<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
---------
FORM 10-Q
---------
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-21402
INTERLINQ SOFTWARE CORPORATION
(Exact name of registrant as specified in its charter)
WASHINGTON 91-1187540
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
11980 N.E. 24TH STREET
BELLEVUE, WA 98005
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(425) 827-1112
(Registrant's telephone number, including area code)
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 report), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
As of October 21, 1999 there were 4,897,852 shares of the registrant's common
stock outstanding.
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<PAGE> 2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTERLINQ SOFTWARE CORPORATION
CONDENSED BALANCE SHEETS
(unaudited)
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
1999 1999
----------- -----------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 3,601,418 $ 5,888,630
Short-term investments 6,207,577 5,874,218
Accounts receivable, net 3,065,528 3,763,446
Inventory, prepaid expenses and other
current assets 1,090,849 934,008
----------- -----------
Total current assets 13,965,372 16,460,302
----------- -----------
Property and equipment, at cost 6,789,993 6,576,456
Less accumulated depreciation and amortization 5,068,658 4,872,314
----------- -----------
Net property and equipment 1,721,335 1,704,142
----------- -----------
Capitalized software costs, net 5,211,082 5,159,249
Goodwill and other intangible assets, net 2,169,547 2,384,377
Other assets 81,521 88,914
----------- -----------
$23,148,857 $25,796,984
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 356,182 $ 440,962
Accrued compensation and benefits 967,774 2,082,743
Other accrued liabilities 192,992 221,535
Customer deposits 832,438 965,204
Deferred software support fees 4,819,459 4,559,597
----------- -----------
Total current liabilities 7,168,845 8,270,041
----------- -----------
NONCURRENT LIABILITIES 32,282 9,854
SHAREHOLDERS' EQUITY:
Common stock 48,979 51,806
Additional paid-in capital 8,006,210 9,409,382
Retained earnings 7,892,541 8,055,901
----------- -----------
Total shareholders' equity 15,947,730 17,517,089
----------- -----------
$23,148,857 $25,796,984
=========== ===========
</TABLE>
See accompanying notes to condensed financial statements
2
<PAGE> 3
INTERLINQ SOFTWARE CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
1999 1998
----------- -----------
<S> <C> <C>
NET REVENUES:
Software license fees $ 1,802,468 $ 3,347,105
Software support fees 2,459,401 1,981,275
Other 604,849 479,687
----------- -----------
Total net revenues 4,866,718 5,808,067
----------- -----------
COST OF REVENUES:
Software license fees 525,352 539,834
Software support fees 705,460 638,812
Other 368,098 262,252
----------- -----------
Total cost of revenues 1,598,910 1,440,898
----------- -----------
Gross profit 3,267,808 4,367,169
----------- -----------
OPERATING EXPENSES:
Product development 935,499 765,812
Sales and marketing 1,365,389 1,448,622
General and administrative 1,151,533 1,155,191
Amortization of goodwill and other intangible assets 214,830 214,833
----------- -----------
Total operating expenses 3,667,251 3,584,458
----------- -----------
Operating income (loss) (399,443) 782,711
Net interest and other income 140,142 154,507
----------- -----------
Income (loss) before income taxes (259,301) 937,218
Income tax expense (benefit) (95,941) 346,770
----------- -----------
Net income (loss) $ (163,360) $ 590,448
=========== ===========
Net income (loss) per share - basic $ (.03) $ .11
Net income (loss) per share - diluted $ (.03) $ .11
Shares used to calculate net income
(loss) per share - basic 5,137,937 5,309,918
Shares used to calculate net income
(loss) per share - diluted 5,137,937 5,564,657
</TABLE>
See accompanying notes to condensed financial statements.
