-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, G8FlNmnSofyjIhG5P7v5xJC9KrOgxNp/GZY5h34k/1qOXGa7eK8wJRzuEh4Q8VjW ZI2rZdEFy4I4nsg/pjG07Q== 0000891020-97-001261.txt : 19970929 0000891020-97-001261.hdr.sgml : 19970929 ACCESSION NUMBER: 0000891020-97-001261 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19970630 FILED AS OF DATE: 19970926 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTERLINQ SOFTWARE CORP CENTRAL INDEX KEY: 0000802242 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 911187540 STATE OF INCORPORATION: WA FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-21402 FILM NUMBER: 97686386 BUSINESS ADDRESS: STREET 1: 11255 KIRKLAND WAY CITY: KIRKLAND STATE: WA ZIP: 98033 BUSINESS PHONE: 2068271112 MAIL ADDRESS: STREET 1: 11255 KIRKLAND WAY CITY: KIRKLAND STATE: WA ZIP: 98033 10-K 1 FORM 10-K 1 - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON D.C. 20549 FORM 10-K (Mark One) X Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended JUNE 30, 1997 OR __ Transition report pursuant to Section 14 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.) 11255 KIRKLAND WAY KIRKLAND, WA 98033 (Address of principal executive offices) (425) 827-1112 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value per share 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 ---- ---- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing sale price of the Common Stock on September 23, 1997 as reported on the Nasdaq National Market, was approximately $24,499,000 As of September 23, 1997, there were 5,297,012 shares of the Registrant's Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Certain portions of the Company's definitive proxy statement for the annual meeting of shareholders of the Company to be held on November 5, 1997, which will be filed with the Securities and Exchange Commission within 120 days after June 30, 1997 are incorporated by reference into Part III of this report. - -------------------------------------------------------------------------------- 2 PART I ITEM 1. BUSINESS OVERVIEW INTERLINQ Software Corporation ("INTERLINQ" or the "Company") works closely with clients to provide comprehensive systems and business solutions for the residential mortgage and construction lending industry. The Company offers a suite of products that together, make up MortgageWare Enterprise ("MW Enterprise"). MW Enterprise provides a business model for the mortgage lending industry, based on enterprise-wide solutions for greater operational efficiency, real-time access to data, and cost-effective means for managing and integrating information. It is designed to automate and streamline business processes companywide in order to lower the cost of each loan transaction. Equally important to the bottom line, an integrated system of reliable information is created by MW Enterprise for analysis within the company. Data is entered only once, managed from a central point, and accessible from every desktop via a browser-based intranet environment. Using this business model, information can be leveraged to perform a variety of mission-critical applications companywide - -- from matching loan programs to a lender and borrower's needs, to risk analysis of all loans within an organization. MortgageWare products are installed and currently supported by the Company for approximately 2,000 customers in 7,000 locations. INTERLINQ's target market is the approximately 32,500 financial institutions in the United States. According to Company estimates based on available industry data, this market is comprised of approximately 20,000 mortgage brokers and bankers, 6,000 banks, 4,500 credit unions and 2,000 savings institutions. The Company expects future revenue growth to come from the sale of mortgage loan servicing technology as well as from the sale of technology designed to provide customers with information access and content, complimenting its current products which address operational efficiency and decrease the costs of each loan transaction. In the near term, continued penetration of the loan production market, new penetration of the mortgage loan servicing market, and additional sales of products and support services to existing customers with its current products, are expected to provide the majority of the Company's revenue. The Company has planned releases of new products and upgrades to existing products scheduled for fiscal 1998. There is no assurance that the Company will be successful in attracting new customers in the loan production and servicing market, or that its existing customers will continue to purchase the Company's products and support services. In addition, there is no assurance that the Company's new products and services will be released in a timely fashion that, if and when released, new products or services 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, gross margins and cash flows. The Company was incorporated in Washington in 1982. Its principal executive office is located at 11255 Kirkland Way, Kirkland, Washington 98033 and its telephone number is (425) 827-1112. 2 3 INTERLINQ'S STRATEGY The Company's strategy is to provide easy-to-use, PC-based software solutions marketed through a direct sales force and to maintain long-term customer relationships which generate recurring revenue. Easy-to-Use Software INTERLINQ believes its customers require software solutions that are specifically designed for financial institutions and that are easy to use and support. Because the residential mortgage and construction lending processes are complex and many of these processes are performed by individuals with little computer experience, the Company's strategy is to provide software solutions that can be purchased, installed and used without extensive technical knowledge. In order to provide consistent, high-quality support and service, the Company does not create customized software. The Company does, however, provide customized integration of MW Enterprise and has, from time to time, upgraded its products with certain customers on a "pay for priority" basis. Product upgrades, nevertheless, often include modifications and enhancements requested by customers. PC Platform The Company believes that reductions in the cost of and increases in the computing power of PCs make its systems increasingly affordable for even small financial institutions. The Company's software runs on industry-standard PCs and networks, thereby providing power, flexibility, ease of use and distribution of workload at a price that the Company believes cannot be matched by minicomputer or mainframe solutions. Direct Sales Force The Company believes that industry specific expertise and knowledge of that industry's technology demands is required to sell its products, and therefore, employs a direct sales force. Its sales personnel are skilled in both residential mortgage and construction lending, as well as PC-based software applications. The Company believes that maintaining its own sales force allows it to develop long-term customer relationships. Long-term Customer Relationships INTERLINQ attempts to build long-term relationships with its customers by providing them with personal contact from management, proactive implementation of training and installation, and continuing services such as consulting, toll-free telephone support and participation in user groups. The Company regularly uses an outside research firm to monitor customer satisfaction as well as industry based survey research to stay abreast of industry needs. The Company believes that its focus on the customer and the industry strengthens its recurring revenue opportunities and decreases the possibility of customer attrition to competitive products. 