INTERLINK ELECTRONICS INC - Annual Report: 2007 (Form 10-K)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2007

OR

For the transition period from              to             

Commission File Number 0-21858

INTERLINK ELECTRONICS, INC.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (805) 484-8855

Securities registered pursuant to Section 12(b) of the Act:

Common Stock

(Title of each class)

Securities registered pursuant to Section 12(g) of the Act:

None

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  x    No  ¨

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  ¨    Non-accelerated filer  x

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, 2007 (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 $21,037,000 based upon the last sale price reported for such date on the Over the Counter market trading system. 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 March 25, 2008, the number of shares of the registrant’s Common Stock outstanding was 13,749,310.

Documents incorporated by reference:

Part III of this Annual Report on Form 10-K incorporates by reference information from the registrant’s Proxy Statement for the 2008 Annual Meeting of Stockholders.

Table of Contents

INTERLINK ELECTRONICS, INC.

TABLE OF CONTENTS

Table of Contents

PART I

Overview

Interlink Electronics, Inc. and its subsidiaries, design, develop, and sell intuitive interface technologies and solutions for a variety of businesses. We have two business segments: Specialty Components and eTransactions.

Our Specialty Components products include cursor control and other input devices for a wide variety of electronic products, including game controllers, cellular telephones, handheld media players and medical devices. We make Force Sensing Resistor (“FSR”) based sensors that we and other companies incorporate into end user products. FSR based technologies, such as MicroNav™, support full mouse functionality and file navigation using miniaturized sensors and supporting systems that consume relatively little power, making them particularly attractive to manufacturers of handheld devices.

Our eTransactions products include signature input devices that we support with proprietary application software. These products enable organizations to capture, secure and legally-bind an electronic signature, as well as record various identity-defining factors such as signature biometrics and fingerprints.

We serve a global customer base from our corporate headquarters in Camarillo, California, where we also manufacture components incorporating our FSR technology. We have a logistics center in Hong Kong and a manufacturing facility in Schenzen, China. We have sales offices in Canada and Tokyo, as well as throughout the United States.

Products for Specialty Components and eTransactions benefit from a diverse technology portfolio based on trade secrets, patented inventions and proprietary software. These technologies include our FSR technology 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.

Market Opportunities

Specialty Components. FSR-based products are used in portable electronic devices where user input must be converted into an electrical signal. Such devices include mobile phones, portable media players, navigation devices, handheld games and digital cameras. Market research firm Informa Telecoms & Media, projects the advanced or high end mobile phone and portable media player markets in particular to grow significantly over the coming years. Opportunities for our products come from this market growth as well as our potential deeper penetration of existing markets. Market requirements for solutions suitable for smaller, thinner devices, lower power consumption, highly refined designs, better navigation and more intuitive usability are also driving increased demand for Interlink products.

FSR sensors are ideally suited for use in handheld devices, and we have developed our MicroNav™ family of sensors in response. As the size of these handheld devices continues to decrease and their functionality becomes increasingly sophisticated, we expect this market to represent a significant growth opportunity.

Additional market opportunities are emerging for us to improve the functionality of standard capacitive sensors that are widely available and competitively priced. Inadvertent activation, where users unintentionally activate a control, is a common problem with capacitive technology. In contrast, FSRs are based on a resistive technology that requires a deliberate application of force to operate. We have had recent success in using FSR technology in combination with capacitive technologies to minimize the latter’s performance issues, enabling FSR sensors to complement competitive technologies and provide us with new opportunities for growth.

We also continue to provide our traditional line of custom sensors and pointing solutions to the medical, industrial, commercial and government markets.

eTransactions. Market research companies such as Celent, TowerGroup and the Robert E. Nolan Company, Inc. highlight the advantages of, and need for, e-signature technology becoming a part of business processes. These analysts point to the need for financial services organizations in particular to implement electronic signatures to gain competitive advantages and achieve operational efficiencies. Compared with traditional processes involving the circulation of paper documents for ink signatures, e-signature processes can offer substantial time and cost savings for document producers, as well as improved customer satisfaction for persons executing these documents. We believe the question is not whether electronic signatures should be implemented, but when and how this technology will be implemented.

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Our eight-year history of providing e-signature solutions has given us a competitive advantage. We believe the market will adopt e-signature technology in both internal and external processes and that we are positioned to capture significant portions of this growing market. Our product offerings have the potential to fulfill the e-signature needs of our customers across all of their channels of business: in-branch, in-the-field and online.

Strategy

Specialty Components. Our objective is to be the leading provider of advanced intuitive interface components to business and consumer markets by:

eTransactions. We focus on markets that have the highest potential for revenue growth, particularly financial services, healthcare, and government. Our strategy also includes ensuring our technology is not only used in the key e-signature applications available today but those that will be the electronic signature applications of choice in the future. Currently, organizations are using e-signatures in a customer facing environment, such as a new account opening at a bank, and also in web based applications, such as applying for automobile insurance online. We continually look to the markets and technologies to determine future applications.

Our strategy involves generating revenues from new and existing customers. New customers are identified by an experienced field sales team as well as through distribution and reseller channels. Typically, our products are initially purchased for one application within the organization. Over time existing customers find additional needs that our products can provide.

Products

Specialty Components. Specialty Components offerings come in three product lines: custom FSR sensors, MicroNav™ sensors and integrated pointing solutions. FSR sensors are very flexible in their configuration and are versatile enough to be designed into a myriad of applications. We are able to deliver solutions in very demanding applications, such as in industrial environments, or those requiring high levels of reliability, such as in medical devices.

The miniaturized sensors that we sell under the MicroNav™ brand come in various formats and permit precise input of a broad range of selections. These sensors enable web surfing, list scrolling, gaming, and menu navigation for portable devices and are designed to fit in small spaces and provide capabilities similar to those of a computer mouse. In some applications we supply the basic sensor and a license to use the related software drivers. We also support various lighting, materials, connection, and actuator designs. We can supply sensor and micro-processor combinations in formats suitable for “drop-in” solutions. We offer all three formats on an OEM basis to manufacturers of various handheld products.

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We sell integrated pointing solutions to manufacturers of notebook computers, rugged electronics and industrial applications. We also sell a diverse assortment of custom FSR sensors for non-computer applications, such as for use in medical devices as safety switches. MicroNav™ sensors, a key focus area of the company, are used in consumer electronics and other portable electronic devices.

eTransactions. Our e-signature products enable organizations to securely capture legally-binding e-signatures and permanently bind that information to the document for archiving and future verification. Our ePad family of products covers the full spectrum of e-signature processes and environments. Key functionality of the ePad family includes full-color LCD displays, fingerprint sensors and device encryption.

Our e-signature software, IntegriSign Signature Software Suite, was introduced in 2004. The desktop version is bundled with every member of the ePad family. This software encrypts and permanently embeds e-signatures in documents along with additional signature data such as date and time. In 2008, server signing functionality will be added to the IntegriSign Signature Software Suite to provide companies the ability to implement end-to-end electronic processes for Web-based transactions.

Offering combined hardware and software solutions, we provide our customers with a single-source for all of their e-signature technology needs. We also offer professional services for organizations requiring customization of their solutions.

Customers

Specialty Components. Our customers include many of the world’s largest consumer electronics manufacturers as well as a variety of familiar names in the medical equipment, computer and industrial equipment markets. These customers include such portable electronic device manufacturers as Samsung, iRiver, Sony, LG, BenQ-Siemens, Pantech and Olympus. Our medical device customers include Varian, Respironics and Medtronic. Other Interlink customers include computer and computer peripheral device manufacturers such as Microsoft and NMB and other equipment manufacturers such as Preh and Siemens.

eTransactions. Our products are sold to different types of companies in different industries. We currently focus on firms in the financial services market (banking, insurance, financial planning and brokerage, auto finance and mortgage) and the government sector at both the federal and state level. We also have significant customers in the healthcare and telecommunication sectors.

Our technology has been implemented by such customers as Farmers Insurance, Metlife, Prudential, State Farm, DealerTrack, Wells Fargo, Wachovia, Chrysler Financial, National Notary Association, PhilipMorrisUSA, Veterans Hospital, Siemens, McKesson, Cerner, Vodafone, Lloyds TSB, Ford Credit, Bristish Airways, El Corte Inglés and BMW.

