LINK

Business Context and Reporting Period

Company: Interlink Electronics, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2002
Business Overview: Interlink Electronics develops and sells electronic components and devices, primarily in four segments: Business Communications, Home Entertainment, E-Transactions, and Specialty Components. The company is a leading supplier of remote controls and presentation systems.

Key Financial Metrics (Six Months Ended June 30, 2002)

Material Changes vs. Prior Period

• Revenue Decline: Revenues decreased 18% to $11.4 million for the six months ended June 30, 2002, compared to $13.9 million in the same period of 2001. This was driven by an 11% decline in the Business Communications segment and a 32% decline in Specialty Components (partly due to the loss of non-recurring licensing revenue).
• Profitability Improvement: Despite lower revenue, the Net Loss improved significantly, decreasing from $1.1 million in the prior year period to $732,000. The Operating Loss narrowed from $1.9 million to $722,000.
• Gross Margin Expansion: Gross profit increased 15% to $4.7 million, with the margin improving to 41.5% from 29.6% in the prior year. This improvement is largely attributed to a $2.0 million inventory reserve charge recorded in the second quarter of 2001 that did not recur in 2002.
• Segment Growth: Home Entertainment revenue surged 138% (driven by Microsoft Xbox components) and E-Transactions revenue grew 51%.
• Expense Reduction: Selling, General, and Administrative (SG&A) expenses decreased 11% to $3.7 million due to staff reductions and cost-cutting programs implemented in 2001.

Outlook, Risks, and Management Commentary

• Liquidity: Management states that existing cash balances are sufficient to fund operations for at least the next twelve months. Working capital remains strong at approximately $18.9 million.
• Debt Restructuring: The company renegotiated its $5 million domestic revolving line of credit, removing financial covenants. Future borrowings must be secured by cash and investments held at the bank. A new $500,000 equipment line of credit was also established.
• Future Revenue Drivers: The company expects continued sales from the Xbox program in Home Entertainment and growth in E-Transactions. However, meaningful revenue from new IntuiTouch products is not expected until 2003.
• Tax Position: No income tax benefit was recorded for the period due to a lack of sufficient probability that additional benefits would be realized. Management noted that if quarterly profitability is not achieved by the end of 2002, the $1.3 million deferred tax asset may need to be eliminated.
• Foreign Exchange: Approximately 40% of 2001 revenues came from Japanese customers. The company uses six-month forward contracts to hedge exposure, but fluctuations lasting longer than six months could materially impact performance.
• Accounting Change: The company dismissed Arthur Andersen LLP and engaged KPMG LLP as its principal independent auditors.

Investor Verification Checklist

• Inventory Valuation: Verify the adequacy of inventory reserves given the $9.3 million inventory balance and the history of write-downs in 2001.
• Deferred Tax Asset: Monitor the company's ability to return to profitability by the end of 2002 to avoid the potential write-off of the $1.3 million deferred tax asset.
• Customer Concentration: Assess the risk associated with the Microsoft Xbox program, which drives the Home Entertainment segment, and the volatility of the E-Transactions segment.
• Debt Covenants: Confirm the terms of the renegotiated credit lines and the requirement to secure future borrowings with cash on hand.
• Non-Recurring Items: Ensure future comparisons exclude the one-time licensing revenue from International Electronics and Engineering (IEE) that impacted the Specialty Components segment in 2001.