Interlink Electronics Inc

NASDAQ:LINK

Welcome to the Interlink Electronics earnings conference call discussing our third quarter ended September 30, 2008 financial results.

After I present the Safe Harbor statement, Kevin Wiley our Chief Executive Officer will discuss a few evens that have occurred during the third quarter and also our expectations for the eTransactions and specialty components business segment for the remainder of the year. In addition Mr. Wiley will comment on the strategies we are incorporating to accelerate growth and increase value in each of our unique businesses. Following that I will present relevant financial information related to the third quarter and the nine months ended September 30, 2008.

Let me first present our Safe Harbor statement. Statements made during this conference call may include forward-looking statements within the meaning of the securities laws. These forward-looking statements describe management’s intentions or expectations with respect to future events or future possibilities and do not relate strictly to historical information. These statements may include the words expects, believes or other similar expressions. Such statements involve and are subject to inherent risks and uncertainties. Many of these risks are described in the section entitled Risk Factors that is included in many of our filings made with the SEC including our 2007 Form 10K filed on March 28, 2008 and our third quarter of 2008 10Q which will be filed today. As a result of such risks and uncertainties, management’s assessment of future events and the forward-looking comments made during this conference call may prove to be incorrect. We cannot assure you that management’s intentions or expectations will not change or that specific statements made today will be realized. Forward-looking statements made during this conference call are made on the assumption that we will continue to operate our business as described herein. We may however make changes in our operations to meet business challenges or to take advantage of unforeseen opportunities. Any such change in the way we operate our business could cause forward-looking statements made herein to be wrong.

I’d now like to turn the call over to Kevin.

We have now completed our third quarter of 2008 and will soon be completing our 2008 fiscal year of operations.

Since I joined Interlink in August this year I have primarily spent my time with key members of each of the business segments and have learned a great deal about the key drivers of each of our business segments and the company as a whole. This learning has provided a foundation in developing the strategies for the company. While the management team operates the business segments with a high degree of autonomy, we spent a significant amount of time working together on the strategies that will take the company forward.

During 2008 we’ve grown the top line revenue in both the eTransactions and specialty components business segments. In addition we continue to review the structure of the company in a way that allows for accountability and analysis of each business segment separately because we believe both represent attractive growth opportunities yet they each have dramatically different operational, structural and capital needs. We’ll continue to carefully measure our capital commitments to each business segment and at the same time do our best to capitalize on the market opportunities we see today and into the future.

All aspects of our third quarter 2008 financial results were significantly improved including top line revenue growth and at the operating income level over second quarter 2008 and third quarter 2007. Our 2008 third quarter revenues of $7.2 million was 8% over second quarter 2008 revenues and 55% over third quarter 2007 revenues. Our operating loss for the third quarter of 2008 was $27,000; however if you exclude the noncash stock-based compensation charges of $144,000, we achieved operating income of $117,000. This is a good accomplishment for us.

As we look towards the end of the year, our 2008 full-year revenue is forecasted to be within our previous revenue projection of between $24 million and $28 million. Our cash balance increased by $400,000 from $9 million at June 30, 2008 to $9.4 million at September 30, 2008.

During the second quarter of 2008 we reduced our payroll and related costs by an annualized amount of $2 million through a reduction in headcount. The impact of this reduction was realized in this quarter.

As part of the strategy and the review of our operating structure in late October 2008 we began the process of transitioning substantially all of the manufacturing operations currently in Camarillo, California to our manufacturing facility in Shenzhen, China. This transition will be completed in the first half of 2009 and will reduce operating costs by an estimated $1.5 million annually while allowing us to become more efficient in our manufacturing processes.

With respect to cash we had earlier stated our goal as being operational cash flow positive during the last six months of 2008. As you can see from our third quarter 2008 results, we made good progress towards this goal. However fourth quarter projections indicate a reduction in top line revenue and therefore we do not expect positive operating cash flow during this quarter.

The lower revenue projection for fourth quarter is primarily due to the early conclusion of a contract from a specialty components customer that was originally expected to conclude in the first quarter of 2009. Additionally, certain eTransactions prospects have notified us of their intent to postpone purchases until 2009 due to the global economic downturn. Our move to turnkey production of certain eTransactions capture devices will allow us to minimize the impact of these postponements on the overall business.

