<PAGE> 1
================================================================================
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 MARCH 31, 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)
<TABLE>
<CAPTION>
WASHINGTON 91-1187540
<S> <C>
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
</TABLE>
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 April 28, 1999, there were 5,129,148 shares of the Registrant's Common
Stock outstanding.
<PAGE> 2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTERLINQ SOFTWARE CORPORATION
CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
MARCH 31, JUNE 30,
1999 1998
----------- -----------
(unaudited) (restated)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,363,726 $ 7,233,826
Short-term investments 6,620,837 6,673,923
Accounts receivable, net 4,321,527 3,400,194
Inventory, prepaid expenses and
other current assets 1,079,952 732,273
----------- -----------
Total current assets 16,386,042 18,040,216
----------- -----------
Property and equipment, at cost 6,457,772 6,434,017
Less accumulated depreciation and amortization 4,657,946 5,434,285
----------- -----------
Net property and equipment 1,799,826 999,732
----------- -----------
Capitalized software costs, net 4,407,936 4,421,806
Goodwill and other intangible assets, net 2,599,208 3,198,021
Other assets 86,864 110,102
----------- -----------
$25,279,876 $26,769,877
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 650,059 $ 690,138
Accrued compensation and benefits 1,632,951 1,745,908
Other accrued liabilities 229,462 670,800
Purchase consideration payable -- 2,600,000
Customer deposits 1,115,667 374,151
Deferred software support fees 4,374,545 3,434,092
----------- -----------
Total current liabilities 8,002,684 9,515,089
----------- -----------
NONCURRENT LIABILITIES 129,730 99,864
SHAREHOLDERS' EQUITY:
Common stock 51,291 53,506
Additional paid-in capital 9,226,466 10,442,835
Retained earnings 7,869,705 6,658,583
----------- -----------
Total shareholders' equity 17,147,462 17,154,924
----------- -----------
$25,279,876 $26,769,877
=========== ===========
</TABLE>
See accompanying notes to condensed financial statements.
2
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INTERLINQ SOFTWARE CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
NET REVENUES:
Software license fees $ 3,331,732 $ 2,616,383 $ 9,837,449 $ 6,315,918
Software support fees 2,187,972 1,753,098 6,255,686 5,181,074
Other 734,206 417,478 1,773,828 1,300,401
----------- ----------- ----------- -----------
Total net revenues 6,253,910 4,786,959 17,866,963 12,797,393
----------- ----------- ----------- -----------
COST OF REVENUES:
Software license fees 643,237 460,531 1,794,361 1,275,742
Software support fees 714,420 661,788 1,984,267 1,788,906
Other 408,576 209,348 951,181 660,794
----------- ----------- ----------- -----------
Total cost of revenues 1,766,233 1,331,667 4,729,809 3,725,442
----------- ----------- ----------- -----------
Gross profit 4,487,677 3,455,292 13,137,154 9,071,951
----------- ----------- ----------- -----------
OPERATING EXPENSES:
Product development 794,457 387,654 2,396,289 1,161,859
Sales and marketing 1,437,625 1,440,171 4,306,430 4,018,322
General and administrative 1,510,841 979,567 4,289,215 2,696,311
Amortization of goodwill and
other intangible assets 214,830 -- 644,496 --
----------- ----------- ----------- -----------
Total operating expenses 3,957,753 2,807,392 11,636,430 7,876,492
----------- ----------- ----------- -----------
Operating income 529,924 647,900 1,500,724 1,195,459
Net interest and other income 130,437 176,406 421,690 551,893
----------- ----------- ----------- -----------
Income before income taxes 660,361 824,306 1,922,414 1,747,352
Income tax expense 244,333 303,994 711,292 661,278
----------- ----------- ----------- -----------
Net income $ 416,028 $ 520,312 $ 1,211,122 $ 1,086,074
=========== =========== =========== ===========
Net income per share - basic $ .08 $ .10 $ .23 $ .21
Net income per share - diluted $ .08 $ .10 $ .22 $ .20
Share used to calculate net income
per share - basic 5,128,864 5,117,018 5,188,055 5,212,108
Shares used to calculate net income
per share - diluted 5,483,071 5,287,921 5,493,362 5,342,757
</TABLE>
See accompanying notes to condensed financial statements.
3
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INTERLINQ SOFTWARE CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
MARCH 31,
1999 1998
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 1,211,122 $ 1,086,074
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,368,528 857,027
Amortization of capitalized software costs 1,599,343 1,128,426
Change in operating assets and liabilities:
Accounts receivable (921,333) (816,238)
Inventory, prepaid expenses, and other
current assets (347,679) (51,109)
Other assets 23,238 36,020
Accounts payable 72,301 107,027
Accrued compensation and benefits,
and other accrued liabilities (554,295) 264,622
Customer deposits 741,516 209,661
Deferred software support fees 925,614 205,315
----------- -----------
Net cash provided by operating
activities 4,118,355 3,026,825
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (1,525,104) (354,082)
Capitalized software costs (1,585,473) (1,267,897)
Proceeds from sales and maturities of
short-term investments 53,086 1,745,767
Cash paid for acquisition (2,712,380) --
----------- -----------
Net cash (used in) provided by
investing activities (5,769,871) 123,788
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 34,167 18,560
Repurchase of common stock (1,252,751) (1,362,100)
----------- -----------
Net cash used in financing activities (1,218,584) (1,343,540)
----------- -----------
Net (decrease) increase in cash and
cash equivalents (2,870,100) 1,807,073
Cash and cash equivalents at beginning of period 7,233,826 7,793,761
----------- -----------
Cash and cash equivalents at end of period $ 4,363,726 $ 9,600,834
=========== ===========
</TABLE>
See accompanying notes to condensed financial statements.