3 4 PRODUCTS AND SERVICES The following table briefly describes INTERLINQ's MortgageWare Enterprise products: POINT-OF-SALE AND ORIGINATION Entre Allows loan officers to prequalify applicants in the field through the use of a Windows-based software that runs on a laptop computer Origination Allows loan officers to enter loan applications directly into a PC, either in the office or in the field MORTGAGE LOAN MANAGEMENT SYSTEM (LMS) Qualifying Allows quick assessment of a potential borrower's ability to qualify for a loan. Processing Handles loan application data entry, document tracking and database maintenance Closing Produces closing documents, including jurisdiction- specific promissory notes and mortgages or deeds of trust Settlement Enables a lender or settlement agent to manage checking accounts, print checks and report IRS data Tracking Produces management reports designed to meet each customer's particular needs MortgageWare for Provides brokers with a scaled-down version of the Brokers MortgageWare LMS designed to meet their specific needs for product and pricing SECONDARY MARKETING Secondary Marketing Allows lenders to evaluate and manage the risk of selling loans on the secondary market MarketLINQ Serves as a central point of data entry and maintenance for all mortgage loan programs and rates, providing automatic distribution enterprise-wide. LOAN SERVICING Loan Servicing Provides lenders with a complete and cost-effective Windows-based loan servicing solution Servicing Gateway A streamlined version of Loan Servicing designed for lenders holding loans for sale CONSTRUCTION LENDING BuilderBLOCK$ Provides ability to service and report essential components of a construction loan ANALYSIS AND COMMUNICATIONS InfoLINQ Provides mortgage lenders with a complete intranet-based environment in which to collect, extract, and distribute business analysis COMLINQ Handles inter-branch electronic communications for MortgageWare software MortgageBase Enables customers to access their MortgageWare database from FoxPro, convert files into an xbase format and print more sophisticated reports Interfaces Utilizing our SmartLINQ technology, customers can interface to other products and systems 4 5 INTERLINQ's believes its strength lies in its ability to provide customers with an integrated approach to originating, servicing, and analysis of loans. The Company offers a variety of products for strategic and tactical business solutions in the mortgage industry, including the MortgageWare Loan Management System, MortgageWare for Brokers, MortgageWare MarketLINQ, MortgageWare Entre, MortgageWare InfoLINQ, MortgageWare Loan Servicing, MortgageWare Secondary Marketing, and BuilderBLOCK$. Together, these technology tools enable the MortgageWare Enterprise business model--a means for greater operational efficiency enterprise-wide, faster access to information, and cost-effective management of information content. MortgageWare Entre. Provides loan officers or brokers ("Originators") with tools to tailor loan programs, enabling better customer service and more expedient completion of each loan application. Designed to improve communication between Originators in the field and the processing department, MortgageWare Entre increases accuracy, timeliness, and back-office tracking of each loan. The Company believes that MortgageWare Entre gives Originators a competitive advantage by enabling them to quickly prequalify borrowers for purchases and refinances, show side-by-side comparisons of different loan programs, take the loan application, give the borrower conditional loan approval on the spot, and produce professional-looking open-house flyers. Additionally, this Windows-based system includes a contact manager for efficient follow-up. MortgageWare Loan Management System. The core product in the MortgageWare family, the MortgageWare Loan Management System, is a PC-based system for residential mortgage loan management, is currently installed in more than 7,000 locations. The latest version of this system has been upgraded to mirror the enterprise-wide data access enhancements of MortgageWare Entre, the Company's laptop origination tool, including the ability to order risk grade evaluation and mortgage insurance through Freddie Mac's Loan Prospector Second Generation, and the ability to request underwriting directly from Fannie Mae. This version has also been enhanced to receive tiered pricing from MarketLINQ, so that lenders can compare actual locked interest rates against rate sheet data. This "intelligent" system directs and streamlines the flow of work throughout a company, supporting the transition from individual workflow to an organizational workflow that boosts efficiency across the entire enterprise. MortgageWare Loan Management System is a modular system that addresses qualifying, point-of-sale origination, processing, closing, settlement, pipeline tracking and management, and inter-branch electronic communications. MortgageWare TC, currently under development, is a Web-based, thin-client version of the MortgageWare Loan Management System. With this technology, the Company believes lenders will be able to support distributed MortgageWare throughout a geographically dispersed user community, thereby enhancing operational efficiency and realizing cost benefits. MortgageWare Secondary Marketing. Secondary Marketing refers to managing the risk of financial loss in the origination and subsequent selling of mortgage loans. In order to maximize profit from the sale of loans in the secondary market, an organization's Secondary Marketing Department requires pipeline information to price loan products and hedge their position. INTERLINQ's Secondary Marketing product offers lenders the ability to examine in-process loans to determine how best to meet loan sale commitments the lender may have made to Fannie Mae, Freddie Mac or other secondary market investors. This product has a visual spreadsheet-style user interface which is designed to enhance its ease of use. 5 6 MortgageWare MarketLINQ. A Windows 95-based product, MarketLINQ serves as a central point of data entry and maintenance for all mortgage loan programs and rates including tiered pricing, which allows an administrator to electronically distribute up-to-date information enterprise-wide on demand. This program ensures that data is entered into the system only one time -- whether it's being used for in-house purposes (such as determining how many current loans are at risk of defaulting), or by a loan officer working to obtain the best interest rate for a borrower. Direct links into Knight-Ridder and Dow Jones Telerate enables the pricing for loan programs to be efficiently managed and rapidly