As I mentioned earlier, we expect to achieve our revenue target for the full year but we do not expect to achieve our cash flow projection for the last three months of 2008.

I also want to comment on our class action lawsuit. Over the past few months we’ve been actively involved in mediation and settlement discussions with the plaintiffs. These talks and discussions have been very productive and allowed us to move forward in a positive way. We are optimistic that we’ll be able to bring this lawsuit to closure through an agreed upon settlement. We believe that the settlement will require minimal cash contribution by the company.

As a management team we continue to focus on realizing efficiencies and taking actions to position each of the business segments for continued revenue and margin growth to achieve profitability. These actions include focusing sales and business development on certain key market segments of both business segments, developing eTransactions turnkey relationships to manage hardware costs more effectively, transitioning manufacturing and operations to our China facility, and managing cash.

To our shareholders, we appreciate your continued support during this time of change and growth.

Now I’d like to turn it back over to Chuck for a more in-depth look at our financials.

I would now like to give a brief overview of the third quarter and the nine months ended September 30, 2008 financial results.

First let me present the third quarter of 2008. Total revenues for the quarter were $7.2 million, up 55% from the 2007 third quarter. eTransactions revenues were $3.3 million, 62% above the comparable prior period quarter, while specialty components revenues were $3.9 million, 49% better than the three months ended September 30, 2007.

Gross profit in the 2008 third quarter was $3.1 million or 43% of revenues compared to $1 million or 22% of revenues in the third quarter of 2007. Our eTransactions gross margins were 48% for the three months ended September 30, 2008 compared to 49% for the comparable prior year period. Our specialty components margin was 39% for the three months ended September 30, 2008 compared to 2% for the three months ended September 30, 2007. The specialty components gross margin in the third quarter of 2008 was positively affected by higher volume of production in the 2008 period compared to the comparable 2007 period.

As we have stated in the past, we expect to see gross margins fluctuate in both of our business segments but expect as revenues for each business segment grow to see improvements in both of our business segments’ gross margins for the 2008 fiscal year compared to the 2007 fiscal year.

Operating expenses for the three months ended September 30, 2008 decreased to $3.2 million from $4.2 million for the three months ended September 30, 2007. This $1 million decrease in operating expenses was primarily due to $1.3 million in decreased selling, general and administration expenses which was offset by a $253,000 increase in product development and research costs.

The decreases in SG&A expenses were primarily related to a reduction in payroll and related costs. Our product development and research costs increased primarily due to increases in payroll and related costs due to the realignment of certain personnel from manufacturing to product development in 2008.

We expect our operating expenses to be slightly higher in the fourth quarter of 2008 compared to the third quarter of 2008 due to the end-of-the-year accounting and other administrative costs associated with closing the fiscal year.

Now let me comment on the first nine months of 2008. Total revenues were $19.7 million, up 56% from the first nine months of 2007. eTransactions revenues were $9.1 million, 44% above the comparable prior period, while specialty components revenues were $10.6 million for the first nine months of 2008, 67% better than the $6.3 million in the comparable nine month period ended September 30, 2007.

Gross profit for the first nine months of 2008 was $8.2 million or 41% of revenues compared to $4.2 million or 33% of revenues for the comparable nine-month period in 2007.

Our eTransactions gross margins decreased from 51% for the first nine months of 2007 to 47% for the nine months ended September 30, 2008 due to higher unabsorbed manufacturing costs in the first nine months of 2008 compared to 2007.

Our specialty components gross margins increased from 15% for the nine months ended September 30, 2007 to 37% for the nine months ended September 30, 2008. The specialty components gross margin was positively affected by increased production volume which absorbed more manufacturing overhead costs and our eTransactions business segment absorbing a larger portion of unabsorbed costs during the first nine months of 2008 than it did in the first nine months of 2007.

Again as we have stated in the past, we do expect to see gross margins fluctuate in both of our business segments.

Operating expenses for the nine months ended September 30, 2008 increased to $11.9 million from $10.5 million for the nine months ended September 30, 2007. This $1.4 million increase in operating expenses was due to $312,000 in increased selling, general and administrative expenses and $1.1 million in increased product development and research costs.

SG&A’s $312,000 increase was attributable to a $288,000 cost in severance costs that was recorded in the second quarter of 2008. Our product development and research costs increased $1.1 million primarily due to increases in payroll and related costs due to the realignment of certain personnel from manufacturing to product development in 2008.