3
<PAGE> 4
INTERLINQ SOFTWARE CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
1999 1998
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (163,360) $ 590,448
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 196,344 251,558
Amortization of capitalized software costs 465,189 503,195
Amortization of goodwill and other
intangible assets 214,830 214,833
Change in operating assets and liabilities:
Accounts receivable 697,918 86,675
Inventory, prepaid expenses and other
current assets (156,841) (67,279)
Other assets 7,393 11,282
Accounts payable (84,780) (220,832)
Accrued compensation and benefits and
other accrued liabilities (1,143,512) (706,123)
Customer deposits (132,766) 151,529
Deferred software support fees 282,290 578,969
----------- -----------
Net cash provided by operating activities 182,705 1,394,255
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (213,537) (337,245)
Capitalized software costs (517,022) (489,634)
Purchases of investments (1,261,044) (1,015,430)
Proceeds from sales and maturities of investments 927,685 2,207,486
Cash paid for acquisition -- (2,670,323)
----------- -----------
Net cash used in investing activities (1,063,918) (2,305,146)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 152,189 5,598
Repurchase of common stock (1,558,188) (1,252,750)
----------- -----------
Net cash used in financing activities (1,405,999) (1,247,152)
----------- -----------
Net decrease in cash and cash equivalents (2,287,212) (2,158,043)
Cash and cash equivalents at beginning of period 5,888,630 7,233,826
----------- -----------
Cash and cash equivalents at end of period $ 3,601,418 $ 5,075,783
=========== ===========
</TABLE>
See accompanying notes to condensed financial statements.
4
<PAGE> 5
INTERLINQ SOFTWARE CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information
pursuant to the rules and regulations of the Securities and Exchange Commission.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three-month period ended September 30, 1999, are not
necessarily indicative of the results for the fiscal year ending June 30, 2000.
The financial statements should be read in conjunction with the financial
statements and notes thereto included in the Company's Annual Report on Form
10-K for the fiscal year ended June 30, 1999.
2. EARNINGS PER SHARE
Basic earnings per share is computed using the weighted average number of common
shares outstanding during the period. Diluted earnings per share is computed
using the weighted average number of common and potentially dilutive securities
outstanding during the period using the treasury stock method. Since the Company
had a net loss for the quarter ended September 30, 1999, no potential common
shares were included in the computation of diluted loss per share for that
quarter.
The following table reconciles the shares used in calculating basic earnings
(loss) per share to the shares used in calculating diluted earnings (loss) per
share:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
1999 1998
--------- ---------
<S> <C> <C>
Shares used to calculate basic earnings
(loss) per share 5,137,937 5,309,918
Dilutive effect of outstanding options -- 254,739
--------- ---------
Shares used to calculate diluted earnings
(loss) per share 5,137,937 5,564,657
========= =========
</TABLE>
Certain options outstanding at the end of each period presented were excluded
from the computation of diluted earnings (loss) per share because their
inclusion would be anti-dilutive as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
1999 1998
---------- ----------
<S> <C> <C>
Options excluded from computation 1,195,750 28,333
Weighted-average exercise price $ 4.74 $ 7.08
</TABLE>
5
<PAGE> 6
3. REVENUE RECOGNITION
The Company accounts for revenue recognition in accordance with the provisions
of Statement of Position 97-2, Software Revenue Recognition ("SOP 97-2"), which
provides specific industry guidance and stipulates that revenue recognized from
software arrangements is to be allocated to each element of the arrangement
based on the relative fair values of the elements, such as software products,
upgrades, enhancements, post contract customer support, consulting and
implementation services, or training. Under SOP 97-2, the determination of fair
value is based on objective evidence that is specific to the vendor. If such
evidence of fair value for each element of the arrangement does not exist, all
revenue from the arrangement is deferred until such time that evidence of fair
value does exist or until all elements of the arrangement are delivered. Revenue
is recognized when persuasive evidence of an arrangement exists and delivery has
occurred, provided the fee is fixed and determinable, collectibility is probable
and the arrangement does not require significant customization of the software.
On July 1, 1999, the Company adopted Statement of Position ("SOP") 98-9. SOP
98-9 amends paragraphs 11 and 12 of SOP 97-2 to require recognition of revenue
using the "residual method" when (1) there is vendor-specific objective
evidence of the fair values of all undelivered elements in a multiple-element
arrangement that is not accounted for using long-term contract accounting, (2)
vendor-specific objective evidence of fair value does not exist for one or more
of the delivered elements in the arrangement, and (3) all revenue-recognition
criteria in SOP 97-2 other than the requirement for vendor-specific objective
evidence of the fair value of each delivered element of the arrangement are
satisfied. Under the residual method, the arrangement fee is recognized as
follows: (1) the total fair value of the undelivered elements, as indicated by
vendor-specific objective evidence, is deferred and subsequently recognized in
accordance with the relevant sections of SOP 97-2 and (2) the difference
between the total arrangement fee and the amount deferred for the undelivered
elements is recognized as revenue related to the delivered elements. The
adoption of SOP 98-9 did not have a material impact on the Company's results of
operations or financial position for the quarter ended September 30, 1999.
