Business Context and Reporting Period
Company: Interlink Electronics, Inc.
Filing Type: Form 10-Q (Unaudited)
Period Ended: September 30, 2006
Business Overview: Interlink develops, manufactures, and sells intuitive interface devices and components, including force sensing resistor (FSR) sensors and input devices. Operations are divided into four segments: Business Communications (branded products), OEM Remotes, E-transactions, and Specialty Components.
Key Financial Metrics
| Metric (in thousands) | Three Months Ended Sep 30, 2006 | Nine Months Ended Sep 30, 2006 | Nine Months Ended Sep 30, 2005 |
|---|---|---|---|
| Revenues | $9,034 | $26,082 | $29,756 |
| Gross Profit | $3,249 | $8,895 | $6,367 |
| Gross Margin % | 36% | 34% | 21% |
| Operating Loss | $(1,837) | $(8,177) | $(5,277) |
| Net Loss | $(1,885) | $(8,109) | $(5,048) |
| Loss Per Share (Basic/Diluted) | $(0.14) | $(0.59) | $(0.37) |
Liquidity and Balance Sheet Highlights (in thousands)
- Cash and Cash Equivalents: $2,221 (Sep 30, 2006) vs. $3,938 (Dec 31, 2005).
- Short-term Investments: $2,000 (Sep 30, 2006) vs. $10,000 (Dec 31, 2005).
- Total Current Assets: $24,373.
- Total Current Liabilities: $6,839.
- Working Capital: $17,534 (Decreased from $22,952 at year-end 2005).
- Long-term Debt: $76 (net of current portion); Total indebtedness was $230,000 as of Sep 30, 2006.
- Net Cash Used in Operating Activities (9 months): $(8,958).
Material Changes vs. Prior Period
- Revenue Decline: Nine-month revenues decreased 12% to $26.1 million, primarily driven by a 24% decline in the OEM Remotes segment due to lower unit sales and average selling prices.
- Margin Improvement: Gross margin improved to 34% (from 21% in 2005). This was largely due to a significant $2.1 million inventory write-down and tooling depreciation charge taken in the third quarter of 2005, which is not present in the current period.
- Operating Expense Increase: Operating expenses rose $5.4 million year-over-year. A primary driver was the adoption of SFAS 123R (Share-Based Payment), resulting in a $3.2 million non-cash stock-based compensation charge for the nine months ended Sep 30, 2006 (compared to $106,000 in 2005).
- Legal and Investigation Costs: The company incurred approximately $615,000 in expenses related to an internal investigation and ongoing legal matters in the first nine months of 2006.
- Inventory Build-up: Inventory levels increased significantly, with raw materials rising from $4.5 million to $9.2 million, contributing to cash outflows.
Guidance, Outlook, Risks, and Contingencies
Going Concern and Liquidity
Management states that current cash and short-term investments ($4.2 million) may be insufficient to fund operations for the next 12 months. The company expects to require additional capital in the immediate future. In December 2006, the company secured a $5 million line of credit, but there is no assurance it will be sufficient or that other financing will be obtained. The independent auditor may include an explanatory paragraph expressing substantial doubt about the company's ability to continue as a going concern.
Legal Proceedings
- Class Action: A securities class action filed in November 2005 alleges false and misleading statements regarding financial condition between 2003 and 2005. The case remains in early stages.
- Derivative Action: A shareholder derivative action was refiled in August 2006 in California state court against current and former officers, seeking treble damages and forfeiture of equity-based compensation.
- Costs: The company has recorded approximately $615,000 in investigation expenses and $266,000 in legal expenses for 2006 not covered by insurance.
Internal Controls
Management concluded that disclosure controls and procedures were ineffective as of September 30, 2006. Material weaknesses were identified in financial reporting closing processes, inventory management, and stock option accounting, leading to restatements of historical financial statements.
Segment Outlook
- OEM Remotes: Facing continued decline in average selling prices and volume.
- E-transactions: Revenues decreased due to fewer large transactions; margins improved to 49%.
- Business Communications: Revenues remained relatively flat; margins decreased due to product mix.
Investor Verification Checklist
- Cash Runway: Verify the sufficiency of the $4.2 million cash balance against the company's burn rate and the status of the $5 million line of credit obtained in December 2006.
- Going Concern Status: Review the upcoming 2006 Annual Report (10-K) for the auditor's opinion regarding the company's ability to continue as a going concern.
- Legal Exposure: Monitor the status of the class action and derivative lawsuits, specifically regarding potential damages not covered by insurance.
- Inventory Valuation: Assess the risk of further inventory write-downs, particularly regarding ROHS compliance and excess/obsolete stock in the OEM Remotes segment.
- Internal Controls: Evaluate the progress of remediation efforts for the identified material weaknesses in financial reporting and inventory management.
- Stock-Based Compensation: Note the significant non-cash impact of SFAS 123R on net loss and future expense recognition ($3.6 million unrecognized cost remaining).