including, without limitation, any imposed by the Board of Governors of the
Federal Reserve System), special deposit or similar requirement against assets
of, deposits with or for the account of, or credit extended by, the Bank or
Reference Bank (or, if applicable, its designated eurodollar lending office), or
shall impose on the Bank or Reference Bank (or, if applicable, its designated
eurodollar lending office) or any relevant interbank eurodollar market or
exchange any other condition affecting any LIBOR Balance, this Note or the
Bank's or Reference Bank's (or, if applicable, its designated eurodollar lending
office's) obligation to compute the interest on the balance of this Note at a
rate based upon a LIBOR Based Rate; and the result of any of the foregoing is to
increase the cost to the Bank or Reference Bank (or, if applicable, the
Reference Bank's designated eurodollar lending office) of maintaining any LIBOR
Balance, or to reduce the amount of any sum received or receivable by the Bank
or Reference Bank (or, if applicable, the Reference Bank's designated eurodollar
lending office) under or with respect to this Note by an amount deemed by the
Bank to be material, then upon demand by the Bank, the undersigned shall pay to
the Bank such additional amount or amounts as will compensate the Bank and the
Reference Bank (and, if applicable, its designated eurodollar lending office)
for such increased cost or reduction. The Bank will promptly notify the
undersigned of any event of which it has knowledge, occurring after the date
hereof, which will entitle the Bank or Reference Bank (or, if applicable, the
Reference Bank's designated

                                        2


eurodollar lending office) to compensation pursuant to this paragraph. A
certificate of the Bank claiming compensation under this paragraph and setting
forth the additional amount or amounts to be paid hereunder shall be conclusive
in the absence of manifest error.

If any applicable law, treaty, rule, or regulation (whether domestic or foreign)
now or hereafter in effect and whether presently applicable to the Bank or
Reference Bank (or, if applicable, its designated eurodollar lending office) or
any change therein or any interpretation or administration thereof by any
governmental authority, central bank or comparable agency charged with the
interpretation or administration thereof or compliance by the Bank or Reference
Bank (or, if applicable, its designated eurodollar lending office) therewith or
with any guidance, request or directive of any such governmental authority,
central bank or comparable agency (whether or not having the force of law),
including any risk-based capital guidelines, affects or would affect the amount
of capital required or expected to be maintained by the Bank or Reference Bank
(or any corporation controlling the Bank or Reference Bank), and the Bank
determines that the amount of such capital is increased by or based upon the
existence of any obligations of Bank hereunder or the maintaining of any LIBOR
Balance hereunder, and such increase has the effect of reducing the rate of
return on Bank's or the Reference Bank's (or its controlling corporation's)
capital as a consequence of such obligations or the maintaining of LIBOR
Balances hereunder to a level below that which the Bank or Reference Bank (or
such controlling corporation) could have achieved but for such circumstances
(taking into consideration its policies with respect to capital adequacy), then
the undersigned shall pay to Bank, within fifteen (15) days of receipt by the
undersigned of written notice from the Bank demanding such compensation, such
additional amounts as are sufficient to compensate the Bank or Reference Bank
(or its controlling corporation) for any increase in the amount of capital and
reduced rate of return which the Bank determines to be allocable to the
existence of any obligations of the Bank hereunder or maintenance of any LIBOR
Balances hereunder. A certificate of Bank as to the amount of such compensation,
prepared in good faith and in reasonable detail by the Bank, which is submitted
by the Bank to the undersigned shall be conclusive and binding for all purposes
absent manifest error.

The undersigned may not repay any LIBOR Balance or convert all or any portion of
a LIBOR Balance to a Prime Rate Balance prior to the expiration of the
applicable LIBOR Interest Period, unless (i) such repayment or conversion is
specifically required by the terms of this Note, (ii) the Bank demands that such
repayment or conversion be made, or (iii) the Bank, in its sole discretion,
consents to such repayment or conversion. If for any reason, whether or not
consent shall have been given or demand shall have been made by the Bank, any
LIBOR Balance is repaid or converted prior to the expiration of the
corresponding LIBOR Interest Period, or any Interest Option which designates a
LIBOR Balance is revoked for any reason whatsoever prior to the commencement of
the applicable LIBOR Interest Period or the undersigned fails for any reason to
borrow the full amount of any LIBOR Balance for which the undersigned has
exercised an Interest Option, or if for any other reason whatsoever, the basis
for determining the Stated Rate shall be changed from a LIBOR Based Rate to the
Prime Rate prior to the expiration of the applicable LIBOR Interest Period, or
the undersigned shall fail to make any payment of principal or interest upon
this Note at any time that the Stated Rate if based on a LIBOR Based Rate, then
the undersigned shall pay to the Bank on demand any amounts required to
compensate the Bank and Reference Bank (and, if applicable, its designated
eurodollar lending office) for any losses, costs or expenses which any of them
may incur as a result thereof, including, without limitation, any loss, cost or
expense incurred in obtaining, liquidating, employing or redeploying deposits
from third parties. Amounts payable by the undersigned to the Bank pursuant to
this paragraph may include, without limitation, amounts equal to the excess, if
any of (a) the amounts of interest which would have accrued on any amounts so
prepaid, refunded, converted or not so borrowed, from the respective dates of
prepayment, refund, conversion or failure to borrow through the last day of the
relevant LIBOR Interest Periods at the applicable rates of interest for the
applicable LIBOR Balances, as provided under this Note, over (b) the amounts of
interest determined by the Bank or Reference Bank (or, if applicable, its
designated eurodollar lending office) which would have accrued to the Bank or
Reference Bank (or if applicable, its designated eurodollar lending office) on
such respective amounts by placing such amounts on deposit for comparable
periods with leading banks in the interbank eurodollar market selected by the
Bank or Reference Bank (or, if applicable, the Reference Bank's designated
eurodollar lending office). The calculation of any such amounts under this
paragraph shall be made as if the Bank or Reference Bank (or, if applicable, the
Reference Bank's designated eurodollar lending office) actually funded or
committed to fund the relevant LIBOR Balances hereunder through the purchase of
underlying deposits in amounts equal to the respective amounts of the applicable
LIBOR Balances and having terms comparable to the applicable LIBOR Interest
Periods; provided, however, that the Bank may fund LIBOR Balances hereunder in
any manner they may elect in their sole discretion, and the foregoing
assumptions shall be utilized only for the purposes of calculating amounts
payable under this paragraph. Upon written request by the undersigned, the Bank
shall deliver to the undersigned a certificate setting for the basis for
determining such losses, costs and expenses which certificate shall be
conclusive in the absence of manifest error.

For any LIBOR Balance, if the Bank or the Reference Bank shall designate a
eurodollar lending office which maintains books separate from those of the Bank
or the Reference Bank, the Bank and the Reference Bank shall have the option of
maintaining and carrying such LIBOR Balance on the Books of such eurodollar
lending office.

The principal amount payable under this Note shall be the sum of all advances
made by the Bank to or at the request of the undersigned, less principal
payments actually received by the Bank. The books and records of the Bank shall
be the best evidence of the principal amount and the unpaid interest amount
owing at any time under this Note and shall be conclusive absent manifest error.
No interest shall accrue under this Note until the date of the first advance
made by the Bank; after that interest on all advances shall accrue and be
computed on the principal balance outstanding from time to time under this Note
until the same is paid in full. AT NO TIME SHALL THE BANK BE UNDER ANY
OBLIGATION TO MAKE ANY ADVANCES TO THE UNDERSIGNED PURSUANT TO THIS NOTE
(NOTWITHSTANDING ANYTHING EXPRESSED OR IMPLIED IN THIS NOTE OR ELSEWHERE TO THE
CONTRARY, INCLUDING WITHOUT LIMIT IF THE BANK SUPPLIES THE UNDERSIGNED WITH A
BORROWING FORMULA) AND THE BANK, AT ANY TIME AND FROM TIME TO TIME, WITHOUT
NOTICE, AND IN ITS SOLE DISCRETION, MAY REFUSE TO MAKE ADVANCES TO THE
UNDERSIGNED WITHOUT INCURRING ANY LIABILITY DUE TO THIS REFUSAL AND WITHOUT
AFFECTING THE UNDERSIGNED'S LIABILITY UNDER THIS NOTE FOR ANY AND ALL AMOUNTS
ADVANCED.

This Note and any other indebtedness and liabilities of any kind of the
undersigned (or any of them) to the Bank, and any and all modifications,
renewals or extensions of it, whether joint or several, contingent or absolute,
now existing or later arising, and however evidenced and whether incurred
voluntarily or involuntarily, known or unknown, or originally payable to the
Bank or to a third party and subsequently acquired by Bank including, without
limitation, any late charges; loan fees or charges; overdraft indebtedness;
costs incurred by Bank in establishing, determining, continuing or defending the
validity or priority of any security interest, pledge or other lien or in
pursuing any of its rights or remedies under any loan document (or otherwise) or
in connection with any proceeding involving the Bank as a result of any
financial accommodation to the undersigned (or any of them); and reasonable
costs and expenses of attorneys and paralegals, whether inside or outside
counsel is used, and whether any suit or other action is instituted, and to
court costs if suit or action is instituted, and whether any such fees, costs or
expenses are incurred at the trial court level or on appeal, in bankruptcy, in
administrative proceedings, in probate proceedings or otherwise (collectively
"Indebtedness"), are secured by and the Bank is granted a security interest in
and lien upon all items deposited in any account of any of the undersigned with
the Bank and by all proceeds of these items (cash or otherwise), all account
balances of any of the undersigned from time to time with the Bank, by all
property of any of the undersigned from time to time in the possession of the
Bank and by any other collateral, rights and properties described in each and
every deed of trust, mortgage, security agreement, pledge, assignment and other
security or collateral agreement which has been, or will at any time(s) later
be, executed by any (or all) of the undersigned to or for the benefit of the
Bank (collectively "Collateral"). Notwithstanding the above, (i) to the extent
that any portion of the Indebtedness is a consumer loan, that portion shall not
be secured by any deed of trust, mortgage on or other security interest in any
of the undersigned's principal dwelling or in any of the undersigned's real
property which is not a purchase money security interest as to that portion,
unless expressly provided to the contrary in another place, or (ii) if the
undersigned (or any of them) has(have) given or give(s) Bank a deed of trust or
mortgage covering California real property, that deed of trust or mortgage shall
not secure this Note or any other indebtedness of the undersigned (or any of
them), unless expressly provided to the contrary in another place, or (iii) if
the undersigned (or any of them) has (have) given or give(s) the Bank a deed of
trust or mortgage covering real property which, under Texas law, constitutes the
homestead of such person, that deed of trust or mortgage shall not secure this
Note or any other indebtedness of the undersigned (or any of them) unless
expressly provided to the contrary in another place.