4. SEGMENT INFORMATION
In fiscal 1999, the Company adopted SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information" ("SFAS 131") which requires disclosure of
financial and descriptive information about the Company's reportable operating
segments. The operating segments reported below are the segments of the Company
for which separate financial information is available and for which operating
profit and loss amounts are evaluated and used by the chief operating decision
maker for making operating decisions, assessing performance and deciding on how
to effectively allocate resources. The Company has two principal businesses and,
therefore, two reportable business segments: Mortgage Technology Division (MTD)
and Enterprise Technology Division (ETD).
Information by operating segment is set forth below (in thousands):
<TABLE>
<CAPTION>
QUARTER ENDED SEPTEMBER 30: MTD ETD TOTAL
-------------------------------------------------------------------------------
<S> <C> <C> <C>
1999 (IN THOUSANDS):
Net revenue $ 4,849 $ 18 $ 4,867
Depreciation and amortization 648 228 876
Operating income (loss) 290 (689) (399)
Capital expenditures 209 5 214
1998 (IN THOUSANDS):
Net revenue 5,750 58 5,808
Depreciation and amortization 741 229 970
Operating income (loss) 1,291 (508) 783
Capital expenditures 294 43 337
Identifiable assets were as follows as of (IN THOUSANDS):
---------------------------------------------------------
September 30, 1999 20,250 2,899 23,149
June 30, 1999 22,575 3,222 25,797
</TABLE>
6
<PAGE> 7
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OVERVIEW
INTERLINQ Software Corporation (the Company), established in 1982, is a
leading provider of technology that helps organizations effectively manage
complex, information-intensive business transactions. The Company's mortgage
technology products are business solutions for banks, savings institutions,
mortgage banks, mortgage brokers, and credit unions. The Company's enterprise
technology product (FlowMan) is a business solution designed to provide a
process-centered, enterprise application integration framework. FlowMan is
currently being integrated with the Company's suite of mortgage technology
products. In addition to this integration, the Company believes that significant
opportunity exists to realize additional value from this technology through (a)
taking the product directly to market, (b) recapitalizing this division as a
joint venture or separate subsidiary, or (c) divesting the technology (while
retaining the rights to its use in the Company's suite of mortgage technology
products). The Company is currently in the process of evaluating all of these
strategic alternatives.
During the quarter ended September 30, 1999, the Company experienced a
significant downturn in software license fee revenue due to a softened sales
environment. This environment was driven by reduced mortgage origination volumes
(related to rising interest rates) as well as uncertainties related to Year 2000
issues.
Over the course of the last decade, the Company believes that mortgage
lenders have purchased technological infrastructure in order to improve their
profits margins as well as to increase their production capacity (in times of
high mortgage origination volume). In fiscal years 1996 and 1997, the Company
focused its product development effort to provide a more diverse and integrated
"enterprise" solution for the mortgage lending industry. The product suite
developed by the Company was designed to provide customers with a platform that
would help them reduce their unit costs and accordingly, increase their profit
margins. Mortgage interest rates increased during the fourth quarter of fiscal
year 1999, coupled with an increase in interest rates by the Federal Reserve.
Rates continued to increase in the first quarter of fiscal 2000 and as such,
mortgage origination volumes have declined. An increasing interest rate
environment leads to lower mortgage origination volumes and thus, lower profit
margins for mortgage lenders. As a result of these lower volumes and lower
profit margins, the Company believes that mortgage lenders will need to continue
to focus their long-term purchasing decisions on solutions that reduce unit
costs and, accordingly, increase profit margins, and will not need any
significant increased production capacity. The Company believes that its suite
of mortgage technology products positions the Company well for this environment.
In addition, the Company has seen recent changes in its prospective sales
pipeline from many transactions representing additional production capacity to
fewer (but in certain cases larger) transactions representing wholesale
infrastructure changes for current and prospective customers. This change in the
Company's pipeline could lead to revenue streams that are much less predictable
than those experienced historically.
The Company believes that issues related to the Year 2000 have also
contributed to the softened sales environment. The Company believes that a
number of mortgage lenders and mortgage servicers have decided to delay
technology purchases until after January 1, 2000.
