10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2007

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                                          to                                         

Commission File Number: 0-13071

INTERPHASE CORPORATION

(Exact name of registrant as specified in its charter)

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

Parkway Centre I
2901 North Dallas Parkway, Suite 200
Plano, Texas 75093
(Address of Principal Executive Offices and Zip Code)

(214) 654-5000
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o                     Accelerated filer o                     Non-accelerated filer þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes o No þ

As of May 8, 2007, shares of common stock outstanding totaled 6,193,490.

INTERPHASE CORPORATION

Index to Form 10-Q
Quarterly Period Ended March 31, 2007

Part I — Financial Information
Item 1.	Condensed Consolidated Financial Statements (unaudited)
	Condensed Consolidated Balance Sheets as of March 31, 2007 and December 31, 2006	2
	Condensed Consolidated Statements of Operations for the three months ended March 31, 2007 and 2006	3
	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2007 and 2006	4
	Notes to Condensed Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	10
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	13
Item 4.	Controls and Procedures	14
Part II — Other Information
Item 1.	Legal Proceedings	15
Item 1A.	Risk Factors	15
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	15
Item 3.	Defaults Upon Senior Securities	15
Item 4.	Submission of Matters to a Vote of Security Holders	15
Item 5.	Other Information	15
Item 6.	Exhibits	15
Rule 13a-14(a)/15d-14(a) Certification
Rule 13a-14(a)/15d-14(a) Certification
Section 1350 Certification
Section 1350 Certification

PART I
FINANCIAL INFORMATION

Item 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

INTERPHASE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)

	March 31,			December 31,
	2007			2006
ASSETS
Cash and cash equivalents	$	5,874		$	9,061
Marketable securities		15,631			13,469
Trade accounts receivable, less allowances of $110 and $118, respectively		3,982			5,824
Inventories		1,874			1,921
Prepaid expenses and other current assets		1,355			1,298
Total current assets		28,716			31,573
Machinery and equipment		6,398			6,308
Leasehold improvements		423			422
Furniture and fixtures		556			554
		7,377			7,284
Less-accumulated depreciation and amortization		(6,473	)		(6,308	)
Total property and equipment, net		904			976
Capitalized software, net		1,398			1,322
Other assets		193			191
Total assets	$	31,211		$	34,062
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Accounts payable	$	900		$	1,372
Deferred revenue		73			98
Accrued liabilities		1,167			1,140
Accrued compensation		1,289			2,067
Total current liabilities		3,429			4,677
Deferred lease obligations		77			85
Long-term debt		3,500			3,500
Total liabilities		7,006			8,262
Commitments and Contingencies
Shareholders’ Equity
Common stock, $0.10 par value; 100,000,000 shares authorized; 6,169,240 and 6,152,141 shares issued and outstanding, respectively		617			615
Additional paid in capital		40,063			39,884
Retained deficit		(15,862	)		(14,059	)
Cumulative other comprehensive loss		(613	)		(640	)
Total shareholders’ equity		24,205			25,800
Total liabilities and shareholders’ equity	$	31,211		$	34,062

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

2

INTERPHASE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

	Three Months Ended
	March 31,
	2007			2006
Revenues	$	5,104		$	8,151
Cost of sales		2,405			4,030
Gross margin		2,699			4,121
Research and development		2,538			1,880
Sales and marketing		1,412			1,344
General and administrative		957			954
Total operating expenses		4,907			4,178
Loss from operations		(2,208	)		(57	)
Interest income, net		201			115
Other income, net		95			137
(Loss) income before income tax		(1,912	)		195
Income tax benefit		(60	)		(115	)
Net (loss) income	$	(1,852	)	$	310
Net (loss) income per share:
Basic EPS	$	(0.30	)	$	0.05
Diluted EPS	$	(0.30	)	$	0.05
Weighted average common shares		6,076			5,822
Weighted average common and dilutive shares		6,076			5,918