Technologies

Specialty Components. Specialty Components products are based on our patented FSR technology. The sensor typically consists of a bottom layer of conductor traces, a proprietary resistive ink top layer and a spacer that separates the two layers. An additional top layer that contains graphics and protects the sensor can also be added. As a user touches the top of the sensor layer it contacts the conductor layer causing a resistance change. As more force is applied the resistance continues to change proportionally to the force.

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. 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.

FSR sensors can be as thin as eight thousandths of an inch, making them particularly well suited for use where space is a critical issue, as in mobile phones and portable electronics. In finger-sensing applications, such as touch pads and scroll rings, they consume less power than do capacitive sensors, which is 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

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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. We continue to improve our proprietary ink formulas, manufacturing process and printing technology.

eTransactions. We have created a comprehensive product line of signature capture devices that range from low cost units with opaque sensors and no visual feedback to products with full color display and high speed communications. To enable this hardware and provide a complete solution to customers, we have built the IntegriSign Signature Software Suite. IntegriSign software is included with our signature capture product line and enables a basic range of electronic ink and digital signing activities to be activated at individual workstations and can be integrated into any corporate or enterprise framework.

We maintain active, in-house product design, engineering support and advanced technology departments in the United States, Japan and China. We also have an exclusive relationship with a third-party software development firm in India that provides us access to additional software engineers for electronic transaction software development and integration. As appropriate, we may engage other third-party 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 currently 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. As a result, we consider this expertise to be one of our more important trade secrets. 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 innovative ways to measure and use FSRs for human input to electronics such as mobile phones or other portable electronics.

The first of our patents for FSRs, which cover certain aspects of the use of a micro-textured surface to produce resistance that varies with force, expired in 1999. However, the FSR sensors that we make today are covered by 25 patents related to their function, formulation and manufacture that expire between 2011 and 2020. 16 FSR-related patents are pending.

Software. We have developed software that we provide with our products. We expect to aggressively develop or acquire additional software application technologies to support this and other markets.

Sales and Marketing

Specialty Components. Development of our MicroNav™ family of sensors has broadened the range of OEM applications that our products address. We are pursuing opportunities to develop these applications by working with our OEMs to customize our solutions into their products. Our sales process identifies opportunities according to their need for our technology and match to our strategic direction.

Our products are sold by Interlink sales personnel as well as independent outside sales representatives. We maintain active, in-house product design, engineering support and advanced technology departments. As appropriate, we may engage outside development firms to facilitate the integration of our products into our customers. Our application support teams address customer requirements and improve our probability that we will be successful in meeting our customers’ needs.

eTransactions. We are a pioneer and innovator in the electronic signature market, selling our e-signature products since 1999. Our efforts initially focused on educating the market on e-signature technology. Today, our marketing strategy is focused on generating market awareness and qualified leads in key strategic markets. We actively pursue high-profile speaking engagements and has forged strategic relationships with key industry players. We have entered into referral and reseller agreements with the top independent software providers. We have also completed cross-selling relationships with complementary solutions such as archiving vendors, e-forms providers and those who have software-only e-signature solution and need our hardware to complement their offering. These relationships allow us to increase our lead generation, which results in more electronic signature solutions for our customers.

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Manufacturing

We maintain a manufacturing facility in our corporate headquarters located in Camarillo, California. In 2001, Interlink Electronics Asia Pacific Limited (IEAP), a wholly owned subsidiary located in Hong Kong was created to coordinate non-U.S. manufacturing activities. In October 2006, Interlink Electronics (China) Company Limited, (IECH), a wholly owned subsidiary located in Shenzhen, China was created. IECH increases our manufacturing and operational capabilities. IECH maintains capabilities for die cutting, assembly and testing of higher volume FSR products, and has a class 10,000 clean room that allows for a significantly cleaner manufacturing environment.

We acquire raw materials and components for our products from a number of sources around the world, including the United States and China. We have worked closely with a small group of manufacturers to 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

Specialty Components. We face competition from a variety of sources that vary depending on the application, with significant competition in the mobile phone and portable electronics device markets. We currently face competition from companies that offer solutions incorporating capacitive technology, as well as, to a lesser extent, other firms offering resistive technology solutions. Competition is also found in the use of touch screens, as these devices have few or no buttons for user input.

Many competitors are larger and have substantial resources at their disposal which could materially affect our ability to compete successfully against them. Many of the companies with which we currently compete or may compete in the future have long-standing customer relationships. These competitors may develop or acquire enhanced technologies sufficient to maintain or improve their market share. Some of our competitors have a diversified product line and already sell other products to our customers. We expect that our success against our competition will depend on our ability to use our technology, design experience and industry relationships to offer timely, innovative and cost-effective solutions to our customers

eTransactions. We are the only manufacturing company offering a combined hardware and software electronic signature solution. We do, however, compete against system integrators that provide similar systems from a variety of sources. With the anticipated growth in the market, we expect to see increased competition from hardware and software providers.

Current competitors consist primarily of organizations that tend to be singularly focused on the software or hardware solution in the electronic signature market. However, a variety of companies that currently supply products or services to our targeted customers can be expected to try to expand their offerings to include advanced signature solutions. 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 will attract additional competitors.

Employees

We had 220 employees as of December 31, 2007. Of that number, 107 are full-time employees in the United States with 100 at our corporate offices and manufacturing facilities in California and 7 located at our regional sales offices throughout the United States. We have 2 employees in a regional sales office in Canada and 1 employee in Korea. Our Japanese subsidiary has 9 employees. We have 1 employee at our Hong Kong subsidiary and 100 employees at our China subsidiary.

Financial Information About Segments and Geographic Areas.

Financial information about our business segments and geographic areas is incorporated herein by reference to Note 15 to the Consolidated Financial Statements included in this Annual Report.

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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.

We also make these reports and information available free of charge through our Internet website (http://www.interlinkelectronics.com) as soon as reasonably practical after we file such materials with the SEC. Information contained on our website is not part of this Annual Report or any other report filed with the SEC.

We have incurred net losses and negative cash flow from operations for the past five fiscal years and expect to experience future quarterly losses. Continued losses and negative cash flow would reduce our internal resources, limit our growth options, require additional cash infusions and could ultimately place our continued viability in question.

We have incurred losses and negative cash flow from operations in each of the previous five fiscal years. These losses resulted from various factors, including declining gross profit margins in our recently divested OEM Remotes business segment, increases in operating costs, increased compliance and regulatory costs, inventory reserve adjustments and internal investigation costs, some of which will continue to affect future results.

As part of an overall strategy to deemphasize our declining margin businesses and focus our efforts on higher margin emerging markets, we sold our OEM Remotes and Branded Products business segments in August of 2007. While we expect the higher margins in our retained businesses to result in positive cash flow by the end of fiscal 2008, we support a constant level of fixed general and administrative expenses with a revenue base that has been reduced by half, which is likely to result in continued net losses and may affect our ability to generate positive cash flow. The report of our independent registered public accounting firm contained in our fiscal 2006 audited financial statements included a going concern qualification. The going concern qualification has been eliminated in our 2007 fiscal year audited financial statements.

Despite our projections and best efforts, we cannot assure you that we will achieve or sustain profitability or positive cash flow. If we do not achieve profitability and positive cash flow, our financial resources will be adversely affected and we may be forced to curtail or discontinue certain operations, which could result in the allocation of fixed costs over an even smaller revenue base or affect our future competitiveness. If we were to require additional financing, such financing could prove dilutive to the interests of existing investors, or we may be required to divest additional business assets.

Our former President and Chief Executive Officer retired on January 4, 2008. Our ability to execute our business strategy could be impaired if we are unable to find and retain a new Chief Executive Officer with necessary and appropriate skills in a timely manner. The loss of the services of other key personnel, or if we are unable to recruit other qualified managers and key personnel in the future, may also impair our ability to operate effectively.

E. Michael Thoben, III, our former President and Chief Executive Officer, retired on January 4, 2008. Mr. Thoben had been with Interlink for the past seventeen years and has substantial experience with our business and technology. John Buckett, Chairman of the Board, has been appointed our interim Chief Executive Officer until a permanent replacement is found. Our Board of Directors is conducting a search for a replacement. If we are unable to find a permanent replacement for Mr. Thoben with the combination of skills and industry experience necessary to execute our business plan and manage our company, our business may suffer. We also may incur significant costs in identifying, hiring, training and retaining Mr. Thoben’s permanent replacement.

