UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2005
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______ TO ______
COMMISSION FILE NUMBER 0-21858
INTERLINK ELECTRONICS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 77-0056625
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
546 FLYNN ROAD
CAMARILLO, CALIFORNIA 93012
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (805) 484-8855
-----------
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock
(TITLE OF EACH CLASS)
Indicate by check mark if the registrant is a well-known seasoned
issuer, as defined in Rule 405 of the Securities Act.
Yes [_] No [X]
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the Act.
Yes [_] No [X]
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [_] No [X]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange
Act. (Check one):
Large accelerated filer [_] Accelerated filer [X] Non-accelerated filer [_]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).
Yes [_] No [X]
On June 30, 2005 (the last business day of the registrant's most
recently completed second fiscal quarter), the aggregate market value of the
shares of Common Stock held by non-affiliates of the registrant was $77,660,000
based upon the last sale price reported for such date on the Nasdaq National
Market. Shares of common stock held by officers and directors of the registrant
are not included in the computations; however, the registrant made no
determination that such individuals are "affiliates" within the meaning of Rule
405 of the Securities Act of 1933.
As of June 30, 2005 the number of shares of the registrant's Common
Stock outstanding was 13,720,929.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of Registrant's Proxy Statement for its 2006 Annual Meeting of
Stockholders are incorporated by reference into Part III of this report.
INTERLINK ELECTRONICS, INC.
TABLE OF CONTENTS
PAGE
ITEM NO. NO.
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PART I
1. Business......................................................... 1
1A. Risk Factors.................................................... 12
2. Properties....................................................... 20
3. Legal Proceedings............................................... 20
4. Submission of Matters to a Vote of Security Holders............. 21
4A. Executive Officers of the Registrant............................ 22
PART II
5. Market for Registrant's Common Equity, Related
Stockholder Matters And Issuer Purchases of Equity Securities.. 23
6. Selected Financial Data......................................... 24
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations............................ 25
7A. Quantitative and Qualitative Disclosures About Market Risk....... 45
8. Financial Statements and Supplementary Data...................... 45
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure........................... 45
9A. Controls and Procedures......................................... 45
9B. Other Information............................................... 51
PART III
10. Directors and Executive Officers of the Registrant............... 51
11. Executive Compensation........................................... 51
12. Security Ownership of Certain Beneficial Owners and Management... 52
13. Certain Relationships and Related Transactions................... 52
14. Principal Accounting Fees and Services........................... 53
PART IV
15. Exhibits, Financial Statement Schedules.......................... 54
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PART I
ITEM 1. BUSINESS
OVERVIEW
We design, develop and sell intuitive interface technologies and
solutions for a variety of business and home applications. Our products include:
o signature input devices, pen input pads and proprietary
application software;
o cursor control and other input devices for a wide variety of
electronic products including game controllers, cellular
telephones, handheld media players and medical devices; and
o interactive remote and integrated input devices, including
remote controls for presentation projectors and advanced
viewing systems.
Our signature and pen input pads record and bind signatures to
contracts or other legally significant documents and also record various
identity-defining factors such as signature biometrics and fingerprints.
Our Specialty Components technologies, such as MICRONAV(TM), support
full mouse functionality and file navigation using miniaturized sensors and
supporting systems that consume relatively little power, thereby making them
particularly attractive to manufacturers of handheld devices.
Our remote control input devices enable a user to control and
communicate with electronic products, such as computers, digital projection
systems and digital televisions, by providing an intuitive device on which the
user can remotely input a variety of commands.
We currently focus on four principal markets that we refer to as our
E-transactions, Specialty Components, OEM Remote Controls and Branded Products
markets. We serve a global customer base from our corporate headquarters in
Camarillo, California, where we also manufacture all of our "force sensing
resistor" or FSR technology. We have sales offices in Tokyo and Taiwan,
production logistics centers in Hong Kong and China and a product-engineering
center in China.
Our products benefit from a diverse technology portfolio based on trade
secrets, patented inventions and proprietary software. These technologies
include our FSR technology, wireless communication technologies and unique or
patented product design features. Alone and in collaboration with our industry
partners, we have developed numerous technologies that support various product
applications.
We make FSR-based sensors that we and others incorporate into
electronic control and input devices. Our FSR technology can capture a
three-dimensional record of any input, recording both the location of the input
on an x/y grid and the pressure applied at any point and is therefore capable of
supporting complex data input and process control functions such as signature
authentication. Our FSR-based sensors are scalable through a wide range of sizes
from a fraction of an inch in diameter to several feet across and can therefore
be applied to requirements as diverse as miniaturized input devices in consumer
products, such as cellular telephones and MP3 players, to seat sensors in
automobiles. Combining our FSR technology with unique or patented designs and
proprietary wireless data transmission technologies permits us to offer a wide
range of intuitive devices on which the user
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can remotely input a variety of commands. We offer our sensors either as
discrete components for installation in a device manufactured by our customer or
as complete devices, such as remote input devices. With respect to the latter,
we offer proprietary, ergonomic designs or are capable of delivering custom
products designed to customer specifications. We also offer, through retail and
other channels, a line of branded products under the Interlink brand name.
MARKET OPPORTUNITIES
E-TRANSACTIONS. Electronic document management and transmission is
becoming more appreciated and accepted for business transactions but, until
recently, signature of transaction documents could only be accomplished by using
a pen and ink on paper followed by physical delivery of the signed documents. In
many areas of commerce this imposes substantial time and cost burdens, most of
which can be substantially reduced by a dependable and verifiable electronic
signature process. Several major industries engage in financially significant
and document intensive transactions as a regular part of their business. These
include the financial industry, in particular the branch banking, insurance,
leasing and mortgage/notary businesses, the healthcare industry and governmental
entities. In addition, many businesses have document intensive processes in
specific areas, including field sales force automation and human relations.
Compared with the traditional process of circulating paper documents
with an ink signature, an electronic signature process can offer substantial
time and cost efficiencies as well as improved customer satisfaction in all of
these applications. For example, a customer in the insurance industry reports
that electronic document processing in its industry can reduce application costs
by up to 90%. A major automobile leasing company reports that electronic
document processing can reduce the time to return a car to inventory at the end
of a lease from several weeks to as little as a few days.
Until 2000, the use of electronic signatures was limited due to
questions about its validity. In that year, Congress enacted the Electronic
Signatures in Global and National Commerce Act, which established that
electronic signatures have the same legal validity as pen and ink signatures on
paper. Other recently enacted federal laws, including the Government Paperwork
Elimination Act, the Patriot Act and the Health Insurance Portability and
Accountability Act, support the move toward electronic documentation by
permitting electronic signatures. The National Notary Association has drafted a
new Model Notary Act that suggests standards for electronic signature and
notarization.
Concerns over identity theft and terrorism have also given impetus to a
need for identity verification. This has increased demand for systems that
utilize biometric information in a way that identifies the signer. Such systems
can combine signature authentication with other identity verification techniques
such as electronic fingerprint capture, password, card swipe or PIN
identification.
SPECIALTY COMPONENTS. Our specialty components market has traditionally
served the dual function of providing a steady revenue stream from a series of
diverse custom products while, at the same time, serving as an incubator for new
applications and technologies. Most recently, it has been the market in which we
have developed our MICRONAV family of sensors. These miniaturized sensors come
in various formats and permit precise input of a broad range of selections. Our
MICRONAV 360 sensor offers smooth pressure-controlled cursor acceleration and a
complete set of actuator reference designs to enable Internet, e-mail, gaming
and menu functions for portable wireless devices. Other members of the MICRONAV
family include circular and linear input pads that enable inputs such as volume
control or list scroll-through. Our MICRONAV sensors are specifically targeted
at the MP3 and
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cellular telephone markets. At the same time, we continue to provide our
traditional line of custom sensors and pointing solutions to the medical,
industrial, commercial and government markets.
OEM REMOTE CONTROLS. The Company focuses its efforts primarily on two
areas of OEM Remote Controls: advanced viewing devices and presentation
projectors. We merged these two business segments following the third quarter of
2005 into a single unit that sells remotes to advanced viewing device
manufacturers and presentation projector manufacturers. This combination is a
result of the increased similarities between the two businesses giving us the
ability to leverage our broad customer relationships with the leading consumer
electronics companies. The combined unit allows us to direct our engineering,
marketing and sales efforts on the high growth, advanced viewing device market
while continuing to maintain our efforts and presence in the established
presentation projector market both of which are consumer oriented and price
competitive.
o Advanced Viewing Devices: Robust viewing device unit growth is
anticipated for the next several years due to a multitude of
technological changes. These changes include: increasing
migration by consumers from analog to digital television, the
increasing adoption of High Definition, or HD, television and
the popularity of thinner LCD, plasma and rear projection
displays. When these three key technologies converge, the
market growth opportunity could be significant, especially
because more broadcasters are offering compelling HD content
and readily available access to this content via satellite or
cable.
o The market growth has attracted many new entrants, all of whom
are very eager to differentiate their viewing device. While
brightness, sharpness and overall picture quality are promoted
by the manufacturers as a differentiator, the intuitive
technology and stylish design of the control device also
appear to be winning differentiators with customers.
o The continued growth of advanced digital television and high
performance viewing devices has substantially increased the
complexity of the processes that these devices may be required
to control, while at the same time permitting the unique
design of intuitive control systems to enhance the overall
appearance and value of the customer's product.
o Presentation Projectors: As computer technology has replaced
traditional presentation devices such as slide and overhead
projectors, the mechanisms to control the presentation process
have undergone a similar evolution. Presentation projectors
enable visual or mixed-media presentations using PowerPoint or
other presentation software. Today, it is possible for a
presenter to control various characteristics of a
sophisticated audio-visual presentation using a small,
wireless device. A presentation given on a computer-driven
presentation projector can be controlled, edited, amplified,
distributed and otherwise manipulated electronically. This
demands a wireless input device that can transmit a wide
variety of commands and support complex control functions in
an intuitive manner.
o Increased portability is enabling many users to travel with a
complete presentation system that fits in a standard
briefcase. In addition, the rapid growth of digital
photography and video has created a consumer application for
computer-linked projectors and has expanded the universe of
original equipment manufacturers of presentation systems to
include many of the leading computer manufacturers such as
BenQ, Dell, Hewlett-Packard, IBM and Lenovo.
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BRANDED PRODUCTS. The explosion of presentation software and continued
growth of digital projectors has driven demand for wireless input devices that
can transmit a wide variety of commands and support complex control functions in
an intuitive manner. Many presentation projectors are shipped with a basic
control device. However, these projector remotes lack the intuitive and advanced
control features provided by our aftermarket branded devices. In addition, some
presenters use their computer monitor or notebook computer instead of a
projector. These consumers constitute a significant market that we address with
our branded wireless presentation devices.
STRATEGY
Our overall strategy is to identify business and consumer markets in
which our competitive strengths enable us to be the leading provider of advanced
intuitive interface devices and to establish and maintain a leadership position
in those markets by implementing the following key strategies:
o LEVERAGING OUR MOMENTUM IN THE E-TRANSACTIONS MARKET. We have
spent the past six years developing our capabilities and
proving our value to our partners and customers. We have
evolved from a simple signature pad provider to a complete
solutions provider offering a signature software platform, a
broad set of signature capture options and professional
services to address the unique needs of the e-transactions
market. In conjunction with the National Notary Association,
we developed a combined electronic signature, notarization and
journal platform to facilitate the migration to electronic
closings. Our technologies, solutions, and approach have
enabled us to secure the largest implementations in the
industries in which we focus including banking, insurance,
auto finance, brokerage, and healthcare, as demonstrated by
our customer relationships with Wells Fargo, State Farm Mutual
Automobile Insurance Company, DealerTrack, Inc., Charles
Schwab & Company, Inc. and Veterans Administration Hospitals.
o USING OUR CORE SENSOR TECHNOLOGY AND INNOVATIVE NEW
APPLICATIONS TO SUPPORT INTEGRATED MICRO-INPUT DEVICES SUCH AS
OUR MICRONAV FAMILY OF PRODUCTS. The advent and increasing
complexity of a wide range of miniaturized consumer
electronics products such as MP3 players, cellular telephones,
digital cameras and video recorders and PDAs have greatly
increased demand for small, low power consuming input devices
that can provide full mouse functionality, including cursor
control. Our patented MICRONAV technology is well suited to
this application and we have invested considerable effort in
the development of this technology and its markets. Using
resistive, rather than the more common capacitive technology
enables our sensors to respond to a broader range of input
pressures (for example, a gloved finger which capacitive
sensors will not record) while consuming less power for
comparable applications. We are developing a broad range of
applications for our MICRONAV products targeted at the tasks
that today's complex handheld devices accomplish.
o MAINTAINING OUR LEADERSHIP POSITION IN THE OEM REMOTE CONTROL
MARKET BY OFFERING EFFECTIVE TECHNOLOGY SOLUTIONS AND
INNOVATIVE DESIGNS. We are one of a few dominant suppliers of
advanced wireless input devices for presentation projector
systems, supplying the majority of all wireless remote
controls used to control presentation projectors. We plan to
leverage our leadership position, strong reputation and
customer relationships to maintain our market share of the
projector OEM market while providing unique remote solutions
as our existing and new customers move into the advanced
viewing device markets. We also plan to maintain and grow our
leadership position in the branded business
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presentation market by continuing to offer and market
effective and innovative presentation and meeting products
under the Interlink Electronics brand. We will offer these
products and solutions through a broad mix of computer, retail
and specialty distribution channels.
o IDENTIFYING FUNDAMENTAL CHANGES IN CONSUMER OR BUSINESS
PRACTICES RESULTING FROM TECHNOLOGICAL CHANGE AND DEVELOPING
TECHNOLOGIES AND PRODUCTS THAT FACILITATE THIS CHANGE. We
remain alert to technological changes that alter the basic
processes that businesses and consumers rely upon. For
example, we developed our EPAD devices in anticipation of the
needs of e-commerce for electronically-verifiable transaction
documentation in a broad range of businesses. We are working
aggressively to identify new applications as they develop and
to apply our existing technologies to the design of solutions
appropriate to these applications. We believe that by applying
a disciplined approach to the identification and selection of
our target markets and applications, we can achieve a leading
position in those markets based on our strong intellectual
property position and market relationships.
o MAINTAINING AND DEVELOPING NEW STRATEGIC RELATIONSHIPS WITH
SOFTWARE DEVELOPERS AND OTHERS ADDRESSING OUR TARGET MARKETS
TO DELIVER TURNKEY SOLUTIONS. We work with software and
hardware developers, integrators and others to provide turnkey
solutions that address our customers' evolving requirements.
We believe that, by coupling our proprietary technologies with
our partners' expertise, we can deliver solutions that
uniquely address our customers' requirements.
o LEVERAGING AND EXTENDING OUR STRONG INTELLECTUAL PROPERTY
POSITION. We have significant expertise in the design and
manufacture of intuitive interface technologies and products.
We intend to continue to broaden our intellectual property
position through internal development to enhance the
competitiveness and size of our current businesses and
diversify into markets and technologies that complement our
current product portfolio. We have numerous trade secrets and
proprietary technologies and manufacturing processes that
further strengthen our intellectual property position.
o OPPORTUNISTICALLY ACQUIRING TECHNOLOGIES AND BUSINESSES THAT
DEEPEN OUR PENETRATION INTO OUR TARGET MARKETS. We anticipate
evaluating acquisition opportunities that we believe will
increase our market share in our target markets, improve our
portfolio of intellectual property or strengthen our customer
base. We also anticipate that we will pursue strategic
acquisitions and alliances with companies that have products
or technologies that complement our current products, expand
our global footprint, enhance our technical capabilities or
expand our service offerings.
PRODUCTS
Our products address customer needs in four principal areas:
E-transactions, Specialty Components, OEM Remote Controls and Branded Products.
E-TRANSACTIONS. Simple signature capture devices that are now common
features of various retail checkout counters are commodity products that are
available from a number of manufacturers. We have targeted applications
requiring features that not only capture an image and biometric information of
the signature but also bind the signature to a related document in such a way
that any alteration in the document will destroy the signature. With our
IntegriSign Signature Software Suite and EPAD products, we provide the
foundation for a legally enforceable transaction that supports
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signature verification. Our electronic signature processes are targeted at
applications requiring some or all of these features.
Since the introduction of our basic EPAD device, we have introduced a
series of functionality enhancements. In 2002, we introduced EPAD-INK, an
LCD-based signature capture product. Our EPAD-ID adds a fingerprint scanner. In
addition to hardware enhancements, we are, internally and in collaboration with
others, developing application software that targets a number of specific market
needs. For example, working in close cooperation with the National Notary
Association, we have developed a specific application of our EPAD-ID product
that provides a platform for electronic signing, notarization and journaling.
Finally, we have recently launched our sophisticated signature device, the
EPAD-XL. This device provides a larger color LCD display for signatures,
marketing messages and soft pinpad, as well as a cardswipe for payment and
security applications.
The IntegrSign Signature Software Suite provides developers with the
plug-ins and tools necessary to integrate our EPAD family of products. In
addition, it supports tablet PCs and fingerprint sensors. IntegriSign permits
signature capture and binding to a specific document in MS Office, InfoPath,
Adobe Acrobat, html and proprietary electronic forms. In addition, the platform
permits biometric authentication of individuals.
We work with a broad range of industry partners to provide turnkey
solutions to specific end-users. Our industry partners include key developers of
signature capture, forms and imaging software, suppliers of related hardware to
our targeted industries and system integrators.
SPECIALTY COMPONENTS. Our specialty components business consists
primarily of two product lines. We sell integrated cursor pointing technologies
to manufacturers of notebook computers and industrial applications and, more
recently, to the manufacturers of handheld electronic devices such as MP3
players and cellular telephones. We also sell a diverse assortment of
custom-designed sensors for non-computer applications, such as for use in
medical devices as safety switches. If the design process involves significant
work, we may charge a product development fee. We continue to market these
devices, both as stand-alone products and as components sold to OEMs for use in
their products.
Mice and other cursor control devices are manufactured using a variety
of sensor technologies. Our FSR-based cursor control sensors are particularly
well suited to applications that require file navigation or full cursor control
but that have limited space or available power, such as cell phones, PDAs and
other handheld devices, or the need to operate in harsh environmental
conditions, such as in industrial environments, or require a high level of
reliability, such as medical applications.
The explosive growth in the use of handheld devices such as cellular
telephones and PDAs and in the applications for which these devices are used,
including games and Internet access, has created a need for miniaturized cursor
control devices that have the full functionality of a mouse but can fit in the
very limited geography of these very small products and can function in very
limited power environments. We believe that our FSR sensors are ideally suited
to this application and have developed our MICRONAV family of sensors in
response to it. One form of MICRONAV sensor provides full 360o cursor control
functionality in a sensor that is less than 10 mm square and less than 1.5 mm in
thickness. Other versions provide strip or ring sensors that can be used
intuitively to control volume, to scroll through a list or for other functions.
In some applications we supply the basic sensor, usually with a protective
shield, and a license to use the related software drivers. We also support
various lighting options and flexible actuator designs and materials. We can
also supply a sensor and micro-processor combination and can incorporate both in
a module format ideal for "drop-in" solutions. We offer all three formats on an
OEM basis to manufacturers of various handheld products.
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OEM REMOTE CONTROLS. Our OEM remote controls address the growing need
for both remote and direct input devices to control an increasingly complex
array of home entertainment products, including high performance viewing devices
and home theaters as well as business projectors. We also sell sensors to
manufacturers of remote controls for integration into their products.
Simple remote control devices for use with presentation projectors,
televisions and other audiovisual products are widely manufactured using other
technologies and are adequate for channel selection, volume control and the
other basic functions for which they are used. Our remote control devices
address more complex requirements such as the remote control of business and
other presentations where the control process must not distract the user's
audience, and the digital television market where the communication process
involves high levels of complexity.
Our OEM remote development efforts are focused on interface devices
that will directly control high end audiovisual products such as front and rear
projectors, LCD and plasma display televisions. Most traditional television
manufacturers and retailers of consumer electronics products have introduced
advanced viewing devices into the home market. We are working both directly with
the manufacturers of these products and, at the chip level, with innovators of
new projection and television technologies in an effort to integrate our
interactive input devices with their products and technologies. Our customers in
this area include Acer, BenQ, Dell, Hewlett Packard, Sony and Sanyo.
Traditional remote input devices use infrared signals, which operate
only on a "line of sight" basis and therefore require the device to be pointed
at the signal receiver on or near the presentation projector. Many of our
products now use radio frequency, or RF, communication to eliminate this
shortcoming and allow control of distant or hidden systems without aiming. We
also support many of the other common communications protocols such as
Bluetooth, 802.11 and Zigbee.
BRANDED PRODUCTS. Our Interlink branded presentation devices are used
to control presentation and meeting room equipment. Many of our interface
devices also incorporate a pointing button to control the cursor and one or more
function selection buttons. Our meeting room products typically control multiple
devices such as computers, projectors and DVD players and are also used as
standard keyboards.
Many of our remote presentation devices incorporate our patented
CLICKTRIGGER button, which allows the presenter to enter the most common
commands (usually to advance to the next slide of a presentation) with the index
finger, leaving the thumb free for less commonly used functions. These devices
are ergonomically designed to allow the device to fit into the hand so that all
controls and functions are available without shifting the position of the
device, making it easier to locate the appropriate button.
CUSTOMERS
E-Transactions: Within the e-transactions market, we serve a diverse
set of customers across several industries including DealerTrack, Inc., Eastman
Kodak Company, Ford Credit Corporation, Jackson National Life Insurance Company,
Nationwide Building Society, Prudential, State Farm Mutual Automobile Insurance
Company, Charles Schwab & Company, Inc., Veterans Administration Hospitals,
DaimlerChrysler Services North America, LLC and Wells Fargo.
Specialty Components: Selected specialty component customers include
manufacturers of handheld devices such as iRiver, Sony, LG, Pantech and Siemens,
as well as computer and computer
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peripheral manufacturers including an assortment of medical device and other
equipment manufacturers.
Branded and OEM Remotes: We sell advanced wireless input devices
principally to OEMs and as branded products through a variety of distributors
and value added resellers. We serve a broad range of customers including many of
the leading global electronics companies such as Acer, BenQ, Dell,
Hewlett-Packard, Hitachi, IBM, InFocus, Lenovo, Mitsubishi, Panasonic, Sanyo,
Sharp, Sony and Toshiba. We offer our branded products through leading
distributors and resellers such as Ingram Micro, CDW, Insight and PC Connection.
As a result of having served many of these clients over a number of
years, we believe that we have established a reputation as a dependable producer
of quality devices and components and as an innovator of solutions that support
our clients.
TECHNOLOGIES
We develop technologies in several areas: force sensing resistors, or
FSRs, wireless communications and remote control user interfaces. We also
develop software to implement many of the applications for which our products
are used.
FORCE SENSING RESISTORS. Many of our products incorporate one or more
FSRs. A basic FSR can detect and accurately measure a force applied to it,
thereby enabling precise control of the process applying the force.
More complex sensors are also possible. One configuration, known as a
"four zone" sensor, has four sensors arranged in a two-by-two square with an
actuator placed directly where the four sensors touch. By toggling the actuator
in any direction, an operator can control the direction and speed of a cursor on
a computer screen. An FSR sensor can also serve as a touchpad by creating a
two-dimensional surface capable of measuring the location and intensity of
pressure applied at any set of coordinates on the grid. In contrast to most
standard touchpads, FSR touchpads can also measure the amount of pressure
applied at any point on the grid, thereby creating a three-dimensional
characterization of input along X, Y, and P (pressure) axes. This type of device
can be used to support functions such as handwriting input, where not only the
outline of the signature but the pressure applied in writing it, can be
measured, or computer cursor control, where variable cursor speed is desirable.
Other sensor configurations include the strip and ring sensors which measure
position and pressure of the touch. These are commonly used to create scrolling
and panning interfaces for control of handheld and other devices.
Our FSR sensors can be as thin as one-hundredth of an inch, making them
particularly well suited for use where space is a critical issue, as in notebook
and sub-notebook keyboards and handheld devices. In finger-sensing applications,
such as touch pads and scroll rings, they consume significantly less power than
do capacitive sensors, the principal competing technology. FSRs are therefore an
appropriate choice for products that depend on battery power, and particularly
for products with limited battery capacity. Also, unlike capacitive sensors
which react to the electrical capacitance in a human finger, FSRs react to
pressure from any object and therefore support pen or gloved hand activation.
FSR sensors have no moving parts and can be packaged in a sealed environment.
They are therefore highly reliable, retaining their performance through millions
of actuations, even in adverse environments involving heat, moisture, and
chemical contamination.
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WIRELESS COMMUNICATIONS AND REMOTE CONTROLS. We have expertise in and
can support any of the popular wireless communication protocols and have
developed our own proprietary communication technologies as well. We have also
created a number of applications that allow our hardware technologies to support
specific functions. These applications, for example, enable our sensors to
support our patented Pad-To-Screen (PTS) mapping, context sensitive scrolling
and gesture control technologies. We expect to develop, or work with others to
develop, new applications that will allow our intuitive interface devices to
control an ever increasing number of interactive functions.
We maintain active, in-house product design, engineering support and
advanced technology departments in the U.S., Japan and China and have a
relationship with an outside software development firm that provides access to
additional application developers for electronic transition software. As
appropriate, we engage outside development firms to facilitate the integration
of our products into our customers' products or handle peak loads greater than
our internal capacity.
INTELLECTUAL PROPERTY
We consider our intellectual property to be a key element of our
ability to compete in our chosen markets. Our intellectual property portfolio
consists of trade secrets, patents and proprietary software.
TRADE SECRETS. FSR sensors are manufactured using proprietary
screen-printing techniques. All proprietary aspects of the manufacturing process
are conducted in-house at Interlink to maintain quality and protect the force
sensing technology. While screen-printing is a common process in various
industries, the quality and precision of printing, as well as the specific
processes required to make high-quality FSR sensors require considerable
expertise. We believe this expertise is difficult to replicate over the short
term and, to our knowledge, no unrelated party has done so. In the course of
developing our products, we have developed expertise in various aspects of
wireless communication, signature content and verification, document security
and other matters that we believe afford us a meaningful advantage in our target
markets. We require our employees to sign nondisclosure agreements and seek to
limit access to sensitive information to the greatest practical extent.
