<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 DECEMBER 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)
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 February 7, there were 4,822,852 shares of the Registrant's Common
Stock outstanding.
<PAGE> 2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTERLINQ SOFTWARE CORPORATION
CONDENSED BALANCE SHEETS
(unaudited)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1999 1999
----------- -----------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 3,434,504 $ 5,888,630
Short-term investments 5,389,417 5,874,218
Accounts receivable, net 2,854,377 3,763,446
Inventory, prepaid expenses & other current assets 1,367,036 934,008
----------- -----------
Total current assets 13,045,334 16,460,302
----------- -----------
Property and equipment, at cost 6,995,604 6,576,456
Less accumulated depreciation and amortization 5,270,505 4,872,314
----------- -----------
Net property and equipment 1,725,099 1,704,142
----------- -----------
Capitalized software costs, net 5,222,277 5,159,249
Goodwill and other intangible assets, net 1,954,718 2,384,377
Other assets 76,106 88,914
----------- -----------
$22,023,534 $25,796,984
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 353,812 $ 440,962
Accrued compensation and benefits 851,986 2,082,743
Other accrued liabilities 138,152 221,535
Customer deposits 763,723 965,204
Deferred software support fees 4,517,135 4,559,597
----------- -----------
Total current liabilities 6,624,808 8,270,041
----------- -----------
NONCURRENT LIABILITIES 31,474 9,854
SHAREHOLDERS' EQUITY:
Common stock 48,229 51,806
Additional paid-in capital 7,680,085 9,409,382
Retained earnings 7,638,938 8,055,901
----------- -----------
Total shareholders' equity 15,367,252 17,517,089
----------- -----------
$22,023,534 $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 SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
-------------------------- --------------------------
1999 1998 1999 1998
---------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
NET REVENUES:
Software license fees $1,721,570 $3,158,612 $3,524,038 $ 6,505,717
Software support fees 2,385,254 2,086,439 4,844,655 4,067,714
Other 606,004 559,935 1,210,853 1,039,622
---------- ---------- ---------- -----------
Total net revenues 4,712,828 5,804,986 9,579,546 11,613,053
---------- ---------- ---------- -----------
COST OF REVENUES:
Software license fees 538,535 611,290 1,063,887 1,151,124
Software support fees 658,389 631,035 1,363,849 1,269,847
Other 385,892 280,353 753,990 542,605
---------- ---------- ---------- -----------
Total cost of revenues 1,582,816 1,522,678 3,181,726 2,963,576
---------- ---------- ---------- -----------
Gross profit 3,130,012 4,282,308 6,397,820 8,649,477
---------- ---------- ---------- -----------
OPERATING EXPENSES:
Product development 993,915 836,020 1,929,414 1,601,832
Sales and marketing 1,249,007 1,420,183 2,614,396 2,868,805
General and administrative 1,197,285 1,623,183 2,348,818 2,778,374
Amortization of goodwill & other
intangible assets 214,830 214,833 429,660 429,666
---------- ---------- ---------- -----------
Total operating expenses 3,655,037 4,094,219 7,322,288 7,678,677
---------- ---------- ---------- -----------
Operating income (loss) (525,025) 188,089 (924,468) 970,800
Net interest and other income 122,481 136,746 262,623 291,253
---------- ---------- ---------- -----------
Income (loss) before income taxes (402,544) 324,835 (661,845) 1,262,053
---------- ---------- ---------- -----------
Income tax expense (benefit) (148,941) 120,189 (244,882) 466,959
---------- ---------- ---------- -----------
Net income (loss) $ (253,603) $ 204,646 $ (416,963) $ 795,094
========== ========== ========== ===========
Net income (loss) per share - basic ($.05) $.04 ($.08) $.15
Net income (loss) per share - diluted ($.05) $.04 ($.08) $.14
Share used to calculate net income
(loss) per share - basic 4,860,026 5,124,097 4,998,982 5,217,008
Shares used to calculate net income
(loss) per share - diluted 4,860,026 5,431,071 4,998,982 5,497,773
</TABLE>
See accompanying notes to condensed financial statements.