Looking forward, the Company is expecting both the interest rate environment
as well as the Year 2000 issues to continue to cause a softened sales
environment and expects to record a loss for the second quarter of fiscal year
2000. Changes in the interest rate environment are difficult to predict and the
Company is not
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<PAGE> 8
expecting any significant decreases in mortgage lending rates through the end of
fiscal year 2000. Although the ability of customers to resolve issues related to
the Year 2000 will vary, the Company expects to begin to see a rebound in
software license fee revenue in the second half of fiscal year 2000, once the
majority of its customers have resolved their Year 2000 problems and return to
the process of purchasing and implementing technological infrastructure.
<TABLE>
<CAPTION>
NET REVENUES
Three months ended September 30,
(In thousands) 1999 1998 Change
- ----------------------------------------------------------------
<S> <C> <C> <C>
Software license fees $1,802 $3,347 (46)%
Software support fees 2,459 1,981 24%
Other 605 480 26%
- ----------------------------------------------------------------
Total net revenues $4,867 $5,808 (16)%
- ----------------------------------------------------------------
</TABLE>
Net revenues consist of software license fees, software support fees and
other revenues (which include training, consulting fees, document fees, and
other miscellaneous sales), net of discounts and sales returns.
Software license fees decreased by 46% for the quarter ended September 30,
1999, compared to the quarter ended September 30, 1998. This decrease in
software license fees was due primarily to increasing interest rates and
concerns about the Year 2000 (as previously discussed). Looking forward, the
Company believes that software license fees will continue to suffer as a result
of these issues through the quarter ending December 31, 1999. The Company cannot
predict changes in the interest rate environment but does not anticipate any
significant decreases in mortgage lending rates through the end of fiscal year
2000. The Company believes that software license fees will rebound somewhat in
the latter half of fiscal year 2000, once customers have resolved their year
2000 issues and resumed the process of purchasing technological infrastructure.
This rebound is expected to come primarily from sales of MortgageWare Loan
Servicing and MortgageWare TC Workflow Tools. It is difficult for the Company to
measure the separate impact of the interest rate environment and the Year 2000
environment and as such, to estimate the net downstream impact on software
license fees. However, the Company expects software license fee revenue to
increase in the latter half of fiscal year 2000 compared to the first half of
the fiscal year.
Software support fees increased by 24% for the quarter ended September 30,
1999, compared to the quarter ended September 30, 1998. This period-to-period
increase was due primarily to higher software sales volume through fiscal year
1999 and a relatively low customer attrition rate. Due in part to changes, from
time to time, in government regulations relating to documentation required for
residential mortgage lending, the vast majority of the Company's customers
purchase annual software support agreements. Because software support fees are
recognized ratably over the term of the annual support agreement (while software
license fees are recognized on product shipment), the percentage change in
software support fees compared to the percentage change in software license fees
is not proportional. Due primarily to the high level of software license fees
earned in fiscal 1999, the Company believes software support fees are likely to
continue to increase at a modest rate for the rest of fiscal year 2000.
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<PAGE> 9
Other revenues increased by 26% for the quarter ended September 30, 1999,
compared to the quarter ended September 30, 1998. This increase was due
primarily to an increase in demand for the Company's consulting services as well
as an increase in VMP document referral fees. The Company expects its other
revenues to increase during the latter half of fiscal year 2000 compared to the
first half of fiscal year 2000, due primarily to increases in demand for
MortgageWare Loan Servicing and to projects which have been delayed by customers
due to the Year 2000 problem.
Despite the interest rate environment discussed above, the Company believes
the overall lending environment as of the end of the fiscal quarter ended
September 30, 1999, to be favorable as compared to most historical measures.
Nonetheless, there can be no assurance that mortgage-lending rates will not
continue to increase or experience a high amount of volatility. Such continued
increases or volatility could have a material adverse effect on the Company's
business, financial condition and results of operations. Even if lending rates
stabilize, if homeowners or potential homeowners perceive such rates as too
high, decisions that would otherwise result in mortgage lending transactions may
be delayed. Such delays may have an adverse effect on the Company's customers,
which could result in an adverse effect on the Company and its results of
operations.
The Company is new to the enterprise application integration (EAI)
marketplace, which is a relatively new, constantly changing and intensely
competitive market. In addition, many of the Company's competitors in this
market have longer operating histories, greater name recognition, and
significantly greater financial technical and marketing resources than the
Company. There is no assurance that the Company's products will be accepted by
the market or that the Company will be competitive within the market, which
would have a material adverse effect on the Company's revenues, profitability
and financial condition.