recalculated as changes in mortgage pricing occur (often multiple times daily). MortgageWare Loan Servicing System. The Company believes that its MortgageWare Loan Servicing enhances a customer's profitability by moving from the current "rent model" to a "buy model." An alternative to service bureau and mainframe-based servicing is offered by the Company. MortgageWare Loan Servicing was designed to exceed industry standards, while being offered at a highly competitive price-point for the industry, along with no-charge access to a customer's servicing information, allowing servicers to gain a cost and information advantage. MortgageWare Loan Servicing utilizes a 32-bit Windows client-server architecture, coupled with advanced information features that automate and manage business events for a loan servicer. Servicing Gateway. A streamlined version of Loan Servicing, Servicing Gateway is an abbreviated, low-cost product designed specifically for those lenders holding loans for sale, so they can collect payments and account for interest paid without the cost of a full servicing operation. BuilderBLOCK$. For construction lending, BuilderBLOCK$ offers a Windows-based system that simplifies and streamlines the management of construction loans. This construction lending product offers an alternative to manual or spreadsheet calculations. The product enables users to automatically prepare 1099 and 1098 forms, enter draw requests, track inspections and print checks. Key features include the automation of IRS reporting for both suppliers and borrowers; the ability for lenders to compare the percentage of building completion against the percentage of funds disbursed to date; and the maintenance of a historical record of all transactions by supplier and contractor. The system is designed to provide quick and easy entry of inspection data; one screen captures information for all loans, and the information is then automatically transferred to each individual loan. MortgageWare InfoLINQ. Introduced in January 1997, MortgageWare InfoLINQ integrates all of INTERLINQ's products to create the synergy of the MW Enterprise business model. InfoLINQ provides mortgage lenders one of the first, complete intranet-based environments in which to collect, extract, and distribute business information. Data in all operational systems of MW Enterprise is accessible for the automated creation and distribution of real-time business reports and analyses through easy-to-use browser-based desktops, to users throughout the enterprise. Rather than committing resources to gathering and crunching of loan data, InfoLINQ users can access real-time information via a customizable "desktop" that is similar to a Web site. InfoLINQ automatically distributes information to each desktop based on what company information is relevant to each user's job. Users can tailor their desktops to most efficiently review the information they want to track, helping them to quickly respond to changes in the market, and optimize profitability. InfoLINQ users can access the MortgageWare database from 6 7 any location on a PC, to speed the process of researching and analyzing the entire mortgage business. This means that after mortgage professionals begin to move a business transaction through the pipeline -- fueled by competitive decisions based on InfoLINQ's access to real-time information and industry-wide analysis -- MortgageWare can be called on to move the process through the pipeline's final stages. Other MortgageWare Information Management Tools. INTERLINQ frequently develops products that it believes speed up the cycle of mortgage loan creation. Other products the Company offers include: COMLINQ. INTERLINQ's electronic communications system is designed to provide a fast, yet easy, method of transferring MortgageWare data between headquarters, branch offices and origination systems. MortgageWare MultiTrac. Multi-tasking capabilities have been added to MortgageWare Loan Management System via MultiTrac, providing one of Windows' main advantages, while retaining MortgageWare functionality. New Products Under Development MortgageWare TC. A browser-based version of the MortgageWare Loan Management System scheduled to ship by the end of 1997, is the first mortgage loan management system to take advantage of the thin-client technology that the Company believes will become the future industry standard. Not only does an enhanced graphical interface heighten MortgageWare's ease-of-use, but thin-client technology also provides cost and efficiency benefits through central management of technology and upgrades at the server level -- lowering costs of managing the desktop and the system. In addition, the improved remote access capabilities allowed with thin-client technology enable lenders to work effectively over a true wide area network (WAN). MortgageWare TC is designed to provide quick and easy access through a Web browser to MortgageWare's integrated modules for each step in the cycle of generating and processing a mortgage loan. All of these modules work from a single database, so information has to be input only once and can be immediately accessed by any authorized user. The Company believes that these features, combined with the capabilities of InfoLINQ, facilitate accessing the most current information possible in a quick and intuitive manner. Secondary Marketing for Windows. Secondary Marketing for Windows is being designed to provide the ability for lenders to automate the process of selling individual loans on the secondary market to investors such as Fannie Mae, Freddie Mac and other secondary market investors. This product, which will interface with other MortgageWare products, is being designed to provide timely data capture from a customer's branch office to its main secondary marketing database, eliminating redundant data entry. Complementary Products and Services INTERLINQ provides training, implementation services and consulting services to assist its customers in the use of its software. These services are typically performed at the customer's location and are tailored to meet the customer's needs. Customers may also attend regional training seminars or consult one of the Company's regionally based trainers for individual assistance. 