3
<PAGE> 4
INTERLINQ SOFTWARE CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31,
--------------------------
1999 1998
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (416,963) $ 795,094
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 398,191 471,994
Amortization of capitalized software costs 956,753 1,032,920
Amortization of goodwill & other intangible
assets 429,659 429,666
Change in operating assets and liabilities:
Accounts receivable 909,069 (397,080)
Inventory, prepaid expenses & other current
assets (433,028) (454,495)
Other assets 12,808 (5,890)
Accounts payable (87,150) 268,666
Noncurrent liabilities 21,620 --
Accrued compensation and benefits,
and other accrued liabilities (1,314,140) (1,162,032)
Customer deposits (201,481) 160,191
Deferred software support fees (42,462) 738,261
----------- -----------
Net cash provided by operating activities 232,876 1,877,295
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (419,148) (1,383,530)
Capitalized software costs (1,019,781) (1,045,338)
Purchases of investments (2,737,852) (1,523,609)
Proceeds from sales and maturities of short-term
investments 3,222,653 1,494,416
Cash paid for acquisition -- (2,712,380)
----------- -----------
Net cash used in investing activities (954,128) (5,170,441)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 146,640 19,340
Repurchase of common stock (1,879,514) (1,252,750)
----------- -----------
Net cash used in financing activities (1,732,874) (1,233,410)
----------- -----------
Net decrease in cash and cash equivalents (2,454,126) (4,526,556)
Cash and cash equivalents at beginning of period 5,888,630 7,233,826
=========== ===========
Cash and cash equivalents at end of period $ 3,434,504 $ 2,707,270
=========== ===========
</TABLE>
See accompanying notes to condensed financial statements.
4
<PAGE> 5
INTERLINQ SOFTWARE CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
DECEMBER 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 December 31, 1999, are not
necessarily indicative of the results for the 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 and the six months ended December 31, 1999, no
potential common shares were included in the computation of diluted loss per
share for those periods.
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 SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
--------------------- ---------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Shares used to calculate basic earnings
(loss) per share 4,860,026 5,124,097 4,998,982 5,217,008
Dilutive effect of outstanding options -- 306,974 -- 280,765
--------- --------- --------- ---------
Shares used to calculate diluted earnings
(loss) per share 4,860,026 5,431,071 4,998,982 5,497,773
========= ========= ========= =========
</TABLE>
Certain options outstanding at the end of each period presented were excluded
from the computation of earnings per share because their inclusion would be
anti-dilutive as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
--------------------- ---------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Options excluded from computation 1,206,802 4,933 1,206,802 28,312
Weighted-average exercise price $4.70 $7.55 $4.70 $7.08
</TABLE>
5
<PAGE> 6
3. REVENUE RECOGNITION
The Company recognizes revenue 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 98-9 ("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 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 or the six-months ended December 31, 1999.
4. SEGMENT INFORMATION
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").
6
<PAGE> 7
Information by operating segment is set forth below:
<TABLE>
<CAPTION>
QUARTER ENDED DECEMBER 31: MTD ETD TOTAL
- ---------------------------------------------------------------------------------------------
1999 (IN THOUSANDS):
<S> <C> <C> <C>
Net revenue $ 4,699 $ 14 $ 4,713
Depreciation and amortization 569 340 909
Operating income (loss) 159 (684) (525)
Capital expenditures 181 24 205
1998 (IN THOUSANDS):
Net revenue 5,774 31 5,805
Depreciation and amortization 1,042 (77) 965
Operating income (loss) 802 (614) 188
Capital expenditures 970 77 1,047
SIX-MONTHS ENDED DECEMBER 31: MTD ETD TOTAL
- ---------------------------------------------------------------------------------------------
1999 (IN THOUSANDS):
Net revenue $ 9,548 $ 32 $ 9,580
Depreciation and amortization 1,217 568 1,785
Operating income (loss) 449 (1,373) (924)
Capital expenditures 390 29 419
1998 (IN THOUSANDS):
Net revenue 11,524 89 11,613
Depreciation and amortization 1,783 152 1,935
Operating income (loss) 2,093 (1,122) 971
Capital expenditures 1,264 120 1,384
MTD ETD TOTAL
- ---------------------------------------------------------------------------------------------
IDENTIFIABLE ASSETS WERE AS FOLLOWS AS OF (IN THOUSANDS):
December 31, 1999 18,918 3,106 22,024
June 30, 1999 22,575 3,222 25,797
</TABLE>
7
<PAGE> 8
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. The Company
is developing a plan under which, if approved by its board of directors, the
Company would form a separate company to take the FlowMan technology to markets
beyond the mortgage industry while retaining the rights to its use in the
Company's suite of mortgage technology products.
The Company experienced a downturn in software license fee revenue due to a
softened sales environment during the six months ended December 31, 1999. This
environment was driven by reduced mortgage origination volumes (related to
rising interest rates) as well as uncertainties related to Year 2000 issues.