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

3

INTERPHASE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Three Months Ended
	March 31,
	2007			2006
Cash flows from operating activities:
Net (loss) income	$	(1,852	)	$	310
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Provision for uncollectible accounts and returns		(8	)		10
Provision for excess and obsolete inventories		100			200
Depreciation and amortization		185			170
Amortization of restricted stock		77			64
Change in assets and liabilities:
Trade accounts receivable		1,850			(412	)
Inventories		(53	)		477
Prepaid expenses and other current assets		2			83
Other assets		—			3
Accounts payable, deferred revenue and accrued liabilities		(474	)		353
Accrued compensation		(789	)		263
Other non-current liabilities		—			(34	)
Deferred lease obligations		(8	)		(36	)
Net cash (used in) provided by operating activities		(970	)		1,451
Cash flows from investing activities:
Purchase of property and equipment		(75	)		(53	)
Purchase of capitalized software		(84	)		(348	)
Proceeds from the sale of marketable securities		2,445			3,318
Purchase of marketable securities		(4,595	)		(1,959	)
Net cash (used in) provided by investing activities		(2,309	)		958
Cash flows from financing activities:
Proceeds from the exercise of stock options		104			316
Net cash provided by financing activities		104			316
Effect of exchange rate changes on cash and cash equivalents		(12	)		(5	)
Net (decrease) increase in cash and cash equivalents		(3,187	)		2,720
Cash and cash equivalents at beginning of period		9,061			3,180
Cash and cash equivalents at end of period	$	5,874		$	5,900

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

4

INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

NOTE 1. — BASIS OF PRESENTATION

Interphase Corporation and subsidiaries (“Interphase” or the “Company”) provide robust building blocks, highly integrated subsystems and innovative gateway appliances for the converged communications network. Building on a 30-year history of providing advanced Input/Output (I/O) solutions for telecommunications and enterprise applications, and addressing the need for high speed connectivity, Interphase has established a key role in delivering next generation AdvancedTCA^® (Advanced Telecommunications Computing Architecture or ATCA), MicroTCA and AdvancedMC™ (Advanced Mezzanine Card or AMC) solutions to the marketplace. The Company’s products enable telecommunications equipment manufacturers to deploy robust and highly scalable network infrastructure equipment into Third Generation Wireless (3G), IP Multimedia Subsystem (IMS), Voice over IP (VoIP) and Broadband Access Networks worldwide, enabling the delivery of advanced IPTV and Triple Play services. See Note 9 for information regarding the Company’s revenues related to North America and foreign countries.

The accompanying condensed consolidated financial statements include the accounts of Interphase Corporation and its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated. While the accompanying condensed consolidated financial statements are unaudited, they have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of the Company, all material standard adjustments and disclosures necessary to fairly present the results of such periods have been made. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. Operating results for the three months ended March 31, 2007, are not necessarily indicative of the results that may be expected for the year ending December 31, 2007. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2006.

NOTE 2. — STOCK-BASED COMPENSATION

The Company accounts for stock-based compensation in accordance with the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payments.” The Company had no unvested stock options nor were any stock options granted during the three months ended March 31, 2007 or 2006, and as a result the Company recorded no stock-based compensation expense related to stock options during the three months ended March 31, 2007 or 2006.

The following table summarizes stock option activity under the Company’s stock option plans:

	Number of			Weighted Average
	Options			Option Price
Balance, December 31, 2006		2,122			9.52
Granted		—			—
Exercised		(17	)		6.07
Canceled		—			—
Balance, March 31, 2007		2,105			9.55

The Interphase Corporation 2004 Long-Term Stock Incentive Plan provides for grants of bonus stock awards (“restricted stock”) to its directors and certain employees at no cost to the recipient. Holders of restricted stock are entitled to cash dividends, if any, and to vote their respective shares. Restrictions limit the sale or transfer of these shares during a predefined vesting period, currently ranging from one to four years, and in some cases is subject to the achievement of certain performance conditions. During the three months ended March 31, 2007, there were 60,000 shares granted at the market price of $11.57. Upon issuance of restricted stock under the plan, unearned compensation equivalent to the market value at the date of grant is recorded as a reduction to shareholder’s equity and subsequently amortized to expense over the respective restriction periods. Compensation expense related to restricted stock was approximately $77,000 and $64,000 for the three months ended March 31, 2007 and 2006, respectively. As of March 31, 2007, there is approximately $1.3 million of total unamortized compensation cost