If an Event of Default as defined in that certain Credit Agreement dated as of
evendate herewith between the undersigned and the Bank occurs or if the
undersigned (or any of them) or any guarantor under a guaranty of all or part of
the Indebtedness ("guarantor") (a) fail(s) to pay any of the Indebtedness when
due, by maturity, acceleration or otherwise, or fail(s) to pay any Indebtedness
owing on a demand basis

                                       3


upon demand; or (b) fail(s) to comply with any of the terms or provisions of any
agreement between the undersigned (or any of them) or any such guarantor and the
Bank; or (c) become(s) insolvent or the subject of a voluntary or involuntary
proceeding in bankruptcy, or a reorganization, arrangement or creditor
composition proceeding, (if a business entity) cease(s) doing business as a
going concern, (if a natural person) die(s) or become(s) incompetent, (if a
partnership) dissolve(s) or any general partner of it dies, becomes incompetent
or becomes the subject of a bankruptcy proceeding or (if a corporation or a
limited liability company) is the subject of a dissolution, merger or
consolidation; or (d) if any warranty or representation made by any of the
undersigned or any guarantor in connection with this Note or any of the
Indebtedness shall be discovered to be untrue or incomplete; or (e) if there is
any termination, notice of termination, or breach of any guaranty, pledge,
collateral assignment or subordination agreement relating to all or any part of
the Indebtedness; or (f) if there is any failure by any of the undersigned or
any guarantor to pay when due any of its indebtedness (other than to the Bank)
or in the observance or performance of any term, covenant or condition in any
document evidencing, securing or relating to such indebtedness; or (g) if the
Bank deems itself insecure believing that the prospect of payment of this Note
or any of the Indebtedness is impaired or shall fear deterioration, removal or
waste of any of the Collateral; or (h) if there is filed or issued a levy or
writ of attachment or garnishment or other like judicial process upon the
undersigned (or any of them) or any guarantor or any of the Collateral,
including without limit, any accounts of the undersigned (or any of them) or any
guarantor with the Bank, then the Bank, upon the occurrence of any of these
events (each a "Default"), may at its option and without prior notice to the
undersigned (or any of them), declare any or all of the Indebtedness to be
immediately due and payable (notwithstanding any provisions contained in the
evidence of it to the contrary), cease advancing money or extending credit to or
for the benefit of the undersigned under this Note or any other agreement
between the undersigned and the Bank, but without affecting Bank's rights and
security interests in any Collateral or the Indebtedness, sell or liquidate all
or any portion of the Collateral, set off against the Indebtedness any amounts
owing by the Bank to the undersigned (or any of them), charge interest at the
default rate provided in the document evidencing the relevant Indebtedness and
exercise any one or more of the rights and remedies granted to the Bank by any
agreement with the undersigned (or any of them) or given to it under applicable
law. In addition, if this Note is secured by a deed of trust or mortgage
covering real property, then the trustor or mortgagor shall not mortgage or
pledge the mortgaged premises as security for any other indebtedness or
obligations. This Note, together with all other indebtedness secured by said
deed of trust or mortgage, shall become due and payable immediately, without
notice, at the option of the Bank,(i) if said trustor or mortgagor shall
mortgage or pledge the mortgaged premises for any other indebtedness or
obligations or shall convey, assign or transfer the mortgaged premises by deed,
installment sale contract instrument, or (ii) if the title to the mortgaged
premises shall become vested in any other person or party in any manner
whatsoever, or (iii) if there is any disposition (through one or more
transactions) of legal or beneficial title to a controlling interest of said
trustor or mortgagor. All payments under this Note shall be in immediately
available United States funds, without setoff or counterclaim.

If this Note is signed by two or more parties (whether by all as makers or by
one or more as an accommodation party or otherwise), the obligations and
undertakings under this Note shall be that of all and any two or more jointly
and also of each severally. This Note shall bind the undersigned, and the
undersigned's respective heirs, personal representatives, successors and
assigns.

The undersigned waive(s) presentment, demand, protest, notice of dishonor,
notice of demand or intent to demand, notice of acceleration or intent to
accelerate, and all other notices and agree(s) that no extension or indulgence
to the undersigned (or any of them) or release, substitution or nonenforcement
of any security, or release or substitution of any of the undersigned, any
guarantor or any other party, whether with or without notice, shall affect the
obligations of any of the undersigned. The undersigned waive(s) all defenses or
right to discharge available under Section 3.605 of the Texas Uniform Commercial
Code and waive(s) all other suretyship defenses or right to discharge. The
undersigned agree(s) that the Bank has the right to sell, assign, or grant
participations or any interest in, any or all of the Indebtedness, and that, in
connection with this right, but without limiting its ability to make other
disclosures to the full extent allowable, the Bank may disclose all documents
and information which the Bank now or later has relating to the undersigned or
the Indebtedness. The undersigned agree(s) that the Bank may provide information
relating to this Note or the Indebtedness or relating to the undersigned to the
Bank's parent, affiliates, subsidiaries and service providers.

The undersigned agree(s) to reimburse the holder or owner of this Note upon
demand for any and all costs and expenses (including without limit, court costs,
legal expenses and reasonable attorneys' fees, whether inside or outside counsel
is used, and whether or not suit is instituted and, if suit is instituted,
whether at the trial court level, appellate level, in a bankruptcy, probate or
administrative proceeding or otherwise) incurred in collecting or attempting to
collect this Note or incurred in any other matter or proceeding relating to this
Note.

The undersigned acknowledge(s) and agree(s) that there are no contrary
agreements, oral or written, establishing a term of this Note and agree(s) that
the terms and conditions of this Note may not be amended, waived or modified
except in a writing signed by an officer of the Bank expressly stating that the
writing constitutes an amendment, waiver or modification of the terms of this
Note. As used in this Note, the word "undersigned" means, individually and
collectively, each maker, accommodation party, indorser and other party signing
this Note in a similar capacity. If any provision of this Note is unenforceable
in whole or part for any reason, the remaining provisions shall continue to be
effective. Chapter 346 of the Texas Finance Code (and as the same may be
incorporated by reference in other Texas statutes) shall not apply to the
Indebtedness evidenced by this Note. THIS NOTE IS MADE IN THE STATE OF TEXAS AND
SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS OF THE
STATE OF TEXAS, WITHOUT REGARD TO CONFLICT OF LAWS PRINCIPLE.

This Note and all other documents, instruments and agreements evidencing,
governing, securing, guaranteeing or otherwise relating to or executed pursuant
to or in connection with this Note or the Indebtedness evidenced hereby (whether
executed and delivered prior to, concurrently with or subsequent to this Note),
as such documents may have been or may hereafter be amended from time to time
(the "Loan Documents") are intended to be performed in accordance with, and only
to the extent permitted by, all applicable usury laws. If any provision hereof
or of any of the other Loan Documents or the application thereof to any person
or circumstance shall, for any reason and to any extent, be invalid or
unenforceable, neither the application of such provision to any other person or
circumstance nor the remainder of the instrument in which such provision is
contained shall be affected thereby and shall be enforced to the greatest extent
permitted by law. It is expressly stipulated and agreed to be the intent of the
holder hereof to at all times comply with the usury and other applicable laws
now or hereafter governing the interest payable on the indebtedness evidenced by
this Note. If the applicable law is ever revised, repealed or judicially
interpreted so as to render usurious any amount called for under this Note or
under any of the other Loan Documents, or contracted for, charged, taken,
reserved or received with respect to the indebtedness evidenced by this Note, or
if Bank's exercise of the option to accelerate the maturity of this Note, or if
any prepayment by the undersigned or prepayment agreement results (or would, if
complied with, result) in the undersigned having paid, contracted for or being
charged for any interest in excess of that permitted by law, then it is the
express intent of the undersigned and Bank that this Note and the other Loan
Documents shall be limited to the extent necessary to prevent such result and
all excess amounts theretofore collected by Bank shall be credited on the
principal balance of this Note or, if fully paid, upon such other Indebtedness
as shall then remaining outstanding (or, if this Note and all other Indebtedness
have been paid in full, refunded to the undersigned), and the provisions of this
Note and the other Loan Documents shall immediately be deemed reformed and the
amounts thereafter collectable hereunder and thereunder reduced, without the
necessity of the execution of any new document, so as to comply with the then
applicable law, but so as to permit the recovery of the fullest amount otherwise
called for hereunder or thereunder. All sums paid, or agreed to be paid, by the
undersigned for the use, forbearance, detention, taking, charging, receiving or
reserving of the indebtedness of the undersigned to Bank under this Note or
arising under or pursuant to the other Loan Documents shall, to the maximum
extent permitted by applicable law, be amortized, prorated, allocated and spread
throughout the full term of such indebtedness until payment in full so that the
rate or amount of interest on account of such indebtedness does not exceed the
usury ceiling from time to time in effect and applicable to such indebtedness
for so long as such indebtedness is outstanding. To the extent federal law
permits Bank to contract for, charge or receive a greater amount of interest,
Bank will rely on federal law instead of the Texas Finance Code for the purpose
of determining the Maximum Rate. Additionally, to the maximum extent permitted
by applicable law now or hereafter in effect, Bank may, at its option and from
time to time, implement any other method of computing the Maximum Rate under the
Texas Finance Code or under other applicable law, by giving notice, if required,
to the undersigned as provided by applicable law now or hereafter in effect.
Notwithstanding anything to the contrary contained herein or in any of the other
Loan Documents, it is not the intention of Bank to accelerate the maturity of
any interest that has not accrued at the time of such acceleration or to collect
unearned interest at the time of such acceleration.

THE UNDERSIGNED AND THE BANK, BY ACCEPTANCE OF THIS NOTE, ACKNOWLEDGE THAT THE
RIGHT TO TRIAL BY JURY IS A CONSTITUTIONAL ONE, BUT THAT IT MAY BE WAIVED. EACH
PARTY, AFTER CONSULTING (OR HAVING HAD THE OPPORTUNITY TO CONSULT) WITH COUNSEL
OF THEIR CHOICE, KNOWINGLY AND VOLUNTARILY, AND FOR THEIR MUTUAL

                                        4


BENEFIT, WAIVES ANY RIGHT TO TRIAL BY JURY IN THE EVENT OF LITIGATION REGARDING
THE PERFORMANCE OR ENFORCEMENT OF, OR IN ANY WAY RELATED TO, THIS NOTE OR THE
INDEBTEDNESS.