4
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INTERLINQ SOFTWARE CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
MARCH 31, 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 March 31, 1999, are not
necessarily indicative of the results for the year ending June 30, 1999. 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, 1998, as amended by Form 10-K/A on March 10, 1999.
2. RESTATEMENT
The management of the Company and the Staff of the Securities and Exchange
Commission had discussions with respect to the methods used to value acquired
in-process research and development recorded and written off at the date of
acquisition of Logical Software Solutions Corporation (LSS). As a result of
these discussions, the Company modified the method used to determine the value
of in-process R&D acquired in connection with the Company's June 1998
acquisition of LSS. Initial calculations of the value of the in-process R&D were
based on the cost required to complete the project, the after-tax cash flows
attributable to the project, and selection of an appropriate rate of return to
reflect the risk associated with the project. Revised calculations were based on
adjusted after-tax cash flows that gave explicit consideration to the Staff's
views on in-process R&D as set forth in its September 15, 1998 letter to the
AICPA, and the Staff's comments for the Company to consider the stage of
completion of the in-process technology at the date of acquisition. As a result
of this modification the Company decreased the amount of the purchase price
allocated to in-process research and development in the LSS acquisition from
$3,615,304 to $1,349,616. This resulted in a corresponding increase to goodwill,
which is being amortized over its useful life of four years on a straight-line
basis. As a result of the significant decrease in the amount of acquired
in-process research and development, there was also a significant decrease in
the corresponding deferred tax asset. Given this decrease, the Company
determined that a valuation allowance was no longer necessary. On March 10,
1999, the Company filed Form 10-K/A for the year ended June 30, 1998, and Forms
10-Q/A for the quarters ended September 30, 1998, and December 31, 1998,
reflecting this restatement.
3. 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 dilutive common equivalent
shares outstanding during the period.
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The following table reconciles the shares used in calculating basic earnings per
share to the shares used in calculating diluted earnings per share:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Weighted average common shares 5,128,864 5,117,018 5,188,055 5,212,108
Dilutive effect of outstanding
options 354,207 170,903 305,307 130,649
--------- --------- --------- ---------
Weighted average common and
common equivalent shares 5,483,071 5,287,921 5,493,362 5,342,757
========= ========= ========= =========
</TABLE>
Certain options outstanding at the end of each period presented were excluded
from the computation of diluted earnings per share because their inclusion would
be anti-dilutive as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
1999 1998 1999 1998
------------- ------------- ------------ -------------
<S> <C> <C> <C> <C>
Options excluded from computation 358 194,562 4,493 271,762
Weighted-average exercise price $8.38 $5.99 $7.55 $5.61
</TABLE>
4. REVENUE RECOGNITION
On July 1, 1998, the Company adopted 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. The adoption of SOP 97-2
did not have a material effect on the Company's revenue recognition.
5. ACQUISITION
On June 30, 1998, the Company acquired substantially all of the assets and
business of Logical Software Solutions Corporation ("LSS"). LSS is an enterprise
application integration developer and service provider. The purchase price
consisted of 233,334 shares of common stock valued at approximately $1,400,000,
cash in the amount of $3,600,000, and $379,000 in direct acquisition costs. The
233,334 shares of common stock issued in the acquisition were placed in escrow
and will vest with time over a six-year period. Vesting of the shares will be
accelerated if annual performance goals to be determined by mutual agreement
among the Company and the former LSS shareholders are met. If all performance
goals are met, the shares will fully vest in three years. The specific
performance goals have not yet been determined.
The acquisition was accounted for using the purchase method of accounting.
Accordingly, the results of operations of the acquired business and the fair
market values of the acquired assets and
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assumed liabilities were included in the Company's financial statements as of
the date of acquisition. The purchase price was allocated to the acquired assets
and assumed liabilities based on fair values.
A portion of the purchase price represents purchased in-process research and
development that has not yet reached technological feasibility and has no
alternative future use. The value assigned to purchased in-process research and
development was determined by identifying research projects in areas for which
technological feasibility has not been established; estimating the costs to
develop the purchased in-process research and development into commercially
viable products; estimating the resulting net cash flows from such projects;
discounting the net cash flows back to the time of acquisition; and applying an
attribution rate based on the estimated percent complete.
The following table presents pro forma results of operations as if the
acquisition had occurred on July 1, 1997, excluding all nonrecurring
acquisition-related charges. The table includes the impact of certain
adjustments such as goodwill amortization and related tax effects. The pro forma
information is not necessarily indicative of the combined results that would
have occurred had the acquisition been in effect for the entire period
presented, nor is it necessarily indicative of results that may occur in the
future.
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
March 31, 1998 March 31, 1998
-------------- --------------
<S> <C> <C>
Total net revenues $ 5,038,000 $ 13,542,000
Net income 302,000 511,000
Net income per share - basic .06 .09
Net income per share - diluted .05 .09
</TABLE>
6. NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 130, Reporting Comprehensive Income ("SFAS
No. 130"). SFAS No. 130 establishes standards for reporting and disclosure of
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general-purpose financial statements. SFAS No. 130, which is
effective for fiscal years beginning after December 15, 1997, requires
reclassification of financial statements for earlier periods to be provided for
comparative purposes. The Company currently has no components of accumulated
other comprehensive income and has not determined the manner in which it will
present the information required by SFAS No. 130 in its annual financial
statements for the year ending June 30, 1999.