5

INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

related to unvested restricted stock remaining to be recognized. The following summarizes the restricted stock activity for the first quarter of 2007:

				Weighted
	Restricted Stock			Average Grant
	Shares			Date Value
Nonvested restricted stock at December 31, 2006		221,425			5.96
Granted		60,000			11.57
Vested		(10,230	)		5.42
Cancelled/Forefeited		(60,000	)		5.40
Nonvested restricted stock at March 31, 2007		211,195			6.81

NOTE 3. — INVENTORIES

Inventories are valued at the lower of cost or market and include material, labor and manufacturing overhead. Cost is determined on a first-in, first-out basis (in thousands):

	March 31, 2007		December 31, 2006
Raw materials	$	1,441	$	1,449
Work-in-process		289		344
Finished goods		144		128
Total	$	1,874	$	1,921

Valuing inventory at the lower of cost or market involves an inherent level of risk and uncertainty due to technology trends in the industry and customer demand for the Company’s products. Future events may cause significant fluctuations in the Company’s operating results. Inventories are written down when needed to ensure the Company carries inventory at the lower of cost or market. Writedowns for the three months ended March 31, 2007 and 2006 were $100,000 and $200,000 respectively.

NOTE 4. — DERIVATIVE FINANCIAL INSTRUMENTS

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 transacted 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.

In an attempt to mitigate the risk described above, the Company may enter into, from time to time, foreign exchange contracts to purchase a fixed amount of Euros on a fixed date in the future at a fixed rate determined at the contract date. These derivative financial instruments do not meet the criteria to qualify as hedges under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and therefore any changes in the market value of these contracts are recognized as a gain or loss in the period of the change. For the three months ended March 31, 2007, the Company recognized a gain of approximately $67,000 related to these foreign exchange contracts. For the three months ended March 31, 2006, the Company recognized a gain of approximately $127,000 related to these foreign exchange contracts. At March 31, 2007 the Company had four foreign exchange contracts outstanding to acquire approximately 1.1 million Euros for each contract on specified dates during the next 10 months. At March 31, 2007, the Company carried an approximately $171,000 asset on the balance sheet, classified in prepaid expenses and other current assets, related to the fair value of its outstanding foreign exchange contracts. There were three such contracts outstanding at December 31, 2006 classified as a $185,000 asset on the balance sheet and included in prepaid expenses and other current assets.

6

INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

NOTE 5. — INCOME TAXES

SFAS No. 109, “Accounting for Income Taxes,” requires that a valuation allowance be established when it is “more likely than not” that all or a portion of a deferred tax asset will not be realized. A review of all available positive and negative evidence needs to be considered, including a company’s current and past performance, the market environment in which the company operates, the utilization of past tax credits, length of carry back and carry forward periods, existing contracts or sales backlog that will result in future profits, as well as other factors.

Forming a conclusion on a valuation allowance is difficult when there is negative evidence such as cumulative losses in recent years. Cumulative losses weigh heavily in the overall assessment. As a result of a review undertaken at December 31, 2002, the Company concluded that it was appropriate to establish a full valuation allowance for its net deferred tax assets. Until an appropriate level of profitability is sustained, the Company expects to continue to record a full valuation allowance on future tax benefits except for those that may be generated in foreign jurisdictions.

The effective tax rate differed from the U.S. statutory rate as we continued to provide a full valuation allowance for our net deferred tax assets at March 31, 2007 and March 31, 2006. During each of the three months ended March 31, 2007 and March 31, 2006, the Company recorded a tax benefit related to its operations in France. This benefit was primarily the result of a 10% research and development tax credit.

The Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), on January 1, 2007. At March 31, 2007, the Company had an uncertain U.S. tax position of approximately $80,000 related to foreign operations. Due to the net operating loss position in the U.S., the Company would not incur tax, interest or penalty currently or in the near future. As such, no adjustment was made to equity and there is no impact on the Company’s effective tax rate. The Company does not anticipate any event in the next twelve months that would cause a change to this position. The Company will recognize any penalties and interest when necessary as tax expense. The U.S. federal returns for the years ending December 31, 2003 and after are open for IRS examination. The year ended December 31, 2002 generated a loss and the 2002 net operating loss (NOL) is still being used by the Company. The IRS may audit up to the NOL amount generated from the year ended 2002 until the statute expiration on open tax years.

The Company is also subject to income tax in France. At March 31, 2007, the Company had an uncertain tax position of approximately $200,000 of which $186,000 is related to a potential tax liability, $10,000 is related to possible interest, and $4,000 is related to a potential penalty. This has been accounted for as a reduction in equity. The uncertain tax position in France will have a favorable impact on the effective tax rate in the amount of $186,000. The Company does not anticipate any event in the next twelve months that would cause a change to this position. The French income tax returns for the years ended December 31, 2004 and subsequent remain open for examination.

NOTE 6. — CREDIT FACILITY

The Company maintains a $5 million revolving bank credit facility with a maturity date of July 31, 2008 and interest rate of LIBOR plus 1.0% (6.375% at March 31, 2007 and December 31, 2006). All borrowings under this facility are secured by marketable securities. The borrowings of $3.5 million are classified as long-term debt on the accompanying balance sheets.

7

INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

NOTE 7. — COMPREHENSIVE INCOME

The following table shows the Company’s comprehensive income (in thousands):

	Three months ended
	March 31,
	2007			2006
Net (loss) income	$	(1,852	)	$	310
Other comprehensive income:
Unrealized holding gain arising during period, net of tax		12			7
Foreign currency translation adjustment		15			(14	)
Comprehensive (loss) income	$	(1,825	)	$	303

NOTE 8. — EARNINGS PER SHARE

Basic earnings per share are computed by dividing reported earnings available to common shareholders by weighted average common shares outstanding. Diluted earnings per share give effect to dilutive potential common shares. Earnings per share are calculated as follows (in thousands, except per share data):

	Three months ended
	March 31,
	2007			2006
Basic (loss) earnings per share:
Net (loss) income	$	(1,852	)	$	310
Weighted average common shares outstanding		6,076			5,822
Basic (loss) earnings per share	$	(0.30	)	$	0.05
Diluted (loss) earnings per share:
Net (loss) income	$	(1,852	)	$	310
Weighted average common shares outstanding		6,076			5,822
Dilutive stock options and restricted stock		—			96
Weighted average common shares outstanding — assuming dilution		6,076			5,918
Diluted (loss) earnings per share	$	(0.30	)	$	0.05
Outstanding stock options and unvested restricted stock that were not included in the diluted calculation because their effect would be anti-dilutive		1,467			1,986

NOTE 9. — SEGMENT INFORMATION

The Company is principally engaged in the design, development, and manufacturing of high-performance connectivity products utilizing advanced technologies being used in next generation telecommunication networks and enterprise data 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.

8

INTERPHASE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Geographic revenues related to North America and foreign countries is as follows (in thousands):

	Three months ended
	March 31,
	2007		2006
Revenues:
North America	$	2,471	$	2,900
Europe		2,053		3,633
Pacific Rim		580		1,618
Total	$	5,104	$	8,151

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

	Three months ended
	March 31,
	2007		2006
Product Revenues:
Broadband telecom	$	4,245	$	5,935
Enterprise SlotOptimizer		377		927
Security		169		274
Storage		136		231
Professional services		41		118
Other		136		666
Total	$	5,104	$	8,151