Our success also will depend, in part, on our ability to attract and retain additional qualified professional, technical, production, managerial and marketing personnel, both domestically and internationally. The loss of other key employees during this transition period would be particularly difficult and could cause significant delays in the implementation of our business plan and an adverse effect on our operations.

Business divestitures, acquisitions and partnering arrangements may disrupt our business, dilute stockholder value and distract management’s attention.

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In August 2007 we completed the sale of our OEM Remotes and Branded Products business segments. As part of our business strategy to focus on higher margin emerging markets, we may consider additional divestitures or acquisitions or discontinue other aspects of our business. Such strategic decisions involve numerous risks, including:

We may fail to replace divested operations with new business segments that contribute to our financial health and strategic objectives. If we fail to properly evaluate and execute acquisitions, investments or divestitures, we may not achieve the anticipated additional benefit to our business and we may incur costs in excess of what we anticipate, which could damage the viability of our ongoing operations.

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. These costs impact our profitability and therefore constitute a competitive disadvantage vis-à-vis much of our competition, especially in light of the recent divestiture of two of our four business segments, which has caused these costs to increase substantially as a percentage of our revenues. These requirements also consume substantial management time that could otherwise be focused on other areas of our business. In addition, our public status requires us to disclose publicly information that can afford a competitor an 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.

A limited number of investors own a majority of our stock and, working together, could control us.

The majority of our stock is owned by institutions managed by a small number of fund managers. To our best knowledge, neither these stockholders nor their fund managers have any agreement or understanding under which they have agreed to act together with respect to the voting of our stock. However, they have expressed common views with respect to various matters relating to our management and governance and these views have influenced related decisions of our Board of Directors. If they were to act together as a group, these fund managers would have the ability to control various aspects of our business and governance, including the replacement of our Board of Directors. Accordingly, other investors may not have the practical ability to oppose management and/or governance decisions that have the support of our institutional investors.

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 federal securities laws based on our restatement of historical financial statements. Other stockholders have brought a derivative action against our former Chief Executive Officer and our former Chief Financial Officer that alleges, among other things, securities-related violations of the California Corporations Code. 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 ability to pursue our business strategy. There is also no assurance that additional lawsuits will not be filed or that the ultimate resolution of these matters will not result in a material adverse effect on our financial condition or results of operations.

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We are emphasizing new markets and if we fail to accurately predict the growth of these new markets, we may suffer reduced earnings.

Historically, the largest contributor to our consolidated sales was our OEM Remotes business segment. In late 2005, we deemphasized and reorganized segments of this business, and in August 2007 we sold this business, together with our Branded Products business. We have devoted significant resources to the development of products and the support of marketing and sales efforts in new markets, such as the MicroNav™ family of file navigation products in our Specialty Components business, and the biometric input pads in our eTransactions business. As we transition to becoming a company with two, rather than four, business units and focus on our remaining businesses, we expect to continue to identify and develop products for new markets. These markets change rapidly and may not all prove to be attractive. We cannot assure you that they will grow or that we will be able to accurately 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 accurately predict successful new products and markets and the growth and demand in new markets may cause us to suffer substantial losses or reduced earnings.

Failure to increase market awareness and acceptance of eTransactions and our eTransaction products may cause our revenues in this market to fall short of our expectations.

We are focusing considerable resources on developing our eTransactions market. The prospects for growth of our eTransactions 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 eTransactions is new and emerging and we cannot be certain that it will continue to develop or grow in a timely manner or that businesses will elect to adopt our products rather than competitive products or to continue 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 eTransactions or our eTransaction products. We expect that we will need to continue to pursue intensive marketing and sales efforts to educate prospective customers about the benefits of eTransactions and our eTransaction products. If market awareness and acceptance of eTransactions do not occur, our revenues and profitability in this market will fall short of our expectations.

If we are unable to keep pace with rapid technological developments, we may not be able to compete effectively.

Technology in our target markets is undergoing rapid change. In order to maintain our position in our existing markets and succeed in new markets, we will have to develop and support innovative technologies. Doing so will require, among other things, that we accomplish the following:

We cannot assure you that we will be able to achieve any of these objectives.

If our products do not support evolving industry standards, they may not achieve or maintain market acceptance and our revenues may decline.

Our eTransactions business customers expect our products to 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 eTransactions products do not support these requirements, they will not be competitive and will not be adopted by the market.

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

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technologies. We cannot assure you that we will be able to contract or otherwise arrange for these services in the future or on a consistent basis. 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.

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 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 on them, we could be forced to incur substantial litigation expenses, and if we were found to have infringed a third-party patent, we could be required to pay substantial damages, pay royalties in the future or be enjoined from infringing in the future.

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, distinct from our more sophisticated ePad products, 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 advanced market, signature capture device manufacturers could elect to expand their existing product lines in an effort to compete in our markets. Such competition could reduce margins or otherwise adversely affect our prospects in our eTransactions market.

Our markets are intensely competitive and many of our potential competitors have resources that we lack.

Our markets are competitive and we expect competition to increase. Our competitors include companies with similar products or technologies and companies that sell complementary products to our target markets. Our competitors and potential competitors may have established business relationships that 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 current and future competitors.

We identified material weaknesses in our internal control over financial reporting in prior fiscal periods and have been required to restate our historical financial statements.

In our Annual Reports for the years ended December 31, 2005 and 2006, we reported material weaknesses in our internal control over financial reporting. As a result of the errors caused by these material weaknesses, we were required to restate our historical financial statements for the fiscal years 2001 through 2004, as well as for the first and second quarters of fiscal 2005. We have taken significant measures to improve our financial reporting process and as of December 31, 2007, we had identified no material weaknesses that remained to be remediated.

Despite our substantial efforts to ensure the integrity of our financial reporting process, we cannot guarantee that we will not identify additional weaknesses as we continue to work with the new systems that we have implemented over the past year and a half. 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, which could erode market confidence in our company, cause the price of our stock to be based on false or misleading information and result in litigation based on such false or misleading information.

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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 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 currently manufacture 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.

Manufacturing is also being done by our China subsidiary and by third parties in China that are identified and managed through our Hong Kong and China subsidiaries. We rely on our subsidiaries 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.

International sales and manufacturing risks could adversely affect our operating results.

Our revenues from international sales accounted for approximately 54%, 62% and 34% of net sales for the years ended December 31, 2007, 2006 and 2005, respectively. We believe that international sales will represent a substantial portion of our sales for the foreseeable future. Our manufacturing is currently performed in China and Camarillo. Our international operations involve a number of risks, including:

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 depreciation 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.

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Environmental directives could increase our costs and/or require us to reserve against inventory.

Environmental directives that affect our manufacturing processes and inventory may be enacted from time to time in the United States and abroad. Any such directives could require us to increase our inventory reserves due to obsolescence or otherwise increase the cost of doing business. In 2006, the Restriction on Hazardous Substances Directive (“ROHS”) went into effect which limited the use of hazardous raw materials in the production of electronic and electrical goods that we sell in the European Union and certain other European countries. While we currently believe our inventory reserve is adequate, we may have additional inventory write downs due to ROHS or other similar restrictions implemented by other markets. In 2007, the Waste Electrical and Electronic Equipment became effective and required companies that sell electronic equipment on the EU market to register with individual member states, mark their products, submit annual reports, provide recyclers with information about product recycling, and either recycle their products or participate in or fund mandatory recycling schemes.

Failure to maintain, develop and expand our OEM relationships could cause demand for our products to decrease.

Our Specialty Components products are sold to OEM customers. If we fail to maintain, develop and expand our relationships with our OEM customers or if those customers are not successful in their marketing and sales efforts, demand for our products may decrease.

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 OEM customers develop, promote and sell our products is based on a number of factors that are largely beyond our ability to control.

Our MicroNav™ sensor sales are dependent on a relatively small number of relatively large contracts; our failure to obtain contracts that we expect to obtain or any event that results in the loss or reduction in size of a contract below our expectations could have a material adverse effect on our results of operation.