From a balance sheet perspective, we have $9.4 million in cash of which $9 million is unrestricted as of September 30, 2008. We’ve increased our cash position by $400,000 from the end of the second quarter to the end of the third quarter and improved operating results in the third quarter compared to the second quarter.

Our inventory levels increased by $440,000 when compared to the December 31, 2007 inventory balance and our accounts payable and related expenses are down over $3.8 million partially the result of a $1.5 million cash pay-down related to the asset sale which occurred in August of 2007.

Our working capital ratio improved to 4.8 to 1 as of September 30, 2008 from 3.3 to 1 as of December 31, 2007.

That concludes our comments for the three and nine months ended September 30, 2008. We are now available to answer any questions you may have.

Yes, we can give a little flavor on that. We’ve always been pretty bullish on both segments.

The eTransactions business segment has really met the expectations that we had expected through the nine months and we do as we’ve stated before really rely on a lot of larger sale customers to drive that revenue. But on top of that for us we are also seeing some of our more software-based products in that business segment helping us in terms of margin and revenue.

We had previously announced a product called [MC] which is a product that we’re going out to companies and promoting as a software-only based product. We had a couple of larger sales with bigger customers as we’ve mentioned. That is important. We are driving just the pipeline in that business quite nicely. As Kevin mentioned, we have a very nice backlog.

We do have a couple of customers who have communicated to us that probably the fourth quarter as we had hoped would not be a time they finalize the transaction, but they certainly haven’t gone away and we expect those in the first part of 2009.

From a specialty components point of view, as you know we’re driven quite a bit from starting at the project level and bringing that up to the revenue level. Nothing really changed from our last conference call in that respect in that we have a few pretty good high volume customers that are driving our revenue. We ended up having one who’s end-of-life process was a little bit sooner than we had been communicated to earlier so that’s driving down our revenues a little bit in Q4.

If we have given that number out in the past, it probably was on a conference call like this and I actually don’t have that number definitively right in front of me. I can tell you that we are still very bullish on that business segment and the pipeline is very healthy.

No. We’re not seeing anything that’s going away. In fact we actually through the last few months have seen a pickup in some customers that we actually didn’t feel were going to move forward as quickly as we thought. Now those are being offset because of some of the economic turmoil we have with some customers who are now delaying a little bit. We’ve seen a little bit of both. We felt we had a pretty good third quarter with what was going on in the economy with some of the customers we had. But I think they like the product and they like what it gives them so we’re not seeing them go away; we’re just seeing them delay.

I think where we’re at right now is in fact the downturn may be helping us in the sense that the eTransactions business actually provides better economies for our customers and efficiencies for our customers. While they’re deferring their purchases for a couple of months, they still see the benefit of the improvement in their operating efficiencies from eTransactions hardware and now more particularly the software offering that we have.

We’re not getting cancelations and there are actually a couple of customers that we were surprised as Chuck mentioned a minute ago to see their activity pick up in the fourth quarter in light of the bit of turmoil that we’re in right now. We actually see it as potentially a positive for the business. I think everybody’s just a little gun-shy to the end of the year but we see things in a pretty good light for the eTransactions business going into 2009.

One particular customer is a software integrator for business operations and the opportunity to move away from paper transactions to paperless transactions is a key point for them in their business development work. The other sector is in the automotive area and that has been one that has obviously if you look at the world around us, but again when you have an opportunity to improve the efficiencies at the dealership level, it’s an important consideration and decision that they’re taking. Again we’re not having any indications that there’s any real fallout. It really is simply a timing issue right now.

I think it’s probably going to take us a couple of quarters. The one thing that we’re doing in terms of moving manufacturing over to China will provide some significant annualized cost reductions at the operating level but it does require a little expenditure upfront to get there as you see in our filing that we did a few weeks ago. The expectation is we’ll probably burn some cash but nothing that’s going to harm us.

We’re extremely focused on expenses right now in every aspect of the business. We’ve got to weather the bit of storm that we’re feeling right now. We’ve got a lot of business development work in the pipeline on the specialty components side that it’s a six to nine to 12 month process and we see that working its way through over the next couple of quarters as well. Then with our cost reduction efforts, we expect to be through all of this in the first half of 2009.