In June 1997, the FASB issued SFAS No. 131, Disclosure About Segments of an
Enterprise and Related Information ("SFAS No. 131"). SFAS No. 131 establishes
standards for the way public business enterprises report information about
operating segments. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. SFAS No. 131 is
effective for fiscal years beginning after December 15, 1997. In the initial
year of application, comparative information for earlier years must be restated.
The Company has not determined the manner in which it will present the
information required by SFAS No. 131 in its annual financial statements for the
year ending June 30, 1999.
On December 22, 1998, the AICPA Accounting Standards Executive Committee issued
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
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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 "residual method"
established by SOP 98-9 is effective for fiscal years beginning after March 15,
1999. The Company believes that the adoption of SOP 98-9 will not have a
material effect on the Company's revenue recognition.
8
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements that have been made
under the provisions of the Private Securities Litigation Reform Act of 1995.
Such forward-looking statements are based on current expectations, estimates and
projections about the Company's industry, management's beliefs and certain
assumptions made by management. When used throughout this discussion, words such
as "anticipates," "expects," "intends," "plans," "believes," "seeks,"
"estimates" and similar expressions are intended to identify such
forward-looking statements. These statements are not guarantees of future
performance and are subject to certain risks, uncertainties and assumptions that
are difficult to predict. The Company's actual actions or results may differ
materially from those discussed in the forward-looking statements. Factors which
could affect the Company's financial results and cause such results to differ
materially from quarter to quarter include, but are not limited to, fluctuations
in quarterly performance and in interest rates, competition, timing and customer
acceptance of new products, the Company's ability to manage growth and integrate
acquired technology, changes in governmental regulations and tax laws, and
general economic conditions and concerns raised by the Year 2000 computer
problem. Additional information regarding these and other risks and
uncertainties is described in the Company's Annual Report on Form 10-K for the
fiscal year ended June 30, 1998, and in other reports filed by the Company from
time to time with the Securities and Exchange Commission. 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 update
publicly any forward-looking statements, whether as a result of new information,
future events or otherwise.
OVERVIEW
INTERLINQ Software Corporation, established in 1982, is a leading provider of
technology that helps organizations effectively manage complex,
information-intensive business transactions.
On June 30, 1998, the Company acquired substantially all of the assets and
business of Logical Software Solutions Corporation ("LSS"). This acquisition
included the LSS technology and specifically FlowMan(R) version 3.2. As a result
of the acquisition, the Company formed two operating divisions - the Mortgage
Technology Division and the Enterprise Technology Division. The operations of
the acquired company are included in the Company's financial statements
beginning on June 30, 1998.
The Mortgage Technology Division provides business solutions to approximately
2,000 banks, savings institutions, mortgage banks, mortgage brokers and credit
unions. The Enterprise Technology Division provides process-centered, enterprise
application integration ("EAI") solutions through third-party application
developers, OEMs and system integrators.
MORTGAGE TECHNOLOGY DIVISION: Through its Mortgage Technology Division, the
Company works closely with clients to provide comprehensive software
applications and business
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solutions for the residential mortgage and construction lending industry,
offering a suite of products, MortgageWare(R) Enterprise, that manages the
entire life cycle of a mortgage loan.
Prior to the mid-1980s, mortgage loans in the United States were originated in a
manual and paper-intensive process. Beginning in the mid-1980s and running
through the mid-1990s, the mortgage lending industry implemented its first wave
of automation with PC-based software solutions for mortgage originations. During
this period, the Company experienced rapid revenue and customer growth by
providing its MortgageWare Loan Management System - designed as a robust,
full-featured and cost-effective PC-based software solution for mortgage
originations.
This first wave of automation accelerated and amplified beginning in 1992, as
mortgage interest rates reached historically low levels and mortgage refinance
volumes soared. In early 1994, the Federal Reserve raised interest rates, which
immediately caused mortgage refinance volumes to decline substantially. As a
result, lenders found themselves with excess labor and mortgage processing
capacity. Consequently, the Company believes, the industry was focused more on
staff reduction and cost cutting than on adding new automated loan management
systems.
From 1996 through early 1999, mortgage-lending rates have reflected a lending
environment that has experienced a high degree of volatility. In spite of this
volatility, overall lending conditions have been considered favorable for the
borrower compared to most historical measures. The Company believes that this
overall favorable lending environment for mortgage-lending activity is driving
an increase in financing of home sales and refinancing of existing mortgages.
During the latter half of fiscal year 1997, the Company observed a shift in the
mortgage origination business, which it attributes to excess production capacity
coupled with a reduced profit margin. Currently, most of this excess production
capacity appears to have been fulfilled, yet profit margins in mortgage loan
origination continue to be low.
During the quarter ended March 31, 1999, the Company saw an increase in software
license fees, compared to the same quarter in the prior year, due to demand for
the MortgageWare Enterprise product suite and the continuing favorable lending
environment. The Company believes that due to intense competition in the
mortgage lending industry and the related lower profit margins, its customers
will continue to shift their long-term purchasing decisions from solutions that
solely increase production capacity to solutions that will help to reduce unit
costs and thereby increase profit margins. Accordingly, during fiscal years 1996
and 1997, the Company sought to diversify its product offerings by developing an
integrated "enterprise" solution for the mortgage lending industry. The Company
believes that this broader enterprise solution has contributed to the increases
in software license revenues over the last several quarters and will allow the
Company to respond advantageously to the recent changes in the mortgage lending
industry. This broader product offering is designed to reduce the cost of
originating, processing, and servicing a mortgage, rather than just increasing
production capacity.