The focus of our MicroNav™ sales effort targets a small number of large OEM manufacturers of handheld products and relates to specific products for which the OEM manufacturer is developing product specifications. We expend considerable effort in preparing for and bidding these contracts and make capacity planning decisions based on our expectations as to the number and size of contracts on which we will be the successful bidder. If our expectations are too optimistic, we are at risk of incurring expense in preparation for sales that we are not able to make. If our expectations are too pessimistic, we are at risk of being unprepared to perform on a contract that we could otherwise have obtained. In addition, the value of any OEM contract to us depends in part on the success of the device in which our products are included. We rely on the OEM customer’s estimates as to the size of the market for their individual products and these estimates are often inaccurate. We cannot assure you that we will be successful in predicting volume and timing in this aspect of our business.

Our corporate offices and principal manufacturing facilities are located in a 44,110 square foot leased facility in Camarillo, California. We sub-lease 11,000 square feet of this building through 2010. This lease on the Camarillo premises expires on 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. Our China subsidiary leases an approximate 20,000 square foot building in Schenzen, China. The lease for the China facility runs until May 31, 2009 and provides for a monthly rent of $3,416. Each of our eTransactions and Specialty Components business segments uses the facilities described in this Item 2.

On November 15, 2005, a class action alleging violations of federal securities laws was filed against Interlink and two of our former officers in the United States District Court for the Central District of California. The complaint, as currently amended, alleges that, between April 24, 2003 and November 1, 2005, the defendants made false and misleading statements and failed to disclose material information regarding Interlink’s results of operations and financial condition. The complaint includes claims under the Securities Act of 1933, as amended (the “Securities Act”) and Exchange Act of 1934, as amended (the “Exchange Act”) and seeks unspecified damages and legal expenses. Mediation of the case has been scheduled for April 24, 2008, but we cannot assure you that the mediation will be successful.

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On January 24, 2006, a shareholder’s derivative action was filed in the Central District of California against two of Interlink’s former officers and the members of our Board of Directors at the relevant time. The derivative complaint contained 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 Interlink 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.

On August 17, 2006, the plaintiff re-filed the derivative action in California state court. The re-filed complaint alleges securities-related violations of the California Corporations Code, as well as various common law and Delaware corporate law claims. The members of our Board of Directors are no longer named as defendants. Plaintiffs seek treble damages based on the difference between the prices at which the named defendants sold their shares and the market value that those shares would have had at the time of such sales but for the allegedly false and misleading financial statements, as well as contribution from the defendants in the event that Interlink is found to have violated the federal securities laws and other unspecified damages.

On November 17, 2006, defendants removed the derivative action to federal court. On January 9, 2007, the court stayed the derivative action pending the defendants’ filing of an answer in the securities class action. That stay is still in effect as of the date of the filing of this Annual Report. In connection with the class action and the derivative proceedings described above, we voluntarily contacted the SEC in 2006 to inform the SEC of both proceedings. Soon thereafter, the SEC responded with several inquiries, to which we responded promptly. On November 16, 2007 we received a letter from the SEC stating that the SEC had closed its investigation but reserving the right to reopen it at any time. Under our Certificate of Incorporation and Bylaws, we are obligated to indemnify our former officers against any loss resulting from claims against them in their capacity as officers of Interlink to the fullest extent not prohibited by law. Whether applicable law will permit such indemnity will depend on the facts of the case as ultimately determined in litigation or resolved as a part of a settlement process. We are also obligated under our charter documents to advance legal expenses for these former officers’ defense, subject to reimbursement if the officers are ultimately determined not to have been entitled to indemnity. We cannot predict the final disposition of these matters or whether we will be liable for amounts not covered by insurance. In addition to the matters identified above, from time to time, we are involved in various legal actions that arise in the ordinary course of business.

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None.

The following table contains information with respect to each person who is an executive officer of Interlink:

John A. Buckett, II has served as Interlink’s interim chief executive officer since January 4, 2008. On March 8, 2008, Mr. Buckett retired as vice president, corporate development at Scientific-Atlanta, a Cisco Company, which is a leading supplier of broadband communications systems, satellite-based video, voice and data communications networks and worldwide customer service and support, a position he had served in since 1998. He is currently a member of the Corporate Management Committee of Scientific-Atlanta, Inc. From 1995 to 1998, Mr. Buckett served as president of the International Division and, before that, as vice president, marketing strategies, for all operating units of Scientific-Atlanta, Inc. Mr. Buckett holds a B.S. degree in electrical engineering from the Georgia Institute of Technology.

Charles C. Best has served as Interlink’s chief financial officer and secretary since August 2005. Mr. Best joined Interlink 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 is a certified public accountant and holds a B.S. degree in business administration and accounting from San Diego State University.

Rodney G. Vesling is senior vice president of the eTransactions business segment. Mr. Vesling joined Interlink Electronics, Inc. in 2000 as vice president of sales and marketing for the specialty and eTransactions business segments. Prior to joining Interlink, Mr. Vesling worked 14 years in the content management and storage industries with the Eastman Kodak Company and Plasmon—formally a division of Philips Electronics. Mr. Vesling holds an economics degree from St. Lawrence University and a MBA with concentrations in Finance and Competitive Strategy from the William E. Simon Graduate School of Business Administration at the University of Rochester.

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PART II

Market Information

Our Common Stock trades through the Over The Counter (“OTC”) market trading system 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.

On March 20, 2008, the closing price of our Common Stock on the OTC market trading system was $1.00.

Holders of Record and Shares Outstanding

As of March 13, 2008 there were approximately 60 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 our outstanding Common Stock is held of record in broker “street names” for the benefit of individual investors. As of March 13, 2008, there were 13,749,310 shares outstanding.

Dividend Policy

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.

Performance Graph⁽¹⁾

The following line graph provides a comparison of the annual percentage change in the cumulative total stockholder return on our Common Stock to the cumulative total return of the Nasdaq Composite Index and a peer group consisting of companies included in the Nasdaq Computer Manufacturers Index. The comparison assumes $100 was invested on January 1, 2003 in our Common Stock and in each of the following indices and, in each case, assumes the reinvestment of dividends.

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Interlink Electronics Cumulative Total Return To Stockholders

1/1/03 - 12/31/07

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The selected financial data presented below was derived from our audited consolidated financial statements. Our consolidated financial statements as of and for the year ended December 31, 2007 were audited by Singer Lewak Greenbaum and Goldstein, LLP. Our consolidated financial statements as of and for the years ended December 31, 2006, 2005, 2004 and 2003 were audited by other auditors. The selected financial data presented below has been prepared in a manner consistent with the guidelines of Statement of Financial Accounting Standards 144 – “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”) – which requires us to present the sale of our OEM Remotes and Branded Products segments⁽¹⁾ on a discontinued operations basis. 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.

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Forward Looking Statements

This Annual Report 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 and do not relate strictly to historical information. These statements may include the words “expects”, “believes”, “anticipates”, “plans”, “may”, “will”, “intends”, “estimates”, “continue” or other similar expressions. Such statements involve inherent risks and uncertainties, many of which are described in the section entitled “Risk Factors” in this Annual 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 Annual 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 Annual Report, they should not be read as constituting any assurance that such expectations will be realized or that management’s expectations will not change. Forward-looking statements in this Annual Report 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. Forward-looking statements speak only as of the date made. We undertake no obligation to publicly release or update forward-looking statements, whether as a result of new information, future events or otherwise.

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We develop, manufacture, market and sell intuitive interface devices and components for a variety of business applications worldwide in our eTransactions and Specialty Components business segments. We generate revenues from the sale of our hardware products, including pen input and signature pads and integrated cursor control. Some of these products, particularly our eTransactions products, incorporate software that we have developed internally or that we license from third parties.

We record our revenues in two business segments: eTransactions (input devices for the electronic signature markets) and Specialty Components (integrated FSR-based sensors, subassemblies and modules that support cursor control and other input functions). We have addressed our Specialty Components market since our inception in 1985 and our eTransactions market since 1999.

In August 2007, we sold our OEM Remote and Branded Products business lines, which had historically accounted for more than half of our revenues. Unless otherwise indicated, all operating trends and comparisons in this Item 7 reflect the operations of our continuing business or components thereof. Information with respect to the performance in 2007 and prior years, of our discontinued operations is reflected in the line item so captioned in our Consolidated Statements of Operations.

