<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, 2000
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 April 28, 2000, there were 4,824,077 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,
2000 1999
----------- -----------
(unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 6,268,614 $ 5,888,630
Short-term investments 2,725,949 5,874,218
Accounts receivable, net 2,605,024 3,763,446
Inventory, prepaid expenses and
other current assets 1,543,196 934,008
----------- -----------
Total current assets 13,142,783 16,460,302
----------- -----------
Property and equipment, at cost 7,105,683 6,576,456
Less accumulated depreciation and amortization 5,475,273 4,872,314
----------- -----------
Net property and equipment 1,630,410 1,704,142
----------- -----------
Capitalized software costs, net 5,192,952 5,159,249
Goodwill and other intangible assets, net 1,739,887 2,384,377
Other assets 68,283 88,914
----------- -----------
$21,774,315 $25,796,984
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 359,074 $ 440,962
Accrued compensation and benefits 669,406 2,082,743
Other accrued liabilities 212,470 221,535
Customer deposits 937,125 965,204
Deferred software support fees 4,607,253 4,559,597
----------- -----------
Total current liabilities 6,785,328 8,270,041
----------- -----------
NONCURRENT LIABILITIES 44,625 9,854
SHAREHOLDERS' EQUITY:
Common stock 48,241 51,806
Additional paid-in capital 7,543,623 9,409,382
Retained earnings 7,352,498 8,055,901
----------- -----------
Total shareholders' equity 14,944,362 17,517,089
----------- -----------
$21,774,315 $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 NINE MONTHS ENDED
MARCH 31, MARCH 31,
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
NET REVENUES:
Software license fees $ 1,715,826 $ 3,331,732 $ 5,239,864 $ 9,837,449
Software support fees 2,461,689 2,187,972 7,306,344 6,255,686
Other 428,194 734,206 1,639,047 1,773,828
------------ ------------ ------------ ------------
Total net revenues 4,605,709 6,253,910 14,185,255 17,866,963
------------ ------------ ------------ ------------
COST OF REVENUES:
Software license fees 542,485 643,237 1,606,372 1,794,361
Software support fees 592,773 714,420 1,956,622 1,984,267
Other 334,199 408,576 1,088,189 951,181
------------ ------------ ------------ ------------
Total cost of revenues 1,469,457 1,766,233 4,651,183 4,729,809
------------ ------------ ------------ ------------
Gross profit 3,136,252 4,487,677 9,534,072 13,137,154
------------ ------------ ------------ ------------
OPERATING EXPENSES:
Product development 999,205 794,457 2,928,619 2,396,289
Sales and marketing 1,187,916 1,437,625 3,802,312 4,306,430
General and administrative 1,319,443 1,510,841 3,668,261 4,289,215
Amortization of goodwill and
other intangible assets 214,830 214,830 644,490 644,496
------------ ------------ ------------ ------------
Total operating expenses 3,721,394 3,957,753 11,043,682 11,636,430
------------ ------------ ------------ ------------
Operating income (loss) (585,142) 529,924 (1,509,610) 1,500,724
Net interest and other income 130,473 130,437 393,096 421,690
------------ ------------ ------------ ------------
Income (loss) before income
taxes (454,669) 660,361 (1,116,514) 1,922,414
------------ ------------ ------------ ------------
Income tax expense (benefit) (168,229) 244,333 (413,111) 711,292
------------ ------------ ------------ ------------
Net income (loss) ($286,440) $ 416,028 ($703,403) $ 1,211,122
============ ============ ============ ============
Net income (loss) per share - basic ($.06) $ .08 ($.14) $ .23
Net income (loss) per share - diluted ($.06) $ .08 ($.14) $ .22
Shares used to calculate net income
(loss) per share - basic 4,827,154 5,128,864 4,942,122 5,188,055
Shares used to calculate net income
(loss) per share - diluted 4,827,154 5,483,071 4,942,122 5,493,362
</TABLE>
See accompanying notes to condensed financial statements.