ENTERPRISE TECHNOLOGY DIVISION: Through its Enterprise Technology Division, the
Company intends to enter the EAI market by marketing
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FlowMan, a software product that integrates disparate systems and applications
to facilitate ongoing process knowledge management by applying its business
process and rules technology across an entire enterprise. FlowMan is designed to
coordinate the execution and timing of all tasks, events and decisions for key
business processes across legacy systems, enterprise applications, client-server
systems and Internet technologies.
Upon acquiring LSS, the Company developed a two-prong strategy to leverage the
FlowMan technology. This two-prong strategy is expected to provide growth and
diversification for the Company, while allowing it to continue to expand and
excel in its core market of mortgage technology.
In the first prong, the Company will integrate the FlowMan technology with the
Company's MortgageWare Enterprise product suite and recently announced the
integration of FlowMan with MortgageWare TC. This is expected to further broaden
the capabilities and the appeal of the Mortgage Technology Division's product
offerings and strengthen the commitment of the Company to enterprise solutions.
In the second prong, the Company has entered the EAI market by marketing FlowMan
on a stand-alone basis, primarily through OEMs, system integrators and
third-party application developers. The Company believes that the product can be
marketed successfully as an application package in other vertical markets and as
a tool kit for use by other application providers. The Company views the EAI
market as being in its early stages of development and expects this market to
grow over the next few years.
CERTAIN DEVELOPMENTS: On December 29, 1998, the Company entered into an
agreement with Terlin, Inc., an affiliate of W.R. Hambrecht + Co., LLC ("WRH")
relating to a leveraged recapitalization of the Company. Under the agreement,
Terlin, Inc. will merge with the Company, with the Company being the surviving
entity. If approved by shareholders, the merger will result in WRH and its
affiliates controlling a majority of the voting stock of the Company and may
result in the Company ceasing to be publicly traded. In the merger, each of
approximately 2,150,000 shares of Terlin, Inc. will convert into one share of
the Company's common stock. In addition, 1,250,000 shares of the Company's
common stock will remain outstanding and all other outstanding shares will be
converted into the right to receive cash in the amount of $9.25 per share. Each
shareholder will be given the opportunity to elect, as to all or a part of his
or her shares, to retain such shares or to receive cash in the amount of $9.25
per share. To the extent that the shareholders elect to retain more or less than
1,250,000 shares, the shareholders will receive additional shares or cash on a
pro rata basis. Additionally, a reverse stock split may take place following the
merger to reduce the number of shareholders to less than 300 to facilitate
taking the Company private.
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NET REVENUES
<TABLE>
<CAPTION>
Three months ended March 31,
(In thousands) 1999 1998 Change
- -----------------------------------------------------------------
<S> <C> <C> <C>
Software license fees $3,332 $2,616 27%
Software support fees 2,188 1,753 25%
Other 734 418 76%
- -----------------------------------------------------------------
Total net revenues $6,254 $4,787 31%
- -----------------------------------------------------------------
</TABLE>
Net revenues consist of software license fees, software support fees and other
revenues (which include training, consulting fees, document referral fees and
other miscellaneous sales), net of discounts and sales returns.
Software license fees were $3,332,000 for the quarter ended March 31, 1999, an
increase of 27% from $2,616,000 in the comparable quarter of the prior year.
Software license fees were $9,837,000 for the nine months ended March 31, 1999,
an increase of 56% from $6,316,000 in the comparable period of the prior year.
These increases were due primarily to the continuing favorable lending
environment and ongoing demand from new and existing customers for the Company's
MortgageWare Enterprise product suite. The components of the product suite that
reflected higher revenues were primarily MortgageWare TC, the Company's software
interface products, MortgageWare Loan Servicing and to a lesser extent,
increased sales of the Company's other products.
Software support fees were $2,188,000 for the quarter ended March 31, 1999, an
increase of 25% from $1,753,000 in the comparable quarter of the prior year.
Software support fees were $6,256,000 for the nine months ended March 31, 1999,
an increase of 21% from $5,181,000 in the comparable period of the prior year.
These period-to-period increases were due primarily to a higher software sales
volume 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 increase in
software support fees compared to software license fees is not directly
proportional. The Company believes software support fees are likely to continue
to increase at a modest rate for the rest of fiscal year 1999.
Other revenues were $734,000 for the quarter ended March 31, 1999, an increase
of 76% from $418,000 in the comparable quarter of the prior year. Other revenues
were $1,774,000 for the nine months ended March 31, 1999, an increase of 36%
from $1,300,000 in the comparable period of the prior year. The increase for the
quarter was due primarily to an increase in demand for the Company's training
and consulting services and VMP referral fees earned by the Company on document
sales. The increase for the nine month period was due primarily to an increase
in demand for the Company's training services and VMP referral fees, partially
offset by a decrease in consulting services. The Company expects its other
revenues to continue to increase during the remainder of fiscal year 1999,
compared to fiscal year 1998, due to the related increase in software license
fee revenue as well as increased demand for consulting services associated with
implementation of MortgageWare Loan Servicing.