2007 Overview

In 2007, our revenues grew 24% compared to 2006 and our gross margins declined from 37% in 2006 to 30% in 2007. We experienced decreases in general and administrative costs in 2007 compared to 2006 due to non-cash stock based compensation expenses resulting from the adoption of FAS123(R) being lower in 2007 by $1,191,000 compared to 2006 and to accounting, legal, consulting, Sarbanes-Oxley internal control costs, and other administrative costs being lower by $1,320,000 in 2007 compared to 2006. We reduced our operating loss from $11.6 million in 2006 to $8.5 million in 2007.

Outlook

We expect revenue growth in our eTransactions business segment as our products continue to set the standard for advanced electronic signature transaction support and more companies make decisions to automate their document process. We also expect growth in unit sales 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. These fluctuations may become more significant as a percentage of revenue as our eTransaction business grows.

We expect our Specialty Components segment to experience steady annual revenue growth based on increased sales of our MicroNav^TM sensor products. In 2007 we had several significant design wins in the cell phone market. Actual results will depend not only on our success in convincing customers to incorporate our sensors into their products but also on the success of the products in which our sensors are incorporated. Accordingly, we believe revenue growth will occur in this sector, though the amount of the increase is difficult to predict.

We expect that general and administrative costs will remain constant or decline slightly from the 2007 levels, exclusive of the non-cash stock based compensation expense. A number of the opportunities that we are considering involve investments in technology, infrastructure or both, which may cause our research and development and product development expenses to increase in 2008.

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 2008. 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 line of credit to increase our cash resources, or to dispose of additional assets. We cannot assure you that such financings will be possible or available on terms that will be attractive to existing investors.

Current Opportunities and Challenges

As part of an overall strategy to deemphasize our declining margin businesses and focus our efforts on higher margin emerging markets, we sold our OEM Remotes and Branded Products business segments in August of 2007. We believe that the sale of these business units will provide us with the capital necessary to advance our strategic business initiatives and to allow us to focus on our

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two business segments we feel have the greatest potential for long-term profitable growth: eTransactions and Specialty Components. While the higher margins in our retained businesses are anticipated to result in improved cash flow by the end of fiscal 2008 and into the future, we support a constant level of fixed general and administrative expenses with a revenue base that has been reduced by half, which is likely to result in continued net losses and may affect our ability to generate positive cash flow. Our principal challenge, therefore, is to grow our eTransactions and Specialty Components business segments to achieve the revenue levels, cost efficiencies and profitability that will sustain and justify our continued investments in these segments. Our ability to manage this challenge will define the level of our success over the next two to three years.

A considerable portion of our effort has been, and will continue to be, directed at emerging markets such as our eTransactions market where our success depends, in part, on our ability to accurately forecast the nature, amount and timing of market requirements in an environment in which historical precedent is limited or non-existent. We rely on information generated by our internal staff and industry partners and on independent market studies for forecasts of market demand in our focus areas, but these studies are themselves based on limited empirical data. An inaccurate forecast of market demand in any of our core market areas would impact our short-term performance and could impact our competitive position and, therefore, our long-term performance.

We are making significant efforts to provide our Specialty Components markets with products that use our proprietary FSR technology. The inability to timely develop and deliver these products to our customers would impact our ability to become profitable in our Specialty Components business segment in the timeframe we are anticipating.

Management faces the constant challenge of balancing our investment in new technology, product development and marketing initiatives 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 cash and earnings even if the investment proves to be justified. We may make investments in new business opportunities that will increase operating costs, decrease margins and negatively impact earnings until the investment produces significant revenue growth.

Our revenues from continuing operations were $19.3 million for the year ended December 31, 2007 and $15.6 million for the year ended December 31, 2006, an increase of 24%. Our current projections show that we will see revenue growth in both the eTransactions and Specialty Components business segments in 2008 when compared to each of the revenue levels in 2007. We expect that certain operating expenses will increase, but we project that other operating expenses, like many general and administrative expenses, will remain relatively constant in 2008. If revenues grow as projected in 2008, operating expenses will likely experience the same relative growth rate, with the result that operating expenses, as a percentage of revenues, should decrease.

Our quarterly results are often affected by volatility in orders for a particular product. Sales of our eTransactions products to large institutions are typically made pursuant to large purchase orders, which can be one-time events or can occur at widely-dispersed intervals. Sales of our Specialty Components products are typically related to our ability to design the product required by our customer and to the product life of the product of their customer. Both of these factors could result in large quarterly and annual revenue fluctuations. Other factors that could cause our estimates to be wrong or could result in trends that are not apparent from our financial statements are described under “Risk Factors” in Item 1A above.

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Quarterly Financial Performance (unaudited)

The following table presents certain financial information for each of the following quarters:

Quarterly revenues increased from the first quarter of 2006 through the fourth quarter of 2006. Each of the first and second quarter of 2007 saw declines in revenue as compared to revenues in the previous quarter. Revenues increased from the second quarter of 2007 through the fourth quarter of 2007. Revenues in our eTransactions business segment have fluctuated due in part to quarter to quarter fluctuations in large unit volume transactions resulting in revenues that vary significantly. Specialty Components revenues are also dependent on the volume and number of customers, which varies from quarter to quarter.

Our gross margins have fluctuated over the past eight quarters ranging from 23% to 60% due to a number of factors including excess unabsorbed manufacturing costs, excess direct labor, and incremental costs related to transitioning manufacturing capabilities to China. In addition, the product mix of transactions, which fluctuates from quarter to quarter, impacts our gross profits as each product has varying gross profit margins. We expect gross margins in both business segments to increase in 2008, but to continue to fluctuate quarter to quarter.

We experienced a gain on the sale of assets of $5,914,000 in 2007 due to the sale of our discontinued business segments in August 2007. Outside of this one time gain, we have experienced net losses from continuing operations in each of the last eight quarters due to a number of factors, including revenue fluctuations, product mix of sales, unabsorbed manufacturing costs and excess legal, accounting and consulting costs.

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Results of Continuing Operations

Business Segment Overview

Revenue and gross profit by market segment are shown in the following table:

Year Ended December 31, 2007 Compared with Year Ended December 31, 2006

eTransactions

Our 2007 eTransaction revenues decreased 7% over 2006 due primarily to delayed shipments of products, longer than anticipated sales cycles, and, in part to slowdowns in the mortgage banking industry. We believe there is continuing industry adoption of our ePad product line. We anticipate revenues will increase in 2008 when compared to 2007, though quarterly revenues will continue to fluctuate 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 business segment as having high growth potential over the next few years. eTransaction gross margins were stronger at 49%, compared to 43% in 2006. We expect gross margins to remain at this general level in 2008.

Specialty Components

Specialty Components revenues increased 78% in 2007 as compared to 2006 due to additional customers and increased shipments of MicroNav^TM products.

Specialty Component gross margins decreased to 12% in 2007 from 28% in 2006 due to the relatively higher unabsorbed costs directly associated with new opportunities in this business segment. In addition, margins associated with the MicroNav^TM products are slightly lower when compared to our historical Specialty Components product margins. As we increase revenues, fill our manufacturing capacity and increase efficiencies, we expect our Specialty Components gross margins to increase in 2008 when compared to 2007.

Operating Expenses

Product development and research costs include internal engineering labor, contract engineering and outside processing costs for the design and development of our products and the enhancement of our technologies. Our product development and research costs decreased $1,835,000, or 38%, from $4.8 million for 2006 primarily due to $235,000 of lower non-cash stock based compensation expenses related to the adoption of Statement of Financial Accounting Standard 123(R) (“FAS123(R)”), $514,000 of lower product development costs related to new projects and to $583,000 of lower payroll and related costs. In addition, $380,000 more product development costs were reclassified to cost of sales as we recognized customer revenue related to these amounts. As a percentage of revenues, our product development and research costs were 15% in 2007, compared to 31% in 2006. We expect that product development and research costs will increase slightly in 2008 and represent a higher percentage of revenues for the foreseeable future.