THIS WRITTEN LOAN AGREEMENT (AS DEFINED BY SECTION 26.02 OF THE TEXAS BUSINESS
AND COMMERCE CODE) REPRESENTS THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY
NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL
AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS BETWEEN THE
PARTIES.

                             BORROWER:

                             INTERPHASE CORPORATION,
                             a Texas corporation

                             By:/s/ Steve Kovac
                                -----------------------------------------
                                Steve Kovac, Chief Financial Officer

2901 Dallas Parkway                 Plano        Texas                75093
- -------------------                 -----        -----              --------
  STREET ADDRESS                    CITY         STATE              ZIP CODE



                                  FOR BANK USE ONLY                          CCAR #
- -------------------------------------------------------------------------------------------------------
                                                                              
LOAN OFFICER INITIALS    LOAN GROUP NAME     OBLIGOR NAME
   RLR                   MIDDLE MARKET       INTERPHASE CORPORATION, A TEXAS CORPORATION
                         NORTH
- -------------------------------------------------------------------------------------------------------
LOAN OFFICER ID. NO.     LOAN GROUP NO.      OBLIGOR NO.         NOTE NO.                 AMOUNT
43527                    90029                                                            $5,000,000.00
- -------------------------------------------------------------------------------------------------------
 

                                        5




[COMERICA - BANK LOGO]        CREDIT AGREEMENT

THIS CREDIT AGREEMENT is made and delivered to be effective as of JULY 25, 2003,
by and between INTERPHASE CORPORATION, a Texas corporation (herein referred to
with all successors, assigns and/or personal representatives as the "Borrower"),
and COMERICA BANK-TEXAS (herein referred to with its successors and assigns as
the "Bank"). For and in consideration of the mutual promises herein contained
and other good and valuable consideration, the receipt and sufficiency of which
are hereby acknowledged, Borrower and Bank agree as follows:

SECTION 1. DEFINITIONS

1.1   Defined Terms. The following terms, as used in this Agreement, shall have
      the meanings set forth below. The singular number shall be deemed to
      include the plural, the masculine gender shall include the feminine and
      neuter genders, and vice versa.

      "AFFILIATE" shall mean, when used with respect to any Person, any other
      Person which, directly or indirectly, controls or is controlled by or is
      under common control with such Person. For purposes of this definition,
      "control" (including, with correlative meanings, the terms "controlled by"
      and "under common control with"), with respect to any Person, shall mean
      possession, directly or indirectly, of the power to direct or cause the
      direction of the management and policies of such Person, whether through
      the ownership of voting securities, by contract or otherwise.

      "AGREEMENT" shall mean this Credit Agreement, including all addenda,
      exhibits and schedules now or hereafter made a part hereof, as the same
      may be amended from time to time.

      "APPLICABLE INTEREST RATE" shall mean, with respect to the Indebtedness
      from time to time outstanding under any promissory note or other Loan
      Document evidencing the Indebtedness, the rate or rates provided in such
      note as the applicable interest rate.

      "COLLATERAL" shall mean all property, assets and rights in which a Lien or
      other encumbrance in favor of or for the benefit of Bank is or has been
      granted or arises or has arisen, or may hereafter be granted or arise,
      under or in connection with any Loan Document, or otherwise, to secure the
      payment or performance of any portion of the Indebtedness.

      "DEBT" shall mean, as of any applicable date of determination thereof, all
      liabilities of a Person that should be classified as liabilities in
      accordance with GAAP. In the case of Borrower, the term "Debt" shall
      include, without limitation, the Indebtedness.

      "DEFAULT" shall mean, any condition or event which, with the giving of
      notice or the passage of time, or both, would constitute an Event of
      Default.

      "ENVIRONMENTAL LAW(s)" shall mean all laws, codes, ordinances, rules,
      regulations, orders, decrees and directives issued by any federal, state,
      local, foreign or other governmental or quasi governmental authority or
      body (or any agency, instrumentality or political subdivision thereof)
      pertaining to Hazardous Materials or otherwise intended to regulate or
      improve health, safety or the environment, including, without limitation,
      any hazardous materials or wastes, toxic substances, flammable, explosive
      or radioactive materials, asbestos, and/or other similar materials; any
      so-called "superfund" or "superlien" law, pertaining to Hazardous
      Materials on or about any of the Collateral, or any other property at any
      time owned, leased or otherwise used by any Loan Party, or any portion
      thereof, including, without limitation, those relating to soil, surface,
      subsurface ground water conditions and the condition of the ambient air;
      and any other federal, state, foreign or local statute, law, ordinance,
      code, rule, regulation, order or decree regulating, relating to, or
      imposing liability or standards of conduct concerning, any hazardous,
      toxic, radioactive, flammable or dangerous waste, substance or material,
      as now or at anytime hereafter in effect.

      "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as
      amended, or any successor act or code.

      "EVENT OF DEFAULT" shall mean any of those conditions or events listed in
      Section 6.1 of this Agreement.

      "GAAP" shall mean generally accepted accounting principles consistently
      applied.

      "GOVERNMENTAL AUTHORITY" shall mean the United States, each state, each
      county, each city, and each other political subdivision in which all or
      any portion of the Collateral is located, and each other political
      subdivision, agency, or instrumentality exercising jurisdiction over Bank,
      any Loan Party, any of the Indebtedness or any Collateral.

      "GOVERNMENTAL REQUIREMENTS" shall mean all laws, ordinances, rules, and
      regulations of any Governmental Authority applicable to any Loan Party,
      any of the Indebtedness or any Collateral.

      "GUARANTOR(s)" shall mean, as the context dictates, any Person(s) (other
      than the Borrower) who shall, at any time, guarantee or otherwise be or
      become obligated for the repayment of all or any part of the Indebtedness.

      "HAZARDOUS MATERIAL" shall mean and include any hazardous, toxic or
      dangerous waste, substance or material defined as such in, or for purposes
      of, any Environmental Law(s).

      "INDEBTEDNESS" shall mean all obligations and liabilities of any Loan
      Party to Bank under any Loan Document, together with all other
      indebtedness, obligations and liabilities whatsoever of Borrower to Bank,
      whether matured or unmatured, liquidated or unliquidated, direct or
      indirect, absolute or contingent, joint or several, due or to become due,
      now existing or hereafter arising, voluntary or involuntary, known or
      unknown, or originally payable to Bank or to a third party and
      subsequently acquired by Bank including, without limitation, any: late
      charges; loan fees or charges; overdraft indebtedness; costs incurred by
      Bank in establishing, determining, continuing or defending the validity or
      priority of any Lien or in pursuing any of its rights or remedies under
      any Loan Document or in connection with any proceeding involving Bank as a
      result of any financial accommodation to Borrower; debts, obligations and
      liabilities for which Borrower would otherwise be liable to the Bank were
      it not for the invalidity or enforceability of them by reason of any
      bankruptcy, insolvency or other law or for any other reason; and
      reasonable costs and expenses of attorneys and paralegals, whether any
      suit or other action is instituted, and to court costs if suit or action
      is instituted, and whether any such fees, costs or expenses are incurred
      at the trial court level or on appeal, in bankruptcy, in administrative
      proceedings, in probate proceedings or otherwise; provided, however, that
      the term Indebtedness shall not include any consumer loan to the extent
      treatment of such loan as part of the Indebtedness would violate any
      Governmental Requirement.

      "LETTER OF CREDIT" shall mean a letter of credit issued by the Bank for
      the account of and/or upon the application of the Borrower in accordance
      with this Agreement, as such Letter of Credit may be amended,
      supplemented, extended or confirmed from time to time.

      "LETTER OF CREDIT LIABILITIES" shall mean, at any time and in respect of
      all Letters of Credit, the sum of (a) the aggregate amount available to be
      drawn under all such Letters of Credit plus (b) the aggregate unpaid
      amount of all Reimbursement Obligations then due and payable in respect of
      previous drawings under such Letters of Credit.

                                       1


      "LIEN" shall mean any valid and enforceable interest in any property,
      whether real, personal or mixed, securing an indebtedness, obligation or
      liability owed to or claimed by any Person other than the owner of such
      property, whether such indebtedness is based on the common law or any
      statute or contract and including, but not limited to, a security
      interest, pledge, mortgage, assignment, conditional sale, trust receipt,
      lease, consignment or bailment for security purposes.

      "LOAN DOCUMENTS" shall mean collectively, this Agreement, any promissory
      notes evidencing Indebtedness, any approved subordination agreement, any
      reimbursement agreement or other documentation executed in connection with
      any Letter of Credit, and any other documents, instruments or agreements
      evidencing, governing, securing, guaranteeing or otherwise relating to or
      executed pursuant to or in connection with any of the Indebtedness or any
      Loan Document (whether executed and delivered prior to, concurrently with
      or subsequent to this Agreement), as such documents may have been or may
      hereafter be amended from time to time.

      "LOAN PARTY" shall mean Borrower, each of its Subsidiaries (whether or not
      a party to any Loan Document) and each other Person who or which shall be
      liable for the payment or performance of all or any portion of the
      Indebtedness or who or which shall own any property that is subject to (or
      purported to be subject to) a Lien which secures all or any portion of the
      Indebtedness.

      "MATERIAL ADVERSE EFFECT" shall mean any act, event, condition or
      circumstance which could materially and adversely affect the business,
      operations, condition (financial or otherwise), performance or assets of
      any Loan Party, the ability of any Loan Party to perform its obligations
      under any Loan Document to which it is a party or by which it is bound or
      the enforceability of any Loan Document.

      "MAXIMUM LEGAL RATE" shall mean the maximum rate of nonusurious interest
      per annum permitted to be paid by Borrower or, if applicable, another Loan
      Party or received by Bank with respect to the applicable portion of the
      Indebtedness from time to time under applicable state or federal law as
      now or as may be hereafter in effect, including Chapter 1 D of Title 79
      Vernon's Texas Civil Statutes (and as the same may be incorporated by
      reference in other Texas statutes), but otherwise without limitation, that
      rate based upon the "weekly ceiling rate" (as defined in Section 303 of
      the Texas Finance Code).

      "PBGC" shall mean the Pension Benefit Guaranty Corporation, or any Person
      succeeding to the present powers and functions of the Pension Benefit
      Guaranty Corporation.

      "PENSION PLAN(s)" shall mean any and all employee benefit pension plans of
      Borrower and/or any of its Subsidiaries in effect from time to time, as
      such term is defined in ERISA.