3
<PAGE> 4
INTERLINQ SOFTWARE CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
MARCH 31,
2000 1999
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (703,403) $ 1,211,122
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization 1,247,449 1,368,528
Amortization of capitalized software costs 1,472,527 1,599,343
Change in operating assets and liabilities:
Accounts receivable 1,158,422 (921,333)
Inventory, prepaid expenses and other
current assets (609,188) (347,679)
Other assets 20,631 23,238
Accounts payable (81,888) 72,301
Accrued compensation and benefits,
and other accrued liabilities (1,422,402) (554,295)
Customer deposits (28,079) 741,516
Deferred software support fees 82,427 925,614
----------- -----------
Net cash provided by operating
activities 1,136,496 4,118,355
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (529,227) (1,525,104)
Capitalized software costs (1,506,230) (1,585,473)
Proceeds from sales and maturities of
short-term investments 3,148,269 53,086
Cash paid for acquisition -- (2,712,380)
----------- -----------
Net cash provided by (used in) investing
activities 1,112,812 (5,769,871)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock 304,901 34,167
Repurchase of common stock (2,174,225) (1,252,751)
----------- -----------
Net cash used in financing activities (1,869,324) (1,218,584)
----------- -----------
Net increase (decrease) in cash and
cash equivalents 379,984 (2,870,100)
Cash and cash equivalents at beginning of period 5,888,630 7,233,826
----------- -----------
Cash and cash equivalents at end of period $ 6,268,614 $ 4,363,726
=========== ===========
</TABLE>
See accompanying notes to condensed financial statements.
4
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INTERLINQ SOFTWARE CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
MARCH 31, 2000
(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 and nine-month periods ended March 31,
2000, 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 nine months ended March 31, 2000, 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 NINE MONTHS ENDED
MARCH 31, MARCH 31,
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Shares used to calculate basic
earnings (loss) per share 4,827,154 5,128,864 4,942,122 5,188,055
Dilutive effect of outstanding
options -- 354,207 -- 305,307
--------- --------- --------- ---------
Shares used to calculate diluted
earnings (loss) per share 4,827,154 5,483,071 4,942,122 5,493,362
========= ========= ========= =========
</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,
2000 1999 2000 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Options excluded from computation 1,111,095 358 1,111,095 4,493
Weighted-average exercise price $ 4.81 $ 8.38 $ 4.81 $ 7.55
</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 nine-months ended March 31, 2000.
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").
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Information by operating segment is set forth below:
<TABLE>
<CAPTION>
QUARTER ENDED MARCH 31: MTD ETD TOTAL
- ---------------------------------------------------------------------
<S> <C> <C> <C>
2000 (IN THOUSANDS):
Net revenue $ 4,605 $ 0 $ 4,605
Depreciation and amortization 651 284 935
Operating income (loss) 93 (678) (585)
Capital expenditures 103 7 110
1999 (IN THOUSANDS):
Net revenue 6,204 50 6,254
Depreciation and amortization 736 297 1,033
Operating income (loss) 1,119 (589) 530
Capital expenditures 139 2 141
</TABLE>
<TABLE>
<CAPTION>
NINE-MONTHS ENDED MARCH 31: MTD ETD TOTAL
- ---------------------------------------------------------------------
<S> <C> <C> <C>
2000 (IN THOUSANDS):
Net revenue $14,153 $ 32 $14,185
Depreciation and amortization 1,868 852 2,720
Operating income (loss) 541 (2,051) (1,510)
Capital expenditures 493 36 529
1999 (IN THOUSANDS):
Net revenue 17,728 139 17,867
Depreciation and amortization 2,091 877 2,968
Operating income (loss) 3,212 (1,711) 1,501
Capital expenditures 1,403 122 1,525
</TABLE>
<TABLE>
<CAPTION>
MTD ETD TOTAL
- ---------------------------------------------------------------------
<S> <C> <C> <C>
IDENTIFIABLE ASSETS WERE AS
FOLLOWS AS OF (IN THOUSANDS):
March 31, 2000 $18,698 $ 3,076 $21,774
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 nine months ended March 31, 2000. This
environment was driven by reduced mortgage origination volumes (related to
rising interest rates) and to the Year 2000 problem.