PATENTS. We regularly file U.S. and foreign patent applications to
cover new or improved technologies, manufacturing methods, and product designs.
These filings protect methods of manufacturing FSR sensors and new innovations
in types of FSR sensors, as well as inventions related to wireless communication
and intuitive control.
The first of our patents for FSRs, which cover certain aspects of the
use of an uneven surface to produce variable resistance, expired in 1999 and
others expired between then and mid 2002. However, the FSR sensors that we make
today are covered by a number of patents related to their function, formulation
and manufacture. Our issued FSR-related patents expire between 2011 and 2020.
Additional FSR-related patents are pending that, if issued, would expire around
2026.
Patents covering wireless communications and intuitive control
inventions relate to our patented high-speed infrared technology as well as
various intuitive control and ergonomic features of our advanced pad-based home
entertainment/personal computer remote controls. These technologies allow
intuitive gestures on pad-based remote controls to control home entertainment
systems, or to highlight parts of a slide during a presentation. They also
include our CLICKTRIGGER input key.
Issued patents covering wireless communications and intuitive control
inventions will expire between 2016 and 2023. Additional such patents are
pending that, if issued, would expire in 2026.
9
SOFTWARE. We have developed software that we use in our products and
have acquired rights to software developed by others. Particularly in our
e-transactions market, we have assembled a portfolio of application specific
software technologies that address our target markets. We expect to aggressively
develop or acquire additional application technologies supporting this and other
markets.
SALES AND MARKETING
For e-transactions sales, we use public relations activity, direct
advertising and trade show participation to generate product awareness.
Promising sales leads and known industry targets are followed up with sales
visits. To a lesser extent, we leverage the sales and marketing resources of our
software partners. We are also teamed with the National Notary Association in
connection with sales of EPAD devices to notaries and the financial service
market.
With the development of our MICRONAV family of sensors, we have
considerably broadened the range of OEM applications that our products address.
We are aggressively pursuing opportunities to develop these applications by
working with our OEMs to design our solutions into their products. To achieve
this result, our specialty components business is supported by internal design
engineers who initially determine whether a sales opportunity should be pursued
and work with new customers to design a product or component to meet the
customer's need.
For sales of Branded and OEM remote control products, we employ a
direct sales team of five people in the U.S., two in Japan and three in Taiwan.
In addition, we have sales and marketing representation in Korea, Singapore and
the United Kingdom. Each sales team is supported by inside sales personnel,
product managers and application engineers.
Current distribution channels for our branded products consist of
distributors such as Ingram Micro and Tech Data, catalogs and specialty
resellers targeting corporate accounts. We market to these channels with direct
sales through our employees. In Europe we use distributors and specialty
resellers. We use these distribution channels not only to increase branded
product sales but also to establish customer demand for new products that
generate OEM sales.
MANUFACTURING
We seek to maximize protection of our proprietary technology by keeping
the development and manufacturing of all FSR sensors at our facility in
Camarillo, California. At the same time, we continue to expand our product
development and manufacturing capabilities in Asia yet limit the transferring of
sensitive technologies.
Prior to 2001, we contracted directly with offshore contract
manufacturers for the manufacture of products other than the sensors themselves.
In late 2001, we formed Interlink Electronics Asia Pacific Limited, or IEAP, to
coordinate our non-U.S. manufacturing activities. Based in Hong Kong, this
wholly owned subsidiary purchases components, assembles them into kits and
distributes the kits to one of several contract manufacturers for assembly.
Finished products are shipped to the customer at the direction of IEAP. IEAP
maintains an active oversight and quality control program and regularly
evaluates the capacity and performance of its contract manufacturers. We believe
that there exists a wide range of choice of contract manufacturers and that
manufacturing can be shifted to other manufacturers, if necessary, without
significant interruption of business.
We acquire raw materials and components for our FSR sensors from a
number of sources, mostly within the United States. We have worked closely with
a small group of manufacturers to
10
create new materials optimized for FSR usage; most of which are supplied to us
on an exclusive basis. The raw materials are processed into their final form
using proprietary material and methods.
COMPETITION
Our E-transactions market is emerging and competition exists today.
Competitors consist primarily of relatively smaller organizations, with respect
to revenue and headcount, which are singularly focused. However, a wide variety
of companies that currently supply products or services to our targeted
customers can be expected to try to expand the range of products or services
that they offer to include advanced signature input devices. Also, manufacturers
of basic point-of-sale signature input devices may develop more advanced
features that address our target markets. If the market for these products grows
as we believe it will, it can be expected to attract additional competitors.
Our Specialty Components business faces competition from a variety of
sources depending on the application. This is especially true in the cell phone
and MP3 markets where numerous technologies compete.
In our OEM Remotes and Branded Products market, we face competition
from manufacturers of less advanced remote devices, including Hoshiden
Corporation, SMK Corporation and Koninklijke Philips Electronics N.V, as well as
our OEM customers themselves who could choose to manufacture some or all of the
products or components that they currently buy from us. With Branded Products,
we face competition from a number of aftermarket control device competitors,
including Logitech, Targus and Kensington.
Many of the companies with whom we currently compete or may compete in
the future have long-standing customer relationships with key potential
customers. These competitors may develop or acquire enhanced technologies
sufficient to maintain or improve their market share. Moreover, competitive
pricing pressures on our OEM customers' products may force them to choose lower
cost, less sophisticated solutions from our competitors. We expect that our
success against our competition will depend on our ability use our technology,
experience and industry relationships to offer timely and effective solutions to
our customers.
EMPLOYEES
The Company had 202 employees as of December 31, 2005. Of that number,
127 are full-time employees in the United States with 118 at our corporate
offices and manufacturing facilities in California and 8 located at our regional
sales offices in the U.S. We have one employee in our regional sales office in
Canada, and five employees in our regional sales office in Taiwan. Our Japanese
subsidiary had 22 employees and 48 employees were associated with our Hong Kong
subsidiary.
AVAILABLE INFORMATION
We file annual reports, quarterly reports, proxy statements and other
information with the Securities and Exchange Commission ("SEC"). You may read
and copy any materials we file with the SEC at the SEC's Public Reference Room
at 100 F. Street, NE, Washington, DC 20549. You may obtain information on the
operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The
SEC maintains an Internet site that contains our reports, proxy statements, and
other information. The SEC's Internet address is http://www.sec.gov.
11
We also make available free of charge through our Internet website the
Company's annual reports on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and, if applicable, amendments to those reports as soon as
reasonably practical after we file such materials with the SEC
(http://www.interlinkelectronics.com). Information contained on the Company's
website is not part of this report or any other report filed with the SEC.
ITEM 1A. RISK FACTORS
WE ARE ENTERING NEW MARKETS AND IF WE FAIL TO ACCURATELY PREDICT THE GROWTH OF
THESE NEW MARKETS, WE MAY SUFFER REDUCED EARNINGS.
Historically, our sales were concentrated in the specialty components
markets, as well as remote control devices for presentation projectors. However,
we have devoted significant resources to the development of products and the
support of marketing and sales efforts in new markets, such as television
remotes and the e-transactions market. We expect to continue to identify and
develop products for new markets. These markets change rapidly and we cannot
assure you that they will grow or that we will be accurately able to forecast
market demand in time to respond appropriately. Our investment of resources in
these markets may either be insufficient to meet actual demand or result in
expenses that are excessive in light of actual sales volumes. Failure to predict
growth and demand accurately in new markets may cause us to suffer substantial
losses or reduced earnings.
OUR OEM REMOTE CONTROLS BUSINESS IS FOCUSED ON CONSUMER MARKETS THAT ARE
INTENSELY PRICE COMPETITIVE. IF WE CANNOT GENERATE VOLUME AND RELATED
MANUFACTURING EFFICIENCIES REQUIRED TO COMPETE IN THESE MARKETS, OUR RESULTS OF
OPERATIONS WILL BE ADVERSELY AFFECTED.
Historically, our OEM Remote Controls business was focused on selling
remote devices in the presentation projector market. As a specialty market, this
sector generated relatively low sales volumes with correspondingly high margins.
However the presentation projector market has become more consumer-oriented and
price competition has increased. We have shifted our OEM Remote Controls
business toward sales to manufacturers of advanced viewing devices which is also
very consumer-oriented and price competitive but which offers the potential for
higher volumes. If we cannot increase production and sales volume, or if we
otherwise fail to achieve production efficiencies, our results of operations and
financial position will be adversely affected.
FAILURE TO MAINTAIN, DEVELOP AND EXPAND OUR OEM RELATIONSHIPS COULD CAUSE DEMAND
FOR OUR PRODUCTS TO DECREASE.
Sales to OEMs constituted 30% of our total sales in 2005. If we fail to
maintain, develop and expand our relationships with significant OEMs, or if
those OEMs are not successful in their marketing and sales efforts, demand for
our products may decrease. For example, our OEM Remote Controls products are
sold to OEMs and consist primarily of remote devices that are packaged with
advanced viewing devices, televisions or presentation systems. If our OEM
customers experience a significant reduction in demand for advanced viewing
devices, televisions or presentation systems it will significantly decrease
demand for our remote devices.
Our ability to generate increased revenues also depends significantly
on the extent to which our OEM customers develop, promote and sell products that
incorporate our technology and products. If our OEM customers do not
successfully develop and market products that incorporate our products, sales of
our products to our OEM customers would be adversely affected. The extent to
which our
12
OEM customers develop, promote and sell our products is based on a number of
factors that are largely beyond our ability to control.
THE LOSS OF ANY SIGNIFICANT CUSTOMER OR ANY CANCELLATION, REDUCTION OR DELAY OF
A LARGE PURCHASE BY A SIGNIFICANT CUSTOMER COULD REDUCE OUR REVENUE AND REQUIRE
US TO WRITE-DOWN INVENTORY.
In 2005, approximately 52% of our total sales were to our OEM Remote
Controls customers and most of these sales were to OEM customers. With the
advent of our MICRONAV family of sensors, we expect that our reliance on OEM
sales will increase. The loss of any key OEM customers, or a significant
reduction in sales to those customers, could significantly reduce our revenue
below anticipated levels. From time to time, we expect to lose other significant
revenue streams and will be required constantly to seek new opportunities with
new and existing customers. Because our expense levels are based on our
expectations as to future revenue and are, to a large extent, fixed in the short
term, a substantial reduction or delay in sales of our products to an OEM
customer, the unexpected loss of any significant OEM or other customer, or
unexpected returns from customers, could harm our business.
FAILURE TO INCREASE MARKET AWARENESS AND ACCEPTANCE OF E-TRANSACTIONS AND OUR
E-TRANSACTION PRODUCTS MAY CAUSE OUR REVENUES IN THIS MARKET TO FALL SHORT OF
OUR EXPECTATIONS.
The prospects for our e-transactions business depend in part on the
acceptance by our target markets of electronic signatures as a replacement for
traditional pen and ink signatures. The market for e-transactions is new and
emerging and we cannot be certain that it will continue to develop or grow or
that businesses will elect to adopt our products rather than continuing to rely
on traditional pen and ink signatures. Businesses that have invested substantial
resources in traditional infrastructures may be reluctant to adopt an electronic
approach to replace their existing systems. Concerns about privacy and fraud may
cause businesses not to adopt e-transactions or our e-transaction products. We
expect that we will need to continue to pursue intensive marketing and sales
efforts to educate prospective customers about the benefits of e-transactions
and our e-transaction products. If market awareness and acceptance of
e-transactions do not occur, our revenues and profitability in this market will
fall short of our expectations.
SALES OF SIMPLE SIGNATURE CAPTURE DEVICES ARE GROWING RAPIDLY AND THE
MANUFACTURERS OF THESE DEVICES COULD BROADEN THEIR PRODUCT RANGE TO INCLUDE
PRODUCTS THAT COMPETE WITH OUR EPAD.
Simple signature capture devices have recently become a common sight at
retail checkout counters and a number of companies manufacture and sell these
devices. While our EPAD product is targeted at a more demanding market,
signature capture device manufacturers could elect to upgrade their existing
products in an effort to compete in our markets. Such competition could reduce
margins or otherwise adversely affect our prospects in our e-transactions
market.
IF WE ARE UNABLE TO KEEP PACE WITH RAPID TECHNOLOGICAL CHANGE AND GAIN MARKET
ACCEPTANCE OF NEW PRODUCTS, WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY.
Technology, both in our markets and in our customers' markets, is
undergoing rapid change. In order to maintain our leadership position in our
existing markets and to emerge as a leader in new markets, we will have to
maintain a leadership position in the technologies supporting those markets.
Doing so will require, among other things, the following:
o we must accurately predict the evolving needs of our customers
and develop, in a timely
13
manner, the technology required to support those needs;
o we must provide products that are not only technologically
sophisticated but are also available at a price within market
tolerances and competitive with comparable products;
o we must establish and effectively defend our ownership of the
intellectual property supporting our products; and
o we must enter into relationships with other companies that
have developed complementary technology on which our products
also depend.
We cannot assure you that we will be able to achieve any of these
objectives.
IF WE FAIL TO MANAGE OUR GROWTH SUCCESSFULLY, OUR OPERATIONS COULD BE ADVERSELY
IMPACTED AND OUR GROWTH COULD BE IMPAIRED.
The ability to operate our business in rapidly evolving markets
requires an effective planning and management process. We expect that growth in
our business will place a significant strain on our personnel, management
systems, infrastructure and other resources. Our ability to manage any potential
future growth effectively will require us to attract, train, motivate and manage
new employees, to integrate new employees into our overall operations and to
continue to improve our operational, financial and management controls and
procedures. If we are unable to implement adequate controls or integrate new
employees into our business in an efficient and timely manner, our operations
could be adversely affected and our growth could be impaired.
MOST OF OUR OEM AND MAJOR RETAIL CUSTOMERS ORDER FROM US ON A "JUST IN TIME"
BASIS, WHICH REQUIRES US TO ESTIMATE DEMAND FOR PARTICULAR PRODUCTS.
The agreements or understandings that we reach with most of our OEM
customers specify various terms such as product design and price, but do not
constitute firm purchase orders for a specific number of products or components.
Our OEM and major retail customers typically place firm purchase orders on a
"just in time" basis and expect products or components to be shipped to them as
soon as they can be made. Accordingly, our backlog of firm orders is typically
quite small in relation to the volume of our sales. In anticipation of customer
demand, we are often required to purchase raw materials and components based on
estimates of customer demand derived from non-binding information furnished by
the customer. If customer purchase orders differ substantially from our
estimates, we may accumulate excess inventory that has to be written off. If we
underestimate demand, we may be unable to meet customer needs, which could harm
our relationship with the customer.
WE RELY ON THIRD PARTIES FOR THE MATERIALS THAT WE USE TO MANUFACTURE OUR
PRODUCTS AND A SHORTAGE OF SUPPLY COULD ADVERSELY AFFECT OUR REVENUES, OPERATING
RESULTS AND CUSTOMER RELATIONSHIPS.
We rely on third-party suppliers for the raw material components of our
products. We cannot assure you that our suppliers will be able to maintain an
adequate supply of these raw materials to enable us to fulfill all of our
customers' orders on a timely basis. A failure to obtain an adequate supply of
the materials for our products could increase our costs of goods sold, cause us
to fail to meet delivery commitments and cause our customers to purchase from
our competitors, which could adversely affect our operating results and customer
relationships. In some situations, we rely on a single supplier for raw material
components of our products. Any disruption in these supplier
14
relationships could prevent us from maintaining an adequate supply of materials
and could adversely affect our results of operation and financial position.
DISRUPTIONS IN OUR MANUFACTURING FACILITIES OR ARRANGEMENTS COULD CAUSE OUR
REVENUES AND OPERATING RESULTS TO DECLINE.
We manufacture all of our FSR sensors at our Camarillo, California
facility. This facility is vulnerable to damage from earthquakes, floods, fires,
power loss and similar events. It could also be subject to break-ins, sabotage
and intentional acts of vandalism. Our insurance may not cover such events and,
if the event is covered, our insurance may not be sufficient to compensate us
for any losses that may occur. Despite any precautions we may take, the
occurrence of a natural disaster or other unanticipated problem at our
manufacturing facility could result in delayed shipment of products, missed
delivery deadlines and harm to our reputation, which may cause our revenues and
operating results to decline.
All of our non-FSR product manufacturing is currently done by third
parties in China identified and managed through our Hong Kong subsidiary. We
rely on our subsidiary to select and contract with contract manufacturers with
suitable manufacturing facilities and appropriately trained employees. An
interruption in our current manufacturing arrangements could adversely affect
our revenues, operating results and customer relationships.
PERFORMANCE, RELIABILITY OR QUALITY PROBLEMS WITH OUR PRODUCTS MAY CAUSE OUR
CUSTOMERS TO REDUCE OR CANCEL ORDERS WHICH WOULD HARM OUR OPERATING RESULTS.
We regularly introduce new products with new technologies or
manufacturing processes. Our products have in the past contained, and may in the
future contain, errors or defects that may be detected at any point in the life
of the product. Detection of such errors could result in delays in shipping and
sales during the period required to correct such errors. Defects may also result
in product returns, loss of sales and cancelled orders, delays in market
acceptance, injury to our reputation, injury to customer relationships and
increased warranty costs, which could have an adverse effect on our business,
operating results and financial condition.
INTERNATIONAL SALES AND MANUFACTURING RISKS COULD ADVERSELY AFFECT OUR OPERATING
RESULTS.
Our revenue from international sales accounted for approximately 55%,
60% and 51% of net sales for 2005, 2004 and 2003, respectively. We believe that
international sales will represent a substantial portion of our sales for the
foreseeable future. Our non-FSR manufacturing is currently performed by third
parties in China. Our international operations involve a number of risks,
including:
o import-export license requirements, tariffs, taxes and other
trade barriers;
o difficulty in staffing and managing foreign operations;
o ability to secure credit and funding;
o difficulty in maintaining an effective system of internal
controls at our foreign manufacturing facility;
o foreign collection problems;
o reduced protection of intellectual property rights;
o international unrest and terrorism;
15
o political and economic instability; and
o transportation risks.
Any of the above factors could adversely affect our operating results.
OUR OPERATING RESULTS COULD BE ADVERSELY AFFECTED BY FLUCTUATIONS IN THE VALUE
OF FOREIGN CURRENCIES.
International sales made through our Japanese subsidiary are generally
denominated in yen. A weak yen would materially affect total revenue and could
result in a decrease in dollar revenue even though sales remained constant or
increased. We also contract for most of our large-volume, non-technical
manufacturing in China. Although we contract in U.S. dollars, a weakening of the
dollar could cause existing contracts to be uneconomic to the vendor and
therefore require a renegotiation. Over the past two years, the valuations of
many foreign currencies have fluctuated significantly relative to the U.S.
dollar. The Japanese yen, in particular, has fluctuated in value due in part to
the economic problems experienced by Asian countries and the recent devaluation
of the U.S. dollar. Although we at times engage in currency hedging transactions
in order to protect ourselves from risks of Japanese yen currency fluctuations,
we cannot assure you that these activities will protect us from such risks.
OUR MARKETS ARE INTENSELY COMPETITIVE AND MANY OF OUR POTENTIAL COMPETITORS HAVE
RESOURCES THAT WE LACK.
Our markets are competitive and we expect competition in our newer
markets to increase. Our competitors include companies with similar products or
technologies, companies that sell complementary products to our target markets
and our OEM customers themselves, who could choose to manufacture products that
they currently buy from us. Our competitors and potential competitors may have
established business relationships that may afford them a competitive advantage
or may create technologies that are superior to ours or that set a new industry
standard that will define the successful product for that market. If any of our
competitors establish a close working relationship with our customers, they may
obtain advance knowledge of our customers' technology choices or may be afforded
an opportunity to work in partnership to develop compatible technologies and may
therefore achieve a competitive advantage. We may be unable to compete
successfully against our current and future competitors.
OUR PRODUCTS ARE OFTEN CUSTOMER-SPECIFIC, AND FROM TIME TO TIME WE MAY NEED TO
WRITE OFF EXCESS OR OBSOLETE INVENTORY.
A substantial percentage of our intuitive interface devices and
components are customer-specific and cannot be easily recycled for sale to other
customers. However, we must have sufficient quantities of our products available
to satisfy our customers' demands. If a particular customer fails to order as
expected or cancels or substantially delays an order, we may have excess
inventory that we may be required to hold for long periods of time or that may
eventually become obsolete. In these situations, we may be required to write off
or write down inventory, which would have a material adverse effect on our
results of operations.
16
EARLY IMPLEMENTATION OF THE RESTRICTION ON HAZARDOUS SUBSTANCES ACT OF 2002
("ROHS") OR THE ADOPTION OF SIMILAR RESTRICTIONS IN MARKETS OUTSIDE OF EUROPE
MAY REQUIRE US TO MAKE ADDITIONAL WRITE-DOWNS OF OUR INVENTORY.
When it goes into effect, the ROHS will limit the use of certain
restricted raw materials in production of consumer goods that are sold in
Europe. Many of these restricted materials are found in our products and in the
components we have in our inventory. Although the ROHS is not effective until
late 2006, many of our OEM customers are implementing the ROHS restrictions
early and are requiring our products to be ROHS-compliant. We previously
determined that we would not be able to adequately reduce our inventory of
non-compliant materials and, as a result, we recorded an expense of $900,000 to
create a reserve for obsolescence. While we currently believe our reserve is
adequate, we may need to reassess it if other OEM customers begin demanding
ROHS-compliant products prior to the effective date of ROHS or if other markets
adopt similar restrictions.
OUR ABILITY TO OPERATE EFFECTIVELY COULD BE IMPAIRED IF WE WERE TO LOSE THE
SERVICES OF KEY PERSONNEL, OR IF WE ARE UNABLE TO RECRUIT QUALIFIED MANAGERS AND
KEY PERSONNEL IN THE FUTURE.
Our success is substantially dependent on the continued availability of
our key management and technical personnel, including the employees listed in
the management table appearing later in this Annual Report. Several of our key
management personnel have been with us throughout most of our history and have
substantial experience with our business and technology. If one or more of our
key management personnel leaves Interlink and we are unable to find a
replacement with the combination of skills and attributes necessary to execute
our business plan, it may have an adverse impact on our business. Our success
will also depend, in part, on our ability to attract and retain additional
qualified professional, technical, production, managerial and marketing
personnel, both domestically and internationally.
IF OUR PRODUCTS DO NOT SUPPORT EVOLVING INDUSTRY STANDARDS, THEY MAY NOT ACHIEVE
OR MAINTAIN MARKET ACCEPTANCE AND OUR REVENUES MAY DECLINE.
Our wireless communication products must communicate using whatever
communication protocol is chosen by the customer. Supporting a particular
communication protocol requires specific technical expertise and we expect that
we will be required to establish and maintain such expertise with respect to
each commonly used communication protocol. New communication protocols are
constantly under development and we may fail to acquire the necessary experience
to support a popular new protocol or to respond to changes in an existing
protocol. In our e-transactions business, our customers will expect that our
products will enable them to comply with applicable requirements relating to
electronic signatures, such as the Electronic Signatures in Global Commerce Act
and procedures adopted by the National Notary Association. If our products do
not support these requirements, sales of our e-transactions products would be
adversely affected.
IF WE ARE NOT ABLE TO PROTECT OUR INTELLECTUAL PROPERTY OR IF WE INFRINGE ON THE
INTELLECTUAL PROPERTY OF OTHERS, OUR BUSINESS AND OPERATING RESULTS COULD BE
ADVERSELY AFFECTED.
We consider our intellectual property to be a key element of our
ability to compete in our chosen markets. We rely on a combination of patents,
trade secrets and proprietary software to establish and protect our intellectual
property rights. We cannot assure you that patents will be issued from any of
our pending applications or that any claims allowed from existing or pending
patents will be sufficiently broad to protect our technology. We also cannot
assure you that any patents issued to us will not be challenged, invalidated or
circumvented, or that the rights granted will provide
17
proprietary protection. Litigation may be necessary to enforce our patents,
trade secrets and other intellectual property rights, to determine the validity
and scope of the proprietary rights of others or to defend against claims of
infringement. Such litigation could result in substantial costs and diversion of
resources and could have a material adverse effect on our business, regardless
of the final outcome of the litigation.
We are not currently engaged in any patent infringement suits but we
have been threatened with one such suit in recent years. Despite our efforts to
maintain and safeguard our proprietary rights, we cannot assure you that we will
be successful in doing so or that our competitors will not independently develop
or patent technologies that are substantially equivalent or superior to our
technologies. If any of the holders of these patents assert claims that we are
infringing them, we could be forced to incur substantial litigation expenses or
to pay substantial royalties. In addition, if we were found to be infringing on
someone else's patent, we could be required to pay substantial damages, pay
royalties in the future and/or be enjoined from infringing in the future.
WE RELY ON OTHERS FOR ASPECTS OF OUR TECHNOLOGY DEVELOPMENT.
Our in-house research and development expertise is focused on our
sensor and communication technologies. We do not have broadly based expertise in
software development, chip design or other critical technological aspects of a
complete product. We rely on other companies with whom we may contract or enter
into joint development agreements to provide these aspects of our product
technologies. We cannot assure you that we will be able to contract or otherwise
arrange for these services in the future. We also cannot assure you that a
developer with whom we contract for technology will not use or permit others to
use similar technology in competition with us.
WE ARE A PUBLIC COMPANY AND ARE THEREFORE REQUIRED TO INCUR COSTS AND TO
DISCLOSE INFORMATION THAT PRIVATE COMPANIES ARE NOT REQUIRED TO INCUR OR
DISCLOSE.
As a public company, we are required to comply with complex and costly
accounting and disclosure requirements that do not apply to foreign companies
that are not public in the United States, private companies or to subsidiaries
or divisions of very large companies for whom the results of the subsidiary or
division are not material. The costs that we are required to incur have recently
increased dramatically, especially in connection with our reporting obligations
under Section 404 of the Sarbanes-Oxley Act of 2002, and these expenses may
continue to be incurred at historically unprecedented levels for the foreseeable
future. These costs impact our profitability and therefore constitute a
competitive disadvantage vis-a-vis much of our competition. These requirements
may also prevent our management from focusing on other areas of our business. In
addition, our public status requires us to disclose publicly information that
can afford a competitor a competitive advantage. If we are unable to maintain
costs associated with our public company status within reasonable parameters, or
if we are required to disclose information that our competitors can use to
compete with us, our ability to remain competitive in our markets could be
adversely affected.