      "PERMITTED ENCUMBRANCES" shall mean: (a) Liens in favor of the Bank; (b)
      Liens for taxes, assessments or other governmental charges which are not
      yet due and payable, incurred in the ordinary course of business and for
      which no interest, late charge or penalty is attaching or which are being
      contested in good faith by appropriate proceedings and, if requested by
      Bank, bonded in an amount and manner satisfactory to Bank; (c) Liens, not
      delinquent, arising in the ordinary course of business and created by
      statute in connection with worker's compensation, unemployment insurance,
      social security and similar statutory obligations; and (d) Liens of
      mechanics, materialmen, carriers, warehousemen or other like statutory or
      common law Liens securing obligations incurred in good faith in the
      ordinary course of business without violation of any Loan Document that
      are not yet due and payable.

      "PERSON" or "PERSON" shall mean any individual, corporation, partnership,
      joint venture, limited liability company, association, trust,
      unincorporated association, joint stock company, government, municipality,
      political subdivision or agency, or other entity.

      "REIMBURSEMENT OBLIGATIONS" shall mean, at any time and in respect of all
      Letters of Credit, the aggregate obligations of the Borrower, then
      outstanding or which may thereafter arise, to reimburse the Bank for any
      amount paid or incurred by the Bank in respect of any and all drawings
      under such Letters of Credit, together with any and all other
      Indebtedness, obligations and liabilities of any Loan Party to Bank
      related to such Letters of Credit arising under this Agreement, any Letter
      of Credit application or any other Loan Document.

      "REVOLVING CREDIT MATURITY DATE" shall mean July 30, 2005 or such earlier
      date on which the entire unpaid principal amount of all Revolving Loans
      becomes due and payable whether by the lapse of time, demand for payment,
      acceleration or otherwise; provided, however, if any such date is not a
      business day, then the Revolving Credit Maturity Date shall be the next
      succeeding business day.

      "REVOLVING CREDIT MAXIMUM AMOUNT" shall mean the lesser of (a)
      $5,000,000.00 , or (b) the maximum amount permitted by an advance formula
      agreement, if applicable.

      "REVOLVING CREDIT NOTE" shall mean the Revolving Credit Note dated July
      25, 2003 in the maximum original principal amount of $5,000,000.00 made by
      Borrower payable to the order of the Bank, as the same may be renewed,
      extended, modified, increased or restated from time to time.

      "REVOLVING LOAN" shall mean an advance made, or to be made, under the
      revolving credit facility to or for the credit of Borrower by the Bank
      pursuant to this Agreement.

      "SUBORDINATED DEBT" shall mean any Debt of Borrower (other than the
      Indebtedness) which has been subordinated to the Indebtedness pursuant to
      a subordination agreement in form and content satisfactory to the Bank.

      "SUBSIDIARY" shall mean as to any particular parent entity, any
      corporation, partnership, limited liability company or other entity
      (whether now existing or hereafter organized or acquired) in which more
      than fifty percent (50%) of the outstanding equity ownership interests
      having voting rights as of any applicable date of determination, shall be
      owned directly, or indirectly through one or more Subsidiaries, by such
      parent entity.

      "UCC" shall mean the Uniform Commercial Code as adopted and in force in
      the State of Texas, as amended.

1.2   Accounting Terms. All accounting terms not specifically defined in this
      Agreement shall be determined and construed in accordance with GAAP.

SECTION 2.  FUNDING LOANS, PAYMENTS, RECOVERIES AND COLLECTIONS

2.1   Funding Loans. Subject to the terms, conditions and procedures of this
      Agreement and each other Loan Document and to the satisfaction of all
      conditions precedent to the making and funding of any loan as set forth in
      any Loan Document, Bank shall make the proceeds of any such loan available
      to Borrower on the disbursement date agreed upon by Bank and Borrower by
      depositing such proceeds into an account maintained by Borrower with Bank
      or as otherwise agreed to in writing by Borrower and Bank.

2.2   Revolving Loans. Subject to the terms and conditions of the Loan Documents
      and to the satisfaction of all conditions precedent to the making and
      funding of any loan as set forth in any Loan Document, the Bank agrees to
      make Revolving Loans to Borrower

                                       2


      at any time and from time to time from the effective date hereof until
      (but not including) the Revolving Credit Maturity Date. The proceeds of
      Revolving Loans shall be used solely for any purpose and other working
      capital needs of Borrower.

      Except as hereinafter provided, Borrower may request a Revolving Loan by
      submitting to Bank a request for advance by an authorized officer or other
      representative of Borrower, subject to the following: (a) each such
      request for advance shall include, without limitation, the proposed amount
      of such revolving loan and the proposed disbursement date, which date must
      be a business day; (b) each such request for advance shall be communicated
      to Bank by 4 p.m. (Dallas, Texas time) on the proposed disbursement date;
      (c) a request for advance, once communicated to Bank, shall not be
      revocable by Borrower; and (d) each request for advance, once communicated
      to Bank, shall constitute a representation, warranty and certification by
      Borrower as of the date thereof that: (i) both before and after the making
      of such Revolving Loan, the obligations set forth in the Loan Documents
      are and shall be valid, binding and enforceable obligations of each Loan
      Party, as applicable; (ii) all terms and conditions precedent to the
      making of such Revolving Loan have been satisfied, and shall remain
      satisfied through the date of such Revolving Loan; (iii) the making of
      such Revolving Loan will not cause the aggregate outstanding principal
      amount of all Revolving Loans plus the Letter of Credit Liabilities, if
      applicable, to exceed the Revolving Credit Maximum Amount; (iv) no Default
      or Event of Default shall have occurred or be in existence, and none will
      exist or arise upon the making of such Revolving Loan; (v) the
      representations and warranties contained in the Loan Documents are true
      and correct in all material respects and shall be true and correct in all
      material respects as of the making of such Revolving Loan; and (vi) the
      request for advance will not violate the terms or conditions of any
      contract, indenture, agreement or other borrowing of any Loan Party.

      Bank may elect (but without any obligation to do so) to make a Revolving
      Loan upon the telephonic or facsimile request of Borrower, provided that
      Borrower has first executed and delivered to Bank a telephone notice
      authorization in form and content satisfactory to Bank. If any such
      Revolving Loan based upon a telephonic or facsimile request is made by
      Borrower, Bank may require Borrower to confirm said telephonic or
      facsimile request in writing by delivering to Bank, on or before 11:00
      a.m. (Dallas, Texas time) on the next business day following the
      disbursement date of such Revolving Loan, a duly executed written request
      for advance, and all other provisions of this Section 2.2 shall be
      applicable with respect to such Revolving Loan. In addition, Borrower may
      authorize the Bank to automatically make revolving loans pursuant to such
      other written agreements as may be entered into by Bank and Borrower.

      Notwithstanding anything contained in this Agreement to the contrary, the
      aggregate principal amount of all Revolving Loans at any time outstanding
      plus the Letter of Credit Liabilities, if applicable, and any amounts owed
      by Borrower to Bank under Borrower's foreign exchange authority, shall not
      exceed the Revolving Credit Maximum Amount. If said limitations are
      exceeded at anytime, Borrower shall immediately, without demand by Bank,
      pay to Bank an amount not less than such excess, or, if Bank, in its sole
      discretion, shall so agree, Borrower shall provide Bank cash collateral in
      an amount not less than such excess, and Borrower hereby pledges and
      grants to Bank a security interest in such cash collateral so provided to
      Bank. Unless otherwise expressly provided in a Loan Document, all sums
      payable by Borrower to Bank under or pursuant to any Loan Document,
      whether principal, interest, or otherwise, shall be paid, when due,
      directly to Bank at any office of Bank located in the State of Texas in
      immediately available United States funds, and without setoff, deduction
      or counterclaim. Bank may, in its discretion, charge any and all deposit
      or other accounts (including, without limitation, any account evidenced by
      a certificate of deposit or time deposit) of Borrower maintained with Bank
      for all or any part of any Indebtedness then due and payable; provided,
      however, that such authorization shall not affect Borrower's obligations
      to pay all Indebtedness, when due, whether or not any such account
      balances maintained by Borrower with Bank are insufficient to pay any
      amounts then due.

      Borrower shall pay to Bank an unused commitment fee in an amount equal to
      the product of (a) .25% multiplied by (b) the difference between (i) the
      maximum face amount of the Revolving Credit Note and (ii) the average
      daily aggregate principal balance of all Revolving Loans outstanding
      during each of Borrower's fiscal quarters. Such fee shall be computed and
      shall be payable quarterly in arrears as of the end of each of Borrower's
      fiscal quarters. Bank shall invoice Borrower for such fees, which invoice
      shall be due and payable within fifteen (15) days after receipt.

      The provisions of Chapter 346 of the Texas Finance Code are specifically
      declared by the parties not to be applicable to any of the Loan Documents
      or the transactions contemplated thereby.

2.3   Letters of Credit. Subject to the terms and conditions of this Agreement
      and the other Loan Documents, the Bank shall, upon request from Borrower
      from time to time prior to the Revolving Credit Maturity Date, issue one
      or more Letters of Credit. The Letter of Credit Liabilities shall not
      exceed $500,000.00; and the sum of (a) the outstanding principal balance
      of all Revolving Loans plus (b) the Letter of Credit Liabilities shall not
      exceed the Revolving Credit Maximum Amount. Letters of Credit may be
      issued solely as commercial letters of credit related to trade financing.
      Each Letter of Credit issued pursuant to this Agreement shall be in a
      minimum amount of $1,000.00. No Letter of Credit shall have a stated
      expiration date later than the Revolving Credit Maturity Date.

      Borrower shall give the Bank written notice requesting each issuance of a
      Letter of Credit hereunder not less than five business days prior to the
      requested issuance date and shall furnish such additional information
      regarding such transaction as Bank may request. The issuance by Bank of
      each Letter of Credit shall, in addition to the conditions precedent set
      forth elsewhere in this Agreement, be subject to the conditions precedent
      that (i) such Letter of Credit shall be in form and substance satisfactory
      to Bank, (ii) Borrower shall have executed and delivered such applications
      and other instruments and agreements relating to such Letter of Credit as
      Bank shall have requested and are not inconsistent with the terms of this
      Agreement (iii) each of the statements in Section 2.2 (d) above are true
      as of the date of issuance of such Letter of Credit with respect to
      issuance of such Letter of Credit (as opposed to making a Revolving Loan),
      and the submission of an application for issuance of a Letter of Credit
      shall constitute a representation, warranty and certification of Borrower
      to that effect, and (iv) no Letter of Credit may be issued if after giving
      effect thereto, the sum of the aggregate outstanding principal balance of
      all Revolving Loans plus the Letter of Credit Liabilities would exceed the
      Revolving Credit Maximum Amount. With respect to the issuance or renewal
      of each Letter of Credit, Borrower shall pay to Bank such letter of credit
      fees and other expenses customarily charged by Bank in connection with the
      issuance or renewals of letters of credit.