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The Company anticipates an increasing contribution to software license fees, and
related increases to software support fees and other revenues, from MortgageWare
Loan Servicing, MortgageWare InfoLINQ, MortgageWare MarketLINQ, MortgageWare
InvestorLINQ and FlowMan for the remainder of fiscal 1999. As discussed above,
the Company believes the overall lending environment to be favorable as of March
31, 1999. Nonetheless, there can be no assurance that mortgage-lending rates
will not increase or continue to experience a high amount of volatility. Such
increases or continued 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 and potential homeowners perceive such
rates as too high, 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 has just entered the relatively new EAI market, which is subject to
constant change and intense competition. 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
business, financial condition and results of operations.
COST OF REVENUES
<TABLE>
<CAPTION>
Three months ended March 31,
(In thousands) 1999 1998 Change
- ------------------------------------------------
<S> <C> <C> <C>
Software license fees $643 $461 40%
Percentage of software
license fees 19% 18%
- ------------------------------------------------
Software support fees $714 $662 8%
Percentage of software
support fees 33% 38%
- ------------------------------------------------
Other $409 $209 96%
Percentage of other 56% 50%
- ------------------------------------------------
Total cost of revenues $1,766 $1,332 33%
Percentage of net
revenues 28% 28%
- ------------------------------------------------
</TABLE>
Cost of software license fees consists primarily of the amortization of
capitalized software development costs and, to a lesser extent, the purchase and
duplication of disks and product documentation. In addition, the Company has
recently introduced certain software interface products, which result in third
party royalties (included in cost of software license fees). As a percentage of
software license fees, cost of software license fees increased to 19% for the
quarter ended March 31, 1999, from 18% in the comparable quarter of the prior
year. As a percentage of software license fees, cost of software license fees
decreased to 18% for the nine months ended March 31, 1999, from 20% in the
comparable period of the prior year. The increase for the quarter is due
primarily to a change in the product mix and lower gross margins on certain
interface products (which require payment of third party royalties). The
decrease for the nine-month period is due primarily to software license fees
increasing at a substantially higher rate than the cost of software license fees
that contain the relatively fixed
13
<PAGE> 14
component of amortization of capitalized software development costs.
Amortization of capitalized software development costs increased to $566,000 for
the quarter ended March 31, 1999, compared to $403,000 in the comparable quarter
of the prior year, and increased to $1,599,000 for the nine-month period ended
March 31, 1999, compared to $1,128,000 in the comparable period of the prior
year. The Company expects the dollar amount of its amortization of capitalized
software development costs to increase for the remainder of fiscal year 1999.
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 33% for the quarter ended March 31, 1999,
from 38% in the comparable quarter of the prior year. As a percentage of
software support fees, cost of software support fees decreased to 32% for the
nine-month period ended March 31, 1999, from 35% in the comparable period of the
prior year. These decreases were due primarily to software support fee revenue
increasing at a rate higher than the cost of software support fees. Payroll
costs have increased since the prior year as the customer support group has
grown; however, these increases have been offset by decreases in the supplies
expense associated with delivering software updates. The Company expects the
dollar cost of software support fees to continue to increase due to the
increased staffing that will be required to support a higher installed base of
the Company's products and in order to support the FlowMan product. The Company
expects that these factors will not lead to a significant increase in the ratio
of the cost of software support fees to software support fees.
Cost of other revenue includes the salaries and reimbursable expenses for the
employees who provide training and consulting services and the net cost of the
Company's annual MortgageWare software users' group meeting. As a percentage of
other revenue, cost of other revenue increased to 56% for the quarter ended
March 31, 1999, from 50% in the comparable quarter of the prior year. As a
percentage of other revenue, cost of other revenue increased to 54% for the
nine-month period ended March 31, 1999, from 51% in the comparable period of the
prior year. These increases were primarily due to lower margins earned on custom
programming partially offset by an increase in high margin VMP document fees.
The Company expects the margins earned on other revenues to continue to vary
with changes in the product mix.
OPERATING EXPENSES
<TABLE>
<CAPTION>
Three months ended March 31,
(In thousands) 1999 1998 Change
- --------------------------------------------------------------
<S> <C> <C> <C>
Product development $ 794 $ 388 105%
Percentage of net
revenues 13% 8%
- --------------------------------------------------------------
Sales & marketing $1,438 $1,440 0%
Percentage of net
revenues 23% 30%
- --------------------------------------------------------------
General & administrative $1,511 $ 980 54%
Percentage of net
revenues 24% 20%
- --------------------------------------------------------------
Amortization of goodwill
and other intangible $ 215 -- nm
assets
Percentage of net
revenues 3% --
- --------------------------------------------------------------
</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,
14
<PAGE> 15
product development expenses increased to 13% for the quarter ended March 31,
1999 from 8% in the comparable quarter of the prior year. As a percentage of net
revenues, product development expenses increased to 13% for the nine-month
period ended March 31, 1999, from 9% in the comparable period of the prior year.
These increases were due primarily to the Company's efforts introduced in the
current fiscal year to develop FlowMan version 4.0 and to operate the related
development office. These efforts resulted in additional product development
expenses of approximately $288,000 for the quarter ended March 31, 1999, and
$805,000 for the nine-month period ended March 31, 1999. The remainder of the
increase resulted from increased headcount, salaries and bonuses related to the
Company's other product development efforts (due in part to the tight market for
technical skills). These increases were offset somewhat by an increase in the
amount of capitalized software development costs. The Company capitalized
$540,000 and $515,000 of development expenditures for the quarters ended March
31, 1999, and 1998, respectively. The Company capitalized $1,585,000 and
$1,268,000 of development expenditures for the nine months ended March 31, 1999,
and 1998, respectively. As a result of development expenses associated with
FlowMan 4.0, the integration of FlowMan with the Company's existing products, as
well as normal enhancements to existing products, the Company expects overall
development spending to continue to increase somewhat during the remainder of
the 1999 fiscal year. No development costs related to FlowMan 4.0 will be
capitalized until the product reaches technological feasibility; therefore, the
Company expects that the amount of capitalized software development costs that
are carried on its balance sheet will only increase slightly or remain flat
until that time.