The Company believes that over the course of the last decade mortgage
lenders have purchased technological infrastructure in order to improve their
profit 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 as a result of an increase in interest rates by the Federal Reserve.
Rates continued to increase in the first and second quarters of fiscal 2000 and
as a result, mortgage origination volumes have declined. An increasing interest
rate environment leads to lower mortgage origination volumes and 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 to
significantly increase their 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 the nature of
its prospective sales pipeline from numerous transactions representing
additional production capacity to fewer, but in certain cases larger,
transactions representing wholesale infrastructure changes for current and
8
<PAGE> 9
prospective customers. This change in the nature of the Company's sales pipeline
could lead to revenue streams that are much less predictable than those
experienced historically. Looking forward, the Company is expecting the interest
rate environment to continue to cause a softened sales environment. Changes in
the interest rate environment are difficult to predict and the Company is not
expecting any significant decreases in mortgage lending rates through the end of
fiscal year 2000.
The Company believes that issues related to the Year 2000 problem have also
contributed to the softened sales environment. The Company believes that a
number of mortgage lenders and mortgage servicers delayed certain technology
purchases until after January 1, 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.
The Company has not identified nor been made aware of any significant issues
or problems related to the change to the year 2000 in its internal systems, the
systems it sells, or the systems of third party vendors.
NET REVENUES
<TABLE>
<CAPTION>
Three months ended December 31,
(In thousands) 1999 1998 Change
- -------------------------------------------------------
<S> <C> <C> <C>
Software license fees $1,722 $3,159 (45%)
Software support fees 2,385 2,086 14%
Other 606 560 8%
- -------------------------------------------------------
Total net revenues $4,713 $5,805 (19%)
- -------------------------------------------------------
</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 were $1,722,000 for the quarter ended December 31,
1999, a decrease of 45% from $3,159,000 in the comparable quarter of the prior
year. Software license fees were $3,524,000 for the six months ended December
31, 1999, a decrease of 46% from $6,506,000 in the comparable period of the
prior year. These decreases in software license fees were due primarily to
increasing interest rates and concerns about the Year 2000 (as previously
discussed). 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 to estimate their
future 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 were $2,385,000 for the quarter ended December 31,
1999, an increase of 14% from $2,086,000 in the
9
<PAGE> 10
comparable quarter of the prior year. Software support fees were $4,845,000 for
the six months ended December 31, 1999, an increase of 19% from $4,068,000 in
the comparable period of the prior year. These period-to-period increases were
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.
Other revenues were $606,000 for the quarter ended December 31, 1999, an
increase of 8% from $560,000 in the comparable quarter of the prior year. Other
revenues were $1,211,000 for the six months ended December 31, 1999, an increase
of 16% from $1,040,000 in the comparable period of the prior year. These
increases were due primarily to an increase in 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 December 31, 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) and
workflow 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 can be no assurance that the Company's products will be accepted
by the market or that the Company will be competitive within the market; lack of
acceptance of the Company's EAI product in the market or an inability to compete
effectively against the Company's competitors would have a material adverse
10
<PAGE> 11
effect on the Company's revenues, profitability and financial condition.
COST OF REVENUES
<TABLE>
<CAPTION>
Three months ended December 31,
(In thousands) 1999 1998 Change
- ---------------------------------------------------------
<S> <C> <C> <C>
Software license fees $539 $611 (12%)
Percentage of software
license fees 31% 19%
- ---------------------------------------------------------
Software support fees $658 $631 4%
Percentage of software
support fees 28% 30%
- ---------------------------------------------------------
Other $386 $280 38%
Percentage of other 64% 50%
- ---------------------------------------------------------
Total cost of revenues $1,583 $1,523 4%
Percentage of net revenues 34% 26%
- ---------------------------------------------------------
</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, and the purchase
and duplication of disks and product documentation. As a percentage of software
license fees, cost of software license fees increased to 31% for the quarter
ended December 31, 1999, compared to 19% for the quarter ended December 31,
1998. As a percentage of software license fees, cost of software license fees
increased to 30% for the six months ended December 31, 1999, from 18% in the
comparable period of the prior year. These increases were due primarily to
software license fees decreasing substantially during these periods with the
cost of software license fees remaining relatively flat. The cost of software
license fees contains the relatively fixed component of amortization of
capitalized software development costs. Amortization of capitalized software
development costs decreased to $492,000 for the quarter ended December 31, 1999,
compared to $530,000 in the comparable quarter of the prior year, and decreased
to $957,000 for the six months ended December 31, 1999, compared to $1,033,000
in the comparable period of the prior year. The Company expects the dollar
amount of its amortization of capitalized software development costs to remain
relatively 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 28% for the quarter ended December 31,
1999, compared to 30% for the quarter ended December 31, 1998. As a percentage
of software support fees, cost of software support fees decreased to 28% for the
six months ended December 31, 1999, from 31% in the comparable period of the
prior year. These decreases were primarily due to software support fees
increasing at a rate higher than the related costs. The cost of software support
fees increased 4% over the year ago quarter, primarily 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.