<TABLE>
<CAPTION>
COST OF REVENUES
Three months ended September 30,
(In thousands) 1999 1998 Change
- --------------------------------------------------------------
<S> <C> <C> <C>
Software license fees $ 525 $ 540 (3)%
Percentage of software
license fees 29% 16%
- --------------------------------------------------------------
Software support fees $ 705 $ 639 10%
Percentage of software
support fees 29% 32%
- --------------------------------------------------------------
Other $ 368 $ 262 40%
Percentage of other 61% 55%
- --------------------------------------------------------------
Total cost of revenues $1,599 $1,441 11%
Percentage of net revenues 33% 25%
- --------------------------------------------------------------
</TABLE>
Cost of software license fees consists primarily of the amortization of
capitalized software development costs and, to a lesser extent, commissions and
royalties paid to third parties for certain interface products, the purchase and
duplication of disks and product documentation. As a percentage of software
license fees, cost of software license fees increased to 29% for the quarter
ended September 30, 1999, compared to 16% for the quarter ended September 30,
1998. This increase was primarily due to software license fees decreasing
substantially during the quarter with the cost of software license fees
remaining relatively flat. The cost of software license fees
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<PAGE> 10
contains the relatively fixed component of amortization of capitalized software
development costs. Amortization of capitalized software development costs
decreased to $465,000 in the quarter ended September 30, 1999, compared to
$503,000 for the same quarter in the previous year. The Company expects the
dollar amount of its amortization of capitalized software development costs to
increase modestly or remain flat for the remainder of fiscal year 2000.
Cost of software support fees includes salaries and other costs related to
providing telephone support, and the purchase, duplication and shipping of disks
associated with software updates. As a percentage of software support fees, cost
of software support fees decreased to 29% for the quarter ended September 30,
1999, compared to 32% for the quarter ended September 30, 1998. This decrease
was primarily due to software support fees increasing at a rate higher than the
related costs. The cost of software support fees increased 10% over the year ago
quarter, representing increased payroll costs for the customer support group.
The Company expects the dollar cost of software support fees to increase due to
the increased staffing that will be required to support a higher installed base
of the Company's products and a more diverse product base. The Company also
expects that these factors may lead to a modest increase in the ratio of the
cost of software support fees to software support fees.
Cost of other revenue includes primarily the salaries and non-reimbursable
expenses for the employees who provide training and consulting services. As a
percentage of other revenue, cost of other revenue increased to 61% for the
quarter ended September 30, 1999, compared to 55% for the quarter ended
September 30, 1998. This increase was primarily due to lower margins earned on
some of the Company's consulting projects.
<TABLE>
<CAPTION>
OPERATING EXPENSES
Three months ended September 30,
(In thousands) 1999 1998 Change
- ----------------------------------------------------------------
<S> <C> <C> <C>
Product development $ 935 $ 766 22%
Percentage of net revenues 19% 13%
- ----------------------------------------------------------------
Sales & marketing $1,365 $1,449 (6)%
Percentage of net revenues 28% 25%
- ----------------------------------------------------------------
General & administrative $1,152 $1,155 0%
Percentage of net revenues 24% 20%
- ----------------------------------------------------------------
Amortization of goodwill
and other intangible assets $ 215 $ 215 0%
Percentage of net revenues 4% 4%
- ----------------------------------------------------------------
</TABLE>
Product development expenses include salaries for software developers and
analysts, facility costs and expenses associated with computer equipment used in
software development, net of costs capitalized. As a percentage of net revenues,
product development expenses increased to 19% for the quarter ended September
30, 1999 compared to 13% for the quarter ended September 30, 1998. The increase
in percentage was due primarily to decreasing revenue combined with increasing
product development expenses. The increase in product development expenses was
due primarily to increases in payroll and related expenses for additional
development staff as well as to increasing overall salaries in a tight labor
market. These increases were offset somewhat by an increase in the amount of
capitalized software development costs. The Company capitalized $517,000 and
$490,000 of
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<PAGE> 11
development expenditures for the quarters ended September 30, 1999, and 1998,
respectively. The Company expects overall development spending to remain flat or
increase only modestly for the remainder of fiscal year 2000.
Sales and marketing expenses consist primarily of salaries, sales
commissions, travel and facility costs for the Company's sales and marketing
personnel, and, to a lesser extent, advertising, trade shows and other
promotional activities. As a percentage of net revenues, sales and marketing
expenses increased to 28% for the quarter ended September 30, 1999, compared to
25% for the quarter ended September 30, 1998. This percentage change was
primarily due to revenues decreasing at a faster rate than sales and marketing
expenses. The decrease in sales and marketing expenses was due primarily to
reduced commissions from the decrease in sales volume.