      Borrower shall be irrevocably and unconditionally obligated forthwith to
      reimburse Bank for any amount paid by Bank upon any drawing under any
      Letter of Credit, without presentment, demand, protest or other
      formalities of any kind, all of which are hereby waived. Unless Borrower
      shall elect to otherwise satisfy such Reimbursement Obligation, such
      reimbursement shall, subject to satisfaction of any conditions provided
      herein for the making of Revolving Loans and to the Revolving Credit
      Maximum Amount, automatically be made by advancing to Borrower a Revolving
      Loan in the amount of such Reimbursement Obligation.

2.4   Intentionally omitted.

2.5   Intentionally omitted.

2.6   Maximum Interest Rate. At no time shall any Applicable Interest Rate or
      default rate in respect of any Indebtedness hereunder, exceed the Maximum
      Legal Rate. In the event that any interest is charged or otherwise
      received by Bank in excess of the Maximum Legal Rate, Borrower hereby
      acknowledges and agrees that any such excess interest shall be the result
      of an accidental and bona fide error, and any such excess shall be deemed
      to have been payment of principal, and not of interest, and shall be
      applied, first, to reduce the principal Indebtedness then outstanding,
      second, any remaining excess, if any, shall be applied to reduce any other
      Indebtedness, and third, any remaining excess, if any, shall be returned
      to Borrower. Notwithstanding the

                                        3


      foregoing or anything to the contrary contained in this Agreement or any
      other Loan Document, but subject to all limitations contained in this
      Section, if at anytime any Applicable Interest Rate or default rate or
      other rate of interest applicable to any portion of the Indebtedness is
      computed on the basis of the Maximum Legal Rate, any subsequent reduction
      in the Applicable Interest Rate, default rate or such other rate of
      interest shall not reduce such interest rate thereafter payable below the
      Maximum Legal Rate until the aggregate amount of interest accrued equals
      the total amount of interest that would have accrued if interest had, at
      all times, been computed solely on the basis of the Applicable Interest
      Rate, default rate or such other interest rate. This Section shall control
      all agreements between the Borrower and the Bank.

2.7   Receipt of Payments by Bank. Any payment by Borrower of any of the
      Indebtedness made by mail will be deemed tendered and received by Bank
      only upon actual receipt thereof by Bank at the address designated for
      such payment, whether or not Bank has authorized payment by mail or in any
      other manner, and such payment shall not be deemed to have been made in a
      timely manner unless actually received by Bank on or before the date due
      for such payment, time being of the essence. Borrower expressly assumes
      all risks of loss or liability resulting from non-delivery or delay of
      delivery of any item of payment transmitted by mail or in any other
      manner. Acceptance by Bank of any payment in an amount less than the
      amount then due shall be deemed an acceptance on account only, and any
      failure to pay the entire amount then due shall constitute and continue to
      be an Event of Default. Prior to the occurrence of any Default, Borrower
      shall have the right to direct the application of any and all payments
      made to Bank hereunder to the Indebtedness evidenced by the respective
      notes evidencing the Indebtedness. Borrower waives the right to direct the
      application of any and all payments received by Bank hereunder at any time
      or times after the occurrence and during the continuance of any Default.
      Borrower further agrees that after the occurrence and during the
      continuance of any Default, or prior to the occurrence of any Default if
      Borrower has failed to direct such application, Bank shall have the
      continuing exclusive right to apply and to reapply any and all payments
      received by Bank at any time or times, whether as voluntary payments,
      proceeds from any Collateral, offsets, or otherwise, against the
      Indebtedness in such order and in such manner as Bank may, in its sole
      discretion, deem advisable, notwithstanding any entry by Bank upon any of
      its books and records. Borrower hereby expressly agrees that, to the
      extent that Bank receives any payment or benefit of or otherwise upon any
      of the Indebtedness, and such payment or benefit, or any part thereof, is
      subsequently invalidated, declared to be fraudulent or preferential, set
      aside, or required to be repaid to a trustee, receiver, or any other
      Person under any bankruptcy act, state or federal law, common law,
      equitable cause or otherwise, then to the extent of such payment or
      benefit, the Indebtedness, or part thereof, intended to be satisfied shall
      be revived and continued in full force and effect as if such payment or
      benefit had not been made or received by Bank, and, further, any such
      repayment by Bank shall be added to and be deemed to be additional
      Indebtedness.

2.8   Conditions Precedent to Loans and Letters of Credit. The obligation of the
      Bank to issue any Letter of Credit, if applicable, or to make any loan
      under or pursuant to this Agreement shall be subject to the following
      conditions precedent:

      a.    Borrower shall have executed and delivered to Bank, or caused to
            have been executed and delivered to Bank, all such instruments,
            agreements, certificates, opinions, financial statements,
            appraisals, evidence of title, evidence of insurance, environmental
            audits, and other information and other documents as the Bank shall
            require, and all of the foregoing shall be in form and content
            acceptable to Bank and all instruments and agreements shall be in
            full force and effect and binding and enforceable obligations of
            Borrower and, to the extent that it is a party thereto or otherwise
            bound thereby, of each other Person who may be a party thereto or
            bound thereby including without limitation: (i) evidence of
            existence, good standing, qualification to conduct business and
            authority for each Loan Party and signatory on behalf of each Loan
            Party; (ii) all notes, guaranties, security agreements, mortgages,
            deeds of trust, pledge agreements, assignments, financing statements
            and other documents requested by Bank to evidence the Indebtedness
            or to create, protect or perfect Liens upon the Collateral required
            by Bank as security for the Indebtedness and to accord Bank a
            perfected security position in the Collateral, subject only to
            Permitted Encumbrances;; (iii) a guaranty agreement from each
            Guarantor required by Bank; (iv) such other documents or agreements
            of security, assurances of Loan Document validity, legality and
            enforceability, and appropriate assurances of validity, perfection
            and priority of Lien as Bank may request, and Bank shall have
            received proof that appropriate security agreements, financing
            statements, mortgages, deeds of trust, collateral and other
            documents covering the Collateral shall have been executed and
            delivered by the appropriate Persons and recorded or filed in such
            jurisdictions and such other steps shall have been taken as
            necessary to perfect and protect, subject only to Permitted
            Encumbrances, the Liens granted thereby.

      b.    All actions, proceedings, instruments and documents required to
            carry out the borrowings and transactions contemplated by this
            Agreement or any other Loan Document or incidental thereto, and all
            other related legal matters, shall have been satisfactory to and
            approved by Bank.

      c.    Each Loan Party shall have performed and complied with all
            agreements and conditions contained in the Loan Documents applicable
            to it and which are then in effect.

      d.    Each of the representations and warranties of each Loan Party under
            any Loan Document shall be true and correct in all material respects
            as if made on each loan disbursement date.

      e.    No Default or Event of Default shall have occurred and be
            continuing; there shall have been no material adverse change in the
            condition (financial or otherwise), properties, business, or
            operations of any Loan Party since the date of the financial
            statements most recently delivered to Bank prior to the date of this
            Agreement; and no provision of law, any order of any Governmental
            Authority, or any regulation, rule or interpretation thereof, shall
            have had any Material Adverse Effect on the validity or
            enforceability of any Loan Document.

SECTION 3.  REPRESENTATIONS AND WARRANTIES

Borrower represents and warrants, and such representations and warranties shall
be deemed to be continuing representations and warranties during the entire life
of this Agreement, and so long as Bank shall have any commitment or obligation
to make any loans or issue any Letters of Credit, if applicable and so long as
any Indebtedness remains unpaid and outstanding under any Loan Document, as
follows:

3.1   Authority. Each Loan Party and, if applicable, each of its partners and
      members who is not a natural Person is duly organized, validly existing
      and in good standing under the laws of the jurisdiction of its
      organization and is duly qualified and authorized to do business in each
      other jurisdiction in which the character of its assets or the nature of
      its business makes such qualification necessary.

3.2   Due Authorization. Each Loan Party has all requisite power and authority
      to execute, deliver and perform its obligations under each Loan Document
      to which it is a party or is otherwise bound, all of which have been duly
      authorized by all necessary action, and are not in contravention of law or
      the terms of any Loan Party's organizational or other governing documents.

3.3   Title to Property. Each Loan Party has good title to all property and
      assets purported to be owned by it, including those assets identified on
      the financial statements most recently delivered to Bank.

3.4   Encumbrances. There are no security interests or other Liens or
      encumbrances on, and no financing statements on file with respect to, any
      of the property or assets of any Loan Party, except for Permitted
      Encumbrances.

                                        4



3.5   Subsidiaries. Borrower has no Subsidiaries except those specifically
      disclosed in the Defined Terms.

3.6   Taxes. Each Loan Party has filed, on or before their respective due dates,
      all federal, state, local and foreign tax returns which are required to be
      filed, or has obtained extensions for filing such tax returns, and is not
      delinquent in filing such returns in accordance with such extensions, and
      has paid all taxes which have become due pursuant to those returns or
      pursuant to any assessments received by any such party, as the case may
      be, to the extent such taxes have become due, except to the extent such
      tax payments are being actively and diligently contested in good faith by
      appropriate proceedings, and if requested by Bank, have been bonded or
      reserved in an amount and manner satisfactory to Bank.

3.7   No-Defaults. There exists no default (or event which, with the giving of
      notice or passage of time, or both, would result in a default) under the
      provisions of any instrument or agreement evidencing, governing, securing
      or otherwise relating to any Debt of any Loan Party or pertaining to any
      of the Permitted Encumbrances.

3.8   Enforceability of Agreement and Loan Documents. Each Loan Document has
      been duly executed and delivered by duly authorized officer(s) or other
      representative(s) of each Loan Party and constitutes the valid and binding
      obligation of each Loan Party, enforceable in accordance with its terms,
      except to the extent that enforcement thereof may be limited by applicable
      bankruptcy, reorganization, insolvency, moratorium or similar laws
      affecting the enforcement of creditors' rights generally at the time in
      effect.