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<PAGE> 12
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 64% for the
quarter ended December 31, 1999, compared to 50% for the quarter ended December
31, 1998. As a percentage of other revenue, cost of other revenue increased to
62% for the six months ended December 31, 1999, from 52% in the comparable
period of the prior year. These increases were due primarily to lower margins
earned on some of the Company's consulting projects and the addition of a loan
servicing consulting group, which did not exist last year.
OPERATING EXPENSES
<TABLE>
<CAPTION>
Three months ended December 31,
(In thousands) 1999 1998 Change
- ----------------------------------------------------------
<S> <C> <C> <C>
Product development $994 $836 19%
Percentage of net revenues 21% 14%
- ----------------------------------------------------------
Sales & marketing $1,249 $1,420 (12%)
Percentage of net revenues 27% 24%
- ----------------------------------------------------------
General & administrative $1,197 $1,623 (26%)
Percentage of net revenues 25% 28%
- ----------------------------------------------------------
Amortization of goodwill $215 $215 0%
Percentage of net revenues 5% 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 21% for the quarter ended December 31,
1999, compared to 14% for the quarter ended December 31, 1998. As a percentage
of net revenues, product development expenses increased to 20% for the six
months ended December 31, 1999, from 14% in the comparable period of the prior
year. The increases in percentages were due primarily to decreasing revenue
combined with increasing product development expenses. The increases in product
development expenses were 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. To compound this increase there was a decrease
in the amount of capitalized software development costs. The Company capitalized
$503,000 and $556,000 of development expenditures for the quarters ended
December 31, 1999, and 1998, respectively. The Company capitalized $1,020,000
and $1,045,000 of development expenditures for the six months ended December 31,
1999, and 1998, respectively. The Company expects overall development spending
to remain relatively flat 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 27% for the quarter ended December 31, 1999, compared to
24% for the quarter ended December 31, 1998. As a percentage of net revenues,
sales and marketing expenses increased to 27% for the six months ended December
31, 1999, compared to 25% in the comparable period of the prior year. These
percentage changes were primarily due to revenues decreasing at a faster rate
than sales and marketing expenses. The decreases in sales and marketing expenses
were due primarily to reduced commissions from the decreases in sales volume.
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<PAGE> 13
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 decreased to 25%
for the quarter ended December 31, 1999, compared to 28% for the quarter ended
December 31, 1998. As a percentage of net revenues, general and administrative
expenses increased to 25% for the six months ended December 31, 1999, from 24%
in the comparable period of the prior year. On a dollar basis, general and
administrative expenses decreased by $426,000 and $429,000 for the quarter and
six-month period ended December 31, 1999, respectively. These decreases were
primarily due to expenses associated with the proposed recapitalization of the
Company in the quarter ended December 31, 1998 (which was eventually terminated
in June of 1999). 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 Logical Software Solutions Corporation ("LSS") on June 30, 1998.
These assets include workforce-in-place, customer lists, trade name, 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 project was substantially completed during fall of
1999, while efforts to integrate the FlowMan technology with the Company's
mortgage technology products continue. The total costs associated with this
project were approximately $1.2 million.
NET INTEREST AND OTHER INCOME
<TABLE>
<CAPTION>
Three months ended December 31,
(In thousands) 1999 1998 Change
- ---------------------------------------------------------
<S> <C> <C> <C>
Net interest and other
income $122 $137 (10%)
Percentage of net revenues 3% 2%
- ---------------------------------------------------------
</TABLE>
The decrease in interest and other income was due primarily to the
reduction in average cash and investment balances held during the period.
As of December 31, 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
13
<PAGE> 14
and other income for the foreseeable future to reflect net interest income.