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, second, and third 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
product development plans and its suite of mortgage technology products position
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
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infrastructure changes for current and 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 fourth quarter of fiscal
year 2000 and early in fiscal year 2001, once the majority of its customers and
prospects 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.
<TABLE>
<CAPTION>
NET REVENUES
Three months ended March 31,
(In thousands) 2000 1999 Change
- -----------------------------------------------------------------
<S> <C> <C> <C>
Software license fees $1,716 $3,332 (49%)
Software support fees 2,462 2,188 13%
Other 428 734 (42%)
- -----------------------------------------------------------------
Total net revenues $4,606 $6,254 (26%)
- -----------------------------------------------------------------
</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 $1,716,000 for the quarter ended March 31, 2000, a
decrease of 49% from $3,332,000 in the comparable quarter of the prior year.
Software license fees were $5,240,000 for the nine months ended March 31, 2000,
a decrease of 47% from $9,837,000 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 remain
flat or rebound somewhat in the fourth quarter of fiscal year 2000, once
customers have 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.
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Software support fees were $2,462,000 for the quarter ended March 31, 2000,
an increase of 13% from $2,188,000 in the comparable quarter of the prior year.
Software support fees were $7,306,000 for the nine months ended March 31, 2000,
an increase of 17% from $6,256,000 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 $428,000 for the quarter ended March 31, 2000, a decrease
of 42% from $734,000 in the comparable quarter of the prior year. Other revenues
were $1,639,000 for the nine months ended March 31, 2000, a decrease of 8% from
$1,774,000 in the comparable period of the prior year. These decreases were due
primarily to decreases in training, custom programming and servicing conversion
revenue. The Company expects its other revenues to continue to decrease during
the fourth quarter of fiscal year 2000 compared to the fourth quarter of fiscal
year 1999.
Despite the interest rate environment discussed above, the Company believes
the overall lending environment as of March 31, 2000, 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
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effect on the Company's revenues, profitability and financial condition.
<TABLE>
<CAPTION>
COST OF REVENUES
Three months ended March 31,
(In thousands) 2000 1999 Change
- ---------------------------------------------------------------------
<S> <C> <C> <C>
Software license fees $ 542 $ 643 (16%)
Percentage of software
license fees 32% 19%
- ---------------------------------------------------------------------
Software support fees $ 593 $ 714 (17%)
Percentage of software
support fees 24% 33%
- ---------------------------------------------------------------------
Other $ 334 $ 409 (18%)
Percentage of other 78% 56%
- ---------------------------------------------------------------------
Total cost of revenues $1,469 $1,766 (17%)
Percentage of net
revenues 32% 28%
- ---------------------------------------------------------------------
</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 32% for the quarter
ended March 31, 2000, compared to 19% for the quarter ended March 31, 1999. As a
percentage of software license fees, cost of software license fees increased to
31% for the nine months ended March 31, 2000, 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
$516,000 for the quarter ended March 31, 2000, compared to $566,000 in the
comparable quarter of the prior year, and decreased to $1,473,000 for the nine
months ended March 31, 2000, compared to $1,599,000 in the comparable period of
the prior year.
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 24% for the quarter ended March 31, 2000,
compared to 33% for the quarter ended March 31, 1999. As a percentage of
software support fees, cost of software support fees decreased to 27% for the
nine months ended March 31, 1999, from 32% in the comparable period of the prior
year. These decreases were primarily due to software support fees increasing
while the related costs were decreasing. The dollar cost of software support
fees decreased 17% over the year ago quarter, primarily representing decreased
payroll costs for the customer support group. The Company expects the dollar
cost of software support fees to increase due to the increased staffing that
will be required to support a higher installed base of the Company's products
and a more diverse product base. The Company also expects that these factors may
lead to a modest increase in the ratio of the cost of software support fees to
software support fees.
Cost of other revenue includes primarily the salaries and non-reimbursable
expenses for the employees who provide training and consulting services. As a
percentage of other revenue, cost of other revenue increased to 78% for the
quarter ended March 31, 2000, compared to 56% for the quarter ended March 31,
1999. As a
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percentage of other revenue, cost of other revenue increased to 66% for the nine
months ended March 31, 2000, from 54% in the comparable period of the prior
year. These increases were due primarily to the decreases in training, custom
programming and servicing conversion revenue described above and to lower
margins earned on the Company's consulting projects. In addition, the Company
added a loan servicing consulting group, which did not exist last year.
