LINK

Business Context and Reporting Period

Company: Interlink Electronics, Inc.
Filing Type: Form 10-Q (Unaudited)
Period Ended: March 31, 2008
Business Overview: Interlink develops and sells intuitive interface devices and components, primarily in two segments: eTransactions (electronic signature capture) and Specialty Components (FSR-based sensors). In August 2007, the company sold its OEM Remotes and Branded Products segments, which are now reported as discontinued operations.

Key Financial Metrics

Cash Flow: Net cash used in operating activities was $3.1 million for Q1 2008, compared to $0.2 million used in Q1 2007. The increase in cash burn was primarily due to payments of accrued payroll and other expenses.

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 38% year-over-year, driven by a 68% surge in Specialty Components revenue and a 9% increase in eTransactions revenue.
• Margin Compression: Gross margin declined from 43% to 34% due to higher unabsorbed manufacturing costs, scrap charges, and excess direct labor costs.
• Operating Expenses: Total operating expenses rose 46% to $4.6 million. This was driven by a $901,000 increase in payroll costs and a $233,000 increase in non-cash stock-based compensation (including $339,000 in accelerated vesting for the former CEO).
• Net Loss Improvement: Despite a wider operating loss, the Net Loss narrowed to $2.1 million from $2.5 million in Q1 2007. This improvement was largely due to a $990,000 gain from the change in fair value of warrant liabilities and the absence of a $1.1 million loss from discontinued operations recorded in Q1 2007.

Guidance, Outlook, and Risks

Management Commentary: Management projects revenue growth for both segments in fiscal 2008. However, they anticipate continued net losses as fixed general and administrative expenses are supported by a revenue base reduced by half following the divestiture of legacy businesses. The company is actively evaluating cost structures to reduce expenses.

Outlook: The company expects higher margins in retained businesses to eventually result in positive cash flow by the end of fiscal 2008, though this is not guaranteed.

Risks and Contingencies:

• Liquidity: The company has a history of negative cash flow and net losses. Continued losses could limit growth options and require additional financing.
• Legal Proceedings: A class action lawsuit and a shareholder derivative action regarding prior financial restatements remain pending. While the SEC indicated it does not intend to recommend enforcement action, the outcome of the litigation is uncertain.
• Leadership Transition: The former CEO retired in January 2008. The company is led by an interim CEO while searching for a permanent replacement.
• Convertible Notes: The company has $5 million in 8% convertible notes maturing in 2010. There is a dispute regarding liquidated damages for a delay in the registration statement effectiveness, though management believes an exception applies.

Investor Verification Checklist

• Cash Burn Rate: Verify the sustainability of the $3.1 million quarterly cash burn against current cash reserves of $10.7 million.
• Margin Recovery: Monitor if gross margins can recover from 34% as manufacturing efficiencies improve and fixed costs are spread over higher volumes.
• Legal Exposure: Track the status of the securities class action and derivative suits for potential settlement costs not covered by insurance.
• Debt Obligations: Review the terms of the $5 million convertible notes and the $5 million line of credit (currently undrawn) to assess refinancing needs.
• CEO Search: Confirm the timeline for appointing a permanent CEO to ensure strategic execution.