3.9   Non-contravention. The execution, delivery and performance by each Loan
      Party of the Loan Documents to which such Loan Party is a party or
      otherwise bound, are not in contravention of the terms of any indenture,
      agreement or undertaking to which any such Loan Party is a party or by
      which it is bound, except to the extent that such terms have been waived
      or that failure to comply with any such terms would not have a Material
      Adverse Effect.

3.10  Actions, Suits, Litigation or Proceedings. There are no actions, suits,
      litigation or proceedings, at law or in equity, and no proceedings before
      any arbitrator or by or before any Governmental Authority, pending, or, to
      the best knowledge of Borrower, threatened against or affecting any Loan
      Party, which, if adversely determined, could materially impair the right
      of any Loan Party to carry on its business substantially as now conducted
      or could have a Material Adverse Effect. No Loan Party is under
      investigation by, or is operating under any restrictions imposed by, any
      Governmental Authority.

3.11  Compliance with Laws. Each Loan Party has complied with all Governmental
      Requirements, including, without limitation, Environmental Laws, to the
      extent that failure to so comply could have a Material Adverse Effect.

3.12  Consents, Approvals and Filings, Etc. Except as have been previously
      obtained or as otherwise expressly provided in this Agreement, no
      authorization, consent, approval, license, qualification or formal
      exemption from, or any filing, declaration or registration with, any
      Governmental Authority and no material authorization, consent or approval
      from any other Person, is required in connection with the execution,
      delivery and performance by any Loan Party of any Loan Document to which
      it is a party. All such authorizations, consents, approvals, licenses,
      qualifications, exemptions, filings, declarations and registrations which
      have previously been obtained or made, as the case may be, are in full
      force and effect and are not the subject of any attack, or to the
      knowledge of Borrower, any threatened attack, in any material respect, by
      appeal, direct proceeding or otherwise

3.13  Environmental Representations. No Loan Party has used Hazardous Materials
      on, in, under or otherwise affecting any real or personal property now or
      at any time owned, occupied or operated by such Person or upon which such
      Person has a place of business which, in any manner, violates any
      Environmental Law, to the extent any such violation could result in a
      Material Adverse Effect, and to the best of Borrower's knowledge, no prior
      or current owner, occupant or operator of any of such property does or has
      used any Hazardous Materials on or affecting such property in any manner
      which violates any Environmental Law to the extent that any such violation
      could result in a Material Adverse Effect. No Loan Party has received any
      notice of any violation of any Environmental Law, and to the best
      knowledge of the Borrower, there have been no actions commenced or
      threatened by any Person against any such property or against any Loan
      Party for non-compliance with any Environmental Law which could result in
      a Material Adverse Effect.

3.14  Accuracy of Information. All financial statements previously furnished to
      Bank have been prepared in accordance with GAAP and fairly present the
      financial condition of Borrower and, as applicable, the consolidated
      financial condition of Borrower and such other Person(s) as such financial
      statements purport to present, and the results of their respective
      operations as of the dates and for the periods covered thereby; and since
      the date(s) of said financial statements, there has been no material
      adverse change in the financial condition of Borrower or any other Person
      covered by such financial statements. Each Loan Party is solvent, able to
      pay its debts as they mature, has capital sufficient to carry on its
      business and has assets the fair market value of which exceed its
      liabilities, and no Loan Party will be rendered insolvent,
      under-capitalized or unable to pay debts generally as they become due by
      the execution or performance of any Loan Document to which it is a party
      or by which it is otherwise bound.

SECTION 4. AFFIRMATIVE COVENANTS

Borrower covenants and agrees that, until all instruments and agreements
evidencing each and every loan, Letter of Credit and other financial
accommodation by the Bank to the Borrower or any Loan Party are fully discharged
and terminated, and thereafter, so long as any Indebtedness remains outstanding,
it will, and, as applicable, it will cause each Loan Party within its control or
under common control to:

4.1   Preservation of Existence, Etc. Preserve and maintain its existence and
      preserve and maintain such of its rights, licenses, and privileges as are
      material to the business and operations conducted by it; qualify and
      remain qualified to do business in each jurisdiction in which such
      qualification is material to its business and operations or ownership of
      its properties, continue to conduct and operate its business substantially
      as conducted and operated during the present and preceding calendar year;
      at all times maintain, preserve and protect all of its franchises and
      trade names and preserve all the remainder of its property and keep the
      same in good repair, working order and condition; and from time to time
      make, or cause to be made, all needed and proper repairs, renewals,
      replacements, betterments and improvements thereto.

4.2   Keeping of Books; Audits of Collateral; Fees. Keep proper books of record
      and account in which full and correct entries shall be made of all of its
      financial transactions and its assets and businesses so as to permit the
      presentation of financial statements prepared in accordance with GAAP; and
      permit Bank, or its representatives, at reasonable times and intervals, at
      Borrower's cost and expense, to examine its books and records and to
      discuss its financial matters with its officers, employees and independent
      certified public accountants; and permit Bank from time to time to audit
      Borrower's accounts, inventory, or other Collateral, provided that such
      audits will be conducted upon reasonable notice. Borrower agrees to
      reimburse Bank, on demand, for customary and reasonable fees and costs
      incurred by Bank for such audits, and for each appraisal of Collateral and
      financial analysis and examination of Borrower performed from time to time
      by its agents.

4.3   Reporting Requirements. Furnish to Bank, or cause to be furnished to Bank,
      the following:

      a.    as soon as possible, and in any event within three (3) calendar days
            after becoming aware of the occurrence or existence of each
            Default or Event of Default hereunder or any material adverse change
            in the financial condition of any Loan Party, a written statement of
            the chief financial officer of Borrower (or in his or her absence, a
            responsible senior officer

                                        5



            of Borrower), setting forth details of such Default, Event of
            Default or change, and the action which Borrower has taken, or has
            caused to be taken, or proposes to take, or to cause to be taken,
            with respect thereto;

      b.    as soon as available, and in any event within 120 days after and as
            of the end of each fiscal year of Borrower, audited financial
            statements of Borrower and such other of the Loan Parties as may be
            required by the Bank, consolidated, as applicable, including a
            balance sheet, income statement, statement of profit and loss,
            surplus reconciliation statement and statement of cash flows, for
            and as of such fiscal year then ending and including such other
            comments and financial details as are usually included in similar
            reports. Such financial statements shall be prepared in accordance
            with GAAP by independent certified public accountants of recognized
            standing selected by Borrower and approved by Bank and containing
            unqualified opinions as to the fairness of the statements therein
            contained;

      c.    as soon as available, and in any event, simultaneously with the
            financial statements to be delivered to Borrower in accordance with
            section 4.3 (b) above, a copy of Borrower's Form 10-K Annual Report
            filed with the Securities and Exchange Commission;

      d.    as soon as available, and in any event within 45 days after and as
            of the end of each calendar month, including the last such reporting
            period of each of Borrower's fiscal years, compiled financial
            statements of Borrower and such of the other Loan Parties as may be
            required by the Bank, consolidated, as applicable, for and as of
            such reporting period, including a balance sheet, income statement,
            statement of profit and loss, surplus reconciliation statement and
            statement of cash flows for and as of such reporting period then
            ending and for and as of that portion of the fiscal year then
            ending, in each case, prepared and certified by the chief financial
            officer of Borrower (or in his or her absence, a responsible senior
            officer of Borrower) and, as applicable, each other Loan Party as to
            consistency with prior financial reports and accounting periods,
            accuracy and fairness of presentation;

      e.    as soon as available, and in any event, simultaneously with the
            financial statements to be delivered to Borrower in accordance with
            section 4.3 (d) above, a copy of Borrower's Form 10-Q Quarterly
            Report filed with the Securities and Exchange Commission;

      f.    as soon as available, and in any event, simultaneously with the
            financial statements to be delivered to Bank in accordance with
            section 4.3(d) above;

      g.    simultaneously with each request for a Revolving Loan, a Borrowing
            Base Certificate (in the form of the attached Exhibit "A"), each
            dated as of the end of such month or year, as the case may be;

4.4   Intentionally omitted.

4.5   Further Assurances; Financing Statements. Furnish Bank, at Borrower's cost
      and expense, upon Bank's request and in form satisfactory to Bank (and
      execute and deliver or cause to be executed and delivered), such
      additional pledges, assignments, mortgages, Lien instruments or other
      security instruments, consents, acknowledgments, subordinations and
      financing statements covering any or all of the Collateral required by
      Bank to secure any Indebtedness together with such other documents or
      instruments as Bank may require to effectuate more fully the purposes of
      any Loan Document.

4.6   Insurance. Maintain insurance coverage by insurers acceptable to Bank on
      its physical assets and against other business risks in such amounts and
      of such types as are customarily carried by companies similar in size and
      nature or as may otherwise be required by Bank, and in the event of
      acquisition of additional property, real or personal, or of the incurrence
      of additional risks of any nature, increase such insurance coverage in
      such manner and to such extent as prudent business judgment and present
      practice would dictate; and in the case of all policies covering property
      subject to any Loan Document or property in which the Bank shall have a
      Lien of any kind whatsoever, other than those policies protecting against
      casualty liabilities to strangers, all such insurance policies shall
      provide that the loss payable thereunder shall be payable to Borrower (or
      other Person providing Collateral) and Bank, with mortgagee's clauses in
      favor of and satisfactory to Bank for all such policies, and such policies
      shall also provide that they may not be canceled or changed without thirty
      (30) days' prior written notice to Bank. Upon the request of Bank, all of
      said policies, or copies thereof, including all endorsements thereon and
      those required hereunder, shall be deposited with Bank.

4.7   Compliance with ERISA. In the event that any Loan Party or any of its
      Subsidiaries maintain(s) or establish(es) a Pension Plan subject to ERISA,
      (a) comply in all material respects with all requirements imposed by ERISA
      as presently in effect or hereafter promulgated, including, but not
      limited to, the minimum funding requirements thereof; (b) promptly notify
      Bank upon the occurrence of a "reportable event" or "prohibited
      transaction" within the meaning of ERISA, or that the PBGC or any Loan
      Party has instituted or will institute proceedings to terminate any
      Pension Plan, together with a copy of any proposed notice of such event
      which may be required to be filed with the PBGC; and (c) furnish to Bank
      (or cause the plan administrator to furnish Bank) a copy of the annual
      return (including all schedules and attachments) for each Pension Plan
      covered by ERISA, and filed with the Internal Revenue Service by any Loan
      Party not later than ten (10) days after such report has been so filed.