BUSINESS ACQUISITIONS OR PARTNERING ARRANGEMENTS MAY DISRUPT OUR BUSINESS,
DILUTE SHAREHOLDER VALUE AND DISTRACT MANAGEMENT'S ATTENTION.
As part of our business strategy, we may consider acquisitions of, or
significant investments in, businesses with services, products or technologies
that we believe could complement or expand our business. Such acquisitions or
investments involve numerous risks, including:
o unanticipated costs and liabilities;
18
o difficulty of integrating the operations, products and
personnel of the acquired business;
o difficulties in managing the financial and strategic position
of acquired or developed products and technologies;
o difficulties in maintaining customer relationships;
o diversion of management's attention;
o inability to maintain uniform standards, controls, policies
and procedures;
o impairment of relationships with acquired employees and
customers occurring as a result of integration of the acquired
business; and
o accounting results that are unrelated to the performance of
either business.
Acquisitions also frequently result in recording of goodwill and other
intangible assets that are subject to potential impairments in the future.
Additionally, if we finance acquisitions by using convertible debt or stock, our
existing stockholders may be diluted which could affect the market price of our
stock. If we fail to properly evaluate and execute acquisitions or investments,
we may not achieve the anticipated additional benefit to our business, and we
may incur costs in excess of what we anticipate.
WE HAVE IDENTIFIED MATERIAL WEAKNESSES IN OUR INTERNAL CONTROL OVER FINANCIAL
REPORTING AND HAVE BEEN REQUIRED TO RESTATE OUR HISTORICAL FINANCIAL STATEMENTS.
In our Annual Report for the year ended December 31, 2004, we reported
material weaknesses in our internal control over financial reporting. Additional
material weaknesses were identified in 2005. As a result of these material
weaknesses, we were required to restate several of our historical financial
statements. We have taken significant measures to improve our financial
reporting process but, despite these measures, continued to have material
weaknesses as of December 31, 2005. As a result, management and our auditors
have concluded that our internal control over financial reporting was
ineffective as of December 31, 2005. These matters are more fully described
elsewhere in this report under the captions "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and "Controls and
Procedures--Internal Control Over Financial Reporting."
Any continuing material weaknesses in our internal control over
financial reporting could result in errors in our financial statements. Such
errors could cause our internal planning and assessment of our business to be
based on false information and could cause our published financial statements to
fail to fairly present our financial condition and results of operations. We
cannot assure you that we will be successful in our effort to eliminate all
material control weaknesses. Any continuing material weaknesses could erode
market confidence in our company, could cause the price of our stock to be based
on false or misleading information and could result in litigation based on any
such false or misleading information.
WE ARE FACING LITIGATION BASED ON OUR RESTATEMENTS OF HISTORICAL FINANCIAL
STATEMENTS, WHICH MAY HAVE A MATERIAL ADVERSE IMPACT ON OUR CASH RESERVES AND
MAY IMPAIR OUR ABILITY TO ACHIEVE OUR BUSINESS OBJECTIVES.
Certain former Interlink stockholders have filed a class action lawsuit
claiming damages under various securities laws based on our restatement of
historical financial statements. Other stockholders have brought a derivative
action against our Chief Executive Officer, our former Chief Financial
19
Officer and our directors, alleging mismanagement. These actions will require a
vigorous defense and could result in a settlement or adverse award that is not
covered by insurance or that exceeds applicable insurance limits. The time and
expense required to defend these claims may also affect our cash resources and
ability to pursue our strategy. There is also no assurance that the ultimate
resolution of these matters will not result in a material adverse effect on our
business, financial condition or results of operations.
ITEM 2. PROPERTIES
Our corporate offices and principal manufacturing facilities are
located in a 44,110 square foot leased facility in Camarillo, California. The
lease on the Camarillo premises runs until February 28, 2010 (with one option to
extend for an additional sixty month period) and provides for a monthly rent
payment of $29,113 with a 3% annual increase. Our Japanese subsidiary, Interlink
Electronics, K.K., leases office space in Tokyo, Japan. Our Hong Kong
subsidiary, Interlink Electronics Asia Pacific Limited, leases office space in
Hong Kong and warehouse space in Hong Kong and mainland China.
ITEM 3. LEGAL PROCEEDINGS
On November 15, 2005, a class action alleging violations of federal
securities laws was filed against the Company and two of its current and former
officers in the United States District Court for the Central District of
California. The complaint alleges that, between April 24, 2003 and November 1,
2005, the Company and two of its current and former officers made false and
misleading statements and failed to disclose material information regarding the
Company's results of operations and financial condition. The complaint includes
claims under the Securities Act and Exchange Act and seeks unspecified damages
and legal expenses.
To date, the Court has not certified a class, and the litigation
remains in its early stages.
On January 24, 2006, a shareholder's derivative action was filed
against two of the Company's current and former officers and the members of its
Board of Directors in the Central District of California. The derivative
complaint contains the same factual allegations as the class action complaint
and sought to recover unspecified damages from the defendants, as well as
forfeiture of their equity-based compensation and contribution from them in the
event that the Company is found to have violated the federal securities laws.
Following a motion made by the defendants to dismiss, or in the alternative,
stay the derivative action, the plaintiff voluntarily dismissed the derivative
action without prejudice on June 14, 2006.
In connection with the class action and the derivative proceedings
described above, an independent investigation was undertaken at the direction of
the Audit Committee by Dorsey & Whitney, LLP. Dorsey & Whitney retained the
services of PricewaterhouseCoopers LLP with respect to various forensic
accounting and electronic procedures performed in the course of the
investigation. The internal investigation and findings are discussed in more
detail in "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
While it intends to vigorously defend against these allegations, the
Company cannot predict the final disposition of these matters or whether the
Company will be liable for amounts not covered by insurance. There is no
assurance, however, that the ultimate resolution of these matters will not
result in a material adverse effect on the Company's business, financial
condition or results of operations.
20
In addition to the matters identified above, from time to time, the
Company is involved in various legal actions that arise in the ordinary course
of business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders, through
the solicitation of proxies or otherwise, during the fourth quarter of the year
ended December 31, 2005.
21
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The following table contains information as of July 15, 2006 with
respect to each person who is an executive officer of Interlink:
NAME AGE POSITION
------------------------------- --- --------------------------------------
E. Michael Thoben, III......... 52 President, Chief Executive Officer and
Chairman of the Board
Charles C. Best................ 46 Chief Financial Officer and
Secretary
Michael W. Ambrose............. 47 Senior Vice President,
Technology & Product Development
E. MICHAEL THOBEN, III has served as Interlink's president, chief
executive officer and chairman of the board of directors since 1994. From 1990
to 1994, he served as Interlink's president and a director. Prior to joining
Interlink in 1990, Mr. Thoben was employed by Polaroid Corporation for 11 years,
as the manager of one of Polaroid's seven strategic business units on a
worldwide basis. Mr. Thoben holds a B.S. degree from St. Xavier University and
has taken graduate management courses at the Harvard Business School and The
Wharton School of Business.
CHARLES C. BEST has served as Interlink's chief financial officer and
secretary since August 2005. Mr. Best joined Interlink Electronics, Inc. in June
2005 as the vice president of finance. From June 2004 to April 2005, Mr. Best
worked for Celetronix USA, Inc., an electronics service manufacturer, as the
vice president and corporate controller. From December 1999 through May 2004,
Mr. Best served as executive vice president and chief financial officer of
BioSource International, Inc., a biotech reagent company. Mr. Best served four
and a half years as vice president and chief financial officer of Cogent Light
Technologies, Inc., a company engaged in the manufacture of surgical lighting
instruments. From 1989 to 1995, Mr. Best worked in various positions including
corporate controller for 3D Systems, Inc., a company engaged in the manufacture
and sale of high tech rapid prototyping equipment. Mr. Best is a certified
public accountant and holds a B.S. degree in business administration and
accounting from San Diego State University.
MICHAEL W. AMBROSE has served as Interlink's vice
president--engineering since June 1999. Between March 1998 and June 1999, he was
director of engineering. From August 1995 to February 1998, Mr. Ambrose served
as the director of marketing of Communication Intelligence Corp., a computer
software company specializing in software for mobile computing, e-signatures and
computer security. Prior to August 1995, he was employed by Logitech Inc., a
computer peripherals company, as the general manager of its Gazelle Business
Unit and as vice president of product marketing for Gazelle Graphic Systems. Mr.
Ambrose holds a B.S. degree in electrical engineering from Washington State
University.
22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.
As of April 10, 2006, our common stock trades on the OTC Bulletin Board
under the symbol "LINK.PK." Prior to April 10, 2006, our common stock traded on
the Nasdaq National Market under the symbol "LINK." The following table sets
forth the high and low closing prices for the common stock as reported on the
OTC Bulletin Board and the Nasdaq National Market for the quarters indicated, as
applicable. These prices do not include retail markups, markdowns or
commissions.
LOW HIGH
----- ------
YEAR ENDED DECEMBER 31, 2004
First Quarter............................................. $6.45 $12.15
Second Quarter............................................ 7.43 12.37
Third Quarter............................................. 7.31 9.99
Fourth Quarter............................................ 7.55 9.94
YEAR ENDED DECEMBER 31, 2005
First Quarter............................................. $6.14 $7.09
Second Quarter............................................ 5.06 5.80
Third Quarter............................................. 5.02 5.50
Fourth Quarter............................................ 2.95 3.68
On June 30, 2006, the closing price of our common stock on the OTC
Bulletin Board was $3.15. As of June 30, 2006 there were approximately 59
stockholders of record of our common stock. We believe the number of beneficial
owners is substantially greater than the number of record holders because a
large portion of Interlink's outstanding common stock is held of record in
broker "street names" for the benefit of individual investors. As of June 30,
2006, there were 13,774,126 shares outstanding.
We have never declared or paid cash dividends on our common stock.
Payment of any cash dividends will depend on the results of our operations, our
financial condition and our capital expenditure plans, as well as other factors
our board of directors may consider relevant. We presently intend to retain any
earnings for use in our business and, therefore, do not anticipate paying any
cash dividends in the foreseeable future.
ISSUER PURCHASES OF EQUITY SECURITIES MADE DURING THE FOURTH QUARTER OF FISCAL
2005
We did not repurchase any shares of our stock in the fourth quarter of 2005.
23
ITEM 6. SELECTED FINANCIAL DATA.
The selected financial data presented below was derived from the
audited consolidated financial statements of the Company. Our consolidated
financial statements as of and for the years ended December 31, 2005, 2004 and
2003 were audited by BDO Seidman, LLP and our consolidated financial statements
as of and for the years ended December 31, 2002 and 2001 were audited by other
auditors. The data presented below should be read in conjunction with
Management's Discussion and Analysis of Financial Conditions and Results of
Operations, the financial statements and the notes thereto and the other
financial information included therein. Historical results are not necessarily
indicative of future performance.
Year Ended December 31,
--------------------------------------------------------
2005 2004(3) 2003(3) 2002(3) 2001(3)
-------- -------- -------- -------- --------
(In thousands, except per-share data)
CONSOLIDATED STATEMENT OF
OPERATIONS DATA:
Revenues ......................... $ 38,239 $ 35,406 $ 31,042 $ 25,042 $ 25,265
Cost of revenues ................. 30,181 24,811 19,676 16,959 16,454
-------- -------- -------- -------- --------
Gross profit ..................... 8,058 10,595 11,366 8,083 8,811
Operating expenses:
Product development and research 4,586 4,158 3,418 3,336 3,518
Selling, general and
administrative ............... 11,844 10,238 8,172 7,457 10,637
-------- -------- -------- -------- --------
Total operating expenses ..... 16,430 14,396 11,590 10,793 14,155
-------- -------- -------- -------- --------
Operating loss ................... (8,372) (3,801) (224) (2,710) (5,344)
-------- -------- -------- -------- --------
Other income (expense):
Minority interest .............. -- -- -- 68 (12)
Interest income (expense), net . 162 15 (44) (132) 174
Other .......................... (95) 17 48 (23) 45
-------- -------- -------- -------- --------
Total other income (expense) 67 32 4 (87) 207
-------- -------- -------- -------- --------
Loss before provision for income
tax expense (benefit) .......... (8,305) (3,769) (220) (2,797) (5,137)
Provision for income tax expense
(benefit)(2) ................... -- -- 28 1,301 (764)
-------- -------- -------- -------- --------
Net loss ......................... $ (8,305) $ (3,769) $ (248) $ (4,098) $ (4,373)
======== ======== ======== ======== ========
Loss per share-basic(1)(2) ....... $ (0.61) $ (0.31) $ (0.02) $ (0.42) $ (0.45)
Loss per share-diluted(1)(2) ..... $ (0.61) $ (0.31) $ (0.02) $ (0.42) $ (0.45)
Weighted average shares-basic(1) . 13,721 11,972 10,339 9,766 9,645
Weighted average shares-diluted(1) 13,721 11,972 10,339 9,766 9,645
DECEMBER 31,
--------------------------------------------------------
2005 2004(3) 2003(3) 2002(3) 2001(3)
-------- -------- -------- -------- --------
CONSOLIDATED BALANCE SHEET DATA: (In thousands)
Working capital $ 22,952 $ 30,455 $ 18,873 $ 16,414 $ 19,333
Total assets 33,171 39,948 25,582 21,766 26,641
Short term debt 154 491 706 933 1,923
Long term debt 154 405 1,010 1,401 1,855
Stockholders' equity 24,272 32,091 19,370 16,300 17,943
----------
(1) As adjusted for the three-for-two stock split effected as a stock
dividend to stockholders of record on March 20, 2000.
(2) Adjustments to provisions for income tax expense during these periods
have fluctuated due to the deferred tax asset valuation allowance. This
has affected the comparability of net income (loss) and earnings per
share amounts.
(3) As restated.
24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
We develop, manufacture, market and sell intuitive interface devices
and components for a variety of business and home applications worldwide. We
generate revenues from the sale of our hardware products, including pen input
and signature pads, integrated cursor control devices and interactive remote
input devices. To a lesser but increasing extent, we derive revenue from the
sale of software combined with our hardware. Depending on the application, this
software may be internally developed or purchased from software partners.
We record our revenue in four market segments: e-transactions (input
devices for the electronic signature markets); specialty components (integrated
FSR-based sensors, subassemblies and modules that support cursor control and
other input functions); OEM remote controls (wireless intuitive input device and
sensor products for use with presentation projectors and advanced viewing
devices) and Interlink branded products (aftermarket remote control devices sold
through retail channels). We have addressed our specialty components market
since our inception in 1985. Our other three markets have evolved out of our
specialty components market. We have addressed our OEM remotes market as a
separate market since 1994 and separately since 2005, branded products since
1994 and our e-transactions market since 1999. The relative revenue and gross
profit contributions of each of these segments is provided below in RESULTS OF
OPERATIONS-BUSINESS SEGMENT OVERVIEW.
2005 OVERVIEW
In 2005, we achieved modest overall revenue growth, compared to 2004,
principally as a result of an increase in e-transactions revenue. Revenues from
OEM remotes, historically our largest market, was flat, compared to 2004, as a
result of a decrease in sales of business communication products and an
offsetting increase in sales of advanced viewing device products. In November
2005, we announced a restructuring of our OEM remotes business as a result of
adverse trends in the presentation projector market. In the restructured
business we are pursuing new orders for OEM remote controls on a more selective
basis and therefore expect to see a continuing decline in revenue from the
presentation projector market offset by an increase in controllers for advanced
viewing devices. We are continuing our emphasis on our e-transactions and
specialty components markets and expect to continue to achieve strong revenue
growth in those markets. In the specialty components market, we are continuing
to emphasize our MICRONAV sensors for use in small, battery operated devices
such as digital music players and cell phones.
We continued to be challenged in 2005 by decreasing margins in our OEM
remotes business and by increases in general and administrative costs, compared
to 2004. The decreasing margins are a result of competitive market pressures in
the lower end of the OEM presentation projector market. The increase in general
and administrative costs is due primarily to increases in accounting personnel
and consultants required to deal with the need to restate various historical
financial statements and to add internal accounting capability in order to
achieve an adequate system of internal controls over financial reporting. We
expect the increased general and administrative cost to continue, although
possibly at lower levels than in 2004 and 2005, and therefore seek to reduce it
over time as a percentage of revenue by increasing revenue in the markets we are
emphasizing.
Cash and cash equivalents at December 31, 2005 totaled $13.9 million.
We consumed $5.1 million of cash in 2005 primarily to fund our 2005 operations.
25
OUTLOOK
We expect continued growth in our e-transactions market as our products
continue to set the standard for advanced e-transaction support and more
companies make decisions to automate their document process. In addition to
growth in unit sales, we expect to achieve revenue growth as a result of
continuing functionality enhancements, such as the addition of thumbprint, voice
and other recognition technologies. As has been the case in the past, we expect
revenue in this sector to fluctuate on a quarterly basis as sales tend to be in
the form of a relatively small number of large contracts.
We expect our specialty products market to experience steady annual
growth based on our MICRONAV sensor products. In 2004 we had some important
initial design wins and we continued in 2005 to expand our target markets,
including most notably the cell phone market. Actual results will depend not
only on our success in convincing customers to incorporate our sensors in their
products but also on the success of the products in which our sensors are
incorporated, Accordingly, we believe that the amount of growth in this sector
is difficult to predict.
We expect our OEM remotes business to experience flat to moderate
growth in 2006 as a result of continuing decline in sales of our remotes to
presentation projector manufacturers offset by an increase in sales of advanced
viewing device remotes. We intend to pursue this market selectively with a view
to achieving improved margins.
With the exception of the fourth quarter of 2005, our branded business
communication business has been growing since we implemented a new distribution
plan in 2004. We expect year over year growth to continue in 2006.
As previously noted, we experienced substantial increases in general
and administrative costs in 2004 and 2005, primarily the result of new and
complex financial control requirements and associated audit costs and a
substantial build-up in our internal accounting capability. We expect general
and administrative costs could continue to increase as the company continues to
improve its infrastructure and comply with regulatory requirements.
Additionally, a number of the opportunities that we are considering involve
investments in technology, infrastructure or both. Based on these issues, we do
not expect that the company will achieve profitability in 2006.
We are involved in class action and derivative proceedings based on our
recent restatements. In connection with that litigation, we may be liable for
costs, expenses or other amounts not covered by insurance.
We expect to use current cash to fund our operations in 2006. As a
result of the pursuit of new opportunities, the funding of continued operating
losses or the litigation described above, we may find it advisable to raise
additional capital through financings to increase our cash resources. There is
no assurance that such financings will be possible or on terms attractive to
existing investors.
CURRENT OPPORTUNITIES AND CHALLENGES
Our principal challenge is to manage margins in our OEM remotes
business while continuing to invest in our e-transactions and specialty products
businesses as they grow to achieve the revenue levels that will sustain and
justify our investments in them. As our business becomes more diverse and
complex, we face challenges in adapting our internal accounting systems to meet
new challenges. Our ability to manage these businesses will define the level of
our success over the next two to three years.
26
Management faces the constant challenge of balancing its investment in
new technology, product development marketing initiatives and enhanced
infrastructure and regulatory costs, against the objective of steady earnings
growth. A decision to make a significant investment in a new technology, product
or marketing effort may have a short-to-medium term negative impact on earnings
even if the investment proves to be justified. We are considering investments in
technologies and infrastructure that will increase operating costs and, in the
short term, decrease margins and negatively impact earnings. We are looking at a
number of ways to make these investments including internal development,
acquisitions and partnering with others. We may be constrained in pursuing some
of these options by our cash position.
FORWARD LOOKING STATEMENTS
This Report, including the two immediately preceding sections, contains
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. In many cases, you can identify forward-looking
statements because they describe management's intentions or expectations with
respect to future events or future possibilities. Such statements involve
inherent risks and uncertainties, many of which are described in the section
entitled "Risk Factors" in this Report. It is likely that, as a result of such
risks and uncertainties, management's assessment of future events and the
forward-looking statements contained in this Report will prove to be incorrect.
As a result, while such statements may be relied on as a reflection of
management's expectations as of the date of this Report, they should not be read
as constituting any assurance that such expectations will be realized or that
management's expectations will not change.
QUARTERLY FINANCIAL PERFORMANCE
The following table presents certain financial information for each of
the following quarters:
QUARTER ENDED (UNAUDITED)
(In thousands except per share data)
-------------------------------------------------------------------------------------------------------------------
DEC. SEPT. JUN. MAR. DEC. SEPT. JUN. MAR. DEC. SEPT.
31, 30, 30, 31, 31, 30, 30, 31, 31, 30,
2005 2005 2005(1) 2005(1) 2004(1) 2004(1) 2004(1) 2004(1) 2003(1) 2003(1)
-------------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Revenues ..... $ 8,484 $ 10,223 $ 10,263 $ 9,269 $ 9,682 $ 9,556 $ 8,232 $ 7,936 $ 8,716 $ 7,848
-------------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Gross Profit . $ 1,691 $ 1,292 $ 1,819 $ 3,256 $ 2,190 $ 2,088 $ 3,183 $ 3,134 $ 2,025 $ 3,285
-------------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Net Income
(loss) ...... $ (3,256) $ (2,689) $ (1,961) $ (398) $ (2,067) $ (1,690) $ (78) $ 66 $ (907) $ 238
-------------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Earnings
(loss) per
share -
basic ...... $ (0.24) $ (0.20) $ (0.14) $ (0.03) $ (0.15) $ (0.15) $ (0.01) $ 0.01 $ (0.08) $ 0.02
-------------- -------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Earnings
(loss) per
share -
diluted .... $ (0.24) $ (0.20) $ (0.14) $ (0.03) $ (0.15) $ (0.15) $ (0.01) $ 0.01 $ (0.08) $ 0.02
-------------------
JUN. MAR.
30, 31,
2003 2003
-------------- -------- --------
Revenues ..... $ 7,476 $ 7,002
-------------- -------- --------
Gross Profit . $ 3,126 $ 2,930
-------------- -------- --------
Net Income
(loss) ...... $ 181 $ 240
-------------- -------- --------
Earnings
(loss) per
share -
basic ...... $ 0.02 $ 0.02
-------------- -------- --------
Earnings
(loss) per
share -
diluted .... $ 0.02 $ 0.02
(1) As restated
27
Quarterly revenues have increased by 21% on a cumulative basis since
March 2003. Sequential growth occurred in each quarter of 2003. The first
quarter of 2004 showed a decline in revenues compared to the fourth quarter of
2003 but we then showed sequential growth for the following year. The first
quarter of 2005 also saw a decline in revenues from the fourth quarter of 2004,
but we then showed sequential growth for the next two quarters. The fourth
quarter of 2005 saw a decline in revenues due in part to lower sales to our
branded products channel and distributor partners as we began a program to
better align our operational activities and manufacturing flow more evenly
throughout each quarter. This allowed for more operational efficiencies and will
more strongly align our partner relationships to our operational strategies.
Our gross profit has fluctuated over the past twelve quarters.
Quarterly gross profit in 2003 ranged from 23% to 42% with the fourth quarter's
margin of 23% being affected by a write off of approximately $1.2 million
related to a certain vendor receivable as discussed in more detail below. For
2004, quarterly gross profits as a percentage of sales ranged from 22% to 40%,
with the third and fourth quarters of 2004 gross margins being affected by
higher material costs due to the ramp up of remote control sales of our home
entertainment market segment. Margins for 2005 were lower in the last half of
the year compared to the first two quarters of the year due to increased costs
associated with the introduction of new EPAD products and due to additional
inventory reserves related to excess and obsolete inventory resulting from the
slowdown in the OEM segments of our business.
Earnings generally remained flat in 2003 with the exception of the
fourth quarter, which was impacted by the $1.1million charge to cost of sales as
noted below. For the first quarter of 2004, we experienced marginal net income.
We have experienced net losses since the second quarter of 2004. During this
period revenue has continued to be relatively steady and strong, while gross
profits and earnings have been impacted by revenues being derived from sales of
wireless input devices on which we earn lower margins. We have also been
impacted by substantially increased selling, general and administrative expenses
as we incurred financial and accounting costs required by new legislation and in
building a more robust finance and accounting infrastructure.
On March 9, 2005, we reported the restatement of our financial
statements for the first three quarters of 2004. The restatements were due to a
misinterpretation of the revenue recognition guidelines regarding a "bill and
hold" product sale in the first quarter of 2004. The resulting restatements
decreased revenues in the first quarter of 2004 by $498,000 and increased
revenues by $74,000 and $114,000 in the second and third quarters of 2004,
respectively. Gross profit and net income were reduced in the first quarter of
2004 by $218,000 and increased by $33,000 and $50,000 in the second and third
quarters of 2004, respectively. Also, in the third quarter of 2004, we
underestimated the ramp up costs and low yields of the start up of our high
volume home entertainment remote control business and overstated inventory and
the amount of manufacturing overhead allocable to inventory. The resulting
restatement increased cost of sales and decreased inventory by $1.2 million and
resulted in a net decrease to gross profit and net income of $1.1 million in the
third quarter of 2004.
On November 2, 2005, we reported our intention to make additional
restatements to our financial results for the years ended December 31, 2003 and
December 31, 2004 and the first two quarters of 2005. The additional
restatements reflect adjustments to correctly account for the following four
items:
o The first item involves a key vendor and was identified in a
recent reconciliation of accounts with that vendor. This issue
relates to a net write-off of $1.1 million of certain
28
receivables primarily originating in the fourth quarter of
2003 due from the vendor, with $167,000 of that amount
originating in the fourth quarter of 2002, and the recording
of $1.0 million in payables due to that same vendor that were
not properly recorded in the Company's accounting system for
the third and fourth quarters of 2004 and the first and second
quarters of 2005.
o The second item relates to the understatement of cost of sales
in the second quarter of 2005 of $372,000 as a result of
certain inventory components being doubled counted and thus
overstated in inventory as of June 30, 2005.
o The third item relates to the understatement of cost of sales
in the first and second quarters of 2005 totaling $616,000 as
a result of certain licensing charges that were not properly
recorded in cost of sales and inventory.
o The fourth item relates to a balance sheet reclassification of
$1.3 million in cash payments made by a customer during the
second and fourth quarters of 2004 as well as the first and
second quarters of 2005 in advance of future shipments of
product. These payments were incorrectly applied against
accounts receivable rather than recorded as deferred revenue.