General and administrative expenses include costs associated with finance,
accounting, purchasing, order fulfillment, administration and facilities. As a
percentage of net revenues, general and administrative expenses increased to 24%
for the quarter ended September 30, 1999, compared to 20% for the quarter ended
September 30, 1998. This was due primarily to net revenues decreasing with
general and administrative expenses remaining flat. On a dollar basis, the
Company expects general and administrative expenses to remain relatively
consistent for the remainder of fiscal year 2000.
Amortization of goodwill and other intangible assets consists of the
straight-line amortization of assets obtained by the Company as a result of its
acquisition of LSS on June 30, 1998. These assets include workforce-in-place,
customer lists, tradename, noncompete and employment agreements and goodwill,
which are being amortized over their estimated useful lives of three to four
years. The Company accounted for the acquisition of LSS under the purchase
method of accounting and accordingly, the results of LSS's operations are
included in the Company's financial statements since the date of acquisition.
The purchase price of LSS was allocated to the fair value of the acquired
assets and assumed liabilities based on their fair values at the date of the
acquisition. Approximately $1,350,000 of the purchase price represented acquired
in-process research and development that had not yet reached technological
feasibility and had no alternative future use. The in-process research and
development project consisted of the development of FlowMan 4.0. This project
encompassed significantly enhancing and adding features and functionality to the
existing FlowMan product. At the time of acquisition, the Company estimated that
the project was 43% complete and that the costs to complete the project would be
approximately $200,000. The Company also estimated that the project would be
complete during fiscal year 1999. The Company now estimates that the project
will be completed during the quarter ending December 31, 1999, and that the
total costs will be approximately $1.2 million.
<TABLE>
<CAPTION>
NET INTEREST AND OTHER INCOME
Three months ended September 30,
(In thousands) 1999 1998 Change
- -------------------------------------------------------------
<S> <C> <C> <C>
Net interest and other
income $140 $155 (9)%
Percentage of net revenues 3% 3%
- -------------------------------------------------------------
</TABLE>
The decrease in interest and other income was due primarily to the reduction
in average
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<PAGE> 12
cash and investment balances held during the period.
As of September 30, 1999, the Company had no interest-bearing debt
outstanding, and anticipates no new debt financing in the foreseeable future.
Accordingly, the Company expects net interest and other income for the
foreseeable future to reflect net interest income.
<TABLE>
<CAPTION>
INCOME TAXES
Three months ended September 30,
(In thousands) 1999 1998 Change
----------------------------------------------------------
<S> <C> <C> <C>
Income taxes $(96) $347 nm
Effective tax rate 37% 37%
----------------------------------------------------------
</TABLE>
Income taxes include federal and state income taxes currently payable and
deferred taxes arising from temporary differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. The effective tax rate was consistent for the quarter
ended September 30, 1999, compared to the quarter ended September 30, 1998.
LIQUIDITY AND CAPITAL RESOURCES
Working capital, which consists principally of cash, cash equivalents and
short-term investments, was $6,797,000 as of September 30, 1999, compared to
$8,190,000 at June 30, 1999. Cash and cash equivalents decreased by $2,287,000
for the quarter ended September 30, 1999. This decrease was primarily due to the
repurchase of the Company's common stock and investments in capitalized software
development and fixed assets.
The Company expects to spend approximately $640,000 for capital expenditures
during the remainder of fiscal year 2000.
Long-term cash requirements, other than normal operating expenses, are
anticipated for development of new software products and enhancement of existing
products, financing anticipated growth, the possible acquisition of other
software products, technologies and businesses, and the possible repurchase of
the Company's common stock. The Company believes that its existing cash, cash
equivalents, short-term investments, and cash generated by operations will be
sufficient to satisfy its currently anticipated cash requirements for the
remainder of fiscal year 2000.
YEAR 2000
The Year 2000 problem arose because many existing computer programs use
only the last two digits to refer to a year. Therefore, these computer programs
do not properly recognize a year that begins with "20" instead of the familiar
"19." If not corrected, many computer applications could fail or create
erroneous results.
The Company has completed efforts to mitigate the impact of the Year 2000
problem on three levels: (i) the products that the Company uses internally to
conduct its business, (ii) the products that it sells, and (iii) the Year 2000
readiness of the Company's vendors.