9

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING STATEMENTS

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

RESULTS OF OPERATIONS

Revenue

Total revenue decreased to $5.1 million for the three months ended March 31, 2007, compared to $8.2 million for the same period in the prior year. The decrease was primarily attributable to Broadband telecom revenue, which decreased approximately 28% to approximately $4.2 million for the three months ended March 31, 2007, compared to $5.9 million in the comparable period. As expected our enterprise SlotOptimizer revenue decreased by approximately 59% to $377,000 for the three months ended March 31, 2007, compared to $927,000 for the same period in the previous year. All other revenues composed primarily of security, legacy networking, professional services and storage product lines, decreased approximately 63% to $482,000, compared to approximately $1.3 million in the comparable period. Included in all other revenues for the first quarter of 2006 was approximately.$400,000 of raw material parts, sold at cost, which reduced our exposure to potential excess and obsolete inventory charges.

During the first quarter of 2007, sales to two customers individually accounted for approximately 33% and 10% of total revenues respectively. During the first quarter of 2006, sales to four customers individually accounted for approximately 21%, 15%, 12% and 10% of total revenues respectively. No other customer accounted for more than 10% of our consolidated revenue in the periods presented.

Gross Margin

For the three months ended March 31, 2007, gross margin, as a percentage of sales, was 53% compared to 51% for the same period in the prior year. The increase in gross margin percentage is primarily due to the sale of approximately $400,000 of raw materials at cost in the first quarter of 2006, which reduced first quarter 2006 product margins, as well as recording $100,000 less in obsolete inventory charges in the first quarter of 2007 compared to the first quarter of 2006. These factors were partially offset by reduced factory utilization as production volumes decreased from the first quarter of 2006. We believe 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.

Research and Development

Our investment in the development of new products through research and development was $2.5 million and $1.9 million for the three months ended March 31, 2007 and 2006, respectively. The increase in research and development expense is primarily due to our continued investment in the area of project related research and development activities on a variable basis. As a percentage of total revenue, research and development expense was approximately 50% in the first quarter of 2007 compared to approximately 23% for the same period in the prior year. The increase in research and development costs as a percentage of total revenue is due to the research

10

and development expense increasing while revenue decreased for the period. We anticipate that spending on research and development will increase slightly in the near future, subject to fluctuations in currency exchange rates because much of our development expense is associated with our engineering lab in France (see Item 3 — Foreign Currency Risk).

Sales and Marketing

Sales and marketing expenses were $1.4 million and $1.3 million for the three months ended March 31, 2007 and 2006, respectively. The increase in sales and marketing expense was due to additional headcount in our sales and marketing teams and increased tradeshow presence during the first three months of 2007. As a percentage of total revenue, sales and marketing expense was approximately 28% in the first quarter of 2007, compared to approximately 16% for the same period in the prior year. The increase in sales and marketing expense as a percentage of total revenue is due to the slight increase in sales and marketing expense while revenue decreased for the period. We will continue to monitor the level of sales and marketing costs concurrently with actual revenue results.

General and Administrative

General and administrative expenses were $957,000 and $954,000 for the three months ended March 31, 2007 and 2006, respectively. As a percentage of total revenue, general and administrative expenses were approximately 19% in the first quarter 2007 and 12% for the same period in the prior year. The increase in general and administrative expenses as a percentage of total revenue is primarily due to revenue decreasing while general and administrative expenses remained flat. We will continue to monitor the level of general and administrative costs concurrently with actual revenue results.

Interest Income, Net

Interest income, net of interest expense, increased to $201,000 for the three months ended March 31, 2007 from $115,000 in the comparable period in the prior year. The increase in interest income, net for the three month period is primarily due to an increase in the investment rates of return and a shift in our investment strategy related to our cash and cash equivalents. We also maintained higher cash and investment balances in the first quarter of 2007 compared to the same period in 2006, resulting in increased interest income during the period.

Other Income, Net

Other income, net was $95,000 for the three months ended March 31, 2007, compared to $137,000 for the same period in the prior year. The decrease in other income for the three months ended March 31, 2007 primarily relates to the change in market value of our foreign exchange derivative financial instruments which resulted in other income of approximately $67,000 and $127,000 for the three months ended March 31, 2007 and 2006, respectively. See Note 4 in Notes to Condensed Consolidated Financial Statements for more information on derivative financial instruments.