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Sales, general and administrative costs, (“SG&A”), include sales, marketing, accounting and administrative labor, sales commissions, advertising, general marketing, and travel and entertainment costs. SG&A decreased $1.3 million, or 11%, from $12.6 million for 2006 to $11.3 million in 2007 primarily due to a $693,000 reduction in non-cash stock based compensation expense related to the adoption of FAS123(R), $1,320,000 in decreased consulting, accounting, legal fees, and costs associated with a 2006 internal investigation. These costs were offset by $731,000 of severance costs incurred in 2007 primarily related to the retirement of our former Chief Executive Officer. Overall, Sarbanes-Oxley compliance costs related to fiscal year 2007 were considerably lower than costs for 2006, with $50,000 incurred in 2007 compared to $395,000 in 2006. As a percentage of revenues, SG&A decreased to 58% of revenues in 2007 versus 81% of revenues in 2006. We will continue to monitor our SG&A expenses closely and anticipate remaining relatively constant in overall SG&A costs on a pure dollar spending level in 2008 compared to 2007, and expect to maintain SG&A expenses as a percentage of revenues to be below current levels.

Operating Results

In summary, the reduction in our operating loss to $8.5 million in 2007, when compared to our operating loss of $11.6 million in 2006, was attributable to the following factors:

Total other income (expense), increased to a net expense of $1.1 million in 2007 as compared to a net other income of $267,000 in 2006. This is attributable to non cash charges of $810,000 related to the change in the fair value of warrants and other discounts related to the $5.0 million of cash raised from existing stockholders in July 2007. In addition, $183,000 in interest has been accrued as of December 31, 2007 and expensed for the year ended December 31, 2007 related to the interest due on the convertible notes issued in the July 2007 financing. Cash balances increased in 2007 due to the $5 million raised through existing shareholders in the July 2007 financing and through the sale of certain assets for $11.5 million in August 2007. We currently have no borrowings under our line of credit.

We have $47.3 million in net operating losses, or NOL, carryforwards for U.S. federal, state and foreign income tax purposes. In determining whether or not a valuation allowance is necessary, forecasts of future taxable income are not considered sufficient evidence to outweigh a history of losses. Accordingly, the assets were fully reserved. This has no effect on our 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, 2007.

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 46% change in ownership for the three-year period ended December 31, 2007. As of December 31, 2007, none of our NOLs have been limited by the Section 382 rules.

Year Ended December 31, 2006 Compared with Year Ended December 31, 2005

eTransactions

In our eTransactions business segment, revenues for 2006 increased 19% over 2005. eTransaction gross margins grew 4%, from 39% in 2005 to 43% in 2006 due to the volume of product sold in the transactions and the mix of products.

Specialty Components

Our Specialty Components experienced an increase of 3% in revenues in 2006 as compared to 2005 due to continued increased shipments of MicroNav^TM products. Specialty Component gross margins declined to 28% in 2006 from 37% in 2005 due to the relatively lower margins associated with the MicroNav^TM products as compared to our historical Specialty Components product margins, as well as unabsorbed costs directly associated with new opportunities in this business segment.

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Operating Expenses

Product development and research costs increased $811,000, or 20%, from $4.0 million for 2005 to $4.8 million for 2006, due primarily to $739,000 of non-cash stock based compensation expenses in 2006 related to the adoption of FAS123(R). As a percentage of revenues, our product development and research costs were 31% in 2006, compared to 29% in 2005.

Sales, general and administrative costs, increased $5.2 million, or 71%, from $7.4 million for 2005 to $12.6 million for 2006, primarily due to $1,991,000 in non- cash stock based compensation expenses in 2006, $612,000 of increased costs related to an internal investigation completed in early 2006 and $1,495,000 increased consulting, accounting and legal fees related to restatement and class action litigation activities. Sarbanes-Oxley compliance costs related to fiscal year 2006 were considerably lower than costs for 2005, with $394,000 incurred in 2006 compared to $565,000 incurred in 2005. As a percentage of revenues, SG&A increased to 81% of revenues in 2006 versus 53% of revenues in 2005.

Operating Results

In summary, our operating loss of $11.6 million in 2006, when compared to our operating loss of $6.1 million in 2005, was attributable to the following factors:

Total other income, net increased to $267,000 in 2006 as compared to $67,000 in 2005. Lower cash balances through 2006 resulted in lower interest income in 2006 compared to 2005 which was offset by lower interest expense in 2006 compared to 2005 related to the pay down of long-term debt. In addition, 2005 incurred significantly higher other expense due to the write off of certain loans to shareholders.

Loss from Discontinued Operations

As a result of the sale of our OEM Remotes and Branded Products business segments in August 2007, we have included in the Consolidated Financial Statements financial information presented in accordance with Statement of Financial Accounting Standards 144 – Accounting for Impairment or Disposal of Long-Lived Assets (“SFAS144”), which requires us to present the sale of these assets on a discontinued operations basis. We recorded a loss from discontinued operations, net of tax, for the years ended December 31, 2007, 2006 and 2005 of $1,957,000, $335,000, and $2,198,000 respectively, representing a loss per share of $0.14 per share, $0.02 per share and $0.16 per share for 2007, 2006, and 2005 respectively.

Gain on Sale of Assets

In conjunction with the sale of assets on August 31, 2007, we recorded a net gain of $5.9 million. This gain was the result of the August 2007 sale of our OEM Remotes and Branded Products segments, which included inventory, accounts receivable and accounts payable, plus certain patents and trademarks.

Liquidity and Capital Resources from Continuing Operations

Our capital resources have historically come from sales of equity securities, the sale of assets, convertible notes and warrants from shareholders and commercial borrowings. In July 2007, we raised $5 million through the sale of convertible notes and warrants to certain existing shareholders. In August 2007, we received $11.5 million through the sale of the OEM Remotes and Branded Products business segments. 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 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.

Our cash, cash equivalents and short term investments increased to $15.6 million as of December 31, 2007, of which (i) $1.4 million is held in an escrow account pursuant to the terms of the asset sale and (ii) $1.5 million is due to the purchaser in the asset sale

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in connection with its facilitating of certain post-sale transactions that permitted continued product shipments to certain of our customers. We used cash from continuing operations of $4.7 million, $9.3 million, and $795,000, in 2007, 2006 and 2005, respectively.

Ongoing 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 international customer base. 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. We continue to evaluate the need for inventory adjustment related to excess and obsolete inventory. Any significant diminution in inventory value would ultimately affect cash flow.

At December 31, 2007 and currently we have a line of credit with a bank with a maximum borrowing limit of $5 million. The line of credit is secured by our accounts receivable and other assets and expires in December 2009. Under the two-year term of the Agreement, we have the ability to draw cash borrowings against the line up to 80% of our eligible accounts receivable as defined in the Agreement. Payments against this line of credit are due upon demand if certain conditions in the Agreement are not met. At December 31, 2007, and as of March 20, 2008, we had no borrowings under this line of credit.

Working capital increased from $15.3 million at December 31, 2006 to $18.7 million at December 31, 2007. The increase from 2006 to 2007 resulted primarily from $5 million raised from the sale of convertible notes and warrants to existing shareholders in July 2007 and from $11.5 million raised from the sale of our discontinued business segments in August 2007. Continuing operations used cash of $4.7 million in 2007 and $9.3 million in 2006. This reduction was due primarily to decreased operating losses year over year.

We spent $226,000 in 2007 and $706,000 in 2006 to purchase additional manufacturing and computer equipment and leasehold improvements.

We made payments on long-term debt of $152,000 and $156,000 in 2007 and 2006, respectively. Net proceeds from the exercise of stock options and stockholder loan repayments were $50,000 and $219,000 in 2006 and 2005, respectively.

Contractual Obligations

We currently have modest commitments for capital expenditures and no material purchase obligations.

In February 2007, we signed a new software licensing agreement with a company for the continued use of software in certain of our products. This agreement supersedes a previous agreement with the same software company and became effective April 1, 2007. The agreement provides for payments of $15 per each seat of software sold packaged with certain of our electronic signature pads. Minimum payments under the agreement are $300,000 per quarter, and quarterly minimum amounts are permitted to be carried forward and applied to future product shipments. The agreement allows for us to purchase the software from the software company at any time during the agreement, which is effective through September 30, 2011.