In connection with the acquisition of LSS, the Company acquired in-process
research and development related to the development of FlowMan 4.0. The Company
incurred approximately $250,000 and $640,000 of FlowMan 4.0 development costs
during the quarter ended March 31, 1999 and the nine-months ended March 31,
1999, respectively. The Company currently estimates the costs to complete the
project to be approximately $310,000. These cost estimates are relatively
consistent with those estimated during the quarters ended December 31, 1998 and
September 30, 1998, but are substantially higher than the original estimate of
$200,000. The Company experienced unforeseen technical complexities and other
project management issues, which led to the increase in costs. The project is
currently expected to be completed during the fourth quarter of fiscal 1999.
At the time of the acquisition of LSS, revenues attributable to FlowMan 4.0 were
projected for purposes of valuing the acquired in-process R&D. The Company
continues to believe that FlowMan 4.0 will produce substantial revenues
subsequent to successful completion. The Company originally expected to market
both FlowMan 3.2 and 4.0 through its existing direct sales force and indirect
distribution channels. During the quarter ended September 30, 1998, the Company
concluded that a majority of sales will come through indirect channels that need
to be developed. The increased need to develop indirect distribution channels
and the one quarter delay in the expected completion date of FlowMan 4.0 from
the third quarter to the fourth quarter of fiscal 1999 have affected the amount
15
<PAGE> 16
and timing of projected revenues. As a result, during the quarter ended
September 30, 1998, the Company revised its projected annual revenue ranges down
to a range of $0.3 million to $6.5 million, as compared to the original
projected annual revenue ranges of $1.0 million to $10.3 million.
Though the Company currently expects that the acquired in-process technology
will be successfully developed, there can be no assurance that commercial or
technical viability of the product will be achieved. If the project is not
successfully developed, the Company may not realize the value assigned to the
in-process R&D project. In addition, the value of goodwill and other acquired
intangible assets may also become impaired. Ongoing operations and financial
results for acquired businesses and the Company are subject to a variety of
factors which may or may not have been known or estimable at the time of such
acquisition, and the estimates discussed above are subject to change.
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 decreased to 23%
for the quarter ended March 31, 1999, from 30% in the comparable quarter of the
prior year. As a percentage of net revenues, sales and marketing expenses
decreased to 24% for the nine months ended March 31, 1999, from 31% in the
comparable period of the prior year. These decreases were primarily due to
revenues increasing at a faster rate than sales and marketing expenses. On a
dollar basis, sales and marketing expenses remained flat for the quarter ended
March 31, 1999, compared to the same quarter of the prior year. Sales and
marketing expenses increased 7% to $4,306,000 for the nine-month period ended
March 31, 1998, from $4,018,000 in the comparable period of the prior year. At
the same time, total net revenues increased by 31% and 40% for the quarter and
the nine-month period ended March 31, 1999, respectively (as discussed above).
The Company expects sales and marketing expenses to continue to increase
modestly on a dollar basis but to remain relatively consistent on a percentage
of revenue basis for the rest of fiscal year 1999, since many sales and
marketing expenses fluctuate with revenue.
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 March 31, 1999, from 20% in the comparable quarter of the
prior year. As a percentage of net revenues, general and administrative expenses
increased to 24% for the nine-month period ended March 31, 1999, from 21% in the
comparable period of the prior year. On a dollar basis, general and
administrative expenses increased 54% to $1,511,000 for the quarter ended March
31, 1999, from $980,000 in the comparable quarter of the prior year, and
increased 59% to $4,289,000 for the nine months ended March 31, 1999, from
$2,696,000 in the comparable period of the prior year. These increases were due
primarily to expenses incurred by the Company for the potential leveraged
recapitalization transaction (as discussed above) in the approximate amounts of
$320,000 and $360,000 for the quarters ended March 31, 1999,
16
<PAGE> 17
and December 31, 1998, respectively. These expenses included investment-banking
fees, legal fees, accounting fees and financial printing fees. To a lesser
extent, general and administrative expenses increased during these periods due
to increased payroll for the department and slight increases in facility costs
related to the relocation of the Company's headquarters during the quarter ended
December 31, 1998. The Company expects general and administrative expenses to
continue to increase on a comparative dollar basis as additional expenses are
expected related to the leveraged recapitalization. The Company expects this to
translate into a modest increase in general and administrative expenses as a
percentage of net revenues.
Amortization of goodwill and other intangible assets consists of the
straight-line amortization of assets acquired by the Company as a result of its
acquisition of LSS on June 30, 1998. These assets include workforce-in-place,
customer lists, tradename, non-compete and employment agreements and goodwill,
which are being amortized over their estimated useful lives of three to four
years.