Not yet. We’re actually in the budgeting process right now for 2009 and we’ve got to finalize that before we can start making projections and comments around where we’ll be. But that process is well underway and we expect to finish it in the next couple of weeks.

Significant might be overkill a bit but lower yes because of the operational costs that we’ve taken out of the business.

The other side to add to that is that not only have the operating costs been removed but we’re also much more focused on the manufacturing side in terms of yield and that obviously improves material margin and flows through to the bottom line. So the focus on getting manufacturing right in both business segments, eTransactions as I mentioned we’re moving to a turnkey contract in order to fix those costs, and then on the operational side for specialty components with the transition to China and the focus on improved operating efficiencies, improved yields and therefore better margins.

On the eTransaction side we continually add new customers and we do ship additional products to existing customers. But primarily the revenue growth based on the model of that business is new customers particularly this last quarter.

On the specialty side it’s more of a project pipeline driven process and we also have what we call a traditional base of older customers who’ve been around a while and we sell applications that are not necessarily focused on our micronav technology and our handheld device market. We do pick up customers here and there and some leave.

But as a whole, on the large mass production type of customer, we did not pick up any new customers but we have a number of them in the pipeline that are getting ready for revenue generation in early ’09.

The specialty components business is a long lead time business so we have what we view as a traditional revenue stream which is our long-term customers, that is repeat business, and then the new project based customers that Chuck mentioned. Those customers have been around for a couple of quarters now. That’s the composition of the component side.

On the eTransactions side some are new customers in terms of an existing customer that has expanded the relationship with us into a different divisions or different branches, so each of that does require a different level of business development. But from a customer point of view we have a pipeline for both businesses and for both segments and both segments have a fairly healthy potential for those customers coming into production and buying from us.

Yes. It’s always dynamic with this particular customer but they notified us. We expected the project to end in the first quarter of 2009 and they notified us that the project was actually going to conclude at the end of this year. That may have changed as of last night. It’s still very much in flux but it’s really a timing issue and the first quarter of ’09 was really not as significant as what we’ve experienced the last three quarters with the customer. We expected it; we just didn’t expect it a quarter early.

Yes, it was.

We actually don’t have that.

We actually don’t go down to the customer level and we haven’t done that in the past. It’s something we can consider going forward.

Yes. I think there was at least one. Just one.

No. It wasn’t that high at all. The 10Q should be filed at this point; if not, very soon. We do talk about large customers in there. It was nothing close to that level. Just around 20%.

No, we didn’t talk about backlog and we typically haven’t on a formal basis. In the past we have made comments about it and at this point we weren’t really prepared to want to make comments on it right now. We did at least mention that we feel it’s very healthy, and it is a good suggestion maybe as we go forward to look at commenting on that.

We’re six weeks into the quarter and we’re very comfortable that we will be above the low end of $4.3 million. We would expect to end up some place close to the midpoint.

No. It isn’t one specific customer. It’s a build-up of a number of opportunities. Again in the pipeline in specialty components originally we thought that we may see one additional opportunity come through in the mass production in the fourth quarter and realized early on in the third quarter that that probably wasn’t going to happen; that it’s probably into the next year.

But then just a combination of a lot of different things in the planning that put us at the $28 million range that we’re not going to be able to deliver on in this quarter. The quarter is down on the revenue side but again as I said I think it’ll be closer to the midpoint of those two numbers the way we finish fourth quarter.

By midyear 2009. We’ve got a schedule done and we’re very comfortable that we will achieve it. We had set a date of completely transitioning by June 30, 2009 but it would appear that barring any unforeseen circumstances we will beat that date by 45 days or so.

I think there are probably other places. There are no sacred cows so we’re looking at all of our expenses. Our facility here is a fairly large facility that through this transition we won’t need the amount of space we have here. We have an obligation till early 2010 for the space but we’re underway right now in terms of seeking what our alternatives are and that’s a fairly big chunk of money but also requires a bit of investment to move as well. We need to look at all aspects of that.

People costs, I think we probably are at the minimum. There may be a few other things that we can do along the way but nothing without potentially harming the business. We’re looking at a reshifting of a few of the headcount towards business development so driving the sales effort and getting away from the administrative costs of the business. I think we’re on a pretty good track. We have to continually stay in the present to make sure we’re hitting the targets.

Thank you everyone for being on the call. We will talk to you soon.