7 8 Electronic forms and custom electronic documents necessary in the loan production process are available to INTERLINQ customers through a special marketing agreement with CBF Systems, Inc., VMP Mortgage Forms Division (VMP). Under this agreement, customers are introduced to these products by INTERLINQ's direct sales force. Responsibility for producing, maintaining compliance, and shipping documents to customers is held by VMP. INTERLINQ receives a portion of the revenue collected by VMP. The Company also sells laser font cartridges and provides laser logo services. The Company has developed interfaces to Fannie Mae's Mornet product and Freddie Mac's Midanet product, which facilitate loan delivery once a loan is closed. In addition, the Company has developed several programs to export servicing data to loan servicing systems for its customers. Customer Service and Support INTERLINQ believes that excellent customer service is key to its success and future growth. For many customers, the MortgageWare product line becomes critical to their daily operations. Accordingly, customers rely on the Company for continued support and enhancement of its products. Customers who buy licenses to use MortgageWare products under the Company's purchase option typically purchase an annual support contract. The support fee for customers who choose INTERLINQ's Partnership Plan or rental option (discussed below) is included in their monthly charge. Regular feedback on the quality of the Company's customer service is an integral part of its customer service strategy. The Company employs an independent research firm that calls each customer at least annually to determine customer satisfaction. The reports are produced monthly and are used by the Company to monitor its procedures to enhance customer satisfaction. In addition, certain customers belong to special interest groups that serve as a resource for product ideas. Currently, there are groups for regulatory compliance, loan processing, secondary marketing, closing/settlement, portable origination, software interfaces, government lending, communications, documents and forms, brokered lending, user interface and training, underwriting, and loan servicing. The Company has a Major Account Services group to serve the needs of its largest customers. As of June 30, 1997, 38 of its customers were included in the program. The Major Account Services staff acts as liaison for each major account customer, following up on issues and setting priorities for system enhancements. With this program, the Company believes that it can better address the needs of its largest customers and improve overall service for all its customers. PRODUCT DEVELOPMENT The MortgageWare product line continues to evolve, with input from many sources, including customers who submit software enhancement request forms suggesting corrections or enhancements, as well as advisory panels for each product. The Company also maintains a database of all product support calls, which provides feedback to its Product Development Department. The Company has organized its Product Development Department into teams working on products or closely related groups of products. These teams include personnel with experience 8 9 in product analysis, software engineering, research and technology, quality assurance, and product marketing. Their objective is to ensure that all products meet INTERLINQ's standards. Employees in these teams are selected for their skills in mortgage lending, software development and marketing. INTERLINQ examines new technologies and platforms on an ongoing basis to determine their potential benefits to customers. The Company currently develops products using the DOS, Windows NT and Windows 95 operating systems, ODBC compliant database options (SQL Server(TM) and MS Access(TM)) Web browser-based interfaces and thin-client technology, and Visual C++ , ACTIVE X programming tools on a PC network. Currently, the MortgageWare Loan Management System and Secondary Marketing product run under the DOS operating system and on major PC networks. A Windows version of Secondary Marketing is planned for fiscal year 1998. Additionally, a thin-client version of the MortgageWare Loan Management System is scheduled to be released by the end of calendar 1997. The Company's other products --MortgageWare Entre, Loan Servicing, MarketLINQ, Servicing Gateway and BuilderBLOCK$--all run under the Windows operating system. The Company's software is generally written in the C language for speed, reliability and ease of maintenance. The Company writes screens, reports and documents in a simple object-oriented language to reduce development time. SALES AND MARKETING The Company employs a direct sales force for all of its markets because it believes that considerable expertise is required to sell its products and that strong customer relationships are key to its success. The Company's direct sales force consists of national sales managers and account/sales executives. These personnel are supported by sales administration and inside sales representatives. As of June 30, 1997, the Company employed 17 sales executives located throughout the country who are each responsible for an assigned geographic territory. An additional sales representative is exclusively devoted to sales of INTERLINQ'S servicing products. Sales executives are expected to maintain relationships with existing customers and are responsible for the generation of new business and expansion of existing business. Sales administration representatives handle contracts and other administrative details, and inside sales representatives qualify sales leads, setting appointments for account and sales executives, and managing much of the sales follow-up. Sales leads are generated through various sources, including magazine advertising, industry databases, trade shows, purchased lists, direct mail, telemarketing, customer referral and membership in various trade organizations. The Company tracks lead sources to determine the most cost-effective use of its promotional budget. The Company offers an unconditional, 60-day, money-back guarantee on most of its products. To date, it has not experienced significant returns under this guarantee. Effective October 1, 1995 the Company amended an existing co-marketing agreement with CMCI Corporation ("CMCI"). The agreement provides for discounted software sold to credit unions through CMCI and a referral fee paid to CMCI for software sold to credit unions directly by the Company and adds conditions allowing for the transfer of CMCI customers to INTERLINQ. The transfer is to take place by September 30, 1998 at which time the agreement is to expire. The Company believes that CMCI's familiarity with credit unions provides the 9 10 Company with a strategic advantage in that market. Revenues under the CMCI arrangement accounted for less than 2% of the Company's net revenues in fiscal year 1997. Licensing Options To attract and retain a wide diversity of customers in the residential mortgage lending industry, the Company has developed three licensing options for its products: Purchase Option. Under this option, the Company's customers may purchase a standard non-exclusive software license to use its products. The Company offers financing for the purchase option and, for an additional annual fee, provides product support services. Approximately 95% of the Company's customers select the purchase option and the additional support services. Partnership Plan Option. Under the Partnership Plan option, customers pay an initial commitment fee, plus a monthly fee based upon the number of loan applications entered into the system. The Partnership Plan option includes the MortgageWare LMS software and software support and is targeted to customers who are unwilling or unable to make the capital commitment associated with the purchase option. Rental Option. Because customers may not wish to commit to the purchase option or the Partnership Plan option, the Company created a limited-capacity version of the MortgageWare LMS software for brokers that is available on a monthly rental plan. In addition, the Secondary Marketing