INCOME TAXES
<TABLE>
<CAPTION>
Three months ended December 31,
(In thousands) 1999 1998 Change
- ---------------------------------------------------------
<S> <C> <C> <C>
Income taxes ($149) $120 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 and
six-month period ended December 31, 1999, and 1998, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Working capital, which consists principally of cash, cash equivalents and
short-term investments, was $6,421,000 as of December 31, 1999, compared to
$8,190,000 at June 30, 1999. Cash and cash equivalents decreased by $2,454,000
for the six months ended December 31, 1999. This decrease was primarily due to
the repurchase of the Company's common stock and investments in capitalized
software development and property and equipment.
The Company expects to spend approximately $400,000 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
During the quarter ended December 31, 1999, the Company 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. Although the Company has not encountered any significant issues or
discrepancies due to the change to the Year 2000, the Company believes that
there is some limited risk and exposure with regard to Year 2000 problems for
the next one to two fiscal quarters.
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
14
<PAGE> 15
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 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 and the
Company's plan to create a separate company to take this technology to 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 creates a new company and 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.
It is difficult for the Company 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
15
<PAGE> 16
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 December 31,
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> 17
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;
accordingly, 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
The Company received a complaint from one of its customers
regarding the performance of purchased product and services worth
less than $141,000. This complaint resulted in the Company filing
a lawsuit for declaratory relief in Washington on January 19
(Interlinq Software Corporation v. Molton, Allen & Williams
Corporation d/b/a MAW Corporation, King County Superior Court No.
00-2-01814-2SEA) and the customer filing a lawsuit for $5 million
in damages in its home state of Alabama on January 24 (Molton
Allen & Williams Corporation v. Interlinq Software Corporation,
District Court for Jefferson County No. CV0000422). The Company
denies the allegations raised by the customer and intends to
vigorously pursue declaratory relief and defend itself on the
claim. The Company is unable to predict the outcome or potential
losses associated with this claim.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Company's Annual Meeting of Shareholders held on
November 9, 1999:
The following nominees were elected to the Board of Directors:
<TABLE>
<CAPTION>
Affirmative Votes Withheld
Votes
-------------- ---------------
<S> <C> <C>
Jiri M. Nechleba 3,841,818 818,825
Theodore M. Wight 4,093,818 566,825
</TABLE>
17
<PAGE> 18
Directors Robert W. O'Rear and Robert J. Gallagher will
continue their current term as directors.
A proposal to amend the Company's 1993 Stock Option Plan (the
Plan) to increase the number of shares of Common Stock to be
granted under the plan was approved as follows:
<TABLE>
<CAPTION>
Affirmative Votes Votes Against Abstentions Non-Votes
----------------- ------------- ----------- -----------
<S> <C> <C> <C>
1,697,944 1,074,021 8,350 2,117,537
</TABLE>
ITEM 5. OTHER INFORMATION
Effective November 30, 1999, the Company named George Sarlo
to its board of directors. Mr. Sarlo is a founder and general
partner of the Walden Group, a venture capital firm
headquartered in San Francisco. Mr. Sarlo also founded
Ashfield & Co., Inc., an investment management company and
has previously served as vice president and Director of
William D. Witter, Inc. and as Portfolio Manager for Capital
Research. He currently serves on several boards of directors,
including that of Invivo Corporation (Nasdaq: SAFE), a
California-based manufacturer of medical devices.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) EXHIBITS
27.1 Financial Data Schedule
b) REPORTS ON FORM 8-K
None
18
<PAGE> 19
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: February 10, 2000
INTERLINQ SOFTWARE CORPORATION
(Registrant)
/s/ Alan Pickerill
----------------------
Alan Pickerill
Vice President Finance
(Principal Financial and Accounting Officer)
19
<PAGE> 20
EXHIBIT INDEX
EXHIBIT NUMBER TITLE
------------------------------- ---------------------------------
27.1 FINANCIAL DATA SCHEDULE
20
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-2000
<PERIOD-START> JUL-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 3,435
<SECURITIES> 5,389
<RECEIVABLES> 2,854
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 13,045
<PP&E> 6,996
<DEPRECIATION> 5,271
<TOTAL-ASSETS> 22,024
<CURRENT-LIABILITIES> 6,625
<BONDS> 0
0
0
<COMMON> 48
<OTHER-SE> 15,319
<TOTAL-LIABILITY-AND-EQUITY> 22,024
<SALES> 1,722
<TOTAL-REVENUES> 4,713
<CGS> 539
<TOTAL-COSTS> 1,583
<OTHER-EXPENSES> 3,655
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (403)
<INCOME-TAX> (149)
<INCOME-CONTINUING> (254)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (254)
<EPS-BASIC> (.05)
<EPS-DILUTED> (.05)
</TABLE>