Income Taxes

Our tax benefit rate was 3% for the three months ended March 31, 2007, compared to a tax benefit rate of 59% for the three months ended March 31, 2006. Although we were in a net income position in 2006, we recorded a tax benefit due to tax credits generated in our foreign operations.

The effective tax rate differed from the U.S. statutory rate as we continued to provide a full valuation allowance for our net deferred tax assets at March 31, 2007 and March 31, 2006. During each of the three months ended March 31, 2007 and March 31, 2006, we recorded a tax benefit related to our operations in France. This benefit was primarily the result of a 10% research and development tax credit.

Net (Loss) Income

We reported net loss of $1.9 million and net income of $310,000 for the three months ended March 31, 2007 and 2006, respectively. Basic loss per share for the three months ended March 31, 2007 was ($0.30). Basic and diluted earnings per share for the three months ended March 31, 2006 was $0.05.

11

LIQUIDITY AND CAPITAL RESOURCES

Consolidated Cash Flows

Cash and cash equivalents decreased $3.2 million for the three months ended March 31, 2007 and increased $2.7 million for the three months ended March 31, 2006. Cash flows are impacted by operating, investing and financing activities.

Operating Activities

Trends in cash flows from operating activities for the three months ended March 31, 2007 and 2006 are generally similar to the trends in our earnings except for provision for uncollectible accounts and returns, provision for excess and obsolete inventories, depreciation and amortization and amortization of restricted stock. Cash used in operating activities totaled $970,000 for the three months ended March 31, 2007, compared to a net loss of $1.9 million. Provision for uncollectible accounts and returns decreased slightly for the three months ended March 31, 2007 compared to the same period in 2006. Provision for excess and obsolete inventories decreased by $100,000 for the three months ended March 31, 2007, compared to the same period in 2006 primarily due to product end of life activities during 2006. Depreciation and amortization increased slightly for the three months ended March 31, 2007, compared to the same period in 2006. Amortization of restricted stock increased slightly for the three months ended March 31, 2007, compared to the three months ended March 31, 2006. See Note 2 in Notes to Condensed Consolidated Financial Statements for more information on restricted stock.

Changes in assets and liabilities result primarily from the timing of production, sales, purchases and payments. Such changes in assets and liabilities generally tend to even out over time and result in trends in cash flows from operating activities generally reflecting earnings trends.

Investing Activities

Cash used in investing activities totaled $2.3 million for the three months ended March 31, 2007 and cash provided by investing activities totaled $958,000 for the three months ended March 31, 2006. Cash used in and provided by investing activities in each of the periods related principally to proceeds from the sale of marketable securities, disbursements for additions to property and equipment, capitalized software and our investments in marketable securities. Additions to property and equipment and capitalized software were $159,000 for the three months ended March 31, 2007, compared to $401,000 for the three months ended March 31, 2006. The additions for the three months ended March 31, 2007 and three months ended March 31, 2006, primarily related to software and equipment purchases for our engineering and manufacturing functions. Purchases of marketable securities increased to $4.6 million for the three months ended March 31, 2007, compared to $2.0 million for the three months ended March 31, 2006. Proceeds from the sale of marketable securities decreased to $2.5 million for the three months ended March 31, 2007, compared to $3.3 million for the three months ended March 31, 2006.

Financing Activities

Net cash provided by financing activities totaled $104,000 for the three months ended March 31, 2007 and $316,000 for the three months ended March 31, 2006 and related to proceeds from employees exercising stock options.

Commitments

Commitments

At March 31, 2007, we had no material commitments to purchase capital assets; however, planned capital expenditures for 2007 are estimated at approximately $2.6 million, the majority of which relate to our investment in a new enterprise performance management system. The remaining planned purchases relate to engineering, manufacturing and general office equipment. Our significant long-term obligations as of March 31, 2007, are our operating leases on facilities and future debt payments related to our credit facility. To date, we have not paid any dividends and do not anticipate paying any dividends in 2007.