<TABLE>
<CAPTION>
OPERATING EXPENSES
Three months ended March 31,
(In thousands) 2000 1999 Change
- -----------------------------------------------------------------------
<S> <C> <C> <C>
Product development $ 999 $ 794 26%
Percentage of net
revenues 22% 13%
- -----------------------------------------------------------------------
Sales & marketing $1,188 $1,438 (17%)
Percentage of net
revenues 26% 23%
- -----------------------------------------------------------------------
General & administrative $1,319 $1,511 (13%)
Percentage of net
revenues 29% 24%
- -----------------------------------------------------------------------
Amortization of goodwill $ 215 $ 215 0%
Percentage of net
revenues 5% 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, product development expenses increased to 22% for the quarter ended
March 31, 2000, compared to 13% for the quarter ended March 31, 1999. As a
percentage of net revenues, product development expenses increased to 21% for
the nine months ended March 31, 2000, from 13% 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 dollar
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 $486,000 and $540,000 of development expenditures for
the quarters ended March 31, 2000, and 1999, respectively. The Company
capitalized $1,506,000 and $1,585,000 of development expenditures for the nine
months ended March 31, 2000, and 1999, respectively. The Company expects overall
development spending to increase slightly for the remainder of fiscal year 2000.
In addition, the Company has recently announced a product development initiative
called Project IQ under which the Company plans to spend $3 million over the
next twelve months to speed development efforts. This project is expected to
result in a series of flexible lending systems aligned with specific business
needs and will migrate the Company's MortgageWare lending system to a new
architectural platform. As a result, the Company expects product development
expenses to increase accordingly over the next fiscal year.
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 26% for the quarter ended March 31, 2000, compared to 23%
for the quarter ended March 31, 1999. As a percentage of net revenues, sales and
marketing expenses increased to 27% for the nine months ended March 31, 2000,
compared to 24% in the
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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
dollar decreases in sales and marketing expenses were due primarily to reduced
commissions from the decreases in sales volume.
General and administrative expenses include costs associated with finance,
accounting, purchasing, order fulfillment, administration and facilities. As a
percentage of net revenues, general and administrative expenses increased to 29%
for the quarter ended March 31, 2000, compared to 24% for the quarter ended
March 31, 1999. As a percentage of net revenues, general and administrative
expenses increased to 26% for the nine months ended March 31, 2000, from 24% in
the comparable period of the prior year. On a dollar basis, general and
administrative expenses decreased by $191,000 and $621,000 for the quarter and
nine-month periods ended March 31, 2000, respectively. These decreases were
primarily due to expenses associated with the proposed re-capitalization of the
Company in the quarter and nine-month periods ended March 31, 1999 (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, non-compete
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.
<TABLE>
<CAPTION>
NET INTEREST AND OTHER INCOME
Three months ended March 31,
(In thousands) 2000 1999 Change
- -----------------------------------------------------------------
<S> <C> <C> <C>
Net interest and other
income $130 $130 0%
Percentage of net
revenues 3% 2%
- -----------------------------------------------------------------
</TABLE>
Net interest and other income was consistent with the quarter ended
March 31, 1999
13
<PAGE> 14
due to a lower average cash and investment balance offset by higher interest
rates.
As of March 31, 2000, the Company had no interest-bearing debt outstanding and
anticipates no new debt financing in the foreseeable future. Accordingly, the
Company expects net interest and other income for the foreseeable future to
reflect net interest income.
<TABLE>
<CAPTION>
INCOME TAXES
Three months ended March 31,
(In thousands) 2000 1999 Change
- -------------------------------------------------------------------
<S> <C> <C> <C>
Income taxes ($168) $244 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
nine-month periods ended March 31, 2000, and 1999, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Working capital, which consists principally of cash, cash equivalents,
short-term investments, and accounts receivable, was $6,357,000 as of March 31,
2000, compared to $8,190,000 at June 30, 1999. Cash and cash equivalents
increased by $380,000 for the nine months ended March 31, 2000.