The cash prepayments have been properly reclassified to
deferred revenue.
These additional restatements reduced stockholders' equity by an
aggregate of $2.7 million and affected prior periods as follows:
o Gross profit and net income for the fourth quarter of 2003
were each reduced by $1.3 million, to a gross profit of $11.4
million and net loss of $248,000.
o For the third quarter of 2004, gross profit was reduced by
$249,000 to $2.1 million and our net loss increased by
$249,000 to $1.7 million.
o For the fourth quarter of 2004, gross profit was reduced by
$178,000 to $3.0 million and our net loss increased by
$178,000 to $1.2 million.
o For the first quarter of 2005, gross profit was reduced by
$238,000 to $2.5 million and our net loss increased by
$238,000 to $1.1 million.
o For the second quarter of 2005, gross profit was reduced by
$945,000 to $2.4 million and our net loss increased by
$945,000 to $1.3 million.
During the closing process for our 2005 year, two additional
restatement issues were discovered. The first issue relates to a terminated
employee's ability to extend the time to exercise any stock options vested
through their respective termination date in a blackout period. If we are in a
blackout period, we will allow the terminated employee to extend their time to
exercise to 30 days after the blackout period is lifted as opposed to 30 days
after termination as stated in the terms of our stock option plan. This practice
results in a re-measurement date as defined under stock option accounting rules
which require a revaluation of any stock options that were given this benefit.
As a result of this discovery, we determined we had to evaluate all
stock options that have been exercised from 2001 through 2005 and determine who
exercised stock options beyond the 30-day period as specified in the stock
option plan. We did this and also determined that since notice of this
29
blackout period extension was given to employees on their termination date that
date constituted the re-measurement date.
We have determined that we have material amounts of expense related to
the expensing of certain options exercised after the 30-day period in 2001, 2004
and 2005. The amount of compensation expense related to 2001, 2004 and 2005 is
$2.4 million, $220,000 and $108,000 respectively. These amounts will be
reflected in our financial statements in the appropriate periods.
The second issue relates to the understatement of cost of sales of
$837,000 in 2004 and an overstatement of cost of sales of $748,000 in 2005 as a
result of certain inventory in transit from the parent company to its Hong Kong
subsidiary being overvalued at December 31, 2004.
These additional restatements reduced stockholders' equity by an
aggregate of $2.8 million and affected prior periods as follows:
o Our net loss for 2001 increased by $2.4 million to a net loss
of $4.4 million.
o Gross profit for 2004 was reduced by $837,000 to a gross
profit of $10.6 million and our net loss for 2004 increased by
$1.0 million, to a net loss of $3.8 million.
o Gross profit for 2005 was increased by $748,000 to a gross
profit of $8.1 million and our net loss decreased by $640,000
to a net loss of $8.3 million.
In November 2005, the Company's audit committee began an internal
investigation into the matters disclosed in the November 2, 2005 announcement.
In connection with the restatement issues identified in November the audit
committee hired outside legal counsel to conduct an internal investigation. They
in turn retained the services of an independent accounting firm to assist with
various forensic accounting and electronic procedures performed in the course of
the investigation.
For the items discovered subsequent to the November 2005 announcement,
the Committee, seeing no evidence suggesting the involvement of any current
employees, instructed senior company management and outside legal counsel to
conduct investigations into these matters.
Based on the findings of the independent and company investigations as
well as senior management's evaluation of the effectiveness of the design and
operation of the company's controls and procedures, the Committee determined
that inadequate internal controls contributed to the restatement issues. The
primary control deficiencies are identified on pages 46 to 47 of this Form 10-K.
30
The following tables present certain financial information for each of
the restated quarters, as originally reported, as affected by both the original
restatement and the additional restatements and as restated:
AS AS
ORIGINALLY ORIGINAL ORIGINALLY ADDITIONAL
REPORTED RESTATEMENT(1) RESTATED(1) RESTATEMENTS AS RESTATED
------------ ------------ ------------ ------------ ------------
(in thousands except per share data)
---------------------------------- ------------ ------------ ------------ ------------ ------------
1ST QUARTER 2001
---------------------------------- ------------ ------------ ------------ ------------ ------------
Revenues ......................... $ 7,389 $ -- $ 7,389 $ -- $ 7,389
---------------------------------- ------------ ------------ ------------ ------------ ------------
Gross Profit ..................... 3,272 -- 3,272 -- 3,272
---------------------------------- ------------ ------------ ------------ ------------ ------------
Net income (loss) ................ 733 -- 733 (2,282) (1,549)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Earnings (loss) per share - basic N/A N/A N/A N/A N/A
---------------------------------- ------------ ------------ ------------ ------------ ------------
Earnings (loss) per share -
diluted .......................... N/A N/A N/A N/A N/A
---------------------------------- ------------ ------------ ------------ ------------ ------------
2ND QUARTER 2001
---------------------------------- ------------ ------------ ------------ ------------ ------------
Revenues ......................... $ 6,539 $ -- $ 6,539 $ -- $ 6,539
---------------------------------- ------------ ------------ ------------ ------------ ------------
Gross Profit ..................... 854 -- 854 -- 854
---------------------------------- ------------ ------------ ------------ ------------ ------------
Net loss ......................... (1,818) -- (1,818) (67) (1,885)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Earnings (loss) per share - basic N/A N/A N/A N/A N/A
---------------------------------- ------------ ------------ ------------ ------------ ------------
Earnings (loss) per share -
diluted .......................... N/A N/A N/A N/A N/A
---------------------------------- ------------ ------------ ------------ ------------ ------------
3RD QUARTER 2001
---------------------------------- ------------ ------------ ------------ ------------ ------------
Revenues ......................... $ 6,036 $ -- $ 6,036 $ -- $ 6,036
---------------------------------- ------------ ------------ ------------ ------------ ------------
Gross Profit ..................... 2,464 -- 2,464 -- 2,464
---------------------------------- ------------ ------------ ------------ ------------ ------------
Net loss ......................... (462) -- (462) (10) (472)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Earnings (loss) per share - basic N/A N/A N/A N/A N/A
---------------------------------- ------------ ------------ ------------ ------------ ------------
Earnings (loss) per share -
diluted .......................... N/A N/A N/A N/A N/A
---------------------------------- ------------ ------------ ------------ ------------ ------------
4TH QUARTER 2003
---------------------------------- ------------ ------------ ------------ ------------ ------------
Revenues ......................... $ 8,716 $ -- $ 8,716 $ -- $ 8,716
---------------------------------- ------------ ------------ ------------ ------------ ------------
Gross Profit ..................... 3,339 -- 3,339 (1,314) 2,025
---------------------------------- ------------ ------------ ------------ ------------ ------------
Net income (loss) ................ 407 -- 407 (1,314) (907)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Earnings (loss) per share - basic $ 0.04 $ -- $ 0.04 $ (0.12) $ (0.08)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Earnings (loss) per share -
diluted .......................... $ 0.04 $ -- $ 0.04 $ (0.12) $ (0.08)
---------------------------------- ------------ ------------ ------------ ------------ ------------
1ST QUARTER 2004
---------------------------------- ------------ ------------ ------------ ------------ ------------
Revenues ......................... $ 8,434 $ (498) $ 7,936 $ -- $ 7,936
---------------------------------- ------------ ------------ ------------ ------------ ------------
Gross Profit ..................... 3,352 (218) 3,134 -- 3,134
---------------------------------- ------------ ------------ ------------ ------------ ------------
Net income (loss) ................ 317 (218) 99 (33) 66
---------------------------------- ------------ ------------ ------------ ------------ ------------
Earnings (loss) per share - basic $ 0.03 $ (0.02) $ 0.01 $ (0.00) $ 0.01
---------------------------------- ------------ ------------ ------------ ------------ ------------
Earnings (loss) per share -
diluted .......................... $ 0.03 $ (0.02) $ 0.01 $ (0.00) $ 0.01
---------------------------------- ------------ ------------ ------------ ------------ ------------
2ND QUARTER 2004
---------------------------------- ------------ ------------ ------------ ------------ ------------
Revenues ......................... $ 8,158 $ 74 $ 8,232 $ -- $ 8,232
---------------------------------- ------------ ------------ ------------ ------------ ------------
Gross Profit ..................... 3,150 33 3,183 -- 3,183
---------------------------------- ------------ ------------ ------------ ------------ ------------
Net income (loss) ................ 76 33 109 (187) (78)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Earnings (loss) per share - basic $ 0.01 $ 0.00 $ 0.01 $ (0.02) $ (0.01)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Earnings (loss) per share -
diluted .......................... $ 0.01 $ 0.00 $ 0.01 $ (0.02) $ (0.01)
---------------------------------- ------------ ------------ ------------ ------------ ------------
(1) Reported on March 9, 2005
31
AS AS
ORIGINALLY ORIGINAL ORIGINALLY ADDITIONAL
REPORTED RESTATEMENT(1) RESTATED(1) RESTATEMENTS AS RESTATED
------------ ------------ ------------ ------------ ------------
(in thousands except per share data)
---------------------------------- ------------ ------------ ------------ ------------ ------------
3RD QUARTER 2004
---------------------------------- ------------ ------------ ------------ ------------ ------------
Revenues ......................... $ 9,442 $ 114 $ 9,556 $ -- $ 9,556
---------------------------------- ------------ ------------ ------------ ------------ ------------
Gross Profit ..................... 3,456 (1,119) 2,337 (249) 2,088
---------------------------------- ------------ ------------ ------------ ------------ ------------
Net loss ......................... (322) (1,119) (1,441) (249) (1,690)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Loss per share - basic ........... $ (0.03) $ (0.09) $ (0.12) $ (0.02) $ (0.15)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Loss per share - diluted ......... $ (0.03) $ (0.09) $ (0.12) $ (0.02) $ (0.15)
---------------------------------- ------------ ------------ ------------ ------------ ------------
4TH QUARTER 2004
---------------------------------- ------------ ------------ ------------ ------------ ------------
Revenues ......................... $ 9,683 $ -- $ 9,683 $ (1) $ 9,682
---------------------------------- ------------ ------------ ------------ ------------ ------------
Gross Profit ..................... 3,205 -- 3,205 (1,015) 2,190
---------------------------------- ------------ ------------ ------------ ------------ ------------
Net loss ......................... (1,052) -- (1,052) (1,015) (2,067)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Loss per share - basic ........... $ (0.08) $ -- $ (0.08) $ (0.07) $ (0.15)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Loss per share - diluted ......... $ (0.08) $ -- $ (0.08) $ (0.07) $ (0.15)
---------------------------------- ------------ ------------ ------------ ------------ ------------
1ST QUARTER 2005
---------------------------------- ------------ ------------ ------------ ------------ ------------
Revenues ......................... $ 9,269 $ -- $ 9,269 $ -- $ 9,269
---------------------------------- ------------ ------------ ------------ ------------ ------------
Gross Profit ..................... 2,722 -- 2,722 534 3,256
---------------------------------- ------------ ------------ ------------ ------------ ------------
Net income (loss) ................ (910) -- (910) 512 (398)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Earnings (loss) per share - basic $ (0.07) $ -- $ (0.07) $ 0.04 $ (0.03)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Earnings (loss) per share -
diluted .......................... $ (0.07) $ -- $ (0.07) $ 0.04 $ (0.03)
---------------------------------- ------------ ------------ ------------ ------------ ------------
2ND QUARTER 2005
---------------------------------- ------------ ------------ ------------ ------------ ------------
Revenues ......................... $ 10,263 $ -- $ 10,263 $ -- $ 10,263
---------------------------------- ------------ ------------ ------------ ------------ ------------
Gross Profit ..................... 3,355 -- 3,355 (1,536) 1,819
---------------------------------- ------------ ------------ ------------ ------------ ------------
Net loss ......................... (342) -- (342) (1,619) (1,961)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Loss per share - basic ........... $ (0.02) $ -- $ (0.02) $ (0.12) $ (0.14)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Loss per share - diluted ......... $ (0.02) $ -- $ (0.02) $ (0.12) $ (0.14)
---------------------------------- ------------ ------------ ------------ ------------ ------------
(1) Reported on March 9, 2005
32
The following table presents the effects of both the original
restatement and the additional restatements on the years ended December 31,
2001, December 31, 2003 and December 31, 2004, which have been previously
reported, and our results for those periods, as restated:
AS AS
ORIGINALLY ORIGINAL ORIGINALLY ADDITIONAL
REPORTED RESTATEMENT(1) RESTATED(1) RESTATEMENTS AS RESTATED
------------ ------------ ------------ ------------ ------------
(in thousands except per share data)
---------------------------------- ------------ ------------ ------------ ------------ ------------
FY 2001
---------------------------------- ------------ ------------ ------------ ------------ ------------
Revenues ......................... $ 25,265 $ -- $ 25,265 $ -- $ 25,265
---------------------------------- ------------ ------------ ------------ ------------ ------------
Gross Profit ..................... 8,811 -- 8,811 -- 8,811
---------------------------------- ------------ ------------ ------------ ------------ ------------
Net loss ......................... (2,014) -- (2,014) (2,359) (4,373)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Loss per share - basic ........... $ (0.21) $ -- $ (0.21) $ (0.24) $ (0.45)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Loss per share - diluted ......... $ (0.21) $ -- $ (0.21) $ (0.24) $ (0.45)
---------------------------------- ------------ ------------ ------------ ------------ ------------
FY 2003
---------------------------------- ------------ ------------ ------------ ------------ ------------
Revenues ......................... $ 31,042 $ -- $ 31,042 $ -- $ 31,042
---------------------------------- ------------ ------------ ------------ ------------ ------------
Gross Profit ..................... 12,680 -- 12,680 (1,314) 11,366
---------------------------------- ------------ ------------ ------------ ------------ ------------
Net income (loss) ................ 1,066 -- 1,066 (1,314) (248)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Earnings (loss) per share - basic $ 0.10 $ -- $ 0.10 $ (0.13) $ (0.02)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Earnings (loss) per share -
diluted .......................... $ 0.09 $ -- $ 0.09 $ (0.12) $ (0.02)
---------------------------------- ------------ ------------ ------------ ------------ ------------
FY 2004
---------------------------------- ------------ ------------ ------------ ------------ ------------
Revenues ......................... $ 35,407 $ -- $ 35,407 $ (1) $ 35,406
---------------------------------- ------------ ------------ ------------ ------------ ------------
Gross Profit ..................... 11,859 -- 11,859 (1,264) 10,595
---------------------------------- ------------ ------------ ------------ ------------ ------------
Net loss ......................... (2,284) -- (2,284) (1,485) (3,759)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Loss per share - basic ........... $ (0.19) $ -- $ (0.19) $ (0.12) $ (0.31)
---------------------------------- ------------ ------------ ------------ ------------ ------------
Loss per share - diluted ......... $ (01.9) $ -- $ (01.9) $ 90.12) $ (0.31)
---------------------------------- ------------ ------------ ------------ ------------ ------------
(1) Reported on March 9, 2005
We identified material weaknesses in our system of internal controls
over financial reporting related to these restatements which are discussed in
Item 9.A "Controls and Procedures" in this Report.
33
RESULTS OF OPERATIONS
BUSINESS SEGMENT OVERVIEW
Revenue and gross profit by market segment are shown in the following
table:
2005 2004(1) 2003(1)
----------------------------- ---------------------------- ----------------------------
PERCENT OF PERCENT OF PERCENT OF
MARKET SEGMENT $000'S TOTAL SALES $000'S TOTAL SALES $000'S TOTAL SALES
------------ ------------ ------------ ------------ ------------ ------------
Business Communications(2):
-Revenue ................. $ 6,552 17% $ 6,070 17% $ 8,133 26%
-Gross Profit ............ 3,407 3,205 4,312
-Gross Profit % of Segment
Revenue ................. 52% 53% 53%
------------ ------------ ------------ ------------ ------------ ------------
OEM Remotes(3):
-Revenue ................. $ 17,846 47% $ 18,762 53% $ 14,114 45%
-Gross Profit ............ (632) 2,185 2,075
-Gross Profit (Loss) % of
Segment Revenue ......... (4)% 12% 15%
------------ ------------ ------------ ------------ ------------ ------------
E-Transactions:
-Revenue ................. $ 8,326 22% $ 5,328 15% $ 4,165 14%
-Gross Profit ............ 3,233 2,491 2,005
-Gross Profit % of Segment
Revenue ................. 39% 47% 48%
------------ ------------ ------------ ------------ ------------ ------------
Specialty Components:
-Revenue ................. $ 5,515 14% $ 5,246 15% $ 4,630 15%
-Gross Profit ............ 2,050 2,714 2,974
-Gross Profit % of Segment
Revenue ................. 37% 52% 64%
------------ ------------ ------------ ------------ ------------ ------------
All Segments:
-Revenue ................. $ 38,239 100% $ 35,406 100% $ 31,042 100%
-Gross Profit ............ 8,058 10,595 11,366
-Gross Profit % of Segment
Revenue ................. 21% 30% 37%
------------ ------------ ------------ ------------ ------------ ------------
(1) As restated.
(2) Branded Only.
(3) Comprised of business segments formerly known as Business
Communications - OEM and Home Entertainment.
YEAR ENDED DECEMBER 31, 2005 COMPARED WITH YEAR ENDED DECEMBER 31, 2004
E-TRANSACTIONS
In our e-transactions segment, we sell electronic signature capture
devices and, depending on the customer requirement, signature-capture software.
Our 2005 e-transaction revenues increased 56% over 2004 due to greater industry
adoption of the EPAD product line. We had a number of high quantity EPAD sales
to customers which represented the primary reason for the large increase in 2005
revenues compared to 2004. We anticipate this trend to continue as we target a
larger client base, including those who have the ability to purchase between
5,000 to 100,000 units per commitment. We see this
34
business segment as having high growth potential in the next few years.
E-transaction gross margins are one of our stronger gross margin business
segments with gross margins typically ranging between 39% and 48%.
SPECIALTY COMPONENTS
Our specialty components segment is comprised of our MICRONAV products,
which targets the rapidly growing handheld consumer electronics product market
and our custom FSRs and FSR-based subassemblies, which target customers in
several vertical markets, such as medical devices, industrial input and military
input products. Continuing from 2004, we have significantly expanded the
MICRONAV market opportunity. As a result, our revenue from the MICRONAV family
of products is anticipated to exceed our traditional Specialty market in the
very near future. Specialty components revenues increased 5% in 2005 as compared
to 2004 due to initial shipments of MICRONAV products to early adopters.
Specialty component gross margins have declined in 2005 compared to
2004 due to the relatively lower margin associated with the MICRONAV products as
compared to our historical specialty components product margins and startup
costs associated with this new component of this business segment.
Because of the early adoption phase of our MICRONAV sensors, Specialty
Components has become a marketing focal point. We continue to pursue
opportunities to incorporate our sensors in various consumer electronic
products. Design cycles for these products are typically long and new business
in this market may develop slowly. In addition, product life cycles in this
industry can be relatively short. Because of our limited experience to date with
these sensors, we are unable to predict the rate at which new business may
develop or the margins that will apply to any business that does develop.
OEM REMOTES
In our OEM remotes segment, we sell wireless remote controls on an OEM
basis to manufacturers of advanced viewing devices, including projectors sold
for TV viewing and for use with certain computer software presentation
applications.
In 2005, and similar to the past few years, OEM average selling prices
are declining due to market demands. For 2005, OEM remotes revenues decreased 5%
as compared to 2004. OEM remotes gross margin declined considerably in 2005 when
compared to 2004 as a result of a $2.5 million write-down of certain inventory
and tooling fixed assets in the third quarter of 2005 due to the slow down in
this market space. Our gross margins have ranged from 12% to 15% in prior years.
For 2005, our gross margin loss for OEM Remotes was 4% primarily as a result of
the $2.3 million write-down.
BRANDED PRODUCTS
Overall, 2005 Branded Products revenues grew 8%. Sales of our
Communicator Suite (up 49%) and Remote Point Navigator (up 26%) were stronger in
2005 than in 2004 and were key products contributing to our year over year
growth. We see this segment of our business continuing to grow as we focus on
bringing new products to market and expanding our geographical presence.
Branded gross margins continue to be strong and remain consistent at
52% to 53%, depending on the product mix in any given quarter or year.
35
OPERATING EXPENSES
Product development and research costs include internal engineering
labor, contract engineering and outside processing costs for the design and
development of our OEM and branded designs and products and the research of our
technologies. Our product development and research costs increased $428,000, or
10.3%, from $4.2 million for 2004 to $4.6 million for 2005, due to the
development of new products in our OEM remotes, EPAD and MICRONAV product lines.
As a percentage of revenues, our product development and research costs remained
constant at 12% in 2005 as compared to 2004. We expect that product development
and research costs will continue to be at this same or slightly higher level of
revenues for the foreseeable future.
Sales, general and administrative costs, or SG&A, include sales,
marketing, accounting and administrative labor, sales commissions, advertising,
general marketing, branded business communications channel marketing and travel
and entertainment costs. SG&A grew 14.6%, from $10.2 million for 2004 to $11.7
million for 2005, primarily due to increased regulatory costs and normal
increases due to the growth of our business. Costs related to complying with the
Sarbanes-Oxley Act of 2002, or SOX, were approximately $340,000 in 2005 compared
to $784,000 in 2004. Overall, SOX compliance costs related to fiscal year 2005
compliance are considerably lower than costs for 2004. The Company also
experienced increased accounting and financial costs, including increases in
accounting and finance department personnel and consulting and other fees. As a
percentage of revenues, SG&A increased to 31% of revenues in 2005 versus 29% of
revenues in 2004. We will continue to monitor our SG&A expenses closely and
anticipate slight increases in overall SG&A on a pure dollar spending level, but
hope to maintain S,G&A expenses as a percentage of revenues at or below current
levels.
OPERATING RESULTS
In summary, our operating results in 2005 were attributable to the
following factors:
o 8% growth in consolidated revenues;
o our e-transactions sector grew 56% over 2004;
o a decline in overall gross margins as a result of:
o a charge of approximately $2.3 million for inventory
and tooling write-downs;
o charges related to the physical inventory year end
reconciliation of inventory quantities and costs from
the taking of a year end physical inventory; and
o general decline in OEM remotes margins.
Total other income, net improved to $67,000 in 2005 as compared to
$32,000 in 2004 due primarily to interest on cash from proceeds of a secondary
offering in September 2004 and to the interest income from loans to
shareholders. In addition, the net pay down of long-term debt reduced interest
expense in 2005 compared to 2004.
We have $39.7 million in net operating loss, or NOL, carryforwards for
U.S. federal tax purposes. In 2000 and 2001, for accounting purposes, we
recognized some of those NOLs as an accrued tax benefit. However, because of our
subsequent losses in 2001 and 2002, in the fourth quarter of 2002 we recorded a
valuation allowance of $1.3 million against our deferred tax assets. This
non-cash charge reduced the net value of the deferred tax assets on the balance
sheet to zero. In determining whether or not a valuation allowance is necessary,
forecasts of future taxable income are
36
not considered sufficient evidence to outweigh a history of losses. Accordingly,
the assets were reserved against in full. This has no effect on the Company's
NOL carryforwards for tax purposes and they continue to be available for up to
20 years. We have maintained the full valuation allowance against our deferred
tax assets as of December 31, 2005.
Section 382 ("Section 382") of the Internal Revenue Code of 1986, as
amended (the "Code"), places a limitation on the realizability of NOLs in future
periods if the ownership of the company has changed more than 50% within a
three-year period. Under Section 382, we have experienced an approximate 43%
change in ownership for the three-year period ended December 31, 2005. As of
December 31, 2005, none of our NOLs have been limited by the Section 382 rules.
YEAR ENDED DECEMBER 31, 2004 COMPARED WITH YEAR ENDED DECEMBER 31, 2003
E-TRANSACTIONS
In our e-transactions segment, we sell electronic signature capture
devices and, depending on the customer requirement, signature-capture software.
Our 2004 e-transaction revenues increased 28% over 2003 due to greater industry
adoption of the EPAD product line and thus a broadening of our client base in
this market.
Our e-transaction gross margin remained relatively unchanged at 47% for
2004 as compared to 48% in 2003.
SPECIALTY COMPONENTS
In our specialty components segment, we sell custom FSRs and FSR-based
subassemblies to many customers in several vertical markets, such as medical
devices, industrial input and military input products. In 2004 we had
significantly expanded the market opportunity reflected by this market by
developing our MICRONAV family of sensors which address applications in the
rapidly growing handheld consumer electronics product market.
Specialty component revenues increased 13% in 2004 as compared to 2003
due to sales of MICRONAV sensors to initial customers in the MP3 player and cell
phone markets.
Specialty component gross margin declined to 52% in 2004 from 64% in
2003 due to the relatively lower margin associated with the MICRONAV products
(approximately 50%) as compared to our historical specialty components product
margins and startup costs associated with this new program.
Because of the development of our MICRONAV sensors, specialty
components have become a marketing focal point. We are aggressively pursuing
several opportunities to incorporate our sensors in various consumer electronic
products. Design cycles for these products are typically long and new business
in this market may develop slowly. Because of our limited experience to date
with these sensors, we are unable to predict the rate at which new business may
develop or the margins that will apply to any business that does develop.
OEM REMOTE CONTROLS
In our OEM remotes segment, we sell wireless remote controls on an OEM
basis to the leading manufacturers of presentation projectors as well as to
manufacturers of advanced viewing devices,
37
including projectors sold for TV viewing, and FSR sensors to Microsoft for
integration into their Xbox game controller.
Our OEM remotes revenues grew 33% in 2004 as compared to 2003,
reflecting initial sales in significant quantities of remote controls for
advanced TV viewing devices and continued sales of sensors for Microsoft's Xbox
controller. Xbox related sales ended in the last half of 2005.
OEM remotes gross margin declined to 12% in 2004 from 15% in 2003 due
to lower margins associated with high volume remote sales and startup costs
associated with these new programs.