Our minimum long-term debt, licensing and operating lease obligations as of December 31, 2007 were as follows (in thousands):

The software license and operating lease obligation 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. The $5 million in convertible promissory notes that we issued to existing

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investors in July 2007 accrue interest at 8% per annum, have a three year term and mature on July 19, 2010. Interest on the convertible notes is payable semi annually, and the outstanding principal balance and all accrued and unpaid interest on the convertible notes is convertible into Common Stock at any time during the term of the convertible notes at the election of the note holder. If the convertible notes are not converted into Common Stock before maturity, the principal balance and all outstanding interest become immediately due and payable, in cash, at maturity.

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 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.

Disposal of Long Lived Assets. On August 31, 2007, we completed the sale of our OEM Remotes and Branded Products business segments. As a result of the sale, the financial information included in the accompanying Condensed Consolidated Financial Statements is presented in accordance with Statement of Financial Accounting Standards 144 – Accounting for Impairment or Disposal of Long-Lived Assets (“SFAS 144”), which requires us to present the sale of these assets on a discontinued operations basis. The balance sheet at December 31, 2006 has been adjusted to reflect the assets and liabilities of the OEM Remotes and Branded Products segments as held for sale. Additionally, the statements of operations and cash flows have been adjusted to reflect the results of these segments as discontinued operations for the periods presented. Certain assumptions were used in determining amounts being presented as assets held for sale and discontinued operations. These assumptions included analyzing and reviewing costs associated with operating the ongoing business subsequent to the asset sale and costs of operations prior to the asset sale.

Accounts Receivable and Allowance for Doubtful Accounts. Our accounts receivable are unsecured and 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, due to the age of the receivable, or other factors, including the customer’s ability to pay and our historical collection experience related to issues not yet specifically identified. We generally offer 30-day payment terms; however, some Japanese OEM customers require as long as 120-day payment terms. If future collections are not as expected, the allowance is adjusted accordingly. We recorded increases to the allowance for doubtful accounts of $70,000, $78,000 and $284,000 for 2007, 2006 and 2005, respectively. Write-offs against the allowance for doubtful accounts totaled $173,000, $112,000 and $7,000 for the years ended December 31, 2007, 2006 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

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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. In 2007, we decreased our reserve by $47,000. In 2006 and 2005, we increased our reserves by $704,000 and $702,000 respectively and wrote off $758,000, $354,000 and $175,000 in 2007, 2006 and 2005, respectively, related to normal business activities. The reserve is discussed in detail in the Business Segment Overview.

Valuation of Derivative Instruments. Statement of Financial Accounting Standards 133, “Accounting for Derivative Instruments and Hedging Activities” requires bifurcation of embedded derivative instruments and measurement of fair value for accounting purposes. Derivative liabilities are adjusted to reflect fair value at each period end, with any increase or decrease in the fair value being recorded in results of operations as Adjustments to Fair Value of Derivatives. The effects of interactions between embedded derivatives are calculated and accounted for in arriving at the overall fair value of the financial instruments. In addition, the fair values of freestanding derivative instruments such as warrant derivatives are valued using Lattice models.

Stock-based compensation. We account for stock-based compensation in accordance with Statement of Financial Accounting Standards No. 123R (“SFAS 123(R)”), Share-Based Payment. Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the vesting period. Determining the fair value of share-based awards at the grant date requires judgment, including estimating expected dividends. In addition, judgment is also required in estimating the amount of share-based awards that are expected to be forfeited. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted. For the year ended December 31, 2007, forfeitures for employees were calculated to be 12.34% while forfeitures for executives were estimated to be 3%, with the total forfeitures for 2007 totaling $265,000. Stock-based compensation expense recognized under SFAS 123(R) for employees and directors for the year ended December 31, 2007 was $3,038,000. The effect on basic and diluted earnings per share for the year ended December 31, 2007 was $(.22) per share. As of December 31, 2007, we have $1,659,000 of unrecognized stock based compensation cost related to non-vested stock options. This cost is expected to be recognized over a weighted average period of 1.03 years, of which $911,000 will be recognized in 2008.

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.

In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition of tax benefits, classification on the balance sheet, interest and penalties, accounting in interim periods, disclosure, and transition. We adopted FIN 48 effective January 1, 2007. We file income tax returns in the U.S. federal jurisdiction, and various states, local and foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2000. As a result of the implementation of Interpretation No. 48, we did not recognize any increase in the liability for unrecognized tax benefits. In addition, we did not record a cumulative effect adjustment related to the adoption of FIN 48.

In the first quarter of 2007, the Inland Revenue Department (IRD) of Hong Kong commenced an examination of our Hong Kong income tax returns for 2003 through 2005. The examination is anticipated to be completed in the 2008 fiscal year. Due to delinquencies in filing annual tax returns for the 2003, 2004 and 2005 fiscal years, the IRD has assessed certain adjustments to our overall reported losses in Hong Kong for those periods stated above. These adjustments, all of which have been paid by us prior to 2007, have resulted in additional income tax assessments and cash payments that have been made for 2003, 2004 and 2005 totaling $456,000 as of the date of this filing. We do not anticipate any further adjustments will be made.

Significant management judgment is required in determining our provision for income taxes, deferred tax assets and liabilities and any valuation reserve recorded against our net deferred tax assets. Management continually evaluates our deferred tax assets as to whether it is likely that any deferred tax asset will be realized.

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When tax returns are filed, it is highly likely that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty as to the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely to be realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

Interest and penalties associated with unrecognized tax benefits are classified as interest and other expense in the statement of income.

As of December 31, 2007, we had NOL carryforwards for federal, state and foreign income tax purposes of $42.9 million, $23.5 million and $4.2 million, respectively, which are available to offset future taxable income in those jurisdictions through 2027.

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 46.1% change in ownership for the three-year period ended December 31, 2007. As of December 31, 2007, none of our NOLs has been limited by the Section 382 rules.

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 19%, 6% and 3% of our revenues for 2007, 2006 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. Accordingly, we mark these contracts to market value and the gain or loss from these contracts is recorded as 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).

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-denominated revenues converted to United States dollars according to Generally Accepted Accounting Principles and the difference is shown in the table above.

Recent Accounting Pronouncements

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an Amendment of FASB Statement No. 115” (“SFAS 159”). This standard permits an entity to choose to measure many financial instruments and certain

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other items at fair value. The objective of SFAS No. 159 is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value, nor does it eliminate disclosure requirements included in other accounting standards, including requirements for disclosures about fair value measurements included in SFAS No. 157, “Fair Value Measurements” and SFAS No. 107, “Disclosures about Fair Value of Financial Instruments.” Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of SFAS No. 157, “Fair Value Measurements.” SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 2007. We are currently evaluating whether the adoption of this statement will have a material effect on its financial conditions, its results of operations or its liquidity.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141R, Business Combinations (SFAS 141R). SFAS 141R requires most identifiable assets, liabilities, noncontrolling interests, and goodwill acquired in a business combination to be recorded at “full fair value.” SFAS 141R applies to all business combinations, including combinations among mutual entities and combinations by contract alone. Under Statement 141R, all business combinations will be accounted for by applying the acquisition method. Statement 141R is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. We are currently evaluating SFAS 141R to understand the impact it may have on future consolidated financial statements.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, Non-controlling Interests in Consolidated Financial Statements (SFAS 160). SFAS 160 requires the ownership interests in subsidiaries held by parties other than the parent to be treated as a separate component of equity and be clearly identified, labeled, and presented in the consolidated financial statements. SFAS 160 is effective for periods beginning on or after December 15, 2008. Earlier adoption is prohibited. We are currently evaluating SFAS 160 to understand its impact it may have on future consolidated financial statements.

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 and average rate option contracts. When we do purchase foreign exchange forward and average rate option contracts, gains or losses are offset by gains or losses on the underlying revenue exposure and consequently a 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 three month duration. Thus, yen/dollar fluctuations lasting more than three months will have an impact on our revenues. For the years ended December 31, 2007 and 2006, we did not enter 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. During the 2007 fiscal year, we recognized no gains on foreign currency exchange contracts which are 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, to the extent we have such foreign currency exchange contacts outstanding. As of December 31, 2007, we do not have any contracts outstanding to hedge our foreign exchange exposure and thus we are exposed to foreign currency exchange rate risk.

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Interest Rate Exposure

Based on our overall interest rate exposure at December 31, 2007, a hypothetical 10% change in interest rates applied to our outstanding debt as of December 31, 2007, would have no material impact on earnings or cash flows over a one-year period.