product is also available on a monthly rental plan. CUSTOMERS The Company's customer base is geographically diverse and covers a broad range of sizes and types of financial institutions. MortgageWare products are installed and currently supported for approximately 2,000 customers in 7,000 locations in all 50 states plus Puerto Rico, Guam, and the U.S. Virgin Islands. This customer base is currently comprised of approximately 750 mortgage brokers and bankers, 650 banks, 500 credit unions and 100 savings institutions. In fiscal year 1997, no single customer accounted for more than 3% of the Company's net revenues. COMPETITION The market for the Company's software products is highly competitive. The Company competes with software vendors offering integrated financial services packages, software consultants and value-added resellers who deliver custom or customized software products, in-house management information services and programming resources of some of the Company's larger existing and potential customers, as well as software vendors offering specialized products for the mortgage lending industry. The Company believes the main competitive factors include price, operating platform compatibility and customer support. Some competitive products cost significantly less than MortgageWare software, and price-sensitive buyers tend to choose these products. Many competitors market competing products on mainframe, mini-computer and PC platforms with a wide array of pricing and have significantly greater financial, technical, marketing and sales resources than the Company; some offer financial services products not offered by the Company. The Company believes it is the leading provider of PC-based software for residential mortgage lending solutions. 10 11 In addition to the Company's current competitors, there are many companies involved in providing software and related services to segments of the financial services industry other than residential mortgage lending. Because of similarities both in the customer base and the types of products and services provided by these other companies compared to those of the Company, these companies are potential competitors of the Company. There is no assurance that the Company would be successful in competing against these potential competitors, should any of them decide to enter the Company's market. INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS INTERLINQ regards its software as proprietary and essential to its business. The Company relies primarily on a combination of copyright, trademark and trade secret laws, employee and third-party nondisclosure agreements, license agreements and other intellectual property protection methods to protect its proprietary technology. The Company has no patents. MORTGAGE LENDING REGULATIONS The residential mortgage lending industry is subject to a variety of government regulations, including the Equal Credit Opportunity Act, the Truth-in- Lending Act, the Real Estate Settlement Procedures Act and the Home Mortgage Disclosure Act, which prohibit discrimination and require the disclosure of certain basic information to borrowers concerning credit terms and settlement costs. Additionally, there are various federal, state and local laws and regulations that govern mortgage lending activities, including consumer protection and usury statutes. Entities engaged in making and selling mortgage loans are often subject to the rules and regulations of one or more of the investors, guarantors and insurers of residential mortgage loans, including the Federal Housing Authority, the Veteran's Administration, Fannie Mae, Freddie Mac and the Government National Mortgage Association. These agencies regulate the origination, processing, underwriting, selling, securitizing and servicing of mortgage loans, prohibit discrimination, establish underwriting guidelines provide for inspections and appraisals, require credit reports on prospective borrowers and fix maximum loan amounts and interest rates. Failure to comply with these laws and regulations could lead to a lender's loss of approved status, termination of its servicing contracts without compensation, demands for indemnification or loan repurchase, class action lawsuits and administrative enforcement actions. Should loan production processes or documentation arising from use of the Company's products result in a customer's violation of such requirements, such customer, or the government authority whose requirements were not met, might claim that the Company is responsible, which could have an adverse effect upon the Company and its reputation in the mortgage lending industry. On October 2, 1995 the Company entered into an agency and compliance delegate agreement with CBF Systems, Inc, VMP Mortgage Forms Division (VMP). Under the terms of this agreement VMP assumes compliance responsibility for all documents sold by and through the Company. MANUFACTURING The principal materials used in the Company's products include computer diskettes and documentation. The manufacturing process includes the development and testing of software by the Company, plus the production of a master copy for duplication. The Company contracts with an outside source for all disk duplication for major product releases and updates. Accompanying documentation, which is minimal since most documentation is on-line, is created 11 12 by the Company and sent to an outside source to be reproduced. The Company generally ships products within a few business days after receipt of an order. Normally the Company has little or no backlog, but has experienced occasional backlogs. At June 30, 1997, the Company's backlog was not material. CERTAIN FACTORS The Company is unable to accurately estimate unit sales of its products and the volume of annual support contracts that its customers will purchase due to the nature of the software markets generally and, in particular, the residential mortgage lending market. In early 1994, the residential mortgage lending market experienced a reduction in mortgage refinance volumes due to a sharp 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. During fiscal years 1997 and 1996, as a result of the moderate increase in mortgage lending and refinance volumes, the Company has seen increases in revenues, operating income and net income. EMPLOYEES As of August 31, 1997, the Company employed 133 people, including 31 in sales and marketing, 40 in product development, 39 in customer service and 23 in operations. None of the Company's employees is represented by a labor union, and the Company believes that its relationship with its employees is good. 12 13 EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company, as of September 27, 1997, are as follows:
NAME Age Position - ------------------------------- ------ ------------------------------------------------------------- Jiri M. Nechleba 39 President and Chief Executive Officer Stephen A. Yount 40 Vice President-Finance, Chief Financial Officer and Secretary Patricia R. Graham 44 Vice President-Sales and Marketing David A. Sperline 48 Vice President-Customer Service