BUSINESS COMMUNICATIONS
In our business communications segment, we sell Interlink-branded
wireless remote controls and keyboards direct to computer products retailers,
corporate resellers and distributors.
Revenues from branded products, which had average selling prices of
approximately $23 to $174, declined 25% from $8.1 million in 2003 to $6.1
million in 2004 as a result of our decision to stop selling to consumer retail
channels.
Business communication gross margin in 2004 remained unchanged at 53%
compared to 2003.
OPERATING EXPENSES
Product development and research costs include internal engineering
labor, contract engineering and outside processing costs for the design and
development of our OEM and branded designs and products and the research of our
technologies. For 2004, our product development and research costs increased
21.7% over 2003 due to development of new products in our OEM remotes, EPAD and
MICRONAV product lines. As a percentage of revenues, product development and
research costs increased to 12% in 2004 as compared to 11% in 2003. We expect
that product development and research costs will continue to exceed 10% of
revenues for the foreseeable future.
SG&A costs include sales, marketing, accounting and administrative
labor, sales commissions, advertising, general marketing, branded business
communications channel marketing and travel and entertainment costs. For 2004,
SG&A grew 25% over 2003 due to approximately $800,000 in SOX costs and to
increased accounting and financial costs and general marketing commensurate with
sales growth. As a percentage of revenues, SG&A increased to 29% in 2004 versus
26% in 2003.
OPERATING RESULTS
In summary, our operating results in 2004 were attributable to the
following factors:
o 14% growth in revenues that occurred primarily in our OEM
remotes and e-transactions sectors;
o a decline in overall gross margins as a result of increased
high volume sales of remote products; and a high ratio of
startup costs associated with these new programs; and
o a substantial increase in SG&A cost attributable to new
financial and accounting requirements.
38
Total other income, net improved to $32,000 in 2004 as compared to
$4,000 in 2003 due to lower debt levels partially and interest income from the
investment of the proceeds of our stock offering that was completed in 2004.
We have $39.7 million in NOL carryforwards for U.S. federal tax
purposes. As described above, these tax assets were reserved against in full.
Our federal NOL carryforwards are not impacted and can continue to be utilized
for up to 20 years. We have maintained the full valuation allowance against our
deferred tax assets as of December 31, 2004.
LIQUIDITY AND CAPITAL RESOURCES
Our capital resources have historically come from sales of equity
securities and commercial borrowing. Our principal historical cash requirements
have been to fund new product and technology development, to support sales,
marketing, inventory and accounts receivable costs and to fund losses from
operations. While we expect operations to eventually generate cash, we
anticipate that additional capital resources will be required to support future
growth and expect to rely on existing cash balances and sales of securities and
commercial financing to provide the required resources. To some extent, we
expect that our rate of growth will be within our control and, accordingly, we
expect to adjust our growth commitments to reflect the availability and
attractiveness of financing arrangements and non-growth-related cash
requirements.
In September 2004, we completed a public stock offering which made a
net contribution of $13.5 million to our capital. We also received $2.7 million
in proceeds from option exercises in 2004. Principally as a result of these
events, our cash and cash equivalents increased from $6 million at the end of
2003 to $19.1 million at the end of 2004. Our cash and cash equivalents
decreased to $13.9 million at the end of 2005 primarily as a result of cash used
by operations. We believe that we are adequately funded to support operations
for the foreseeable future.
Cash flow comes principally from collection of accounts receivable and,
to a lesser extent, from interest or other return on financial investments. We
maintain what we believe to be appropriate reserves for doubtful accounts and
are not aware of any prospective development that would impact collections
differently from our historical experience. It is our common practice to allow
payment terms of greater than 30 days (generally 45-90 days) for our branded
products and Asian customer base. In 2005, sales to customers with terms greater
than 30 days were 12% of our overall sales, as compared to 19% in 2004. To the
extent our growth in these areas continues to increase as a percentage of total
revenues, our average days to collect on our accounts receivable will increase
and this would slow down our average cash collections. On two occasions, we have
made substantial inventory reserve adjustments that reflect management's
judgment as to the recoverable value of inventory. We do not currently
anticipate the need for a further inventory adjustment but any significant
diminution in inventory value would ultimately affect cash flow.
In May 2006, we terminated our U.S. bank line of credit and,
accordingly, we no longer have that line available to us.
Working capital increased from $18.9 million at the end of 2003 to
$30.5 million at December 31, 2004 and decreased to $23.0 million at December
31, 2005. The increase in 2004 resulted primarily from our stock offering and
additional option exercises. The decrease in 2005 resulted from our losses from
operation.
39
Operations used cash of $1.3 million in 2004 and $4.2 million in 2005.
The change was due primarily to increased operating losses year over year.
We spent $362,000 in 2005 and $973,000 in 2004 to purchase additional
manufacturing and computer equipment.
We made payments on long-term debt of $588,000 and $820,000 in 2005 and
2004, respectively. Net proceeds from the exercise of stock options and
stockholder loan repayments were $220,000 and $2.7 million in 2005 and 2004,
respectively.
CONTRACTUAL OBLIGATIONS
We currently have modest commitments for capital expenditures and no
material purchase obligations.
Our long-term debt and operating lease obligations as of December 31,
2005 are set forth in the following table:
LESS THAN 1-3 4TH
TOTAL 1 YEAR YEARS YEAR
--------- --------- --------- ---------
Long-term debt obligations ...... $ 308 $ 154 $ 154 $ --
Software licenses ............... $ 900 $ 600 $ 300 $ --
Operating lease obligations ..... 1,713 469 836 408
--------- --------- --------- ---------
Total ........................... $ 2,921 $ 1,223 $ 1,290 $ 408
========= ========= ========= =========
These amounts may increase as we pursue our growth strategy but the
amount of any such growth will depend on the particular requirements of any
growth commitment, the availability and attractiveness of equity capital
arrangements and our general liquidity position.
APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's discussion and analysis of the Company's financial
condition and results of operations are based upon the consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial
statements requires management to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosures of contingent assets and liabilities. On an on-going basis,
management evaluates estimates, including those related to the valuation of
inventory and the allowance for uncollectible accounts receivable. We base our
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions. We believe the
following critical accounting policies affect our more significant judgments and
estimates used in the preparation of our consolidated financial statements:
REVENUE RECOGNITION. We recognize revenue in accordance with SEC Staff
Accounting Bulletin ("SAB") No. 104, "Revenue Recognition." SAB No. 104 requires
that four basic criteria must be met before revenue can be recognized: (1)
persuasive evidence of an arrangement exists; (2) delivery has occurred or
services rendered; (3) the fee is fixed and determinable; and (4) collectibility
is reasonably assured. Determination of criteria (3) and (4) require
management's judgments regarding
40
the fixed nature of the fee charged for services rendered and products delivered
and the collectibility of those fees. To satisfy the criteria, we: (1) input
orders based upon receipt of a customer purchase order; (2) record revenue upon
shipment of goods and when risk of loss and title has transferred; (3) confirm
pricing through the customer purchase order; and (4) validate creditworthiness
through past payment history, credit agency reports and other financial data.
All customers have warranty rights and some customers also have explicit or
implicit rights of return. We comply with Statement of Financial Accounting
Standards No. 48 with respect to sell-through and returns and the related
recording of reserves for potential customer returns. Should changes in
conditions cause management to determine the revenue recognition criteria are
not met for certain future transactions, such as a determination that
collectibility was not reasonably assured, revenue recognized for any reporting
period could be adversely affected.
ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS. Our accounts
receivable are unsecured, and we are at risk to the extent such amounts become
uncollectible. We continually monitor individual account receivable balances,
and provide for an allowance of doubtful accounts at the time collection may
become questionable based on payment performance or age of the receivable and
other factors related to the customer's ability to pay. We generally offer
30-day payment terms. However, some of our distributors in the business
communications-branded market and some of our Japanese OEM customers require as
long as 180-day payment terms. We recorded an increase to the allowance for
doubtful accounts of $176,000 and $284,000 for 2003 and 2005, respectively; and
a decrease to the allowance of $22,000 in 2004. Write-offs against the allowance
for doubtful accounts totaled $3,000, $589,000 and $7,000 for the years ended
December 31, 2003, 2004 and 2005, respectively.
INVENTORY RESERVE. At each balance sheet date, we evaluate our ending
inventories for excess quantities and obsolescence. This evaluation includes
analyses of forecast sales levels by product and historical demand. We write off
inventories that are considered obsolete and reserve against inventories that
may become obsolete. Remaining inventory balances are adjusted to approximate
the lower of our cost or market value and result in a new cost basis in such
inventory until sold. If future demand or market conditions are less favorable
than our projections, additional inventory write-down may be required, and would
be reflected in cost of sales in the period the revision is made. Based on
lowered expectations for future demand in the OEM Remotes segment as well as
limitations on the use of certain restricted raw materials prompted by early
adoption of the Restriction of Hazardous Substances Act of 2002 by many of our
customers , we increased our reserve for excess and obsolete inventory by
approximately $1.9 million in the third quarter of 2005. The reserve is
discussed in detail in the BUSINESS SEGMENT OVERVIEW under OEM Remotes.
PROVISION FOR INCOME TAX. As part of the process of preparing our
financial statements, as required by Statement of Financial Accounting Standards
("SFAS") No. 109 "Accounting For Income Taxes", we are required to estimate our
income taxes in each of the jurisdictions in which we operate. This process
involves estimating our actual current tax exposure together with assessing
temporary differences resulting from differing treatment of items for tax and
accounting purposes. These differences result in deferred tax assets and
liabilities, which are included in our balance sheet. We must then assess the
likelihood that our deferred tax assets will be recovered from future taxable
income and to the extent we believe that recovery is not likely, we must
establish a valuation reserve. To the extent we establish a reserve or increase
this reserve in a period, we must include an expense within the tax provision in
the statements of operations.
Significant management judgment is required in determining our
provision for income taxes, deferred tax asset and liabilities and any valuation
reserve recorded against our net deferred tax assets.
41
Management continually evaluates the Company's deferred tax asset as to whether
it is likely that the deferred tax asset will be realized.
We first achieved profitable operations in 1995. Because of NOL
carryforwards available both for our U.S.-based and Japan-based operations, we
did not accrue income tax expense until 1999. In that year, due to the
expiration or full utilization of NOL carryforwards in California and Japan, we
began to record a provision for income tax expense in those jurisdictions. By
the end of 2000, we also began to accrue an income tax benefit related to our
federal NOL carryforwards to be used in future periods. However, in mid-2001, we
began to record quarterly tax losses and suspended any further recognition of
NOL carryforward tax benefits. In the fourth quarter of 2002 and for the 2003,
2004 and 2005 years, based on historical and prospective evidence, we concluded
that we did not have sufficient evidence to be able to recognize our NOL
carryforward benefits as assets and thus we recognized a valuation allowance
against our deferred tax asset balance.
As of December 31, 2005, the Company had NOL carryforwards for federal,
state and foreign income tax purposes of $39.7 million, $23.9 million and $5.9
million, respectively, which are available to offset future taxable income in
those jurisdictions through 2025.
FOREIGN EXCHANGE EXPOSURE. We have established relationships with most
of the major OEMs in the business communications market. Many of these OEMs are
based in Japan and approximately 23%, 28% and 23% of our revenues for 2003, 2004
and 2005, respectively, came from Japanese customers. Revenues from these
customers are denominated in Japanese yen and as a result we are subject to
foreign currency exchange rate fluctuations in the yen/dollar exchange rate. We
may use foreign currency forward contracts to hedge this exposure. We use
revenue forecasts from our Japanese subsidiary to determine the amount of our
forward contracts to purchase and we attempt to enter into these contracts when
we believe the yen value is relatively strong against the U.S. dollar. To the
extent that our revenue forecast may be inaccurate or the timing of forecasting
the yen's strength is wrong, our actual hedge gains or losses may not
necessarily correlate with the effect of foreign currency rate fluctuations on
our revenues. We mark these contracts to market value and the gain or loss from
these contracts is recorded in business communications revenue. These hedge
transactions are classified as economic hedges and do not qualify for hedge
accounting under SFAS No.133 "Accounting For Derivative Instruments and Hedging
Activities". In addition, because our Japanese subsidiary's functional currency
is the yen, the translation of the net assets of that subsidiary into the
consolidated results will fluctuate with the yen/dollar exchange rate.
The following table illustrates the impact of foreign currency
fluctuations on our yen-denominated revenues and the effectiveness of our
foreign currency hedging activity (in thousands).
2005 2004 2003
----- ----- -----
Increase (decrease) in revenues resulting from
foreign currency fluctuations ..................... $ 121 $(232) $ 294
Hedging gains (losses) ............................ 47 (57) (211)
----- ----- -----
Net revenue impact ................................ $ 168 $(289) $ 83
===== ===== =====
We calculate the "increase (decrease) in revenues resulting from
foreign currency fluctuations" by calculating the U.S. dollar equivalent of our
yen-denominated revenues for the year using the yen/dollar exchange rate at the
beginning of the year. The resulting product is compared to our yen-
42
denominated revenues converted to U.S. dollars according to GAAP and the
difference is shown in the table above.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment."
This statement is a revision to SFAS No. 123, "Accounting for Stock-Based
Compensation" and APB Opinion No. 25, "Accounting for Stock Issued to
Employees." This statement establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services, primarily focusing on the accounting for transactions in which an
entity obtains employee services in share-based payment transactions. Entities
will be required to measure the cost of employee services received in exchange
for an award of equity instruments based on the grant-date fair value of the
award (with limited exceptions). That cost will be recognized over the period
during which an employee is required to provide service, the requisite service
period (usually the vesting period), in exchange for the award. The grant-date
fair value of employee share options and similar instruments will be estimated
using option-pricing models. If an equity award is modified after the grant
date, incremental compensation cost will be recognized in an amount equal to the
excess of the fair value of the modified award over the fair value of the
original award immediately before the modification. This statement is effective
as of the beginning of the first annual reporting period that begins after June
15, 2005. We adopted SFAS No. 123R as of January 1, 2006.
We are currently assessing the impact of this accounting standard on our
consolidated results of operations or financial position for 2006. Based on
current calculations, we expect that we will incur non cash expenses of
approximately $4.0 million in 2006.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of
Nonmonetary Assets," an amendment of APB Opinion No. 29, "Accounting for
Nonmonetary Transactions." The amendments made by SFAS No. 153 are based on the
principle that exchanges of nonmonetary assets should be measured based on the
fair value of the assets exchanged. Further, the amendments eliminate the narrow
exception for nonmonetary exchanges of similar productive assets and replace it
with a broader exception for exchanges of nonmonetary assets that do not have
commercial substance. Previously, APB Opinion No. 29 required that the
accounting for an exchange of a productive asset for a similar productive asset
or an equivalent interest in the same or similar productive asset should be
based on the recorded amount of the asset relinquished. SFAS No. 153 is
effective for nonmonetary asset exchanges occurring in fiscal periods beginning
after June 15, 2005. Earlier application is permitted for nonmonetary asset
exchanges occurring in fiscal periods beginning after the date of issuance. We
adopted SFAS No. 153 as of January 1, 2006. The adoption of this statement is
not expected to have a material impact on the Company's consolidated results or
operations or financial position.
In October 2004, the American Jobs Creation Act of 2004 ("Act") became
effective in the U.S. Two provisions of the Act may impact the Company's
provision (benefit) for income taxes in future periods, namely those related to
the Qualified Production Activities deduction ("QPA") and Foreign Earnings
Repatriation ("FER").
The QPA will be effective for the Company's U.S. federal tax return
year beginning after December 31, 2004. In summary, the Act provides for a
percentage deduction of earnings from qualified production activities, as
defined, commencing with an initial deduction of three percent for tax years
beginning in 2005 and increasing to nine percent for tax years beginning after
2009, with the result that the Statutory federal tax rate currently applicable
to the Company's qualified production activities of 35 percent could be reduced
initially to 33.95 percent and ultimately to 31.85 percent.
43
However, the Act also provides for the phased elimination of the
Extraterritorial Income Exclusion provisions of the Internal Revenue code. Due
to the interaction of the law provisions noted above as well as the particulars
of the Company's tax position, the ultimate effect of the QPA on the Company'
future provision (benefit) for income taxes has not been determined at this
time. The FASB issued FASB Staff Position FAS 109-1, Application of FASB
Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on
Qualified Production Activities Provided by the American Jobs Creation Act of
2004 ("FSP 109-1"), in December 2004. FSP 109-1 required that tax benefits
resulting from the QPA should be recognized no earlier than the year in which
they are reported in the entity's tax return, and that there is to be no
revaluation of recorded deferred tax assets and liabilities as would be the case
had there been a change in an applicable statutory rate.
The FER provision of the Act provides generally for a one-time 85
percent dividends received deduction for qualifying repatriations of foreign
earnings to the U.S. Qualified repatriated funds must be reinvested in the U.S.
in certain qualifying activities and expenditures, as defined by the Act. In
December 2004, the FASB issued FASB Staff Position FAS 109-2, Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision with the
American Jobs Creation Act of 2004 ("FSP 109-2"). FSP 109-2 allows additional
time for entities potentially impacted by the FER provision to determine whether
any foreign earnings will be repatriated under said provisions. At this time,
the Company has not undertaken an evaluation of the application of the FER
provision and any potential benefits of effecting repatriations under said
provision. Numerous factors, including previous actual and deemed repatriations
under federal tax law provisions, are factors impacting the availability of the
FER provision to the Company and its potential benefit to the Company, if any.
The Company intends to examine the issue and will provide updates in subsequent
periods.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections--a replacement of APB Opinion No. 20 and FASB Statement No.
3." SFAS No. 154 requires retrospective application of a voluntary change in
accounting principle to prior periods' financial statements and also requires
that a change in method of depreciation, amortization, or depletion for
long-lived, non-financial assets be accounted for as a change in accounting
estimate that is affected by a change in accounting principle. SFAS No. 154 is
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. We believe the adoption of SFAS No. 154 will
not have a material impact on our results of operations or financial condition.
In March 2005, the FASB issued Financial Interpretation No. 47
"Accounting for Conditional Asset Retirements Obligations" ("FIN 47"). FIN 47
clarifies that the term "conditional asset retirement obligation" as used in
FASB Statement No. 143 "Accounting for Asset Retirement Obligations," refers to
a legal obligation to perform an asset retirement activity in which the timing
or method of settlement are conditional on a future event that may or may not be
within the control of the entity. The obligation to perform the asset retirement
activity is unconditional even though uncertainty exists about the timing or
method of settlement. Thus, the timing or method of settlement may be
conditional on a future event. Accordingly, an entity is required to recognize a
liability for the fair value of a conditional asset retirement obligation if the
fair value of the liability can be reasonably estimated. FIN 47 also clarifies
when an entity would have sufficient information to reasonably estimate the fair
value of an asset retirement obligation. FIN 47 is effective no later than the
end of fiscal years ending after December 15, 2005. We do not expect the
adoption of this statement to have a material impact on our results of
operations or financial position.
44
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
FOREIGN CURRENCY EXCHANGE RATE RISK - Our Japanese subsidiary,
Interlink Electronics K.K., generally makes sales and collects its accounts
receivable in Japanese yen. To hedge these revenues against future movements in
exchange rates, we may purchase foreign exchange forward contracts. Gains or
losses on the forward contracts are then offset by gains or losses on the
underlying revenue exposure. Accordingly, sudden or significant change of
foreign exchange rates would not have a material impact on net income or cash
flows to the extent future revenues are protected by forward currency contracts.
These contracts, however, typically have a six-month duration. Thus, yen/dollar
fluctuations lasting more than six months will have an impact on our revenues.
During 2005, 2004 and 2003, we entered into foreign currency exchange contracts
in the normal course of business to manage our exposure against foreign currency
fluctuations on revenues denominated in foreign currencies. The principal
objective of such contracts is to minimize the risks and costs associated with
financial and global operating activities. We do not utilize financial
instruments for trading or other speculative purposes. The fair value of foreign
currency exchange contracts is estimated by obtaining quotes from bankers. At
December 31, 2005, we had foreign currency exchange contracts outstanding with a
notional value of $900,000. During fiscal 2005, we recognized $47,000 of gains
on foreign currency exchange contracts which is reflected in revenue in the
accompanying consolidated statements of operations. Our hedging policies are
designed to offset the effect of a yen devaluation on our revenues; thus, a
hypothetical 10% devaluation of the yen would reduce our yen denominated
revenues by 10%; but our theoretical hedging gains would offset that effect for
a period of time.
INTEREST RATE EXPOSURE - Based on our overall interest rate exposure at
December 31, 2005, a hypothetical 10% change in interest rates applied to our
outstanding debt as of December 31, 2005, would have no material impact on
earnings or cash flows, over a one-year period.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The information required by this item is included at pages F-1 to F-21
and as listed in Item 15 of Part IV.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
ITEM 9A. CONTROLS AND PROCEDURES.
DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this Report (the "Evaluation
Date"), we carried out an evaluation, under the supervision and with the
participation of our management, including our Chief Executive Officer and our
Chief Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based
upon that evaluation, our Chief Executive Officer and our Chief Financial
Officer concluded that as of the Evaluation Date, our disclosure controls and
procedures were ineffective in alerting them in a timely manner to material
information relating to the Company and its subsidiaries that is required to be
included in the reports that we file or submit under the Securities Exchange Act
of 1934.
45
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
SYSTEM OF INTERNAL CONTROL OVER FINANCIAL REPORTING: Management is
responsible for establishing and maintaining an adequate system of internal
control over financial reporting. This system is designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation
of financial statements for external purposes in accordance with accounting
principles generally accepted in the United States of America.
Our internal control over financial reporting includes those policies
and procedures that (i) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the Company; (ii) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of financial
statements in accordance with accounting principles generally accepted in the
United States of America, and that receipts and expenditures of the Company are
being made only in accordance with authorizations of management and directors of
the Company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use or disposition of the
Company's assets that could have a material effect on the financial statements.
Management conducted an evaluation of the effectiveness of the system
of internal control over financial reporting based on the framework in Internal
Control-Integrated Framework (the "Framework") issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Based on its
evaluation, management concluded that the Company's system of internal control
over financial reporting was ineffective as of December 31, 2005. This
conclusion was reached based on the identification of material weaknesses
described below:
o Certain weaknesses were identified related to the closing and
financial reporting of our quarterly and annual financial
statements. These weaknesses resulted in adjustments in
accounts receivable and allowance for doubtful accounts, sales
return reserves, prepaid expenses and other assets, accounts
payable, stockholders' equity and due from stockholders. The
failure to have identified certain material adjustments to the
financial statements also resulted in the following
restatement issues:
- failure to identify $1.0 million in payables due to a
vendor, for the third and fourth quarters of 2004 and
the first and second quarters of 2005, that were not
properly recorded and a write-down of $1.1 million of
certain net receivables from the same vendor, for the
fourth quarters of 2002 and 2003, as a result of not
reconciling accounts with the vendor in a timely
manner; and
- failure to record stock option expense, in accordance
with generally accepted accounting principles (GAAP),
of $2,400,000, $221,000 and $108,000 for 2001, 2004
and 2005, respectively, by allowing terminated
employees to extend the period in which to exercise
their options to 30 days after a black out period as
opposed to 30 days after termination as explicitly
stated in our stock option plan. This practice
results in a re-measurement date as defined under
stock option accounting rules, which require a
revaluation of any stock options given this benefit.
While these adjustments were correctly identified and made as
a result of a review of the financial statements, this
material weakness prevented us from filing our Quarterly
Report on Form 10-Q for the quarter ended September 30, 2005
and our Annual Report on Form 10-K for the year ended December
31, 2005 in a timely manner. At the direction of our
46
Chief Executive and Chief Financial Officers, we are adopting
new closing processes and procedures that we believe will
remediate this material weakness.
o We identified a material weakness related to certain
weaknesses in our inventory management, reserves for excess
and obsolete inventory and costing process, in the course of
reviewing our inventory records. These adjustments resulted in
the following restatement issues:
- failure to recognize approximately $616,000 of
software license costs remaining in inventory that
should have been expensed in the first and second
quarters of 2005;
- failure to identify an additional $372,000 of certain
inventory components that were double-counted
resulting in an overstatement of inventory as of June
30, 2005; and
- failure to properly recognize $837,000 of overstated
inventory in transit from our US and Japan operations
to our Hong Kong subsidiary as of December 31, 2004
and $748,000 of overstated cost of sales in 2005, for
a net increase to cost of sales of $89,000.
At the direction of the Chief Executive and Chief Financial
Officers, we have developed and are implementing revised
internal control procedures related to our inventory
management and costing process that we believe will remediate
this material weakness.
o Due to the number of deficiencies and significant deficiencies
found within the Sales Order to Cash, Procure to Payment and
Stockholders' Equity processes, in addition to the items
discussed above, we have assessed the financial control
environment as a whole as a material weakness.
Our management, including our Chief Executive Officer and Chief
Financial Officer, do not expect that our disclosure controls and procedures or
internal control over financial reporting will prevent all error and all fraud.
A control system no matter how well designed and implemented, can provide only
reasonable, not absolute, assurance that the control system's objectives will be
met. Further, the design of a control system must reflect the fact that there
are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all
control issues within a company are detected. The inherent limitations include
the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple errors or mistakes. Controls can also be
circumvented by the individual acts of some persons, by collusion of two or more
people or by management override of the controls. Because of the inherent
limitations in a cost-effective control system, misstatements due to error or
fraud may occur and not be detected.
ATTESTATION REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Management's assessment of the effectiveness of our internal control
over financial reporting has been audited by BDO Seidman, LLP, an independent
registered public accounting firm, and their attestation report is presented on
the next page.
47
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
Interlink Electronics, Inc.