(i) Internal Products
The Company has taken an inventory of all software and hardware systems used
internally
13
<PAGE> 13
to conduct its ongoing business. These systems include client/server systems,
LAN systems, PC systems and related software, security systems, and voice mail
systems. The Company has performed testing to confirm Year 2000 readiness on
these systems and believes that all significant systems are Year 2000-ready. The
Company did not retain any outside consultants to assist in the Year 2000
problem and, based on its review of its internal systems, believes the aggregate
costs of completing Year 2000 readiness were not material. There can be no
assurance that the Company's internal systems do not contain undetected errors
relating to the Year 2000 problem. The Company believes that significant
record-keeping and operational deficiencies could occur should any of the
Company's significant internal systems prove not to be Year 2000-ready, which
could have material adverse effects on the Company's business, financial
condition and results of operations. The Company has developed limited
contingency plans to address operational issues should any deficiencies in its
significant systems arise.
(ii) The Company's Products
The Company believes that all of the products it sells in the operation of
its business have been made Year 2000-ready.
In addition to internal testing, the Company has published recommendations
to its customers with regard to the testing that they should be performing
in-house on the Company's products to ensure Year 2000 readiness. The Company
did not calculate separately from its product development costs, the costs of
making its products Year 2000-ready. The Company believes that any incremental
Year 2000-related expense has been less than $100,000. Year 2000 readiness was
addressed as a routine engineering exercise as successive versions or upgrades
of the Company's products were released. No third-party consulting firms were
retained to specifically address the Year 2000 issue relating to the Company's
products.
There can be no assurance that the Company's products do not contain
undetected errors relating to the Year 2000 problem that may result in material
additional cost or liabilities of unknown magnitude, which could have a material
adverse effect on the Company's business, financial condition and results of
operations. However, because the Company believes that all of its products are
Year 2000-ready, no formal contingency plans have been developed to respond to
such effects.
The Company believes that the purchasing patterns of customers and potential
customers has been and will continue to be affected by the Year 2000 problem in
a variety of ways. The Company believes that certain industry groups and large
financial institutions have been making recommendations that mortgage lenders
protect themselves from further Year 2000 exposure by deferring the purchase and
implementation of new software programs (whether or not they purport to be Year
2000-ready) until after January 1, 2000. Also, the Company believes that some
customers may defer purchasing the Company's products because those customers
will be diverting resources to address their own Year 2000 problems. Although
the Company believes that the impact of the Year 2000 problem is resulting
14
<PAGE> 14
in a reduction in software sales, the Company has not been able to directly
measure the impact of these decisions for the fiscal quarter ended September 30,
1999. In addition, the Company believes that it is currently not possible to
predict the overall impact of these decisions over the course of the 2000 fiscal
year.
(iii) The Company's Vendors
The Company has identified third-party vendors upon whom it places
significant reliance and is attempting to ascertain their readiness for the Year
2000 problem. Although the Company believes it is prudent to assess its vendors'
Year 2000 readiness, it is unable to accurately predict the impact to the
Company if certain vendors are not Year 2000-ready. Significant disruption in
the businesses of the Company's customers and third-party vendors may have
material adverse effects on the Company's business, financial condition and
results of operations. Limited contingency plans have been developed to address
operational issues should certain of the Company's significant third-party
vendors prove not to be Year 2000-ready.
FORWARD-LOOKING STATEMENTS
The matters described herein contain forward-looking statements which
involve known and unknown risks, uncertainties and other factors that may cause
actual results, performance, or achievements of the Company or industry trends
to differ materially from those expressed or implied by such forward looking
statements. When used in this discussion, the words "believes", "anticipates",
and similar expressions are intended to identify forward-looking statements.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date hereof. The Company undertakes no
obligation to publicly release the result of any revisions to these
forward-looking statements that may be made to reflect events or circumstances
after the date hereof or to reflect the occurrence of unanticipated events. The
discussion and analysis herein should be read in conjunction with the Risk
Factors and other information contained in the Company's Annual Report on Form
10-K for the year ended June 30, 1999, and "Certain Additional Factors Affecting
Future Results" below.
CERTAIN ADDITIONAL FACTORS AFFECTING FUTURE RESULTS
There can be no assurance that the Company will be successful in attracting
new customers in the mortgage technology market, or that its existing customers
will continue to purchase its products and support services. In addition, there
can be no assurance that the Company's new mortgage technology products and
services will be released in a timely fashion and that, if and when released,
new products or services or its efforts to integrate the FlowMan product, into
its existing mortgage software products will be well- received by its target
market or that others will not successfully develop competing products and
services. Each of these events could have a material adverse effect upon the
Company's revenues, financial condition, and results of operations.