JIRI M. NECHLEBA has been President and Chief Executive Officer since September 11, 1995. From 1993 through August, 1995, he served as Senior Vice President and General Manager of SolutionWare, a subsidiary of A.C. Nielsen, a division of Dun & Bradstreet, and a provider of information systems to the consumer packaged goods industry. From 1985 to 1993, Mr. Nechleba was an independent management consultant to a variety of industries. Mr. Nechleba holds two Bachelor of Science degrees from the Massachusetts Institute of Technology. STEPHEN A. YOUNT has been Vice President-Finance, Chief Financial Officer and Secretary of the Company since October 1991. Additionally, upon the resignation of the Company's President and Chief Executive Officer, Robert M. Delf in January, 1995, Mr. Yount was appointed Interim President by the Board of Directors. He continued in this capacity until the hiring of Jiri Nechleba as President and Chief Executive Officer on September 11, 1995. During 1991, Mr. Yount held a temporary position with PF Industries & Acrotech, Inc., an aerospace company, where he served as Chief Financial Officer. From 1989 to 1991, Mr. Yount was the President and Chief Financial Officer of PacSoft Incorporated, a civil engineering software firm. Mr. Yount earned a CPA certificate in 1982 and holds a BA in Business Administration from the University of Washington. PATRICIA R. GRAHAM has been Vice President-Sales and Marketing of the Company since March 25, 1996. From 1990 to 1995, she was with A.C. Nielsen Co., a subsidiary of Dun & Bradstreet and served in various capacities including executive vice president. From 1981 to 1990 she was employed by Information Resources, Inc. and departed holding the position of Senior Vice President. Ms. Graham holds a Masters degree in political science from Rutgers University. DAVID A. SPERLINE has been Vice President-Customer Service of the Company since January 1992. Mr. Sperline worked briefly as an independent consultant before joining the Company. From March 1988 to 1991, Mr. Sperline was Director of Product Quality Assurance at Aldus Corporation, a desk-top publishing software company. Prior to that, he was Director of Software Development for Pacer Corporation, a producer of computer hardware and software for movie theaters. Mr. Sperline holds a BA in Business Administration from the University of Washington. 13 14 ITEM 2. PROPERTIES The Company is currently subleasing and occupying approximately 46,000 square feet of office space in Kirkland, Washington. This sublease expires in November 1998 and does not contain a renewal option. The Company believes that its current facilities will be adequate for its needs through the end of fiscal year 1998, as well as the remaining term of the sublease. Because the Company does not have a renewal option for its current facilities, it anticipates a thorough evaluation of the available office space near its current headquarters in Kirkland, Washington. As of September 1997, the vacancy rate has declined for office space and, accordingly, lease rates have increased substantially in the geographic area where the Company's headquarters are located. Accordingly, the Company anticipates a potential substantial increase in its lease rate for its current facility or another facility when the current sublease expires in November 1998. ITEM 3. LEGAL PROCEEDINGS The Company is not party to any litigation that would have a material adverse effect on the Company or its business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of fiscal year 1997. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Common Stock has traded on the Nasdaq National Market under the symbol INLQ since April 27, 1993. The Company has 2,812 shareholders as of September 23, 1997, based on computations including participants in security positions listings, as defined by Rule 17Ab-8 of the Exchange Act. Presented below are quarterly closing stock price ranges as reported on Nasdaq National Market for the periods indicated.
HIGH Low ------------ ---------- Fiscal year ended June 30, 1998 First quarter (through September 23, 1997) $4.63 $3.50 Fiscal year ended June 30, 1997 Fourth quarter $4.13 $3.63 Third quarter 6.00 3.75 Second quarter 5.50 3.50 First quarter 4.50 3.38 Fiscal year ended June 30, 1996 Fourth quarter $5.50 $3.19 Third quarter 3.75 2.88 Second quarter 3.50 3.00 First quarter 4.13 3.25
The Company has never paid dividends on its Common Stock. The Company intends to retain future earnings for use in its business and therefore does not anticipate paying dividends in the foreseeable future. There is no assurance that the Company will ever pay dividends on its Common Stock. 14 15 ITEM 6. SELECTED FINANCIAL DATA
Years Ended June 30, 1997 1996 1995 1994 1993 - ------------------------------------------------ -------- --------- -------- -------- ------- (In thousands except per share data) STATEMENTS OF OPERATIONS DATA: Net revenues: Software license fees $ 7,055 $ 6,232 $ 4,314 $11,438 $10,122 Software support fees 6,073 5,773 5,483 4,707 2,824 Other 1,239 1,088 1,196 2,344 2,086 -------- --------- -------- -------- ------- Total net revenues 14,367 13,093 10,993 18,489 15,032 -------- --------- -------- -------- ------- Cost of revenues: Software license fees 1,500 1,653 1,424 1,244 1,188 Software support fees 1,856 1,678 1,788 2,062 1,791 Other 683 589 642 1,014 943 -------- --------- -------- -------- ------- Total cost of revenues 4,039 3,920 3,854 4,320 3,922 -------- --------- -------- -------- ------- Gross profit 10,328 9,173 7,139 14,169 11,110 -------- --------- -------- -------- ------- Operating expenses: Product development 2,147 2,060 1,123 891 670 Sales and marketing 4,011 4,230 4,244 5,801 4,366 General and administrative 3,152 3,010 3,404 3,278 2,147 Other general expenses - nonrecurring _____ _____ 952 _____ _____ -------- --------- -------- -------- ------- Total operating expenses 9,310 9,300 9,723 9,970 7,183 -------- --------- -------- -------- ------- Operating income (loss) 1,018 (127) (2,584) 4,199 3,927 Net interest and other income (expense) 719 811 676 322 (98) -------- --------- -------- -------- ------- Income (loss) before income taxes, extraordinary item and cumulative effect of change in accounting principle 1,737 684 (1,908) 4,521 3,829 Income taxes 627 251 (780) 1,532 1,368 -------- --------- -------- -------- ------- Income (loss) before extraordinary item and cumulative effect of change in accounting principle 1,110 433 (1,128) 2,989 2,461 Extraordinary item - tax benefit of net operating loss carryforwards _____ _____ _____ _____ 138 Cumulative effect of change in accounting principle _____ _____ _____ (109) _____ -------- --------- -------- -------- ------- Net income (loss) $1,110 $433 ($1,128) $2,880 $2,599 ======== ========= ======== ======== ======= PER SHARE DATA: Income (loss) before extraordinary item and cumulative effect of change in accounting principle $.19 $.07 ($.19) $.46 $.47 -------- --------- -------- -------- ------- Net income (loss) $.19 $.07 ($.19) $.45 $.50 -------- --------- -------- -------- ------- Weighted average number of common and common equivalent shares outstanding 5,842 6,171 5,831 6,471 5,241 BALANCE SHEET DATA: Cash, cash equivalents and investments $13,831 $14,218 $14,373 $14,585 $14,434 Working capital 11,623 12,823 13,638 13,753 13,233 Total assets 21,067 22,321 21,609 23,838 20,306 Total shareholders' equity 16,050 17,771 17,338 18,703 16,121