Camarillo, California
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control over Financial Reporting, that Interlink
Electronics, Inc. did not maintain effective internal control over financial
reporting as of December 31, 2005, because of the material weaknesses relating
to inventory valuation, quarterly and annual closing processes, application of
accounting policies as it relates to stock-based compensation, and the entity
level control environment, based on criteria established in INTERNAL
CONTROL--INTEGRATED FRAMEWORK issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Interlink Electronics, Inc.'s
management is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness of internal
control over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the company's
internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over
financial reporting, evaluating management's assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements of the Company will
not be prevented or detected. The following material weaknesses have been
identified and included in management's assessment:
48
1. As of December 31, 2005, the Company did not maintain effective
controls over the application of appropriate accounting policies
related to the measurement of stock-based compensation. During the year
ended December 31, 2005, and for several preceding years, the company
allowed employees who were terminated during a "black-out" period to
exercise vested stock options up to 30 days following the end of the
"black-out" period as opposed to 30 days after termination as called
for under the terms of the Company's stock option plan. The change in
terms resulted in a re-measurement of the stock-based compensation at
the termination date. This resulted in restatements of the Company's
previously issued financial statements for the years ended December 31,
2001 and 2004, as well as for the first and second quarters of the year
ended December 31, 2005.
2. As of December 31, 2005, the Company did not maintain effective
controls over inventory costing, master file maintenance and inventory
movement, and reserves for excess and obsolete inventory. This material
weakness resulted in significant adjustments in the fourth quarter, as
well as the restatement of financial statements previously issued in
the year ended December 31, 2004 and the first and second quarters of
the year ended December 31, 2005.
3. The company did not maintain effective controls over its quarterly and
annual financial statement close process in the United States and Hong
Kong which resulted in a significant number of adjustments in accounts
receivable and allowance for doubtful accounts, sales return reserves,
prepaid expenses and other assets, accounts payable, stockholders'
equity and due from stockholders. There was not a documented review by
accounting personnel with appropriate financial reporting expertise of
routine and non-routine transactions to ensure that the transactions
are accounted for in accordance with generally accepted accounting
principles in the United States of America. There were also significant
errors noted in the reconciliation of amounts receivable from and
payable to a significant vendor as of December 31, 2005 and prior
periods, which resulted in the restatement of amounts previously
reported in the years ended December 31, 2003 and 2004 and in the first
and second quarters of the year ended December 31, 2005. This material
weakness impacts the Company's ability to report financial information
in conformity with U.S. generally accepted accounting principles
("GAAP"), which could affect all significant financial statement
accounts and has partially resulted in the restatements referred to
above.
4. The number and magnitude of the various audit adjustments and
restatements, supplemented by the number of deficiencies and
significant deficiencies found in our testing of the significant
processes of Sales Order to Cash, Procure to Payment, and Stockholders'
Equity, resulted in the conclusion of a material weakness for the
financial reporting control environment as a whole.
These material weaknesses were considered in determining the nature, timing and
extent of audit tests applied in our audit of the 2005 consolidated financial
statements, and our opinion regarding the effectiveness of the Company's
internal control over financial reporting does not affect our opinion on those
consolidated financial statements.
In our opinion, management's assessment that Interlink Electronics, Inc. did not
maintain effective internal control over financial reporting as of December 31,
2005, is fairly stated, in all material respects, based on criteria established
in INTERNAL CONTROL--INTEGRATED FRAMEWORK issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO). Also in our opinion,
49
because of the effect of the material weaknesses described above, Interlink
Electronics, Inc. has not maintained effective internal control over financial
reporting as of December 31, 2005, based on criteria established in INTERNAL
CONTROL--INTEGRATED FRAMEWORK issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
The scope of our work was not sufficient to enable us to express, and we do not
express, an opinion on management's comments in their assessment regarding the
remediation of the material weaknesses.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheet of
Interlink Electronics, Inc. as of December 31, 2005 and the related consolidated
statements of operations, changes in stockholders' equity and comprehensive
loss, and cash flows for the year then ended, and our report dated July 21, 2006
expressed an unqualified opinion.
/s/ BDO Seidman, LLP
-----------------------
BDO Seidman, LLP
Los Angeles, California
July 21, 2006
50
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING DURING LAST FISCAL QUARTER
In connection with the restatements discussed above in "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
with respect to the material weaknesses identified by management as of December
31, 2004 and December 31, 2005, management has taken significant measures to
improve our financial reporting process during the last fiscal quarter. These
measures have included assessing the adequacy of controls, implementing remedial
procedures, taking corrective action to address our material weaknesses and
replacing, augmenting and upgrading the financial staff. In particular, the
following changes in internal control over financial reporting have occurred
during the last fiscal quarter:
o We identified the two material weaknesses during the fourth
quarter of 2005 and during the course of the 2005 year end
audit process described above in Management's Report on
Internal Control Over Financial Reporting as of December 31,
2005 and subsequently are taking the remedial actions related
to each, as described above.
Other than as discussed above, there was no change in the Company's
internal control over financial reporting during the last fiscal quarter that
materially affected, or is likely to materially affect, the Company's internal
control over financial reporting.
ITEM 9B. OTHER INFORMATION.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Information with respect to our directors and our audit committee has
been included in our definitive proxy statement for our 2006 Annual Meeting of
Stockholders (the "2006 Proxy Statement") and is incorporated herein by
reference. Information with respect to our executive officers is included under
Item 4A of Part I of this Report. Information with respect to compliance with
Section 16(a) of the Securities Exchange Act of 1934, as amended, has been
included in the 2006 Proxy Statement and is incorporated herein by reference.
CODE OF BUSINESS CONDUCT AND ETHICS
The Interlink Electronics, Inc. Code of Business Conduct and Ethics for
Directors, Officers and Employees is available at our website
(http://www.interlinkelectronics.com) and will be provided in print without
charge to any stockholder who submits a request in writing to: Interlink
Electronics, Inc., 546 Flynn Road, Camarillo, California 93012, Attention:
Corporate Secretary. The Code applies to our chief executive officer and chief
financial officer, and to all directors, officers and employees of the Company.
The Code provides that any waiver of the Code may be made only by the Board of
Directors.
ITEM 11. EXECUTIVE COMPENSATION.
Information with respect to executive compensation has been included in
the 2006 Proxy Statement and is incorporated herein by reference.
51
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
Information with respect to security ownership of certain beneficial
owners and management and equity compensation plan information has been included
in the 2006 Proxy Statement and is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
THE SHAREHOLDER LOANS
In late 2000, E. Michael Thoben, III, our Chairman, President and Chief
Executive Officer, Paul D. Meyer, our former Chief Financial Officer and
Executive Vice President, and Michael W. Ambrose, our Senior Vice President,
Technology and Product Development, exercised certain incentive stock options to
purchase Common Stock of Interlink and then sold the Common Stock obtained on
that exercise. By early 2001, the price of Interlink's Common Stock had declined
significantly and, among others, Messrs. Thoben, Meyer and Ambrose determined
that they would purchase Common Stock of Interlink in the open market. To
complete the purchase, and after considering the benefit to Interlink and its
stockholders, Interlink's board of directors, with Mr. Gu, Mr. Thoben and Mr.
Lutz each recusing himself from the decision, agreed to accept a promissory note
from each of Messrs. Meyer, Ambrose and Lutz in the amount of $42,892, from Mr.
Gu in the amount of $40,883 and from Mr. Thoben in the amount of $42,936. Each
promissory note is dated May 1, 2001, bears interest at the rate of 5% per annum
and is secured by all right, title and interest in the shares purchased with the
money borrowed under the note and all distributions received, receivable or
otherwise distributed in respect to or in exchange for the shares purchased. We
refer to these notes as the "Shareholder Loans." As subsequently amended upon
the approval of the Board of Directors in June 2002, the Shareholder Loans are
due and payable on November 1, 2006. As of December 31, 2005, the outstanding
balance of principal and accrued and unpaid interest on the Shareholder Loans
was $52,900, $52,900, $50,422 and $5,772 in the case of Messrs. Meyer, Ambrose,
Gu and Thoben, respectively. Mr. Thoben has paid the full amount of principal
owing under his Shareholder Loan as of December 31, 2005 and the remaining
balance of accrued interest was paid in full in 2006. Mr. Lutz has paid the full
amount of all principal and interest owing under his Shareholder Loan.
Due to concerns about the collectability of certain of the Shareholder
Loans and in an effort to treat our current officers and directors in an
equivalent fashion, we have reserved $72,054 of the outstanding balance of
principal and accrued and unpaid interest due on the Shareholder Loans from our
executive officers and directors. This reserve was recorded as of December 31,
2005 and is reflected in the accompanying consolidated financial statements.
On June 21, 2006, the disinterested members of our Board of Directors
approved a proposal to eliminate the outstanding Shareholder Loans by allowing
each of the borrowers to surrender the shares pledged as collateral as a payment
against the loan. The remaining amount of the Shareholder Loans will be forgiven
by Interlink. Each borrower has agreed to the Board's proposal.
THE 16(B) LOANS
As a result of a miscalculation of the time period between the sale of
the underlying Common Stock following the exercise of the stock options and the
purchase of the Common Stock in the open market, the purchases occurred five
months after the date of the sales and, pursuant to Section 16(b) of the
Securities Exchange Act of 1934, as amended, resulted in liability of Messrs.
Thoben, Meyer
52
and Ambrose to Interlink in the amount of the deemed profit measured by the
difference between the sale and purchase prices. The amount of the liabilities
as of June 11, 2001 were $132,652, $132,109 and $104,050 for Messrs. Thoben,
Meyer and Ambrose, respectively. Because of the amount of these liabilities,
Messrs. Thoben, Meyer and Ambrose were unable to make immediate payment without
substantial disruption to their personal financial affairs. Accordingly, after
considering the matter carefully, and having obtained the advice of counsel,
Interlink's Board of Directors, with Mr. Thoben recusing himself from the
decision, unanimously agreed to accept promissory notes from the individuals
evidencing the debt. Among the factors considered by the Board in reaching this
decision was the ongoing contribution to Interlink being made by each of the
individuals and the interest of Interlink in avoiding unnecessary pressures and
distractions on these individuals at a critical time in Interlink's history.
Each promissory note bears interest at the rate of 7% per annum and is secured
by Interlink options that had a value as of June 11, 2001 equal to 150% of the
principal amount due under the note. We refer to these notes as the "16(b)
Loans." As subsequently amended upon the approval of the Board of Directors in
June 2002, the 16(b) Loans are due and payable in three equal annual
installments beginning on June 11, 2006. As of December 31, 2005, the
outstanding balance of principal and accrued and unpaid interest on the 16(b)
Loans was $114,776, $126,610 and $25,213 in the case of Messrs. Meyer, Ambrose
and Thoben, respectively. The outstanding balance of principal and accrued and
unpaid interest of $25,213 for Mr. Thoben was paid in full in 2006.
Upon his departure from Interlink in early 2006, Mr. Meyer surrendered
the options that he had pledged as collateral in partial payment of his 16(b)
Loan.
Due to concerns about the collectability of certain of the 16(b) Loans
and in an effort to treat our current officers and directors in an equivalent
fashion, we have reserved $189,766 of the outstanding balance of principal and
accrued and unpaid interest due on the 16(b) Loans from our executive officers
and directors. This reserve was recorded as of December 31, 2005 and is
reflected in the accompanying financial statements.
Our Board of Directors is considering a proposal to eliminate the
outstanding 16(b) Loan of Mr. Ambrose by allowing him to surrender the stock
options he pledged as collateral as a payment against the loan. The remaining
portion of the loan would be forgiven by Interlink.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
Information with respect to audit fees, audit-related fees, tax fees,
all other fees and the audit committee's pre-approval policies and procedures
has been included in the 2006 Proxy Statement and is incorporated herein by
reference.
53
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
(a) 1. FINANCIAL STATEMENTS. PAGE
IN THIS
REPORT
-------
Index to Consolidated Financial Statements.................... F-1
Report of Independent Registered Public Accounting Firm....... F-2
Consolidated Balance Sheets................................... F-3
Consolidated Statements of Operations......................... F-4
Consolidated Statements of Stockholders' Equity and
Comprehensive Income (Loss)................................. F-5
Consolidated Statements of Cash Flows......................... F-6
Notes to Consolidated Financial Statements.................... F-7
2. FINANCIAL STATEMENT SCHEDULES.
The following information is filed as part of this Form 10-K and should
be read in conjunction with the financial statements contained herein:
Schedule II Valuation and Qualifying Accounts
All other schedules have been omitted because they are inapplicable,
not required by the instructions or because the required information is either
incorporated herein by reference or included in the financial statements or
notes thereto included in this report.
54
3. EXHIBITS.
The exhibits listed below are filed as part of this report.
EXHIBIT
NUMBER
3.1 Certificate of Incorporation, as amended (incorporated by
reference to Exhibit 3.1 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 2000).
3.2 Bylaws (incorporated by reference to Exhibit 3.2 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2000).
10.1* 1996 Stock Incentive Plan, as amended (incorporated by reference
to Exhibit 10.2 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 2000).
10.2* Form of Incentive Stock Option Agreement (incorporated by
reference to Exhibit 10.2 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 2004).
10.3* Form of Non-Statutory Stock Option Agreement (incorporated by
reference to Exhibit 10.3 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 2004).
10.4 Lease Agreement dated August 15, 1998 to lease premises in
Camarillo, California (incorporated by reference to Exhibit 10.8
to the Registrant's Annual Report on Form 10-K for the year ended
December 31, 1998), as amended by the First Amendment to Lease
dated July 23, 2003 between Mobile Park Investment, Inc. and the
Registrant, as amended by the Second Amendment to Lease dated
January 23, 2004 between Mobile Park Investment, Inc. and the
Registrant (incorporated by reference to Exhibit 10.4 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003), as amended by the Third Amendment to Lease
dated October 14, 2004 between Mobile Park Investment, Inc. and
the Registrant (incorporated by reference to Exhibit 10.4 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2004), as amended by the Fourth Amendment to Lease
dated March 24, 2005 between Mobile Park Investment, Inc. and the
Registrant.
10.5 Pledge Agreement between George Gu and the Registrant dated May
1, 2001 (incorporated by reference to Exhibit 10.13 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.6 Pledge Agreement between E. Michael Thoben and the Registrant
dated May 1, 2001 (incorporated by reference to Exhibit 10.15 to
the Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.7 Pledge Agreement between Paul D. Meyer and the Registrant dated
May 1, 2001 (incorporated by reference to Exhibit 10.16 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.8 Pledge Agreement between Michael W. Ambrose and the Registrant
dated May 1, 2001 (incorporated by reference to Exhibit 10.17 to
the Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.9 Secured Promissory Note of George Gu, as Borrower, in the amount
of $40.883 dated as of May 1, 2001, in favor of the Registrant
(incorporated by reference to Exhibit 10.18 to the Registrant's
Annual Report on Form 10-K for the year ended December 31, 2003).
10.10 Secured Promissory Note of Merritt M. Lutz, as Borrower, in the
amount of $42,892 dated as of May 1, 2001, in favor of the
Registrant (incorporated by reference to Exhibit 10.19 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.11 Secured Promissory Note of Michael Thoben, as Borrower, in the
amount of $42,892 dated as of May 1, 2001, in favor of the
Registrant (incorporated by reference to Exhibit 10.20 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
55
10.12 Secured Promissory Note of Paul D. Meyer, as Borrower, in the
amount of $42,892 dated as of May 1, 2001, in favor of the
Registrant (incorporated by reference to Exhibit 10.21 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.13 Secured Promissory Note of Michael W. Ambrose, as Borrower, in
the amount of $42,892 dated as of May 1, 2001, in favor of the
Registrant (incorporated by reference to Exhibit 10.22 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.14 First Amendment to Secured Promissory Note dated June 11, 2002
between the Registrant, George Gu, Paul D. Meyer and Michael W.
Ambrose (incorporated by reference to Exhibit 10.23 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.15 Pledge Agreement between Paul D. Meyer and the Registrant dated
June 11, 2001 (incorporated by reference to Exhibit 10.25 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.16 Pledge Agreement between Mike Ambrose and the Registrant dated
June 11, 2001 (incorporated by reference to Exhibit 10.26 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.17 Secured Promissory Note of Paul D. Meyer, as Borrower, in the
amount of $132,109 dated as of June 11, 2001, in favor of the
Registrant (incorporated by reference to Exhibit 10.28 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.18 Secured Promissory Note of Mike Ambrose, as Borrower, in the
amount of $104,050 dated as of June 11, 2001, in favor of the
Registrant (incorporated by reference to Exhibit 10.29 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.19 First Amendment to Secured Promissory Note dated June 11, 2002
between the Registrant, E. Michael Thoben, Paul D. Meyer and Mike
Ambrose (incorporated by reference to Exhibit 10.30 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
21.1 Subsidiaries of the Registrant.
23.1 Consent of BDO Seidman, LLP.
24.1 Power of Attorney (see signature page).
31.1 Certification of Chief Executive Officer of Registrant Pursuant
to SEC Rule 13a-14(a)/15d-14(a), as Adopted Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer of Registrant Pursuant
to SEC Rule 13a-14(a)/15d-14(a), as Adopted Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer of Registrant Pursuant
to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer of Registrant Pursuant
to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
----------------
* Management contract or compensatory plan or arrangement.
56
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Camarillo, State of California on July 24, 2006.
INTERLINK ELECTRONICS, INC.
By: /s/ CHARLES C. BEST
-------------------------------------
CHARLES C. BEST
CHIEF FINANCIAL OFFICER AND SECRETARY
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints E. Michael Thoben, III and Charles C.
Best, and each of them, his or her attorneys-in-fact and agents, each with full
power of substitution, for him or her and in his or her name, place and stead,
in any and all capacities, to sign any and all amendments to this Report, and to
file the same, with all exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents full power and authority to do and perform each and
every act and thing requisite and necessary to be done in connection with this
Report, as fully to all intents and purposes as he or she might or could do in
person, hereby ratifying and confirming all that any of said attorneys-in-fact
and agents, or his substitute or substitutes, may lawfully do or cause to be
done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on July 24, 2006 on
behalf of the Registrant and in the capacities indicated:
SIGNATURES TITLE
/S/ E. MICHAEL THOBEN, III President, Chief Executive Officer and
--------------------------- Chairman of the Board of Directors
E. Michael Thoben, III (Principal Executive Officer)
/S/ CHARLES C. BEST Chief Financial Officer and Secretary
------------------------------------ (Principal Financial Officer and
Charles C. Best Principal Accounting Officer)
/S/ GEORGE GU Director
------------------------------------
George Gu
/S/ EUGENE F. HOVANEC Director
------------------------------------
Eugene F. Hovanec
/S/ MERRITT M. LUTZ Director
------------------------------------
Merritt M. Lutz
/S/ JOHN A. BUCKETT, II Director
------------------------------------
John A. Buckett, II
/S/ EDWARD HAMBURG Director
------------------------------------
Edward Hamburg
57
INTERLINK ELECTRONICS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Index to Consolidated Financial Statements.............................. F-1
Report of Independent Registered Public Accounting Firm................. F-2
Consolidated Balance Sheets............................................. F-3
Consolidated Statements of Operations................................... F-4
Consolidated Statements of Stockholders' Equity and Comprehensive
Income (Loss)........................................................ F-5
Consolidated Statements of Cash Flows................................... F-6
Notes to Consolidated Financial Statements.............................. F-7
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders of Interlink Electronics, Inc.
Camarillo, California
We have audited the accompanying consolidated balance sheets of
Interlink Electronics, Inc. (a Delaware corporation) and subsidiaries as of
December 31, 2005 and 2004 and the related consolidated statements of
operations, stockholders' equity and comprehensive income (loss), and cash flows
for the three years ended December 31, 2005. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Interlink
Electronics, Inc. and its subsidiaries as of December 31, 2005 and 2004, and the
results of their operations and their cash flows for the three years in the
period ended December 31, 2005 in conformity with accounting principles
generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the effectiveness of the
Company's internal control over financial reporting as of December 31, 2005,
based on the criteria established in INTERNAL CONTROL - INTEGRATED FRAMEWORK
issued by the Committee of Sponsoring Organizations of the Treadway Commission
and our report dated July 21, 2006 expressed an unqualified opinion on
management's assessment of the effectiveness of the Company's internal control
over financial reporting and an adverse opinion on the effectiveness of the
Company's internal control over financial reporting.
/s/ BDO Seidman, LLP
Los Angeles, California
July 21, 2006
F-2
INTERLINK ELECTRONICS, INC.
CONSOLIDATED BALANCE SHEETS (In thousands, except par value)
ASSETS DECEMBER 31,
Current assets: 2005 2004(1)
-------- --------
Cash and cash equivalents ............................ $ 3,938 $ 6,067
Short-term investments, available for sale ........... 10,000 13,000
Accounts receivable, less allowance for
doubtful accounts and product returns of $423
and $198 in 2005 and 2004, respectively (Note 3) ... 9,184 8,248
Inventories, net of reserves of $1,739 and
$412 in 2005 and 2004, respectively ................ 8,119 10,256
Prepaid expenses and other current assets ............ 456 335
-------- --------
Total current assets ............................... 31,697 37,906
Property and equipment, net (Note 4) ................... 1,099 1,669
Patents and trademarks, less accumulated
amortization of $1,201 and $1,144
in 2005 and 2004, respectively ................... 308 265
Other assets ........................................... 67 108
-------- --------
Total Assets .................................... $ 33,171 $ 39,948
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt ................. $ 154 $ 491
Accounts payable ..................................... 5,731 5,641
Accrued payroll and related expenses ................. 1,931 1,030
Deferred revenue ..................................... 863 188
Accrued taxes and other expenses ..................... 66 102
-------- --------
Total current liabilities .......................... 8,745 7,452
-------- --------
Long-term debt, net of current portion ................. 154 405
Commitments and contingencies
Stockholders' equity:
Preferred stock, $5.00 par value
(100 shares authorized, none issued and
outstanding) ...................................... -- --
Common stock, $0.00001 par value
(50,000 shares authorized, 13,754
and 13,676 issued and outstanding
at December 31, 2005 and 2004, respectively) ...... 50,740 50,413
Due from stockholders ................................ (157) (429)
Accumulated other comprehensive loss ................. (490) (377)
Accumulated deficit .................................. (25,821) (17,516)
-------- --------
Total stockholders' equity ....................... 24,272 32,091
-------- --------
Total Liabilities and Stockholders' Equity .... $ 33,171 $ 39,948
======== ========
See accompanying notes to the consolidated financial statements.
(1) As restated
F-3
INTERLINK ELECTRONICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)
YEARS ENDED DECEMBER 31,
--------------------------------
2005 2004(1) 2003(1)
-------- -------- --------
Revenues ................................... $ 38,239 $ 35,406 $ 31,042
Cost of revenues ........................... 30,181 24,811 19,676
-------- -------- --------
Gross profit ............................ 8,058 10,595 11,366
-------- -------- --------
Operating expenses:
Product development and research ........ 4,586 4,158 3,418
Selling, general and administrative ..... 11,733 10,238 8,172
-------- -------- --------
Total operating expenses ........... 16,319 14,396 11,590
-------- -------- --------
Operating loss ............................. (8,261) (3,801) (224)
-------- -------- --------
Other income (expense):
Interest income (expense), net ......... 162 15 (44)
Other income (expense) ................. (95) 17 48
-------- -------- --------
Total other income, net .............. 67 32 4
-------- -------- --------
Loss before provision for income
tax expense ............................. (8,194) (3,769) (220)
Provision for income tax expense ........... 111 -- 28
-------- -------- --------
Net loss ................................... $ (8,305) $ (3,769) $ (248)
======== ======== ========
Loss per share--basic ...................... $ (0.61) $ (0.31) $ (0.02)
Loss per share--diluted .................... $ (0.61) $ (0.31) $ (0.02)
Weighted average shares--basic ............. 13,721 11,972 10,339
Weighted average shares--diluted ........... 13,721 11,972 10,339
See accompanying notes to the consolidated financial statements.
(1) As restated
F-4
INTERLINK ELECTRONICS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS)
(In thousands)
ACCUMULATED
COMPREHEN- TOTAL
COMMON STOCK DUE FROM SIVE STOCK-
--------------------- STOCK- INCOME ACCUMULATED HOLDER'S
SHARES AMOUNT HOLDERS (LOSS) DEFICIT(1) EQUITY(1)
---------- ---------- ---------- ---------- ---------- ----------
Balance, December 31, 2002 ......... 9,778 $ 31,433 $ (797) $ (837) $ (13,499) $ 16,300
Comprehensive income:
Net loss ....................... -- -- -- -- (248) (248)
Foreign currency translation
adjustment .............. -- -- -- 446 -- 446
----------
Comprehensive income ........ -- -- -- -- -- 198
Loan payments from stockholders .. -- -- 277 -- -- 277
Exercise of employee stock options 1,377 2,594 -- -- -- 2,594
---------- ---------- ---------- ---------- ---------- ----------
Balance, December 31, 2003 ......... 11,155 34,027 (520) (391) (13,747) 19,369
---------- ---------- ---------- ---------- ---------- ----------
Comprehensive loss:
Net loss ....................... -- -- -- -- (3,769) (3,769)
Foreign currency translation
adjustment .............. -- -- -- 14 -- 14
----------
Comprehensive loss ........... -- -- -- -- -- (3,755)
Loan payments from stockholders .. -- -- 91 -- -- 91
Issuance of common stock,
net of issuance costs ....... 1,830 13,503 -- -- -- 13,503
Exercise of employee stock options 691 2,883 -- -- -- 2,883
---------- ---------- ---------- ---------- ---------- ----------
Balance, December 31, 2004 ......... 13,676 50,413 (429) (377) (17,516) 32,091
---------- ---------- ---------- ---------- ---------- ----------
Comprehensive loss:
Net loss ....................... -- -- -- -- (8,305) (8,305)
Foreign currency translation
adjustment .............. -- -- -- (113) -- (113)
----------
Comprehensive loss ........... -- -- -- -- -- (8,418)
Interest due from stockholders . -- -- (79) -- -- (79)
Write-off of stockholder loans and
interest ................... -- -- 351 -- -- 351
Exercise of employee stock
options ................. 78 327 -- -- -- 327
---------- ---------- ---------- ---------- ---------- ----------
Balance, December 31, 2005 ......... 13,754 $ 50,740 $ (157) $ (490) $ (25,821) $ 24,272
========== ========== ========== ========== ========== ==========
See accompanying notes to the consolidated financial statements.
