LINK

Business Context and Reporting Period

Company: Interlink Electronics, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2006
Business Overview: Interlink designs, develops, and sells intuitive interface technologies, including signature input devices, cursor control sensors (MicroNav), and remote control devices. Operations are divided into four segments: E-transactions, Specialty Components, OEM Remotes, and Branded Products. The company manufactures FSR sensors in Camarillo, California, and utilizes contract manufacturing in Asia.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Total revenue decreased 5% year-over-year, primarily driven by a 24% drop in the OEM Remotes segment due to restructuring and market pressures. This was partially offset by a 19% increase in E-transactions revenue.
• Margin Improvement: Overall gross margin improved from 21% to 28%, aided by a recovery in OEM Remotes margins (from negative 4% to 12%) following a $2.5 million inventory write-down in 2005.
• Expense Surge: Operating expenses increased 36% to $22.2 million. This was largely due to a $4.2 million non-cash stock-based compensation charge resulting from the implementation of FAS 123(R), as well as increased legal and accounting fees related to financial restatements and litigation.
• Liquidity Deterioration: Cash and cash equivalents dropped significantly from $13.9 million to $2.9 million due to operating losses and the liquidation of short-term investments.

Guidance, Outlook, and Risks

Going Concern Warning: Auditors have expressed substantial doubt regarding the company's ability to continue as a going concern. Management states that current cash resources ($2.9 million) may be insufficient to fund operations for the next 12 months without additional financing.

Outlook:

• E-transactions & Specialty Components: Expected to continue growing in 2007.
• OEM Remotes: Expected to decline in revenue in 2007 as the company shifts focus from presentation projectors to advanced viewing devices to improve margins.
• Profitability: Management does not expect to achieve profitability in 2007.

Key Risks & Contingencies:

• Financing Needs: The company obtained a $5 million secured line of credit in December 2006 but must raise additional capital to avoid curtailing operations.
• Litigation: Facing a class action lawsuit and a shareholder derivative action related to historical financial restatements. Costs not covered by insurance are being accrued.
• Internal Controls: While most material weaknesses in internal controls have been remediated, a weakness regarding inventory costing methods remains as of December 31, 2006.

Investor Verification Checklist

• Cash Runway: Verify the sufficiency of the $2.9 million cash balance against the $10 million annual operating cash burn rate.
• Financing Status: Confirm the status of the $5 million line of credit and any progress on equity or debt financing to fund 2007 operations.
• Legal Exposure: Monitor the status of the securities class action and derivative lawsuits regarding potential damages and insurance coverage limits.
• Inventory Valuation: Review the remaining material weakness in inventory costing and the adequacy of reserves for excess/obsolete inventory, particularly in the OEM Remotes segment.
• Stock-Based Compensation: Assess the impact of the $4.2 million non-cash charge on future earnings and the remaining unrecognized stock-based compensation cost ($3.3 million).