NET INTEREST AND OTHER INCOME
<TABLE>
<CAPTION>
Three months ended March 31,
(In thousands) 1999 1998 Change
- -------------------------------------------------------
<S> <C> <C> <C>
Net interest and other
Income $130 $176 (26%)
Percentage of net
revenues 2% 4%
- -------------------------------------------------------
</TABLE>
Net interest and other income, which consists primarily of interest income,
decreased 26% to $130,000 for the quarter ended March 31, 1999, from $176,000 in
the comparable quarter of the prior year. Net interest and other income
decreased 24% to $422,000 for the nine-month period ended March 31, 1999, from
$552,000 in the comparable period of the prior year. These decreases were due
primarily to the reduction in cash and investments resulting from the purchase
of LSS, significant purchases of property, equipment and leasehold improvements,
the repurchase of the Company's common stock and cash deposits made for federal
income tax. These uses of cash were offset somewhat by the cash generated by
operations.
If the leveraged recapitalization with WRH is approved by shareholders (as
discussed above), the Company expects to incur net interest expense for the
foreseeable future rather than net interest income due to the use of cash and
the related debt that would be incurred.
INCOME TAXES
<TABLE>
<CAPTION>
Three months ended March 31,
(In thousands) 1999 1998 Change
- ------------------------------------------------
<S> <C> <C> <C>
Income taxes $244 $304 (20%)
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 with that in the
comparable periods of the prior year.
LIQUIDITY AND CAPITAL RESOURCES
Working capital, which consists principally of cash, cash equivalents and
short-term investments, was $8,383,000 as of March 31, 1999, compared to
$8,525,000 at June 30, 1998. Cash and cash equivalents decreased by $2,870,000
for the nine months ended March 31, 1999. Additions to cash and cash equivalents
included $4,118,000
17
<PAGE> 18
provided by operations. Principal uses of cash and cash equivalents included
$2,712,000 for the acquisition of LSS, $1,253,000 for the repurchase of common
stock, $1,585,000 of capitalized software costs and $1,525,000 for the purchase
of property and equipment.
The Company expects to spend approximately $100,000 for capital expenditures
during the remainder of the fiscal year ending June 30, 1999. The Company's
facility lease expired in November 1998, and the Company entered into a
seven-year lease for a new facility. Net occupancy costs have increased only
slightly as a result of this move; however, during the six months ended December
31, 1998, the Company incurred approximately $815,000 of tenant improvement
costs and fixed asset purchases related to this move.
Long-term cash requirements, other than normal operating expenses, are
anticipated for development of new software products and enhancement of existing
products (including FlowMan version 4.0); financing anticipated growth; the
possible acquisition of other software products, technologies and businesses;
and the possible repurchase of the Company's common stock.
As of March 31, 1999, the Company had no interest-bearing debt outstanding. If
the shareholders approve the leveraged recapitalization of the Company pursuant
to the agreement between the Company and Terlin, Inc., (as discussed above) the
Company expects the transaction to result in the origination of approximately
$22,500,000 of long-term debt financing. In addition, the transaction would
result in a significant reduction of the cash and investment balances held by
the Company since these resources would be partially used to finance the
recapitalization. The remaining balance of cash and investments will depend on
the timing of the transaction and the cash generated and/or used before the
transaction closes. The Company believes the net use of cash, cash-equivalents
and short term investments in this transaction will be approximately $8,500,000.
If the transaction is not approved, the Company believes that no new debt
financing would be required and that its existing cash, cash equivalents,
short-term investments, and cash generated by operations will be sufficient to
satisfy its other currently anticipated cash requirements for fiscal year 1999.
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 initiated 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 to conduct its ongoing business. These systems include client/server
systems, LAN systems, PC
18
<PAGE> 19
systems and related software, security systems and voice mail systems. The
Company has been notified by its vendors that certain of these systems are
currently Year 2000-ready, while other systems are scheduled for purchase or
update during the remainder of the 1999 fiscal year. The Company has performed
limited testing to confirm Year 2000 readiness on certain of these systems, and
intends to complete such testing by June 30, 1999. The Company has not retained
any outside consultants to assist in the Year 2000 problem and based on its
review of its internal systems, the Company believes the aggregate costs of
completing Year 2000 readiness will not be material. The Company believes that
significant record-keeping and operational deficiencies could occur should the
Company's internal products not be made Year 2000-ready, which could have
material adverse effects on the Company's business, financial condition and
results of operations. However, because the Company believes that the majority
of its internal systems are Year 2000-ready, no formal contingency plans have
been developed to respond to such effects.
(ii) The Company's Products
A majority of the products that the Company sells in the operation of its
business have been made Year 2000-ready. All of the products have been evaluated
for the Year 2000 problem and significant steps have been taken to make each
product Year 2000-ready. The following products have been made Year 2000-ready
and have been subjected to testing for the Year 2000 problem: MortgageWare Loan
Servicing, MortgageWare Loan Management System, MortgageWare TC, MortgageWare
Entre, MortgageWare MarketLINQ, MortgageWare InvestorLINQ, MortgageWare InfoLINQ
and BuilderBlock$TM. 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 these products to ensure Year 2000 readiness.
The Company believes that all of its products will be Year 2000-ready by the end
of the 1999 fiscal year. The Company has not calculated 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 $75,000 and any additional costs in achieving Year 2000 readiness are not
expected to be material. Year 2000 readiness has been and is continuing to be
addressed as a routine engineering exercise as successive versions or upgrades
of the Company's products are released. No third-party consulting firms or
Company personnel have been retained by the Company to specifically address Year
2000 issues relating to the Company's products. However, there can be no
assurances 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
19
<PAGE> 20
of its products will be Year 2000-ready, no formal contingency plans have been
developed to respond to such effects. In addition, the Company believes that the
purchasing patterns of customers and potential customers may 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 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. In contrast, other customers may
accelerate their decisions to purchase the Company's products to replace
non-Year 2000-ready applications. The Company has not been able to directly
measure any impact of these decisions for the nine months ended March 31, 1999,
and believes that it is not possible to predict the overall impact of these
decisions.