(1) As restated
F-5
INTERLINK ELECTRONICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
YEARS ENDED DECEMBER 31,
--------------------------------
Cash flows from operating activities: 2005 2004(1) 2003(1)
-------- -------- --------
Net loss ................................................. $ (8,305) $ (3,769) $ (248)
Adjustments to reconcile net loss to
net cash provided by (used in) operating activities:
Provision for (recovery of) allowance for
doubtful accounts receivable .......................... 284 (22) 176
Provision for loans and interest due from stockholders . 352 -- --
Increase (decrease) in reserves for excess inventories . 1,433 (425) (195)
Stock-based compensation ............................... 108 220 --
Interest due from stockholders ......................... (79) -- --
Depreciation and amortization .......................... 989 609 593
Changes in operating assets and liabilities:
Accounts receivable .................................. (1,219) 897 (3,991)
Inventories .......................................... 705 (1,193) (1,437)
Prepaid expenses and other current assets ............ (121) (82) 6
Other assets ......................................... 40 (47) 7
Accounts payable ..................................... 90 1,864 1,743
Deferred revenue ..................................... 675 188 --
Accrued payroll and other accrued expenses ........... 863 503 (188)
-------- -------- --------
Net cash used in operating activities ............. (4,185) (1,257) (3,534)
-------- -------- --------
Cash flows from investing activities:
Sales (purchase) of marketable securities ............... 3,000 (11,001) (1,999)
Purchases of property and equipment ..................... (362) (973) (643)
Costs of patents and trademarks ......................... (101) (123) (177)
-------- -------- --------
Net cash provided by (used in) investing activities 2,537 (12,097) (2,819)
-------- -------- --------
Cash flows from financing activities:
Principal payments on long term debt ................... (588) (820) (618)
Payments from stockholders ............................. -- -- 87
Proceeds from the issuance of common stock,
net of issuance costs .............................. -- 13,503 --
Proceeds from exercise of employee stock options ....... 220 2,662 2,594
-------- -------- --------
Net cash provided by (used in) financing activities . (368) 15,345 2,063
-------- -------- --------
Effect of exchange rate changes on cash and cash equivalents (113) 14 446
-------- -------- --------
Increase (decrease) in cash and cash equivalents ..... (2,129) 2,005 (3,844)
Cash and cash equivalents:
Beginning of year .................................... 6,067 4,062 7,906
-------- -------- --------
End of year .......................................... $ 3,938 $ 6,067 $ 4,062
======== ======== ========
Supplemental disclosure of cash flow information:
Interest paid ........................................... $ 36 $ 84 $ 91
Income taxes paid ....................................... $ 45 $ 1 $ 1
Non-cash transactions:
Repayment of amounts due from stockholders via offset
of accrued amounts due to stockholders ................ $ -- $ 91 $ 190
See accompanying notes to the consolidated financial statements.
(1) As restated
F-6
INTERLINK ELECTRONICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER
31, 2005
1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Interlink Electronics, Inc. and its subsidiaries are engaged in the
development of intuitive interface technologies and solutions for business and
home applications. Our products include interactive remote input devices, pen
input pads, and integrated cursor control devices. Our remote input devices
enable a user to control and communicate with various products such as
computers, digital projection systems, digital televisions and other electronic
products, by providing an intuitive device on which the user can remotely input
a variety of commands. We also design and sell products that record and bind
signatures to legal documents. Our products incorporate proprietary sensor and
wireless communication technologies and ergonomic designs. We record revenue in
four market segments that we refer to as our e-transactions (input devices for
the electronic signature markets), specialty components (integrated FSR-based
sensors, subassemblies and modules that support cursor control and other input
functions), OEM remote controls (wireless intuitive input device and sensor
products for use with presentation projectors and advanced viewing devices) and
Interlink branded products (aftermarket remote control devices sold through
retail channels).
SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION--We recognize revenue in accordance with SEC Staff
Accounting Bulletin ("SAB") No. 104, "Revenue Recognition." SAB No. 104 requires
that four basic criteria must be met before revenue can be recognized: (1)
persuasive evidence of an arrangement exists; (2) delivery has occurred or
services rendered; (3) the fee is fixed and determinable; and (4) collectibility
is reasonably assured. Determination of criteria (3) and (4) require
management's judgments regarding the fixed nature of the fee charged for
services rendered and products delivered and the collectibility of those fees.
To satisfy the criteria, we: (1) input orders based upon receipt of a customer
purchase order; (2) record revenue upon shipment of goods and when risk of loss
and title transfer; (3) confirm pricing through the customer purchase order; and
(4) validate creditworthiness through past payment history, credit agency
reports and other financial data. All customers have warranty rights and some
customers also have explicit or implicit rights of return. We comply with
Statement of Financial Accounting Standards No. 48 with respect to sell-through
and returns and the related recording of reserves for potential customer
returns. Should changes in conditions cause management to determine the revenue
recognition criteria are not met for certain future transactions, such as a
determination that collectibility was not reasonably assured, revenue would be
recognized at a later time.
ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS--Our accounts
receivable are unsecured, and we are at risk to the extent such amounts become
uncollectible. We continually monitor individual account receivable balances,
and provide for an allowance of doubtful accounts at the time collection may
become questionable based on payment performance or age of the receivable and
other factors related to the customer's ability to pay. We generally offer
30-day payment terms. However, some of our distributors in the business
communications-branded market and some of our Japanese OEM customers require as
long as 180-day payment terms. We recorded an increase to the allowance for
doubtful accounts of $176,000 and $284,000 for 2003 and 2005, respectively; and
a decrease to the allowance of $22,000 in 2004. Write-offs against the allowance
for doubtful accounts totaled $7,000, $589,000 and $3,000 for the years ended
December 31, 2005, 2004 and 2003, respectively.
F-7
RESERVE FOR ESTIMATED PRODUCT RETURNS--While not an explicit part of
the Company's terms and conditions of product sales except for some customers,
it does, on a discretionary basis, grant product exchanges for its distribution
and reseller customers in its branded business communications market for similar
products of equal value if these exchanges meet certain other criteria. The
Company records provisions for the estimated amounts of products to be returned
in such exchanges through adjustments to revenues and cost of revenues. The
Company estimates future product returns based on recent return history,
inventory status and product "sell-through" statistics received from its major
distributors, discussions regarding product activity with its major reseller
customers, and current industry product and technology trends.
INVENTORY RESERVE--At each balance sheet date, we evaluate our ending
inventories for excess quantities and obsolescence. This evaluation includes
analyses of forecast sales levels by product and historical demand. We write off
inventories that are considered obsolete. Remaining inventory balances are
adjusted to approximate the lower of our cost or market value and result in a
new cost basis in such inventory until sold. If future demand or market
conditions are less favorable than our projections, additional inventory
write-down may be required, and would be reflected in cost of sales in the
period the revision is made. Based on lowered expectations for future demand in
the OEM Remotes segment as well as limitations on the use of certain restricted
raw materials prompted by early adoption of the Restriction of Hazardous
Substances Act of 2002 by many of our customers, we increased our reserve for
excess and obsolete inventory by approximately $1.9 million in the third quarter
of 2005.
PROVISION FOR INCOME TAX--As part of the process of preparing our
financial statements, as required by Statement of Financial Accounting Standards
("SFAS") No. 109 "Accounting For Income Taxes", we are required to estimate our
income taxes in each of the jurisdictions in which we operate. This process
involves estimating our actual current tax exposure together with assessing
temporary differences resulting from differing treatment of items for tax and
accounting purposes. These differences result in deferred tax assets and
liabilities, which are included in our balance sheet. We must then assess the
likelihood that our deferred tax assets will be recovered from future taxable
income and to the extent we believe that recovery is not likely, we must
establish a valuation reserve. To the extent we establish a reserve or increase
this reserve in a period, we must include an expense within the tax provision in
the statements of operation.
Significant management judgment is required in determining our
provision for income taxes, deferred tax asset and liabilities and any valuation
reserve recorded against our net deferred tax assets. Management continually
evaluates its deferred tax asset as to whether it is likely that the deferred
tax asset will be realized.
As of December 31, 2005, the Company had net operating loss ("NOL")
carryforwards for federal, state and foreign income tax purposes of $39.8
million, $23.9 million and $5.9 million, respectively, which are available to
offset future taxable income in those jurisdictions through 2025.
FOREIGN EXCHANGE EXPOSURE--Many of our OEM customers are based in Japan
and approximately 20%, 28% and 23% of our 2005, 2004 and 2003 revenues,
respectively, came from Japanese customers. Revenues from these customers are
denominated in Japanese yen and as a result we are subject to foreign currency
exchange rate fluctuations in the yen/dollar exchange rate. We use foreign
currency forward contracts to hedge this exposure. We use revenue forecasts from
our Japanese subsidiary to determine the amount of our forward contracts to
purchase and we expect to enter into these contracts when we believe the yen
value is relatively strong against the U.S. dollar. To
F-8
the extent that our receivable forecast may be inaccurate or the timing of
forecasting the yen's strength is wrong, our actual holding gains or losses may
not necessarily correlate with the effect of foreign currency rate fluctuations
on our revenues. We mark these contracts to market value and the gain or loss
from these contracts is recorded in business communications revenue. In
addition, because our Japanese subsidiary's functional currency is the yen, the
translation of the net assets of that subsidiary into the consolidated results
will fluctuate with the yen/dollar exchange rate.
The changes in the fair values of our foreign currency contracts are as
follows (in thousands):
2005 2004 2003
-------- -------- ---------
Hedging gains (losses) ....... $ 47 $ (57) $ (211)
======== ======== ========
CONSOLIDATION POLICY--The consolidated financial statements include the
accounts of the Company, its 100 percent-owned Japanese subsidiary, and its 100
percent-owned Hong Kong subsidiary. All material intercompany accounts and
transactions have been eliminated.
SHIPPING AND HANDLING--The Company accounts for shipping and handling
costs in accordance with EITF 00-10, "Accounting for Shipping and Handling Fees
and Costs" which requires fees billed to customers to be included in revenue.
During 2005, 2004 and 2003 related shipping and handling expenses of $222,000,
$220,000 and $167,000, respectively, are included in selling, general and
administrative expenses in the accompanying consolidated statements of
operations.
FOREIGN CURRENCY TRANSLATION/TRANSACTIONS--The accounts of the
Company's Japanese subsidiary has been translated according to the provisions of
SFAS No. 52, "Foreign Currency Translation." The books and records of the Hong
Kong subsidiary are maintained in the U.S. dollar. Management has determined
that the functional currency of its Japanese subsidiary is the Japanese yen and
is the U.S. dollar for the Hong Kong subsidiary. Translation gains or losses for
the Japanese subsidiary are reflected as other comprehensive income in the
consolidated statement of stockholders' equity and comprehensive income (loss).
All of the accumulated other comprehensive income represents cumulative
translation adjustments. The Japanese subsidiary's assets and liabilities are
translated into U.S. dollars using the period-end exchange rate. Revenues and
expenses are translated at average rates during the year. Any gains or losses
resulting from foreign currency transactions are reflected in the consolidated
statements of operations for the period in which they occur.
CASH AND CASH EQUIVALENTS--The Company invests excess cash in highly
liquid commercial paper. Investments of original maturities less than 90 days
are classified as cash equivalents. At December 31, 2005, the Company had cash
and cash equivalents of $3.9 million at financial institutions in excess of
federally insured limits.
F-9
MARKETABLE SECURITIES--The Company invests excess cash in highly liquid
short-term investments available for sale. The debt and equity securities listed
below are auction rate securities that typically can be auctioned and liquidated
within a 30 day period. At December 31, 2005, the Company had short-term
investments available for sale as follows:
Short-term Investments Available for Sale
ORIGINAL MARKET UNREALIZED
COST VALUE GAIN (LOSS) MATURITY DATE
------- ------- ---------- -------------
2005:
Debt Securities $ 4,000 $ 4,000 $0 Dec. 2039 -
Dec. 2040
Equity Securities 6,000 6,000 $0 N/A
------- -------
$10,000 $10,000
======= =======
2004:
Equity Securities $ 6,000 $ 6,000 $0 N/A
US Treasury Securities 7,000 7,000 $0 January 06, 2005
------- -------
$13,000 $13,000
======= =======
FINANCIAL INSTRUMENTS--The carrying amounts of the Company's short-term
trade receivables and payables and long-term debt obligations approximate their
fair value as interest rates approximate market rates for similar instruments.
During 2005, 2004 and 2003, the Company entered into foreign currency exchange
contracts in the normal course of business to manage its exposure against
foreign currency fluctuations on revenues denominated in foreign currencies. The
principal objective of such contracts is to minimize the risks and costs
associated with financial and global operating activities. The Company does not
utilize financial instruments for trading or other speculative purposes. The
fair value of foreign currency contracts is estimated by obtaining quotes from
bankers. At December 31, 2005, the Company had foreign currency contracts
outstanding with a notional value of $900,000. During fiscal 2005, 2004 and
2003, the Company recognized a $47,000 gain, a $57,000 loss and a $211,000 loss,
respectively, on foreign exchange contracts that are included in business
communication revenue in the accompanying consolidated statements of operations.
INVENTORIES--Inventories are stated at the lower of cost or market and
include material, labor, and factory overhead. Cost is determined using the
average cost method.
PROPERTY AND EQUIPMENT--Property and equipment are carried at cost less
accumulated depreciation and amortization. Depreciation is recorded on the
straight-line basis over the estimated useful lives of the assets, which range
from three to ten years. Amortization of leasehold improvements is based upon
the estimated useful lives of the assets or the term of the lease (including
appropriate renewal options), whichever is shorter. Maintenance and repairs are
charged to operations as incurred, while significant improvements are
capitalized. Upon retirement or disposition of property, the asset and related
accumulated depreciation or amortization is removed from the accounts and any
resulting gain or loss is charged to operations. The carrying value of property
and equipment
F-10
is assessed periodically and/or when factors indicating an impairment are
present. The Company recognizes impairment losses when the expected future cash
flows are less than the asset's carrying value, in which case the asset is
written down to its estimated fair value.
PATENTS AND TRADEMARKS--The costs of acquiring patents and trademarks
are amortized on a straight-line basis over their estimated useful lives,
ranging from seven to seventeen years. Amortization expense for the years ended
December 31, 2005, 2004 and 2003 was $57,000, $35,000 and $9,000, respectively.
Amortization expense on existing costs for patents and trademarks over
the next 5 years is summarized as follows:
2006-------------------------------- $ 85
2007-------------------------------- 83
2008-------------------------------- 82
2009-------------------------------- 43
2010-------------------------------- 15
--------
Total------------------------------- $ 308
========
RESEARCH AND DEVELOPMENT--Research and development costs are expensed
as incurred.
ADVERTISING COSTS--Advertising costs were $899,000, $1,000,000 and
$1,200,000 for 2005, 2004 and 2003, respectively and were expensed as incurred
in accordance with Statement of Position (SOP) 93-7.
RECLASSIFICATIONS--Certain prior year amounts have been reclassified to
conform to the current year presentation.
STOCK-BASED COMPENSATION-- Interlink has adopted the provisions of SFAS
No. 123, "Accounting for Stock-Based Compensation." In accordance with SFAS No.
123, Interlink has elected the disclosure-only provisions related to employee
stock options and follows the Accounting Principles Board ("APB") Opinion No. 25
in accounting for stock options issued to employees. Under APB Opinion No. 25,
compensation expense, if any, is recognized as the difference between the
exercise price and the fair value of the common stock on the measurement date,
which is typically the date of grant, and is recognized over the service period,
which is typically the vesting period.
For all options granted during 2005, 2004 and 2003, the fair value of
the Company's stock equaled the option price at the measurement date.
Accordingly, no compensation cost has been recognized for these plans except for
the restatement amounts referenced in "Management's Discussion and Analysis of
Financial Condition and Results of Operations." Had compensation cost for the
Company's plans been determined based on the fair value at the grant dates for
awards under the plans consistent with the method of SFAS No. 123, "Accounting
for Stock-Based Compensation," the Company would have recorded stock-based
compensation expense as follows (in thousands, except per share information):
F-11
2005 2004(1) 2003
---------- ---------- ----------
Net loss - as reported ............................... $ (8,305) $ (3,769) $ (248)
Stock-based compensation expense included in reported
net income, net of related tax effects ............ 108 221 --
Stock-based compensation expense determined under fair
value based method, net of related tax effects .... (3,182) (2,422) (6,329)
---------- ---------- ----------
Net loss-pro forma ....................... $ (11,379) $ (5,970) $ (6,577)
========== ========== ==========
Basic loss per share - as reported ................... $ (0.61) $ (0.31) $ (0.02)
- pro forma ..................... (0.83) (0.50) (0.64)
Diluted loss per share - as reported ................. $ (0.61) $ (0.31) $ (0.02)
- pro forma ................... (0.83) (0.50) (0.64)
(1) As restated
USE OF ESTIMATES--The preparation of consolidated financial statements
in conformity with accounting principles generally accepted in the United States
of America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reported period. Actual results could differ
from those estimates.
2. RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment."
This statement is a revision to SFAS No. 123, "Accounting for Stock-Based
Compensation" and APB Opinion No. 25, "Accounting for Stock Issued to
Employees." This statement establishes standards for the accounting for
transactions in which an entity exchanges its equity instruments for goods or
services, primarily focusing on the accounting for transactions in which an
entity obtains employee services in share-based payment transactions. Entities
will be required to measure the cost of employee services received in exchange
for an award of equity instruments based on the grant-date fair value of the
award (with limited exceptions). That cost will be recognized over the period
during which an employee is required to provide service, the requisite service
period (usually the vesting period), in exchange for the award. The grant-date
fair value of employee share options and similar instruments will be estimated
using option-pricing models. If an equity award is modified after the grant
date, incremental compensation cost will be recognized in an amount equal to the
excess of the fair value of the modified award over the fair value of the
original award immediately before the modification. This statement is effective
as of the beginning of the first annual reporting period that begins after June
15, 2005. We adopted SFAS No. 123R as of January 1, 2006. We are currently
assessing the impact of this accounting standard on our consolidated results of
operations or financial position for 2006. Based on current calculations, we
expect that we will incur non cash expenses of approximately $4.0 million in
2006.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of
Nonmonetary Assets," an amendment of APB Opinion No. 29, "Accounting for
Nonmonetary Transactions." The amendments made by SFAS No. 153 are based on the
principle that exchanges of nonmonetary assets should be measured based on the
fair value of the assets exchanged. Further, the amendments eliminate the narrow
exception for nonmonetary exchanges of similar productive assets and replace it
with a broader exception for exchanges of nonmonetary assets that do not have
commercial substance. Previously, APB Opinion No. 29 required that the
accounting for an exchange of a productive asset for a similar productive asset
or an equivalent interest in the same or similar productive asset should be
based on the recorded amount of the asset relinquished. SFAS No. 153 is
effective for nonmonetary asset
F-12
exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier
application is permitted for nonmonetary asset exchanges occurring in fiscal
periods beginning after the date of issuance. We adopted SFAS No. 153 as of
January 1, 2006. The adoption of this statement is not expected to have a
material impact on the Company's consolidated results or operations or financial
position.
In October 2004, the American Jobs Creation Act of 2004 ("Act") became
effective in the U.S. Two provisions of the Act may impact the Company's
provision (benefit) for income taxes in future periods, namely those related to
the Qualified Production Activities deduction ("QPA") and Foreign Earnings
Repatriation ("FER").
The QPA will be effective for the Company's U.S. federal tax return
year beginning after December 31, 2004. In summary, the Act provides for a
percentage deduction of earnings from qualified production activities, as
defined, commencing with an initial deduction of three percent for tax years
beginning in 2005 and increasing to nine percent for tax years beginning after
2009, with the result that the Statutory federal tax rate currently applicable
to the Company's qualified production activities of 35 percent could be reduced
initially to 33.95 percent and ultimately to 31.85 percent. However, the Act
also provides for the phased elimination of the Extraterritorial Income
Exclusion provisions of the Internal Revenue code. Due to the interaction of the
law provisions noted above as well as the particulars of the Company's tax
position, the ultimate effect of the QPA on the Company' future provision
(benefit) for income taxes has not been determined at this time. The FASB issued
FASB Staff Position FAS 109-1, Application of FASB Statement No. 109, Accounting
for Income Taxes, to the Tax Deduction on Qualified Production Activities
Provided by the American Jobs Creation Act of 2004 ("FSP 109-1"), in December
2004. FSP 109-1 required that tax benefits resulting from the QPA should be
recognized no earlier than the year in which they are reported in the entity's
tax return, and that there is to be no revaluation of recorded deferred tax
assets and liabilities as would be the case had there been a change in an
applicable statutory rate.
The FER provision of the Act provides generally for a one-time 85
percent dividends received deduction for qualifying repatriations of foreign
earnings to the U.S. Qualified repatriated funds must be reinvested in the U.S.
in certain qualifying activities and expenditures, as defined by the Act. In
December 2004, the FASB issued FASB Staff Position FAS 109-2, Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision with the
American Jobs Creation Act of 2004 ("FSP 109-2"). FSP 109-2 allows additional
time for entities potentially impacted by the FER provision to determine whether
any foreign earnings will be repatriated under said provisions. At this time,
the Company has not undertaken an evaluation of the application of the FER
provision and any potential benefits of effecting repatriations under said
provision. Numerous factors, including previous actual and deemed repatriations
under federal tax law provisions, are factors impacting the availability of the
FER provision to the Company and its potential benefit to the Company, if any.
The Company intends to examine the issue and will provide updates in subsequent
periods.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and
Error Corrections--a replacement of APB Opinion No. 20 and FASB Statement No.
3." SFAS No. 154 requires retrospective application of a voluntary change in
accounting principle to prior periods' financial statements and also requires
that a change in method of depreciation, amortization, or depletion for
long-lived, non-financial assets be accounted for as a change in accounting
estimate that is affected by a change in accounting principle. SFAS No. 154 is
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. We believe the adoption of SFAS No. 154 will
not have a material impact on our results of operations or financial condition.
F-13
In March 2005, the FASB issued Financial Interpretation No. 47
"Accounting for Conditional Asset Retirements Obligations" ("FIN 47"). FIN 47
clarifies that the term "conditional asset retirement obligation" as used in
FASB Statement No. 143 "Accounting for Asset Retirement Obligations," refers to
a legal obligation to perform an asset retirement activity in which the timing
or method of settlement are conditional on a future event that may or may not be
within the control of the entity. The obligation to perform the asset retirement
activity is unconditional even though uncertainty exists about the timing or
method of settlement. Thus, the timing or method of settlement may be
conditional on a future event. Accordingly, an entity is required to recognize a
liability for the fair value of a conditional asset retirement obligation if the
fair value of the liability can be reasonably estimated. FIN 47 also clarifies
when an entity would have sufficient information to reasonably estimate the fair
value of an asset retirement obligation. FIN 47 is effective no later than the
end of fiscal years ending after December 15, 2005. We do not expect the
adoption of this statement to have a material impact on our results of
operations or financial position.
3. INVENTORIES
Inventories consisted of the following at (in thousands):
DECEMBER 31,
--------------------
2005 2004
-------- --------
Raw material ............................ $ 4,475 $ 5,217
Work in process ......................... 1,230 1,908
Finished goods .......................... 4,153 3,543
Reserve for excess and obsolete inventory (1,739) (412)
-------- --------
Total inventories ....................... $ 8,119 $ 10,256
======== ========
4. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following at (in thousands):
DECEMBER 31,
--------------------
2005 2004
-------- --------
Furniture, machinery and equipment ........... $ 7,685 $ 7,497
Leasehold improvements ....................... 511 337
-------- --------
8,196 7,834
Less accumulated depreciation and amortization (7,097) (6,165)
-------- --------
Property and equipment, net .................. $ 1,099 $ 1,669
======== ========
Depreciation and leasehold amortization expense charged to operations
amounted to $932,000, $574,000 and $584,000 for the years ended December 31,
2005, 2004 and 2003, respectively.
5. DUE FROM STOCKHOLDERS
During May 2001, the Company loaned certain directors, officers and
members of senior management a combined total of $469,000 for open market
purchases of Company Common Stock. The loans have an interest rate of 5% and are
secured by the stock purchased. As subsequently amended upon the approval of the
Board of Directors in June 2002, the notes are due and payable on November 1,
2006. These notes are referred to collectively as the "Shareholder Loans." In
June 2001, certain officers were required to remit to the Company $369,000, as
required under Section 16(b) of the Securities Exchange Act of 1934 and in
settlement of that obligation the Company accepted
F-14
promissory notes that accrue interest at 7% per year and are due and payable in
three equal annual installments. In June 2002, the Board of Directors approved
the extension of these officer loans to require the first payment to be due in
2006. These loans are referred to collectively as the "16(b) Loans." The
Shareholder Loans and the 16(b) Loans are included in stockholders' equity in
the accompanying balance sheet. In 2005, 2004 and 2003, certain officers,
directors and members of the senior management repaid a combined total of $900,
$93,000 and $280,000, respectively, primarily via an offset of accrued amounts
due to them.
Due to concerns about the nature of collectability of certain amounts
stated above and in an effort to treat the Company's current officers and
directors in an equivalent fashion, the Company has reserved $385,480 of the
outstanding balance of principal and accrued and unpaid interest due on the
Shareholder and 16(b) Loans. Of the reserved amount, $261,820 is due from the
Company's current and former executive officers and directors. This reserve was
recorded as of December 31, 2005 and is reflected in the financial statements.
Additionally, on June 21, 2006, the disinterested members of the Company's Board
of Directors approved a proposal to eliminate the Shareholder Loans by allowing
each of the borrowers to surrender the shares pledged as collateral as a payment
against his or her loan. The remaining amount of the shareholder loan would be
forgiven by the Company. Each borrower has agreed to the Board's proposal.
6. LINE OF CREDIT
In June 2004, the Company renewed its $3 million domestic revolving
line of credit with Wells Fargo Bank, which remained unused at December 31,
2005. In May 2006, the Company terminated the line of credit.
7. LONG-TERM DEBT
The Company's Japanese subsidiary, Interlink Electronics, K.K., has
borrowed unsecured loans from three banks. The loans have interest rates ranging
from 1.875% to 2.5% and are payable in Japanese yen in monthly installments
through the year 2007. The combined balance outstanding as of December 31, 2005
and 2004 was $308,000 and $896,000, respectively.