4.8   Environmental Covenants. Comply with all applicable Environmental Laws,
      and maintain all permits, licenses and approvals required under applicable
      Environmental Laws, where the failure to do so could have a Material
      Adverse Effect. Promptly notify Bank, in writing, as soon as Borrower
      becomes aware of any condition or circumstance which makes any of the
      environmental representations or warranties set forth in this Agreement
      incomplete, incorrect or inaccurate in any material respect as of any
      date; and promptly provide to Bank, immediately upon receipt thereof,
      copies of any material correspondence, notice, pleading, citation,
      indictment, complaint, order, decree, or other document from any source
      asserting or alleging a violation of any Environmental Law by any Loan
      Party, or of any circumstance or condition which requires or may require,
      a financial contribution by any Loan Party, or a clean-up, removal,
      remedial action or other response by or on behalf of any Loan Party, under
      applicable Environmental Law, or which seeks damages or civil, criminal or
      punitive penalties from any Loan Party or any violation or alleged
      violation of any Environmental Law. Borrower hereby agrees to indemnify,
      defend and hold Bank, and any of Bank's past, present and future officers,
      directors, shareholders, employees, representatives and consultants,
      harmless from any and all claims, losses, damages, suits, penalties,
      costs, liabilities, obligations and expenses (including, without
      limitation, reasonable legal expenses and attorneys' fees, whether inside
      or outside counsel is used) incurred or arising out of any claim, loss or
      damage of any property, injuries to or death of any persons, contamination
      of or adverse effects on the environment, or other violation of any
      applicable Environmental Law, in any case, caused by any Loan Party or in
      any way related to any property owned or operated by any Loan Party or due
      to any acts of any Loan Party or any of its officers, directors,
      shareholders, employees, consultants and/or representatives INCLUDING ANY
      CLAIMS, LOSSES, DAMAGES, SUITS, PENALTIES, COSTS, LIABILITIES, OBLIGATIONS
      OR EXPENSES, RESULTING FROM BANK'S OWN NEGLIGENCE; provided however, that
      the foregoing indemnification shall not be applicable, and Borrower shall
      not be liable for any such claims, losses, damages, suits, penalties,
      costs, liabilities, obligations or expenses, to the extent (but only to
      the extent) the same arise or result from any gross negligence or willful
      misconduct of Bank or any of its agents or employees.

SECTION 5. NEGATIVE COVENANTS

Borrower covenants and agrees that, until all instruments and agreements
evidencing each and every loan, Letter of Credit and other financial
accommodation by the Bank to the Borrower or any Loan Party are fully discharged
and terminated, and thereafter, so long as

                                        6



any Indebtedness remains outstanding, it with not, and it will not allow any
Loan Party within its control or under common control to, without the prior
written consent of the Bank:

5.1   Capital Structure; Business Objects or Purpose; Mergers; Asset
      Disposition; Acquisitions. Purchase, acquire or redeem any of its equity
      ownership interests; or enter into any reorganization or recapitalization;
      or reclassify its equity ownership interests; or make any material change
      in its capital structure or general business objects or purpose; or change
      its name, or enter into any merger or consolidation, unless Borrower is
      the surviving entity thereunder.

5.2   Subordinate Indebtedness. Subordinate any indebtedness due to it from any
      Person to indebtedness of other creditors of such Person.

SECTION 6. EVENTS OF DEFAULT

6.1   Events of Default. The occurrence or existence of any of the following
      conditions or events shall constitute an "Event of Default" hereunder: (a)
      non-payment of any principal, interest or other sums due upon the
      Indebtedness at such time the same becomes due or, if applicable, upon
      expiration of the grace period, if any; (b) default in the observance or
      performance of any of the other conditions, covenants or agreements of any
      Loan Party set forth in this Agreement or any other Loan Document; (c) any
      representation or warranty made by any Loan Party in any Loan Document
      shall be untrue or incorrect in any material respect; (d) any default or
      event of default, as the case may be, shall occur under any other Loan
      Document and shall continue beyond the applicable grace period, if any;
      and (e) any change in the management, ownership or control of Borrower,
      whether by reason of incapacity, death, resignation, termination or
      otherwise which, in Bank's sole judgment, could become a Material Adverse
      Effect;

6.2   Remedies Upon Event of Default. Upon the occurrence and at any time during
      the existence or continuance of any Event of Default, but without
      impairing or otherwise limiting the Bank's right to demand payment of all
      or any portion of the Indebtedness which is payable on demand, at Bank's
      option, Bank may give notice to Borrower declaring all or any portion of
      the Indebtedness remaining unpaid and outstanding, whether under the notes
      evidencing the Indebtedness or otherwise, to be due and payable in full
      without presentation, demand, protest, notice of dishonor, notice of
      intent to accelerate, notice of acceleration or other notice of any kind,
      all of which are hereby expressly waived, whereupon all such Indebtedness
      shall immediately become due and payable. Furthermore, upon the occurrence
      of a Default or Event of Default and at any time during the existence or
      continuance of any Default or Event of Default, but without impairing or
      otherwise limiting the right of Bank, if reserved under any Loan Document,
      to make or withhold financial accommodations at its discretion, to the
      extent not yet disbursed, any commitment by Bank to make any further loans
      or, if applicable, issue any further Letters of Credit shall automatically
      terminate. The foregoing rights and remedies are in addition to any other
      rights, remedies and privileges Bank may otherwise have or which may be
      available to it, whether under this Agreement, any other Loan Document, by
      law, or otherwise.

6.3   Waiver of Defaults. No Default or Event of Default shall be waived by Bank
      except in a written instrument specifying the scope and terms of such
      waiver and signed by an authorized officer of Bank, and such waiver and
      shall be effective only for the specific time(s) and purpose(s) given. No
      single or partial exercise of any right, power or privilege hereunder, or
      any delay in the exercise thereof, shall preclude other or further
      exercise of Bank's rights. No waiver of any Default or Event of Default
      shall extend to any other or further Default or Event of Default. No
      forbearance on the part of Bank in enforcing any of Bank's rights or
      remedies under any Loan Document shall constitute a waiver of any of its
      rights or remedies. Borrower expressly agrees that this Section may not be
      waived or modified by Bank by course of performance, estoppel or
      otherwise.

6.4   Discretionary Credit and Credit Payable Upon Demand. TO THE EXTENT THAT
      ANY OF THE INDEBTEDNESS SHALL, AT ANYTIME, BE PAYABLE UPON DEMAND, NOTHING
      CONTAINED IN THIS AGREEMENT, OR ANY OTHER LOAN DOCUMENT, SHALL BE
      CONSTRUED TO PREVENT BANK FROM MAKING DEMAND, WITHOUT NOTICE AND WITH OR
      WITHOUT REASON, FOR IMMEDIATE PAYMENT OF ALL OR ANY PART OF SUCH
      INDEBTEDNESS AT ANY TIME OR TIMES, WHETHER OR NOT A DEFAULT OR EVENT OF
      DEFAULT HAS OCCURRED OR EXISTS. IN THE EVENT THAT SUCH DEMAND IS MADE UPON
      ANY PORTION OF THE INDEBTEDNESS, THE BANK, AT ITS ELECTION, MAY TERMINATE
      ANY COMMITMENT TO MAKE ANY FURTHER LOANS OR, IF APPLICABLE, ISSUE ANY
      FURTHER LETTERS OF CREDIT UNDER THIS AGREEMENT OR OTHERWISE. FURTHERMORE,
      TO THE EXTENT ANY LOAN DOCUMENT AUTHORIZES THE BANK, AT ITS DISCRETION, TO
      MAKE OR TO DECLINE TO MAKE FINANCIAL ACCOMMODATIONS TO THE BORROWER,
      NOTHING CONTAINED IN THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT SHALL BE
      CONSTRUED TO LIMIT OR IMPAIR SUCH DISCRETION OR TO COMMIT OR OTHERWISE
      OBLIGATE THE BANK TO MAKE ANY SUCH FINANCIAL ACCOMMODATION.

SECTION 7. MISCELLANEOUS

7.1   Governing Law. Each Loan Document shall be deemed to have been delivered
      in and shall be governed by and construed and enforced in accordance with
      the laws of the State of Texas, except to the extent that the UCC, other
      personal property law or real property law of another jurisdiction where
      Collateral is located is applicable, and except to the extent expressed to
      the contrary in any Loan Document.

7.2   Costs and Expenses. Borrower shall pay Bank, on demand, all costs and
      expenses, including, without limitation, reasonable attorneys' fees and
      legal expenses (whether inside or outside counsel is used), incurred by
      Bank in perfecting, revising, protecting or enforcing any of its rights or
      remedies against any Loan Party or any Collateral, or otherwise incurred
      by Bank in connection with any Default or Event of Default or the
      enforcement of the Loan Documents or the Indebtedness. Following Bank's
      demand upon Borrower for the payment of any such costs and expenses, and
      until the same are paid in full, the unpaid amount of such costs and
      expenses shall constitute Indebtedness and shall bear interest at the
      highest default rate of interest provided in any Loan Document.

7.3   Successors and Assigns; Participation. This Agreement shall be binding
      upon and shall inure to the benefit of Borrower and Bank and their
      respective successors and assigns. The foregoing shall not authorize any
      assignment or transfer by Borrower of any of its respective rights, duties
      or obligations hereunder, such assignments or transfers being expressly
      prohibited. Bank, however, may freely assign, whether by assignment,
      participation or otherwise, its rights and obligations hereunder, and is
      hereby authorized to disclose to any such assignee or participant (or
      proposed assignee or participant) any financial or other information in
      its knowledge or possession regarding any Loan Party or the Indebtedness.

7.4   Reliance on and Survival of Various Provisions. All terms, covenants,
      agreements, representations and warranties of any Loan Party made in any
      Loan Document, or in any certificate, report, financial statement or other
      document furnished by or on behalf of any Loan Party in connection with
      any Loan Document, shall be deemed to have been relied upon by Bank,
      notwithstanding any investigation heretofore or hereafter made by Bank or
      on Bank's behalf, and those covenants and agreements of Borrower set forth
      in Section 4.8 hereof (together with any other indemnities of Borrower
      contained elsewhere in any Loan Document) shall survive the termination of
      this Agreement and the repayment in full of the Indebtedness.