The information required by this Item 8 is incorporated herein by reference to the Consolidated Financial Statements and accompanying notes included in this Annual Report.

Our Board of Directors, with the approval of the Audit Committee, dismissed BDO Seidman, LLP as our independent registered public accountants effective August 15, 2007. During our two most recent fiscal years prior to, and during the subsequent interim period through, the date of dismissal, there were no disagreements between us and BDO Seidman, LLP on any matters of accounting principles or practices, financial statement disclosure or auditing scope or procedure, or any “reportable events” as defined under Item 304(a)(1)(v) of Regulation S-K promulgated by the Securities and Exchange Commission. The Board of Directors, with the approval of the Audit Committee, subsequently engaged the firm of Singer Lewak Greenbaum and Goldstein, LLP to be our independent registered public accountants.

Evaluation of Disclosure Controls and Procedures.

Our management has evaluated, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Annual Report pursuant to Rule 13a-15(b) under the Securities Exchange Act. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this Annual Report, our disclosure controls and procedures were effective to ensure that (i) information required to be disclosed by the company is accumulated and communicated to the company’s management as appropriate to allow timely decisions regarding required disclosure and (ii) information required to be disclosed by the company in the reports that the company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Notwithstanding the preceding sentence, we continue to engage in efforts to improve our disclosure controls and procedures.

Management’s Report on Internal Control Over Financial Reporting

Management is responsible for establishing and maintaining an adequate and effective system of internal control over financial reporting, as defined in Rule 13a-15(f) under the Exchange Act. 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. Under the supervision and with the participation of our management, we assessed the effectiveness of internal controls over financial reporting as of December 31, 2007. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control—Integrated Framework. Based on our assessment we determined that, as of December 31, 2007, our internal control over financial reporting is effective.

This Annual Report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management’s report in this Annual Report.

Changes in Internal Control Over Financial Reporting During Last Fiscal Quarter

There have been no changes in our internal control over financial reporting that occurred during the last fiscal quarter of the period covered by this Annual Report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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Limitations on the Effectiveness of Controls

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. 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. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Our Board of Directors recently determined that the 2008 Annual Meeting of Stockholders will be held on June 24, 2008. As a result, (i) the deadline for submitting stockholder proposals for inclusion in the 2008 Proxy Statement is now a reasonable time before we begin printing the 2008 Proxy Statements, which we expect to be on or about May 12, 2008, and (ii) management proxies will have the right to exercise their discretionary authority without discussion of a matter in the proxy statement if notice of such matter is not received a reasonable time in advance of when we mail the 2008 Proxy Statement to stockholders, which we expect to be on or about May 21, 2008.

PART III

Information regarding our directors has been included in our definitive proxy statement for our 2008 Annual Meeting of Stockholders (the “2008 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 Annual Report.

Information regarding our audit committee and our audit committee expert has been included in the 2008 Proxy Statement and is incorporated herein by reference.

Information regarding the process by which stockholders may nominate directors has been included in the 2008 Proxy Statement and is incorporated herein by reference.

Information regarding disclosure of compliance with Section 16(a) of the Exchange Act has been included in the 2008 Proxy Statement and is incorporated herein by reference.

We have adopted a Code of Business Conduct and Ethics for the guidance of our directors, officers, and employees, including our principal executive, financial and accounting officers. Our code of conduct, along with other corporate governance documents, is posted on our website at www.interlinkelectronics.com. A copy of our Code of Business Conduct and Ethics 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 of our directors, officers and employees. The Code provides that any waiver of the Code may be made only by the Board of Directors. Any waivers or amendments to our code of conduct will be posted on our website.

Information regarding executive compensation has been included in the 2008 Proxy Statement and is incorporated herein by reference.

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Information setting forth the security ownership of certain beneficial owners and management has been included in the 2008 Proxy Statement and is incorporated herein by reference.

Information regarding our equity compensation plan has been included in the 2008 Proxy Statement and is incorporated herein by reference.

Information regarding certain relationships and related transactions, and director independence, has been included in the 2008 Proxy Statement and is incorporated herein by reference.

Principal Accounting Fees and Services

We incurred the following fees for services performed by our principal accounting firms for the years ended December 31, 2007 and 2006.

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Audit Committee Pre-Approval Policies and Procedures

The Audit Committee has pre-approved all audit, audit-related and permitted non-audit services provided to us by Singer Lewak Greenbaum and Goldstein, LLP and BDO Seidman, LLP and the related fees for such services, and has concluded that such services are compatible with the auditors’ independence. The Audit Committee Charter has established policies and procedures under which all audit and non-audit services performed by our principal independent accountants must be approved in advance by the Audit Committee. During the approval process, the Audit Committee considers the impact of the types of services and the related fees on the independence of the auditor. The services and fees must be deemed compatible with the maintenance of the auditor’s independence, including compliance with SEC rules and regulations. Throughout the year, the Audit Committee reviews any revisions to the estimates of audit and non-audit fees initially approved.

PART IV

(a) 1. Financial Statements.

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 Annual Report.

3. Exhibits.

The exhibits listed in the Exhibit Index to this Annual Report are incorporated herein by reference.

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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 March 28, 2008.

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POWER OF ATTORNEY

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Charles C. Best, his attorney-in-fact and agent, with full power of substitution, for him and in his 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 attorney-in-fact and agent 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 might or could do in person, hereby ratifying and confirming all that any of said attorney-in-fact and agent, 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 March 28, 2008 on behalf of the Registrant and in the capacities indicated:

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INTERLINK ELECTRONICS, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

F-1

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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 sheet of Interlink Electronics, Inc. (the “Company”) as of December 31, 2007 and the related consolidated statement of operations, stockholders’ equity and comprehensive loss, and cash flows for the year ended December 31, 2007. Our audit also included the financial statement schedule of Interlink Electronics, Inc. listed in Item 15(a). These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these 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. at December 31, 2007 and the results of its operations and its cash flows for the year ended December 31, 2007, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

We were not engaged to examine management’s assertion about the effectiveness of Interlink Electronic Inc.’s internal control over financial reporting as of December 31, 2007 included in the accompanying Item 9A Controls and Procedures and, accordingly, we do not express an opinion thereon.

As discussed in Note 3 to the financial statements, the Company sold its Branded Products and OEM Remotes business segments during the year, and accordingly have retrospectively accounted for the historical operations as discontinued. We audited the adjustments necessary to restate the 2006 and 2005 balance sheets, statements of operations, and cash flows resulting from the accounting for these segments as discontinued operations. In our opinion, such adjustments are appropriate and have been properly applied.

As discussed in Note 2 to the consolidated financial statements, the Company has adopted the provisions of Statement of Financial Accounting Standards Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109” on January 1, 2007.

/s/ Singer Lewak Greenbaum and Goldstein, LLP

Los Angeles, California

March 26, 2008

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Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders of Interlink Electronics, Inc.

Camarillo, California

We have audited, before the effects of the adjustments to retrospectively account for the Branded Products and OEM Remotes business segments as discontinued operations as described in Note 3, the accompanying consolidated balance sheet of Interlink Electronics, Inc. as of December 31, 2006 and the related consolidated statements of operations and comprehensive loss, stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2006. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these 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. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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, before the effects of the adjustments to retrospectively account for the Branded Products and OEM Remotes business segments as discontinued operations as described in Note 3, present fairly, in all material respects, the financial position of Interlink Electronics, Inc. at December 31, 2006, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.

We were not engaged to audit, review, or apply any procedures to the adjustments to retrospectively account for the Branded and OEM businesses as discontinued operations as described in Note 3 and, accordingly, we do not express an opinion or any other form of assurance about whether the adjustments are appropriate and have been properly applied. Those adjustments were audited by Singer Lewak Greenbaum and Goldstein, LLP.

As more fully described in Note 1 to the consolidated financial statements, effective January 1, 2006, the company adopted Statement of Financial Accounting Standard No. 123 (Revised 2004), Share-Based Payment.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the 2006 financial statements, the Company has suffered recurring losses from operations that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Signed BDO Seidman, LLP

Los Angeles, California

April 5, 2007

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INTERLINK ELECTRONICS, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except par value)

See accompanying notes to the consolidated financial statements.

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INTERLINK ELECTRONICS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)