12

Off-Balance Sheet Arrangements

At March 31, 2007, we had four foreign exchange contracts outstanding to acquire approximately 1.1 million Euros for each contract on specified dates during the next 10 months. We have a $171,000 asset, classified in prepaid expenses and other current assets, on the balance sheet at March 31, 2007, representing the fair value of these contracts. There were three such contracts outstanding at December 31, 2006 classified as a $185,000 asset on the balance sheet and included in prepaid expenses and other current liabilities.

Other

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

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

Management’s Discussion and Analysis of Financial Condition and Results of Operations in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and other material included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency Risk

The Company is exposed to adverse movements in foreign currency exchange rates because it conducts business on a global basis and in some cases in foreign currencies. The Company’s operations in France are measured in the local currency and converted into U.S. Dollars based on published exchange rates for the periods reported and are therefore subject to risk of exchange rate fluctuations. The Euro to U.S. Dollar translation accounted for charges of approximately $410,000 and $229,000 for the three months ended March 31, 2007, and 2006, respectively.

In an attempt to mitigate the risk described above, we may enter into, from time to time, foreign exchange contracts to purchase a fixed amount of Euros on a fixed date in the future at a fixed rate determined at the contract date. These derivative financial instruments do not meet the criteria to qualify as hedges under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” and therefore any changes in the market value of these contracts are recognized as a gain or loss in the period of the change. For the three months ended March 31, 2007, we recognized a gain of approximately $67,000 related to these foreign exchange contracts. For the three months ended March 31, 2006, we recognized a gain of approximately $127,000 related to these foreign exchange contracts. At March 31, 2007, we had four foreign exchange contracts outstanding to acquire approximately 1.1 million Euros for each contract on specified dates during the next 10 months. At March 31, 2007, we carried an approximately $171,000 asset on the balance sheet, classified in prepaid expenses and other current assets, related to the fair value of our outstanding foreign exchange contracts. There were three such contracts outstanding at December 31, 2006 classified as a $185,000 asset on the balance sheet and included in prepaid expenses and other current assets.

Market Price Risk

We had no equity hedge contracts outstanding as of March 31, 2007 or December 31, 2006.

13

Interest Rate Risk

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

A hypothetical 50 basis point increase in interest rates would be expected to result in an approximate decrease of less than 1% in the fair value of our available-for-sale securities at March 31, 2007. This potential change is based on sensitivity analyses performed on our marketable securities at March 31, 2007. Actual results may differ materially. We estimate that the same hypothetical 50 basis point increase in interest rates would have resulted in an approximate decrease of less than 1% in the fair value of our available-for-sale securities at March 31, 2006.

Our credit facility bears interest at a variable rate tied to the London Interbank Offered Rate (LIBOR). The current interest rate on our credit facility is 6.375% (LIBOR + 1%). In an attempt to mitigate interest rate fluctuations, we from time to time may enter into agreements with our lender to fix the interest rate; our agreement at March 31, 2007 expires on May 7, 2007. A hypothetical 100 basis point increase in LIBOR would increase annual interest expense on this credit facility by approximately $35,000.

Item 4. CONTROLS AND PROCEDURES

(a)

Evaluation of Disclosure Controls and Procedures. The Company’s management, under the supervision of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), performed an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this quarterly report. Based on that evaluation, the CEO and CFO concluded that the Company’s disclosure controls and procedures are effective, to give reasonable assurance that the information required to be disclosed by the Company in reports that it files under the Exchange Act is accumulated and communicated to management, including the CEO and CFO, to allow timely decisions regarding disclosure and that information is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC.

(b)

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

14

PART II
OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

None.

Item 1A. RISK FACTORS

There have been no material changes from the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2006.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

Item 3. DEFAULTS UPON SENIOR SECURITIES

None.

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

None.

Item 5. OTHER INFORMATION

None.