The Company expects to spend approximately $200,000 for capital expenditures
during the remainder of fiscal year 2000. Additionally, the company expects to
spend $3 million over the next twelve months to speed its development efforts.
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,
14
<PAGE> 15
performance, or achievements of the Company or industry trends to differ
materially from those expressed or implied by such forward looking statements.
When used in this discussion, the words "believes", "anticipates", and similar
expressions are intended to identify forward-looking statements. Readers are
cautioned not to place undue reliance on these forward-looking statements, which
speak only as of the date hereof. The Company undertakes no obligation to
publicly release the result of any revisions to these forward-looking statements
that may be made to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events. The discussion and analysis
herein should be read in conjunction with the Risk Factors and other information
contained in the Company's Annual Report on Form 10-K for the year ended June
30, 1999, and "Certain Additional Factors Affecting Future Results" below.
CERTAIN ADDITIONAL FACTORS AFFECTING FUTURE RESULTS
There can be no assurance that the Company will be successful in attracting
new customers in the mortgage technology market or that its existing customers
will continue to purchase its products and support services. In addition, there
can be no assurance that the Company's new mortgage technology products and
services will be released in a timely fashion and that, if and when released,
new products or services or its efforts to integrate the FlowMan product into
its existing mortgage software products will be well-received by its target
market or that others will not successfully develop competing products and
services. Each of these events could have a material adverse effect upon the
Company's revenues, financial condition and results of operations.
There can be no assurance that the Company will be successful in attracting
new customers in the EAI market or that its existing customers 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
15
<PAGE> 16
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 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 March 31, 2000.
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.
In December 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin No. 101 ("SAB 101") "Revenue Recognition in Financial
Statements" which the Company expects to adopt no later than July 1, 2000. SAB
101 provides guidance on revenue recognition issues. The Company does not
expect the adoption of SAB 101 to have a material impact on its financial
statements.
In March 2000, the FASB issued Interpretation No. 44 (FIN 44), "Accounting
for Certain Transactions Involving Stock Compensation, an interpretation of
APB Opinion No. 25." FIN 44 will be effective July 1, 2000. This interpretation
provides guidance for applying APB Opinion No. 25 "Accounting for Stock Issued
to Employees." The Company does not expect the adoption of FIN 44 to have a
material impact on its financial statements.
In March 2000, the Emerging Issues Task Force (EITF) of the FASB reached a
consensus on Issue No. 00-2, "Accounting for Web Site Development Costs" which
provides guidance on when to capitalize versus expense costs incurred to
develop a web site. The consensus is effective for web site development costs
in quarters beginning after June 30, 2000. The Company has not yet determined
the impact, if any, this Issue will have on the Company's 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
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) EXHIBITS
27.1 Financial Data Schedule
b) REPORTS ON FORM 8-K
None
17
<PAGE> 18
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 12, 2000
INTERLINQ SOFTWARE CORPORATION
(Registrant)
/s/ Alan Pickerill
------------------------------------
Alan Pickerill
Vice President Finance
(Principal Financial and Accounting
Officer)
18
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<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JUN-30-2000
<PERIOD-START> JUL-01-1999
<PERIOD-END> MAR-31-2000
<CASH> 6,269
<SECURITIES> 2,726
<RECEIVABLES> 2,605
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 13,143
<PP&E> 7,106
<DEPRECIATION> 5,475
<TOTAL-ASSETS> 21,774
<CURRENT-LIABILITIES> 6,785
<BONDS> 0
0
0
<COMMON> 48
<OTHER-SE> 14,896
<TOTAL-LIABILITY-AND-EQUITY> 21,774
<SALES> 1,716
<TOTAL-REVENUES> 4,606
<CGS> 542
<TOTAL-COSTS> 1,469
<OTHER-EXPENSES> 3,721
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (455)
<INCOME-TAX> (168)
<INCOME-CONTINUING> (286)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (286)
<EPS-BASIC> (.06)
<EPS-DILUTED> (.06)
</TABLE>