(iii) The Company's Vendors
The Company has identified third-party vendors upon which it places significant
reliance and plans to ascertain their readiness for the Year 2000 problem during
the 1999 fiscal year. The Company does not expect to incur any material costs in
ascertaining the Year 2000-readiness of its significant vendors. 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. However,
because the Company expects that its significant third-party vendors are or will
be Year 2000-ready, no formal contingency plans have been developed to respond
to such effects.
CERTAIN ADDITIONAL FACTORS AFFECTING FUTURE RESULTS
If the proposed merger between the Company and Terlin, Inc. is completed as
planned, the Company will have substantially more indebtedness than it has had
historically. Consequently, a portion of cash flow available from operations
will be dedicated to the payment of principal and interest on indebtedness,
thereby reducing the funds that would otherwise be available to the Company for
research and development, acquisitions and future business opportunities. In
addition, the Company's ability to obtain additional financing in the future may
be limited. Furthermore, the higher degree of leverage will make the Company
relatively more vulnerable to economic downturns and competitive pressures. Each
of these factors could materially adversely affect the Company's operating
results and financial condition.
If, on the other hand, the merger is abandoned, under certain circumstances and
depending on the reasons for the termination, the Company may be obligated to
either reimburse Terlin for all its reasonable out-of-pocket expenses and fees,
pay Terlin $625,000 plus reimbursements for all its reasonable out-of-pocket
expenses and fees, or pay Terlin $1,250,000 plus reimbursements for all its
reasonable out-of-pocket expenses and fees. There is no assurance that the
merger will be
20
<PAGE> 21
completed as planned, and any such termination payments could materially
adversely affect the Company's operating results and financial condition.
The Company's business divisions face intense competition at many levels. The
market for mortgage-related software products is highly competitive. Similarly,
the EAI software market is intensely competitive and subject to rapid change.
The Company believes that the main competitive factors in both markets include
price, operating platform compatibility, ease of implementation and use, and
customer support. Any change in such factors could materially adversely affect
the Company's business, operating results and financial condition.
There is 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 is 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 technology into the
MortgageWare Enterprise 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 is no assurance that the Company will be successful in attracting new
customers in the EAI market, or that its existing customers will continue to
purchase its products and support services. In addition, there is no assurance
that FlowMan 4.0 will be released in a timely fashion or that, if and when
released, it will be well received by its target market or that others will not
successfully develop competing products and services. Nor is there any assurance
that the Company will be successful in its efforts to develop the required new
indirect sales channels, given its plans to market FlowMan through third party
application developers, OEMs, and system integrators. 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. Nor can there be 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
21
<PAGE> 22
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. Increases in interest rates, or changes in
tax laws or other governmental regulations relating to the mortgage industry
could have a material adverse effect on the Company's financial condition and
results of operations.
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 130, Reporting Comprehensive Income ("SFAS
No. 130"). SFAS No. 130 establishes standards for reporting and disclosure of
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general-purpose financial statements. SFAS No. 130, which is
effective for fiscal years beginning after December 15, 1997, requires
reclassification of financial statements for earlier periods to be provided for
comparative purposes. The Company currently has no other components of
comprehensive income and has not determined the manner in which it will present
the information required by SFAS No. 130 in its annual financial statements for
the year ending June 30, 1999.
In June 1997, the FASB issued SFAS No. 131, Disclosure About Segments of an
Enterprise and Related Information ("SFAS No. 131"). SFAS No. 131 establishes
standards for the way public business enterprises report information about
operating segments. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. SFAS No. 131 is
effective for fiscal years beginning after December 15, 1997. In the initial
year of application, comparative information for earlier years must be restated.
The Company has not determined the manner in which it will present the
information required by SFAS No. 131 in its annual financial statements for the
year ending June 30, 1999.
On December 22, 1998, the AICPA Accounting Standards Executive Committee issued
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 "residual method" established by SOP 98-9 is effective
for fiscal years beginning after March 15, 1999. The Company believes that the
adoption of SOP 98-9 will not have a material effect on the Company's revenue
recognition.
22
<PAGE> 23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's exposure to market risk associated with activities in financial
and commodity instruments, derivative or otherwise, is not material.
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
27.1 Financial Data Schedule which is submitted electronically
to the Securities and Exchange Commission for information
purposes only and is not filed.
b) REPORTS ON FORM 8-K
None.
23
<PAGE> 24
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: May 7, 1999
INTERLINQ SOFTWARE CORPORATION
(Registrant)
/s/ STEPHEN A. YOUNT
Stephen A. Yount
Executive Vice President and Chief
Financial Officer
(Principal Financial and Accounting
Officer)
24
<PAGE> 25
EXHIBIT
INDEX
<TABLE>
<CAPTION>
EXHIBIT NUMBER TITLE
-------------- -----
<S> <C>
27.1 FINANCIAL DATA SCHEDULE
</TABLE>
25
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> JUL-01-1998
<PERIOD-END> MAR-31-1999
<CASH> 4,364
<SECURITIES> 6,621
<RECEIVABLES> 4,322
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 16,386
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0
0
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</TABLE>
