LINK

Business Context and Reporting Period

Company: Interlink Electronics, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 1998
Business Overview: Interlink designs, manufactures, and sells input devices for computers and electronic products based on proprietary Force Sensing Resistor (FSR) technology. Products include sensors, modules, and complete devices such as remote controls, touchpads, and pointing sticks. Approximately 85% of revenue is generated from Original Equipment Manufacturer (OEM) sales, with a significant portion (approx. 50%) derived from Japanese customers.

Key Financial Metrics (Year Ended Dec 31, 1998)

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 15% to $22.1 million in 1998 compared to $19.2 million in 1997, driven by growth in the computerized presentation projector market.
• Margin Compression: Gross margin declined to 37% from 38% in 1997 (and 48% in 1996). Management attributes this to a shift toward OEM sales, which carry lower margins, and increased price competition in the hardware industry.
• Operating Efficiency: Selling, General, and Administrative (SG&A) expenses decreased as a percentage of sales to 26% in 1998 from 29% in 1997, due to the amortization of fixed costs over a larger revenue base.
• One-Time Charges: Net income in 1998 was negatively impacted by a one-time legal settlement expense of $355,000. Conversely, 1997 results were impacted by a one-time write-off related to manufacturing yield problems with the VersaPad technology.
• Cash Flow: Operating activities consumed approximately $479,000 in cash in 1998, primarily due to growth in accounts receivable and inventory. This contrasts with 1997, where operations consumed $3.0 million.

Guidance, Outlook, and Risks

• Outlook: Management expects the Custom Applications product line to show minimal or negative growth as focus remains on the Computer Pointing Device line. The company anticipates continued revenue growth from OEM relationships in the presentation projector market.
• Liquidity: The company maintains a $3.0 million unused U.S. line of credit and a $1.1 million Japanese line of credit (with $132,000 drawn). Management believes existing cash balances are sufficient for the next twelve months.
• Year 2000 Compliance: The company believes its products and internal systems are largely Year 2000 compliant. Estimated costs to resolve remaining deficiencies are under $100,000, with completion expected by mid-1999.
• Risks:
  • Customer Concentration: In 1998, three customers accounted for over 10% of sales each (15%, 14%, and 10%).
  • Foreign Exchange: Approximately 50% of revenues come from Japanese customers, exposing the company to yen/dollar fluctuations.
  • Supply Chain: Reliance on third-party microcontrollers; past shortages have occurred, though none were material.
  • Patent Expiration: The first of the initial FSR patents expired on February 9, 1999.
• Legal Contingencies: The company is appealing a February 1997 summary judgment against it in a patent infringement suit against InControl Corporation. Management does not believe the outcome will materially affect 1999 results.

Investor Verification Checklist

• OEM Dependency: Verify the stability of relationships with the top three customers, who collectively represent nearly 40% of revenue.
• Margin Sustainability: Assess whether the decline in gross margins (from 48% in 1996 to 37% in 1998) is a permanent structural shift due to OEM mix or temporary pricing pressure.
• Cash Conversion: Monitor the trend of cash used in operating activities, as growth in receivables and inventory is currently consuming cash despite profitability.
• Patent Portfolio: Review the status of the patent portfolio following the expiration of the initial FSR patents in early 1999 and the outcome of the InControl litigation appeal.
• Year 2000 Costs: Confirm that the estimated $100,000 cost for Y2K remediation remains accurate as supplier compliance data is received.