7.5   Complete Agreement; Conflicts. This Agreement, the other Loan Documents,
      and any commitment letter previously issued by Bank with respect thereto
      (provided that in the event of any inconsistency or conflict between this
      Agreement and the other Loan

                                        7



      Documents, on one hand, and such commitment letter, on the other hand,
      this Agreement and the Loan Documents shall control), contain the entire
      agreement of the parties thereto and supercede all prior agreements and
      understandings related to the subject matter hereof, and none of the
      parties shall be bound by anything not expressed in writing. In the event
      that, and to the extent that, any of the terms, conditions or provisions
      of any of the other Loan Documents are inconsistent with or in conflict
      with any of the terms, conditions or provisions of this Agreement, the
      applicable terms, conditions and provisions of this Agreement shall govern
      and control. Any amendments or modifications hereto shall be in writing
      signed by all parties.

7.6   Counterparts. This Agreement may be executed in any number of counterparts
      and by different parties on separate counterparts, each of which, when
      executed and delivered, shall be deemed to be an original, and all of
      which, when taken together, shall constitute but one and the same
      agreement.

7.7   WAIVER OF JURY TRIAL. BANK AND BORROWER EACH ACKNOWLEDGE THAT THE RIGHT TO
      TRIAL BY JURY IS A CONSTITUTIONAL ONE, BUT THAT IT MAY BE WAIVED. EACH OF
      THEM, AFTER CONSULTING OR HAVING HAD THE OPPORTUNITY TO CONSULT, WITH
      COUNSEL OF THEIR CHOICE, KNOWINGLY, VOLUNTARILY AND INTENTIONALLY WAIVES
      ANY RIGHT EITHER OF THEM MAY HAVE TO A TRIAL BY JURY IN ANY LITIGATION
      BASED UPON OR ARISING OUT OF ANY LOAN DOCUMENT OR ANY OF THE TRANSACTIONS
      CONTEMPLATED BY THE LOAN DOCUMENTS OR ANY COURSE OF CONDUCT, DEALING,
      STATEMENTS (WHETHER ORAL OR WRITTEN), OR ACTION OF EITHER OF THEM. THESE
      PROVISIONS SHALL NOT BE DEEMED TO HAVE BEEN MODIFIED IN ANY RESPECT OR
      RELINQUISHED BY BANK OR BORROWER, EXCEPT BY A WRITTEN INSTRUMENT EXECUTED
      BY EACH OF THEM.

7.8   ORAL AGREEMENTS INEFFECTIVE. THIS AGREEMENT AND THE OTHER "LOAN
      AGREEMENTS" (AS DEFINED IN SECTION 26.02(A)(2) OF THE TEXAS BUSINESS &
      COMMERCE CODE, AS AMENDED) REPRESENT THE FINAL AGREEMENT BETWEEN THE
      PARTIES, AND THIS AGREEMENT AND THE OTHER WRITTEN LOAN AGREEMENTS MAY NOT
      BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL
      AGREEMENTS BETWEEN THE PARTIES. THERE ARE NO UNWRITTEN ORAL AGREEMENTS
      BETWEEN THE PARTIES.

WITNESS the due execution hereof as of the day and year first above written.

BANK:                                           BORROWER:

COMERICA BANK-TEXAS                             INTERPHASE CORPORATION,
                                                a Texas corporation

 By: /s/ Richard L. Rogers                      By: /s/ Steve Kovac
     ---------------------------------------        -------------------------
         Richard L. Rogers, Vice President              Steve Kovac, Chief
         Texas Division                                 Financial Officer

                                        8



[COMERICA BANK LOGO] AMENDMENT NOTE AND CREDIT AGREEMENT

This Amendment to Note and Credit Agreement ("Amendment"), is made, delivered,
and effective as of November 5, 2004, by and between INTERPHASE CORPORATION, a
Texas corporation("Borrower") and COMERICA BANK, successor by merger with
Comerica Bank - Texas ("Bank").

WHEREAS, Bank has made a revolving loan to Borrower evidenced by that certain
Master Revolving Note made by Borrower to the order of Bank in the original
principal amount of $5,000,000.00 dated June 25, 2003 ("Note"); and

WHEREAS, the indebtedness evidenced by the Note is subject to the terms and
conditions of that certain Credit Agreement ("Credit Agreement") by and between
Borrower dated as of even date with the Note; and

WHEREAS, Bank and Borrower desire to amend the Note and Credit Agreement as set
forth below;

NOW, THEREFORE, in consideration of the premises and the mutual promises
contained in this Amendment, Borrower and Bank agree as follows:

1.    The Maturity Date of the Note is now July 31, 2007 (the "Maturity Date").

2.    The term "Applicable Margin", as used in the Note, shall now mean 0% for
      the Prime Rate Balance and one percent (1%) for each LIBOR Balance.

3.    The Credit Agreement is hereby amended such that the term "Revolving
      Credit Maturity Date", contained in Section 1.1 of the Credit Agreement,
      shall now have the following definition:

            "REVOLVING CREDIT MATURITY DATE" shall now mean July 31, 2007 or
            such earlier date on which the entire unpaid principal amount of all
            Revolving Loans becomes due and payable whether by the lapse of
            time, demand for payment, acceleration or otherwise; provided,
            however, if any such date is not a business day, then the Revolving
            Credit Maturity Date shall be the next succeeding business day.

4.    Borrower is responsible for all costs incurred by Bank, including without
      limit reasonable attorneys' fees (whether inside or outside counsel is
      used), with regard to the preparation and execution of this Amendment.

5.    The execution of this Amendment shall not be deemed to be a waiver of any
      Default or Event of Default.

6.    All the terms used in this Amendment which are defined in the Note and/or
      Credit Agreement shall have the same meaning as used in the Note and/or
      Credit Agreement, unless otherwise defined in this Amendment.

7.    Borrower waives, discharges, and forever releases Bank, Bank's employees,
      officers, directors, attorneys, stockholders, and their successors and
      assigns, from and of any and all claims, causes of action, allegations or
      assertions that Borrower has or may have had at any time up through and
      including the date of this Amendment, against any or all of the foregoing,
      regardless of whether any such claims, causes of action, allegations or
      assertions are known to Borrower or whether any such claims, causes of
      action, allegations or assertions arose as result of Bank's actions or
      omissions in connection with the Note or Credit Agreement, or any
      amendments, extensions or modifications thereof, or Bank's administration
      of the Indebtedness or otherwise, INCLUDING ANY CLAIMS, CAUSES OF ACTION,
      ALLEGATIONS OR ASSERTIONS RESULTING FROM BANK'S OWN NEGLIGENCE, except and
      to the extent (but only to the extent) caused by Bank's gross negligence
      or willful misconduct.

8.    This Amendment is not an agreement to any further or other amendment of
      the Note or Credit Agreement.

9.    Borrower expressly acknowledges and agrees that except as expressly
      amended in this Amendment, the Note and Credit Agreement, as amended,
      remain in full force and effect and are ratified, confirmed and restated.
      This Amendment shall neither extinguish nor constitute a novation of the
      Note or indebtedness evidenced thereby.

10.   THIS AMENDMENT AND THE OTHER "LOAN AGREEMENTS" (AS DEFINED IN SECTION
      26.02(A)(2) OF THE TEXAS BUSINESS & COMMERCE CODE, AS AMENDED) REPRESENT
      THE FINAL AGREEMENT BETWEEN THE PARTIES, AND THIS AGREEMENT AND THE OTHER
      WRITTEN LOAN AGREEMENTS MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR,
      CONTEMPORANEOUS OR SUBSEQUENT ORAL AGREEMENTS BETWEEN THE PARTIES. THERE
      ARE NO UNWRITTEN AGREEMENTS BETWEEN THE PARTIES.]

      IN WITNESS WHEREOF, the parties have executed and delivered this Amendment
      on the date set forth above.

      BORROWER:                                       BANK:

      INTERPHASE CORPORATION,                   COMERICA BANK
      a Texas corporation

      By: /s/ Steve Kovac                             By: /s/ Richard Rogers
          ------------------------------------            ----------------------
          Steve Kovac, Chief Financial Officer            Richard Rogers, Senior
                                                          Vice President, Texas
                                                          Division

EX-23.(A)

Exhibit 23(a)

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We have issued our report dated March 7, 2005, accompanying the consolidated financial statements included in the Annual Report of Interphase Corporation on Form 10-K for the year ended December 31, 2004. We hereby consent to the incorporation by reference of said report in the Registration Statements of Interphase Corporation on Form S-8 (File No. 333-91029 and 333-97971).

/s/ GRANT THORNTON LLP

Dallas, Texas
March 7, 2005

EX-23.(B)

Exhibit 23(b)

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-91029 and 333-97971) of Interphase Corporation of our report dated March 5, 2004 relating to the financial statements which appears in this Form 10-K.

/s/ PricewaterhouseCoopers LLP

Dallas, Texas
March 17, 2005

EX-31.(A)

Exhibit 31(a)

CERTIFICATION PURSUANT TO RULE 13a-14(a) and 15d-14(a)

I, Gregory B. Kalush, certify that:

1.	I have reviewed this report on Form 10-K of Interphase Corporation (the “Company”);
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this report;
4.	The Company’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the Company and we have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Evaluated the effectiveness of the Company’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and

(c) Disclosed in this report any change in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting; and

5.   The Company’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Company’s auditors and the Audit Committee of the Company’s Board of Directors:

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Company’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Company’s internal control over financial reporting.

Date:	March 18, 2005	Signature:	/s/ Gregory B. Kalush
			Chief Executive Officer

EX-31.(B)

Exhibit 31(b)

CERTIFICATION PURSUANT TO RULE 13a-14(a) and 15d-14(a)

     I, Steven P. Kovac, certify that:

1.	I have reviewed this report on Form 10-K of Interphase Corporation (the “Company”);
2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this report;
4.	The Company’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the Company and we have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Evaluated the effectiveness of the Company’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and

(c) Disclosed in this report any change in the Company’s internal control over financial reporting that occurred during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting; and

5.   The Company’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Company’s auditors and the Audit Committee of the Company’s Board of Directors:

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Company’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the Company’s internal control over financial reporting.

Date:	March 18, 2005	Signature:	/s/ Steven P. Kovac
			Chief Financial Officer

EX-32.(A)

Exhibit 32(a)

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Interphase Corporation (the “Company”) on Form 10-K for the year ended December 31, 2004, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Gregory B. Kalush, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

     (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

     (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Gregory B. Kalush

Gregory B. Kalush
Chief Executive Officer
March 18, 2005

EX-32.(B)

Exhibit 32(b)

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Interphase Corporation (the “Company”) on Form 10-K for the year ended December 31, 2004, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Steven P. Kovac, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

     (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

     (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ Steven P. Kovac

Steven P. Kovac
Chief Financial Officer
March 18, 2005