15 16 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL Prior to the mid 1980's, mortgage loans in the United States were originated in a manual and paper-intensive process. Then, beginning in the mid 1980's and running through the mid 1990's, the mortgage lending industry implemented its first wave of automation with PC-based software solutions for mortgage originations. During this period of time, the Company experienced rapid revenue and customer growth by providing its MortgageWare Loan Management System - - a robust, full-featured and cost-effective PC-based software solution. This first wave of automation was accelerated and amplified from 1992 to early 1994 as mortgage interest rates reached historically low levels and mortgage refinance volumes soared. Then, in early 1994, the Federal Reserve raised interest rates. This event immediately caused mortgage refinance volumes to plummet. As a result, lenders found themselves with excess labor and mortgage processing capacity. During the remainder of 1994 and for most of 1995, the Company believes that the industry was focused more on staff reduction, than adding new automated loan management systems. Mortgage lending rates available during the Company's fiscal years 1996 and 1997 reflected a lending environment that experienced a high degree of volatility. In spite of this volatility, the overall lending conditions have been considered favorable for the borrower compared to most historical measures. With this overall favorable lending environment, the Company believes that mortgage lending activity has increased, driven by an increase in financing of home sales and refinancing of existing mortgages. However, during the last half of fiscal year 1997, the Company began to observe a shift in the mortgage origination business. There appeared to be a trend towards sufficient production capacity coupled with a reduced profit margin. Although lending activity has increased, the Company believes that because most mortgage lenders have already automated their origination operations and have sufficient production capacity, the Company experienced only a modest increase in software license fees during fiscal year 1997 compared to fiscal year 1996 for its loan origination software. Historically, when mortgage origination volumes increased due to favorable lending rates, the Company experienced increased software license fees as lenders increased production capacity. The Company now believes that due to reduced profit margins, its customers are shifting their purchasing decisions to solutions that reduce unit costs and accordingly, increase profit margins, rather than increasing production capacity. During 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. It is the Company's belief that this broader "enterprise" solution will position the Company well for this recent change in the mortgage lending industry. This broader product offering focuses more on reducing the cost of originating, processing, and servicing a mortgage, than on solely increasing production capacity. NET REVENUES
Increase (In thousands) 1997 Increase 1996 (Decrease) 1995 - -------------- ---- -------- ---- ---------- ---- Software license fees $ 7,055 13% $ 6,232 44% $ 4,314 Software support fees 6,073 5% 5,773 5% 5,483 Other 1,239 14% 1,088 (9)% 1,196 ------- -- ------- -- ------- Total net revenues $14,367 10% $13,093 19% $10,993 ======= == ======= == =======
16 17 Net revenues consist of software license fees, software support fees, and other revenues, which include training fees, custom document fees, and other miscellaneous sales, net of discounts and sales returns. Software license fees increased by 13% for fiscal year 1997 compared to fiscal year 1996, and increased by 44% for fiscal year 1996 compared to fiscal year 1995. The increase in software license fees in fiscal year 1997 compared to fiscal year 1996 was primarily due to a combination of the overall favorable lending conditions discussed above, which resulted in modest increases in software license fees for most previously developed products, and software license fees for three new products: MortgageWare Loan Servicing, MortgageWare InfoLINQ and MortgageWare MarketLINQ. The increase in software license fees in fiscal year 1996 compared to fiscal year 1995 was primarily due to a combination of the overall favorable lending conditions discussed above, which increased software license fees for previously developed products, and software license fees for three new products: MortgageWare Entre and interfaces to Freddie Mac's and Fannie Mae's automated underwriting systems. Software support fees increased by 5% for fiscal year 1997 compared to fiscal year 1996, and by 5% as well, for fiscal year 1996 compared to fiscal year 1995. These year-to-year increases reflected a combination of a modest number of new customer additions during fiscal years 1997 and 1996, and, to a lesser extent, a low, but fairly constant attrition rate in the installed customer base during both fiscal years. Due in part to changes, from time to time, in government regulations applicable to documentation required for residential mortgage lending, the vast majority of the Company's customers purchase annual software support agreements. However, because software support fees are recognized ratably over the term of the annual support agreement, whereas software license fees are recognized on product shipment, the percentage increase in software support fees compared to software license fees is not directly proportional. The Company believes software support fees are likely to continue to increase at a modest rate in fiscal year 1998. Other revenues -- training fees, custom document fees, and other miscellaneous sales -- increased by 14% for fiscal year 1997 compared to fiscal year 1996, and decreased by 9% for fiscal year 1996 compared to fiscal year 1995. The increase in other revenues in fiscal year 1997 compared to fiscal year 1996, was primarily due to an increase in on-site training fees. This increase in training fees was primarily due to an increase, beginning in the first quarter of fiscal year 1997, in the daily fee charged for on-site training. Additionally, the document fees from the marketing agreement with VMP Electronic Laser Forms increased substantially in fiscal year 1997 compared to fiscal year 1996. The Company expects these fees to continue to increase in fiscal year 1998. The decrease in other revenues in fiscal year 1996 compared to fiscal year 1995 was primarily due to a decrease in document fees. During the quarter ended December 31, 1995, the Company announced a marketing agreement with VMP Electronic Laser Forms to market their comprehensive library of mortgage lending documents to MortgageWare customers. The transition from the Company offering its own lending documents to offering this comprehensive library was slower than anticipated in fiscal year 1996. In addition to the expected increase in revenue from documents discussed above, the Company also expects an increase in consulting fees during fiscal year 1998 compared to fiscal year 1997, due to the Company's recent recognition of demand for its services to assist customers in effectively implementing and integrating its product suite to reduce the cost of originating and processing a mortgage loan, as well as providing timely and relevant information for its customers' decision-makers. 