At December 31, 2005, scheduled maturities of long-term debt for the
next three years and thereafter are as follows (in thousands):
DEBT
--------
2006--------------------------------- $ 154
2007--------------------------------- 154
2008--------------------------------- --
Thereafter--------------------------- --
--------
Total 308
Less current portion----------------- (154)
---------
Long term portion-------------------- $ 154
========
During 2005, 2004 and 2003, the Company incurred $23,000, $84,000 and
$77,000, respectively, in interest expense.
F-15
8. STOCKHOLDERS' EQUITY
PREFERRED STOCK--The Company is authorized to issue 100,000 shares of
Preferred Stock. As of December 31, 2005, none were issued or outstanding. In
the future, the Preferred Stock may be issued in one or more series with such
rights and preferences as may be fixed and determined by the Board of Directors.
COMMON STOCK--The Company is authorized to issue 50,000,000 shares of
Common Stock.
9. STOCK OPTIONS
Under the terms of the Company's 1996 Stock Incentive Plan, as amended
(the "Plan"), officers and key employees may be granted non-qualified or
incentive stock options and outside directors and independent contractors of the
Company may be granted non-qualified stock options. The aggregate number of
shares, which may be issued under the Plan, is 7,250,000. Options are granted at
fair market value on the date of grant and generally vest ratably over 36 months
and have a five or ten-year term but terminate earlier if employment is
terminated. As of December 31, 2005, 6,827,000 have been granted (4,062,000 are
outstanding and 2,765,000 have either been exercised, forfeited or expired) and
there were 423,000 options available for grant.
In 2006, the Company determined it had improperly accounted for stock
option exercises of certain terminated employees during 2001 through 2005. When
the Company was in an internally defined blackout period, it allowed terminated
employees to extend their stock option exercise privileges beyond the Plan's
stated 30 days. The Company evaluated all stock options that have been exercised
from 2001 through 2005 and determined who exercised stock options beyond the
30-day period specified in the Plan. It was determined that the termination date
constituted a re-measurement date, as defined under stock option accounting
rules which require a revaluation of any stock options that were given this
benefit.
The amount of expense related to certain stock options exercised after
the 30-day period was $2.4 million, $220,000 and $108,000 in 2001, 2004 and
2005, respectively. These amounts are reflected in our financial statements in
the appropriate periods.
Information concerning stock options under the Plan is summarized as
follows (in thousands, except price per share information):
2005 2004 2003
-------------------- -------------------- --------------------
WTD. AVG. WTD. AVG. WTD. AVG.
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
-------- -------- -------- -------- -------- --------
Outstanding beginning of year 3,563 $ 6.08 3,416 $ 4.66 3,617 $ 3.72
Granted ..................... 812 5.89 948 9.45 1,201 4.49
Exercised ................... (78) 2.81 (691) 3.85 (1,377) 2.01
Forfeited and expired ....... (235) 8.26 (110) 5.37 (25) 6.13
-------- -------- -------- -------- -------- --------
Outstanding end of year ..... 4,062 $ 5.98 3,563 $ 6.08 3,416 $ 4.66
======== ======== ======== ======== ======== ========
Exercisable end of year ..... 2,739 $ 5.50 2,449 $ 5.03 2,442 $ 4.49
======== ======== ======== ======== ======== ========
F-16
The following table summarizes information about stock options
outstanding as of December 31, 2005 (in thousands, except contractual life and
exercise price per share information):
------------- ------------- ------------- ------------- -------------
Months
Remaining
Exercise # of On Options
Price Per Options Contractual Options Un-
Share Outstanding Life Exercisable exercisable
------------- ------------- ------------- ------------- -------------
$ 2.40 382 10 382 0
------------- ------------- ------------- ------------- -------------
2.70 42 27 36 6
------------- ------------- ------------- ------------- -------------
2.94 454 26 454 0
------------- ------------- ------------- ------------- -------------
3.04 39 21 39 0
------------- ------------- ------------- ------------- -------------
3.30 5 26 5 0
------------- ------------- ------------- ------------- -------------
3.54 3 14 3 0
------------- ------------- ------------- ------------- -------------
4.30 14 24 14 0
------------- ------------- ------------- ------------- -------------
4.42 276 12 276 0
------------- ------------- ------------- ------------- -------------
5.49 12 114 2 10
------------- ------------- ------------- ------------- -------------
5.50 13 0 13 0
------------- ------------- ------------- ------------- -------------
5.51 80 4 80 0
------------- ------------- ------------- ------------- -------------
5.56 7 113 1 6
------------- ------------- ------------- ------------- -------------
5.65 15 33 9 6
------------- ------------- ------------- ------------- -------------
5.70 500 114 83 417
------------- ------------- ------------- ------------- -------------
6.14 18 111 4 14
------------- ------------- ------------- ------------- -------------
6.15 252 111 56 196
------------- ------------- ------------- ------------- -------------
6.45 462 35 321 141
------------- ------------- ------------- ------------- -------------
6.87 659 2 659 0
------------- ------------- ------------- ------------- -------------
7.54 31 33 23 8
------------- ------------- ------------- ------------- -------------
7.82 13 110 4 9
------------- ------------- ------------- ------------- -------------
7.98 5 107 2 3
------------- ------------- ------------- ------------- -------------
9.40 742 102 370 372
------------- ------------- ------------- ------------- -------------
10.60 38 39 22 16
------------- ------------- ------------- ------------- -------------
Total 4,062 2,858 1,204
------------- ------------- ------------- ------------- -------------
The weighted average fair value at the date of grant for stock options
granted during 2005, 2004 and 2003 was $4.21, $4.62 and $2.27 per option,
respectively. The fair value of options at the date of grant was estimated using
the Black-Scholes model with the following weighted average assumptions:
2005 2004 2003
---- ---- ----
Estimated weighted average life (years)....... 3.0 2.7 3.0
Interest rate................................. 3.3% 3.5% 3.0%
Volatility.................................... 119% 60% 63%
Dividend yield................................ 0% 0% 0%
10. EARNINGS PER SHARE
For all periods presented, per share information was computed pursuant
to provisions of SFAS No. 128 "Earnings Per Share." The computation of earnings
per share--basic is based upon the weighted average number of common shares
outstanding during the periods presented. Earnings per share--diluted also
includes the effect of common shares contingently issuable from options and
warrants (in periods which they have a dilutive effect).
F-17
Common stock equivalents are calculated using the treasury stock
method. Under the treasury stock method, the proceeds from the assumed
conversion of options and warrants are used to repurchase outstanding shares,
using a yearly average market price.
The following table contains information necessary to calculate
earnings per share (in thousands):
YEARS ENDED DECEMBER 31,
------------------------------
2005 2004 2003
-------- -------- --------
Weighted average shares outstanding ................. 13,721 11,972 10,339
Effect of dilutive securities; options and warrants . --(1) --(1) --(1)
-------- -------- --------
Weighted average shares--diluted .................... 13,721 11,972 10,339
======== ======== ========
-----------
(1) Due to the net loss, the diluted share calculation result was
anti-dilutive. Thus, the basic weighted average shares were used.
Shares of common stock equivalents of approximately 3.6 million shares
2005 and 2004, respectively and 1.0 million shares for 2003, were
excluded from the diluted share calculation because they were
anti-dilutive.
11. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES--The Company leases its facilities and certain
equipment under operating leases expiring through 2009. Rent expense totaled
approximately $467,000, $452,000 and $382,000 for 2005, 2004 and 2003,
respectively. Minimum lease commitments at December 31, 2005 are summarized as
follows (in thousands):
2006----------------------------- $ 469
2007----------------------------- 415
2008----------------------------- 421
2009----------------------------- 408
--------
$ 1,713
========
LEGAL MATTERS-- On November 15, 2005, a class action alleging
violations of federal securities laws was filed against the Company and two of
its current and former officers in the United States District Court for the
Central District of California. The complaint alleges that, between April 24,
2003 and November 1, 2005, the Company and two of its current and former
officers made false and misleading statements and failed to disclose material
information regarding the Company's results of operations and financial
condition. The complaint includes claims under the Securities Act and Exchange
Act and seeks unspecified damages and legal expenses.
To date, the Court has not certified a class, and the litigation
remains in its early stages.
On January 24, 2006, a shareholder's derivative action was filed
against two of the Company's current and former officers and the members of its
Board of Directors in the Central District of California. The derivative
complaint contains the same factual allegations as the class action complaint
and sought to recover unspecified damages from the defendants, as well as
forfeiture of their equity-based compensation and contribution from them in the
event that the Company is found to have violated the federal securities laws.
Following a motion made by the defendants to dismiss, or in the alternative,
stay the derivative action, the plaintiff voluntarily dismissed the derivative
action without prejudice on June 14, 2006.
F-18
In connection with the class action and the derivative proceedings
described above, an independent investigation was undertaken at the direction of
the Audit Committee by Dorsey & Whitney, LLP. Dorsey & Whitney retained the
services of PricewaterhouseCoopers LLP with respect to various forensic and
electronic procedures performed in the course of the investigation. Related to
this internal investigation, the Company has recorded approximately $147,000 in
expense for 2005 and $690,000 in expense for 2006 to date for amounts not
covered by insurance.
In connection with the class action proceeding, the Company has
recorded approximately $127,000 in expense for 2006 to date for amounts not
covered by insurance.
Other than the amounts described above, the Company cannot estimate the
possible loss or range of loss, if any, associated with the resolution of the
class action and derivative proceedings. While it intends to vigorously defend
against these allegations, the Company cannot predict the final disposition of
these matters or whether the Company will be liable for amounts not covered by
insurance. There is no assurance, however, that the ultimate resolution of these
matters will not result in a material adverse effect on the Company's business,
financial condition or results of operations.
In addition to the matters identified above, from time to time, the
Company is involved in various legal actions that arise in the ordinary course
of business.
12. INCOME TAXES
The provision for income taxes for the years ended December 31, 2005,
2004 and 2003 is as follows (in thousands):
2005 2004 2003
-------- -------- --------
Current taxes:
Federal .................. $ -- $ -- $ --
State .................... -- -- --
Foreign .................. 111 -- 28
-------- -------- --------
Sub Total ......... 111 -- 28
Deferred taxes:
Federal .................. -- -- --
State .................... -- -- --
Foreign .................. -- -- --
-------- -------- --------
Sub Total .......... -- -- --
-------- -------- --------
Provision for income taxes $ 111 $ -- $ 28
======== ======== ========
Differences between the provision for income taxes and income taxes at
statutory federal income tax rate for the years ended December 31, 2005, 2004
and 2003 are as follows (in thousands):
2005 2004 2003
------- ------- -------
Income tax benefit at the statutory federal rate ... $(2,786) $(1,281) $ (84)
State income taxes, net of federal income tax effect (324) (181) 31
Foreign taxes at rates different than U.S. taxes ... 96 126 326
Valuation allowance ................................ 2,646 1,187 (245)
Other .............................................. 479 149 --
------- ------- -------
Total provision for income taxes ...... $ 111 $ -- $ 28
======= ======= =======
F-19
The tax effects of temporary differences and carryforwards that give
rise to a significant portion of the deferred tax assets are summarized as
follows (in thousands):
Deferred tax assets: 2005 2004
-------- --------
Net operating loss carryforwards ... $ 17,958 $ 15,695
Credits ............................ 220 228
Accruals ........................... 373 206
Reserves ........................... 1,078 736
State taxes ........................ (911) (703)
Other .............................. 108 18
-------- --------
Total deferred tax assets .......... 18,826 16,180
Valuation allowance ................ (18,826) (16,180)
-------- --------
Net deferred tax assets ........... $ -- $ --
======== ========
As of December 31, 2005, approximately $8.2 million of the total
deferred tax assets result from "excess" tax benefits resulting from the
exercise of employee stock options and will be recorded to stockholders' equity
if recognized.
In assessing the realizability of deferred tax assets, management
considered whether it is more likely than not that some portions or all of the
deferred tax assets will be realized. The ultimate realization of deferred tax
assets is dependent on the generation of future taxable income during the
periods in which those temporary differences become deductible and the periods
before the carryforwards expire. Based on the level of historical taxable income
and projections for future taxable income over the periods in which the deferred
tax assets are deductible, management believes there is insufficient evidence to
conclude that it is more likely than not that the results of future operations
will generate sufficient taxable income to realize a portion of the net deferred
tax assets. Accordingly, the Company has recorded a valuation allowance against
its entire net deferred tax asset during the years ended December 31, 2005 and
2004.
Consolidated U.S. income (loss) before taxes was $(4,914,000),
$(3,341,000) and $506,000 for the years ended December 31, 2005, 2004 and 2003,
respectively. The corresponding income (loss) before taxes for non U.S. based
operations was $(3,391,000), $(428,000) and $(754,000) for the years ended
December 31, 2005, 2004 and 2003, respectively.
The Company has not provided withholding and U.S. federal income taxes
on undistributed earnings of its foreign subsidiaries because the Company
intends to reinvest those earnings indefinitely or they will be offset by the
approximate credits for foreign taxes paid. It is not practical to determine the
U.S. federal tax liability, if any, which would be payable if such earnings were
not invested indefinitely.
As of December 31, 2005, the Company had NOL carryforwards for federal,
state and foreign income tax purposes of $39.7 million, $23.9 million and $5.9
million, respectively, which are available to offset future taxable income in
those jurisdictions through 2025.
Section 382 ("Section 382") of the Internal Revenue Code of 1986, as
amended (the "Code"), places a limitation on the realizability of NOLs in future
periods if the ownership of the company has changed more than 50% within a
three-year period. Under Section 382, we have experienced an approximate 43%
change in ownership for the three-year period ended December 31, 2005. As of
December 31, 2005, none of our NOLs have been limited by the Section 382 rules.
F-20
13. SEGMENT INFORMATION
BUSINESS SEGMENTS--The Company has four business segments: (i) business
communications; (ii) OEM remotes; (iii) e-transactions; and (iv) specialty
components. The accounting policies of the segments are the same as those
described in the significant accounting policies; however, the Company evaluates
performance based on revenue and gross profit. The Company does not allocate
depreciation, any other income, expenses or assets to these segments, nor does
it track revenue by product.
Reportable segment information for the years ended December 31, 2005,
2004 and 2003 is as follows (in thousands):
SPECIALTY
BUSINESS OEM E- COMPONENTS
COMMUNICATIONS REMOTES TRANSACTIONS AND OTHER TOTAL
-------------- ------- ------------ --------- -----
2005
Revenue................ $6,552 $17,846 $8,326 $5,515 $38,239
Gross profit........... 3,407 (632) 3,233 2,050 8,058
2004
Revenue................ $6,070 $18,762 $5,328 $5,246 $35,406
Gross profit(1)........ 3,511 1,731 2,583 2,769 10,595
2003
Revenue................ $8,133 $14,114 $4,165 $4,630 $31,042
Gross profit(1)........ 4,312 2,075 2,005 2,974 11,366
(1) As restated
GEOGRAPHIC INFORMATION--The Company attributes revenues to different
geographic areas on the basis of the location of the customer. The Company's
revenues and long-lived assets by geographic area for the years ended December
31, 2005, 2004 and 2003 are as follows (in thousands):
YEARS ENDED DECEMBER 31,
---------------------------------------------------------
2005 2004 2003
----------------- ----------------- -----------------
LONG- LONG- LONG-
LIVED LIVED LIVED
REVENUES ASSETS REVENUES ASSETS REVENUES ASSETS
------- ------- ------- ------- ------- -------
United States ...... $17,135 $ 1,245 $14,087 $ 1,246 $15,210 $ 911
Japan .............. 7,571 107 10,040 587 7,140 522
Asia ............... 9,492 55 3,883 6,208 14
(other than Japan) . 101
Europe and other ... 4,041 -- 7,396 -- 2,484 --
------- ------- ------- ------- ------- -------
$38,239 $ 1,407 $35,406 $ 1,934 $31,042 $ 1,447
======= ======= ======= ======= ======= =======
MAJOR CUSTOMERS--In 2005, 2004 and 2003, no single customer exceeded
10% of total revenues. One customer accounted for 11% of the accounts receivable
at December 31, 2005, 15% at December 31, 2004, and 20% at December 31, 2003.
14. 401K SAVINGS PLAN
In 1995 the Company implemented a savings plan for all eligible
employees, which qualifies under Section 401(k) of the Internal Revenue Code.
Participating employees may contribute up to 25% of their pretax salary, but not
more than statutory limits. The Company matches 50% of the first $1,000
F-21
a participant contributes. The Company expensed $36,000, $35,000 and $37,000 in
2005, 2004 and 2003, respectively, related to this plan.
15. MATERIAL ADJUSTMENTS
In the fourth quarter of 2004, the Company reduced its revenue and
accounts receivable by $704,000 and reduced its cost of sales and gross profit
by $351,000 for a customer contract that did not meet the revenue recognition
requirements of the SEC's guidelines for "bill and hold" contracts. The Company
also recorded a reduction in its inventory and an increase in cost of sales of
$257,000 for a correction of its inventory valuation method. Additionally, in
the third and fourth quarters of 2004, the Company increased its cost of sales
and decreased its gross profit by $249,000 and $178,000, respectively for
certain invoices received from a major vendor that had not been properly
recorded in the Company's accounting system.
In 2005, the Company recorded restatement adjustments for the following
items:
o The first item involves a key vendor and was identified in a
recent reconciliation of accounts with that vendor. This issue
relates to a net write-off of $1.1 million of certain
receivables primarily originating in the fourth quarter of
2003 due from the vendor, with $167,000 of that amount
originating in the fourth quarter of 2002, and the recording
of $1.0 million in payables due to that same vendor that were
not properly recorded in the Company's accounting system for
the third and fourth quarters of 2004 and the first and second
quarters of 2005.
o The second item relates to the understatement of cost of sales
in the second quarter of 2005 of $372,000 as a result of
certain inventory components being doubled counted, and thus
overstated in inventory as of June 30, 2005.
o The third item relates to the understatement of cost of sales
in the first and second quarters of 2005 totaling $616,000 as
a result of certain licensing charges that were not properly
recorded in cost of sales and inventory.
o The fourth item relates to a balance sheet reclassification of
$1.3 million in cash payments made by a customer during the
second and fourth quarters of 2004 as well as the first and
second quarters of 2005 in advance of future shipments of
product. These payments were incorrectly applied against
accounts receivable rather than recorded as deferred revenue.
The cash prepayments have been properly reclassified to
deferred revenue.
o The fifth item relates to a terminated employee's ability to
extend the time to exercise any stock options vested through
their respective termination date in a blackout period to 30
days after the blackout period is lifted as opposed to 30 days
after termination as stated in the terms of our stock option
plan resulting in a re-measurement date and a non-cash
compensation expense related to 2001, 2004 and 2005 of $2.4
million, $220,000 and $108,000 respectively.
o The sixth item relates to the understatement of cost of sales
of $837,000 in 2004 and an overstatement of cost of sales of
$748,000 in 2005 as a result of certain inventory in transit
from the parent company to its Hong Kong subsidiary being
overvalued at December 31, 2004.
F-22
These restatement adjustments reduced stockholders' equity by an
aggregate of $5.5 million and affected prior years as follows:
o Our net loss for 2001 was increased by $2.4 million to a net
loss of $4.4 million.
o Gross profit for 2002 was increased by $167,000 to a gross
profit of $8.1 million and our net loss was decreased by
$167,000 to a net loss of $4.1 million.
o Gross profit and net income for 2003 were reduced by $1.3
million to a gross profit of $11.4 million and a net loss of
$248,000.
o Gross profit for 2004 was reduced by $1.3 million to a gross
profit of $10.6 million and our net loss was increased by $1.5
million to a net loss of $3.8 million.
o Gross profit for 2005 was reduced by $357,000 to a gross
profit of $8.1 million and our net loss was increased by
$465,000 to a net loss of $8.3 million.
F-23
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
Interlink Electronics, Inc.
Camarillo, California
The audits referred to in our report dated July 21, 2006 relating to the
consolidated financial statements of Interlink Electronics, Inc., which is
contained in Item 15 of this Form 10-K, included the audit of the financial
statement schedule listed in the accompanying index. The financial statement
schedule is the responsibility of the Company's management. Our responsibility
is to express an opinion on this financial statement schedule based upon our
audits.
In our opinion such financial statement schedule presents fairly, in all
material aspects, the information set forth therein.
/s/ BDO Seidman, LLP
-----------------------
BDO Seidman, LLP
Los Angeles, California
July 21, 2006
F-24
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2005, 2004 AND 2003
(in thousands)
ADDITIONS
BALANCE AT CHARGED
BEGINNING TO COSTS & BALANCE AT
DESCRIPTION OF YEAR EXPENSE(1) DEDUCTIONS END OF YEAR
---------- ---------- ---------- ----------
ALLOWANCE FOR
DOUBTFUL ACCOUNTS:
December 31, 2005 ....... $ 59 284 7 $ 336
December 31, 2004 ....... $ 670 (22) 589 $ 59
December 31, 2003 ....... $ 497 176 3 $ 670
RESERVE FOR INVENTORY
OBSOLESCENCE:
December 31, 2005 ....... $ 658 1,433 352 $ 1,739
December 31, 2004 ....... $ 1,420 (425) 337 $ 658
December 31, 2003 ....... $ 1,818 (195) 202 $ 1,420
DEFERRED TAX ASSET
VALUATION ALLOWANCE:
December 31, 2005 ....... $ 16,180 2,646 -- $ 18,826
December 31, 2004 ....... $ 14,401 1,779 -- $ 16,180
December 31, 2003 ....... $ 13,229 1,171 -- $ 14,401
(1) THE ADDITIONS FOR THE DEFERRED TAX ASSET VALUATION ALLOWANCE INCLUDE
ADDITIONAL PAID IN CAPITAL (APIC) OF $1,283 FOR 2004 AND $1,416 FOR
2005.
F-25
EXHIBIT INDEX
EXHIBIT
NUMBER
3.1 Certificate of Incorporation, as amended (incorporated by
reference to Exhibit 3.1 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 2000).
3.2 Bylaws (incorporated by reference to Exhibit 3.2 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2000).
10.1* 1996 Stock Incentive Plan, as amended (incorporated by reference
to Exhibit 10.2 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 2000).
10.2* Form of Incentive Stock Option Agreement (incorporated by
reference to Exhibit 10.2 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 2004).
10.3* Form of Non-Statutory Stock Option Agreement (incorporated by
reference to Exhibit 10.3 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 2004).
10.4 Lease Agreement dated August 15, 1998 to lease premises in
Camarillo, California (incorporated by reference to Exhibit 10.8
to the Registrant's Annual Report on Form 10-K for the year ended
December 31, 1998), as amended by the First Amendment to Lease
dated July 23, 2003 between Mobile Park Investment, Inc. and the
Registrant, as amended by the Second Amendment to Lease dated
January 23, 2004 between Mobile Park Investment, Inc. and the
Registrant (incorporated by reference to Exhibit 10.4 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003), as amended by the Third Amendment to Lease
dated October 14, 2004 between Mobile Park Investment, Inc. and
the Registrant (incorporated by reference to Exhibit 10.4 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2004), as amended by the Fourth Amendment to Lease
dated March 24, 2005 between Mobile Park Investment, Inc. and the
Registrant.
10.5 Pledge Agreement between George Gu and the Registrant dated May
1, 2001 (incorporated by reference to Exhibit 10.13 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.6 Pledge Agreement between E. Michael Thoben and the Registrant
dated May 1, 2001 (incorporated by reference to Exhibit 10.15 to
the Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.7 Pledge Agreement between Paul D. Meyer and the Registrant dated
May 1, 2001 (incorporated by reference to Exhibit 10.16 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.8 Pledge Agreement between Michael W. Ambrose and the Registrant
dated May 1, 2001 (incorporated by reference to Exhibit 10.17 to
the Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.9 Secured Promissory Note of George Gu, as Borrower, in the amount
of $40.883 dated as of May 1, 2001, in favor of the Registrant
(incorporated by reference to Exhibit 10.18 to the Registrant's
Annual Report on Form 10-K for the year ended December 31, 2003).
10.10 Secured Promissory Note of Merritt M. Lutz, as Borrower, in the
amount of $42,892 dated as of May 1, 2001, in favor of the
Registrant (incorporated by reference to Exhibit 10.19 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.11 Secured Promissory Note of Michael Thoben, as Borrower, in the
amount of $42,892 dated as of May 1, 2001, in favor of the
Registrant (incorporated by reference to Exhibit 10.20 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
F-26
10.12 Secured Promissory Note of Paul D. Meyer, as Borrower, in the
amount of $42,892 dated as of May 1, 2001, in favor of the
Registrant (incorporated by reference to Exhibit 10.21 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.13 Secured Promissory Note of Michael W. Ambrose, as Borrower, in
the amount of $42,892 dated as of May 1, 2001, in favor of the
Registrant (incorporated by reference to Exhibit 10.22 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.14 First Amendment to Secured Promissory Note dated June 11, 2002
between the Registrant, George Gu, Paul D. Meyer and Michael W.
Ambrose (incorporated by reference to Exhibit 10.23 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.15 Pledge Agreement between Paul D. Meyer and the Registrant dated
June 11, 2001 (incorporated by reference to Exhibit 10.25 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.16 Pledge Agreement between Mike Ambrose and the Registrant dated
June 11, 2001 (incorporated by reference to Exhibit 10.26 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.17 Secured Promissory Note of Paul D. Meyer, as Borrower, in the
amount of $132,109 dated as of June 11, 2001, in favor of the
Registrant (incorporated by reference to Exhibit 10.28 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.18 Secured Promissory Note of Mike Ambrose, as Borrower, in the
amount of $104,050 dated as of June 11, 2001, in favor of the
Registrant (incorporated by reference to Exhibit 10.29 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.19 First Amendment to Secured Promissory Note dated June 11, 2002
between the Registrant, E. Michael Thoben, Paul D. Meyer and Mike
Ambrose (incorporated by reference to Exhibit 10.30 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 2003).
21.1 Subsidiaries of the Registrant.
23.1 Consent of BDO Seidman, LLP.
24.1 Power of Attorney (see signature page).
31.1 Certification of Chief Executive Officer of Registrant Pursuant
to SEC Rule 13a-14(a)/15d-14(a), as Adopted Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer of Registrant Pursuant
to SEC Rule 13a-14(a)/15d-14(a), as Adopted Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer of Registrant Pursuant
to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer of Registrant Pursuant
to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
* Management contract or compensatory plan or arrangement.
F-27