Item 6. EXHIBITS

15

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). (2)
3 (a)	Certificate of Incorporation of the registrant. (1)
3 (b)	Amendment to Articles of Incorporation of the registrant. (3)
3 (c)	Amended and Restated Bylaws of the registrant adopted on December 5, 1995 and amended on January 19, 1999. (5)
4 (a)	Rights Agreement dated as of December 7, 2000 by and between the Company and Computershare Investor Services, LLC as Rights Agent. (4)
10 (a)	Lease on Facility at Parkway Center, Phase I, Plano, Texas. (6)
10 (b)	Lease on Facility at 2105 Luna Road, Carrollton, Texas. (6)
10 (c)	Note and Credit Agreement between Interphase Corporation and Comerica Bank, including Amendment dated November 5, 2004. (7)
10 (d)	Employment Agreement with Gregory B. Kalush, dated March 12, 1999. *(9)
10 (e)	Employment Agreement for Chief Technology Officer with Felix V. Diaz, dated May 22, 1996. *(9)
10 (f)	Employment, Confidentiality, and Non-Competition Agreement with Thomas N. Tipton, Jr., dated December 19, 2005. *(9)
10 (g)	Employment, Confidentiality, and Non-Competition Agreement with Randall E. McComas, dated February 15, 2002. *(9)
10 (h)	Employment Agreement with Deborah A. Shute, dated November 24, 1999. *(9)
10 (i)	Employment, Confidentiality, and Non-Competition Agreement with James W. Gragg, dated November 1, 2004. *(9)
10 (j)	Employment, Confidentiality, and Non-Competition Agreement with Prasad Kallur, dated May 23, 2005. *(9)
10 (l)	Interphase Corporation 2004 Long-Term Stock Incentive Plan *(8)
31 (a)	Rule 13a-14(a)/15d-14(a) Certification. (10)
31 (b)	Rule 13a-14(a)/15d-14(a) Certification. (10)
32 (a)	Section 1350 Certification. (10)
32 (b)	Section 1350 Certification. (10)

(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 August 6, 1996, and incorporated herein by reference.
(3)	Filed as an exhibit to Report on Form 10-K for the year ended December 31, 1999, and incorporated herein by reference.
(4)	Filed as an exhibit to Form 8-K on January 9, 2001, and incorporated herein by reference.
(5)	Filed as an exhibit to Report on Form 10-K for the year ended December 31, 2001, and incorporated herein by reference.
(6)	Filed as an exhibit to Report on Form 10-Q for the quarter ended September 30, 2002, and incorporated herein by reference.
(7)	Filed as an exhibit to Report on Form 10-K for the year ended December 31, 2004, and incorporated herein by reference.
(8)	Filed as an exhibit to Schedule 14a on March 31, 2005 and incorporated herein by reference.
(9)	Filed as an exhibit to Report on Form 10-K for the year ended December 31, 2005 and incorporated herein by reference.
(10)	Filed herewith
*	Management contract or compensatory plan or arrangement.

16

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	INTERPHASE CORPORATION (Registrant)
Date: May 14, 2007	By:	/s/ Thomas N. Tipton Jr.
		Thomas N. Tipton Jr.
		Chief Financial Officer, Vice President of Finance and Treasurer (Principal Financial and Accounting Officer)

17

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-Q 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Company and 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) Designed such internal control over financial reporting, or caused such an internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) 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

(d) 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: May 14, 2007	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, Thomas N. Tipton Jr., certify that:

1.	I have reviewed this report on Form 10-Q 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)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Company and 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) Designed such internal control over financial reporting, or caused such an internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) 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

(d) 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: May 14, 2007	Signature:	/s/ Thomas N. Tipton Jr.
		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 Quarterly Report of Interphase Corporation (the “Company”) on Form 10-Q for the quarter ended March 31, 2007, 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 

May 14, 2007 

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 Quarterly Report of Interphase Corporation (the “Company”) on Form 10-Q for the quarter ended March 31, 2007, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Thomas N. Tipton Jr., 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/ Thomas N. Tipton Jr.  

Thomas N. Tipton Jr. 

Chief Financial Officer 

May 14, 2007