There can be no assurance that the Company will be successful in attracting
new customers in the EAI market, or that its existing customers
15
<PAGE> 15
will continue to purchase its products and support services. In addition, there
can be no assurance that FlowMan 4.0 will be well-received by its target market
or that others will not successfully develop competing products and services.
Each of these events could have a material adverse effect upon the Company's
revenues, financial condition, and results of operations.
Expansion of the Company's operations in the EAI software market will
require significant additional expenses and capital and could strain the
Company's management, financial and operational resources. There can be no
assurance that the Company's experience and leadership in the mortgage-related
software market will benefit the Company as it enters new markets, and gross
margins attributable to new business areas may be lower than those associated
with the Company's existing business activities. Similarly, there can be no
assurance that the Company will be able to expand its operations in a
cost-effective or timely manner. Furthermore, any new business launched by the
Company that is not favorably received by consumers could damage the Company's
reputation or the INTERLINQ brand. The lack of market acceptance of such efforts
or the Company's inability to generate satisfactory revenues from such expanded
services or products to offset their cost could have a material adverse effect
on the Company's business, prospects, financial condition and results of
operations.
The Company is unable to accurately estimate unit sales of its products and
the volume of annual support contracts that its customers will purchase due in
general to the nature of the software markets, and specifically to the cyclical
and volatile nature of the residential mortgage lending market, and the
development stage of the EAI market. In early 1994, the residential mortgage
lending market experienced a reduction in mortgage refinance volumes due to a
rise in interest rates. The Company experienced a significant decrease in net
revenues, operating income and net income during the fourth quarter of fiscal
1994, which continued through most of fiscal year 1995. The Company believes
that the current environment of increased mortgage lending rates contributed to
the downturn in net revenues, operating income and net income for the quarter
ended September 30, 1999.
NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 133 "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and
reporting standards for derivative instruments embedded in other contracts, and
for hedging activities. The Statement requires that entities recognize all
derivatives as either assets or liabilities on the balance sheet and measure
these derivatives at fair value. SFAS 133 also specifies a new method of
accounting for hedging transactions, prescribes the type of items and
transactions that may be hedged, and specifies detailed criteria to be met to
qualify for hedge accounting. This Statement is effective for financial
statements for periods beginning after June 15, 2000. The Company does not
expect the adoption of this Statement to have a material impact on the
financial statements.
16
<PAGE> 16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not use derivative financial instruments in its investment
portfolio. Its financial instruments consist of cash and cash equivalents,
short-term investments, trade accounts and contracts receivable and accounts
payable. The Company's exposure to market risk for changes in interest rates
relates primarily to its short-term investments and short-term obligations,
thus, fluctuations in interest rates would not have a material impact on the
fair value of these securities.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
27 Financial Data Schedule
(b) REPORTS ON FORM 8-K
None
17
<PAGE> 17
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DATED: November 12, 1999
INTERLINQ SOFTWARE CORPORATION
(Registrant)
/s/ Stephen A. Yount
-----------------------------------------
Stephen A. Yount
Executive Vice President and Chief
Financial Officer (Principal Financial
and Accounting Officer)
18
<PAGE> 18
Exhibit Index
<TABLE>
<CAPTION>
EXHIBIT
NUMBER TITLE
------- -----
<S> <C>
27 FINANCIAL DATA SCHEDULE
</TABLE>
19
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-2000
<PERIOD-START> JUL-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 3,601
<SECURITIES> 6,208
<RECEIVABLES> 3,066
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 13,965
<PP&E> 6,790
<DEPRECIATION> 5,069
<TOTAL-ASSETS> 23,149
<CURRENT-LIABILITIES> 7,169
<BONDS> 0
0
0
<COMMON> 49
<OTHER-SE> 15,899
<TOTAL-LIABILITY-AND-EQUITY> 23,149
<SALES> 1,802
<TOTAL-REVENUES> 4,867
<CGS> 525
<TOTAL-COSTS> 1,599
<OTHER-EXPENSES> 3,667
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (259)
<INCOME-TAX> (95)
<INCOME-CONTINUING> (163)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (163)
<EPS-BASIC> (.03)
<EPS-DILUTED> (.03)
</TABLE>