17 18 Looking forward, the Company anticipates an increasing contribution to software license fees, and related increases to software support fees and other revenues, from its newer products MortgageWare Loan Servicing, MortgageWare InfoLINQ, and MortgageWare MarketLINQ. As discussed above, the Company believes the overall lending environment to be favorable as of the end of fiscal year 1997 despite experiencing a high degree of volatility. Nonetheless, there can be no assurance that mortgage lending rates will not increase or continue to experience a high amount of volatility. Such increases or continued volatility could have a material adverse effect on the Company's revenues, profitability, and financial condition. Even if lending rates stabilize, if such rates are perceived as being too high, homeowners and potential homeowners may delay decisions that would otherwise result in mortgage lending transactions. Such delays may have an adverse effect upon the Company's customers, and upon the Company and its operations. COST OF REVENUES
Increase Increase (In thousands) 1997 (Decrease) 1996 (Decrease) 1995 - ------------------------------------- ------ ---------- ------ ---------- ------ Software license fees $1,500 (9)% $1,653 16% $1,424 Percentage of software license fees 21% _____ 27% _____ 33% ------ ------ ------ ------ ------ Software support fees 1,856 11% 1,678 (6)% 1,788 Percentage of software support fees 31% _____ 29% _____ 33% ------ ------ ------ ------ ------ Other 683 16% 589 (8)% 642 Percentage of other revenues 55% _____ 54% _____ 54% ------ ------ ------ ------ ------ Total cost of revenues $4,039 3% $3,920 2% $3,854 Percentage of net revenues 28% _____ 30% _____ 35% ====== ====== ====== ====== ======
Cost of software license fees includes the purchase and duplication of disks, product documentation, and amortization of capitalized software development costs. As a percentage of software license fees, cost of software license fees decreased from 27% to 21% for fiscal year 1997 compared to fiscal year 1996, and decreased from 33% to 27% for fiscal year 1996 compared to fiscal year 1995. The decrease for fiscal year 1997 compared to fiscal year 1996 was primarily due to a combination of software license fees increasing and the cost of software license fees decreasing. The dollar amount of cost of software license fees decreased 9% to $1.50 million for fiscal year 1997, compared to $1.65 million for fiscal year 1996. This decrease was primarily due to a decrease in amortization of capitalized software development costs associated with the MortgageWare Loan Management System for DOS that was partially offset by the introduction of amortization of capitalized software development costs for MortgageWare Loan Servicing released during the first quarter of fiscal year 1997. Amortization of capitalized software development costs was $1,290,000, $1,430,000, and $1,250,000 for fiscal years 1997, 1996, and 1995, respectively. As a result of releasing several new products during fiscal year 1997 that will have amortization of capitalized software development costs, the Company expects the dollar amount of its amortization of capitalized software development costs to increase significantly for fiscal year 1998 compared to fiscal year 1997. 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 18 19 increased from 29% to 31% for fiscal year 1997 compared to fiscal year 1996, and decreased from 33% to 29% for fiscal year 1996 compared to fiscal year 1995. The increase in fiscal year 1997 compared to fiscal year 1996 was primarily due to a higher salary cost and a less efficient ratio of customer support staff to customers. The decrease in fiscal year 1996 compared to fiscal year 1995 was primarily due to a more efficient ratio of customer service support staff to customers. Looking forward, because the level of staffing and customer service expenses are related to the size of the Company's customer base and the number of different products offered, the Company expects the dollar cost of software support fees to increase in accordance with its customer base and expanded product offering, and to increase as a percentage of software support fees. Cost of other revenue includes the purchase and duplication of disks associated with custom documents, the salaries and reimbursable expenses for the employees who provide training and consultation services, and the net cost of the Company's annual MortgageWare software users' group meeting. As a percentage of other revenue, cost of other revenue increased slightly from 54% to 55% for fiscal year 1997 compared to fiscal year 1996 and was unchanged at 54% for fiscal year 1996 compared to fiscal year 1995. The slight increase in fiscal year 1997 compared to fiscal year 1996 was primarily due to a combination of a slightly higher payroll cost and increased depreciation from upgrading the trainers' equipment. OPERATING EXPENSES
Increase Increase (In thousands) 1997 (Decrease) 1996 (Decrease) 1995 ------ ---------- ------- ---------- ------ Product development $2,148 4% $2,060 83% $1,123 Percentage of net revenues 15% _____ 16% _____ 10% ------ ------ ------- ------ ------ Sales and marketing 4,011 (5)% 4,230 0% 4,244 Percentage of net revenues 28% _____ 32% _____ 39% ------ ------ ------- ------ ------ General and administrative 3,152 5% 3,010 (12)% 3,404 Percentage of net revenues 22% _____ 23% _____ 31% ------ ------ ------- ------ ------ Other general expenses - nonrecurring _____ _____ _____ _____ 952 Percentage of net revenues _____ _____ _____ _____ 9% ------ ------ ------- ------ ------
Product development expenses include salaries for software developers and analysts, facility costs, and expenses associated with computer equipment used in software development. As a percentage of net revenues, product development expenses decreased from 16% to 15% for fiscal year 1997 compared to fiscal year 1996, and increased from 10% to 16% for fiscal year 1996 compared to fiscal year 1995. The decrease for fiscal year 1997 compared to fiscal year 1996 is primarily due to net revenues increasing more than product development expenses. The increase for fiscal year 1996 compared to fiscal year 1995 is primarily due to a combination of increased costs associated with the development of new software products, MortgageWare Entre, MortgageWare Loan Servicing, and MortgageWare for Windows, and the maturity of MortgageWare for DOS requiring a greater percentage of development expenditures for maintenance, instead of enhancement, which is capitalized. The Company capitalized $877,000, $790,000, and $1,793,000 of development expenditures for fiscal years 1997, 1996, and 1995, respectively. During fiscal year 1997, the Company released three significant new products, MortgageWare Loan Servicing, MortgageWare InfoLINQ, and MortgageWare 19 20 MarketLINQ. During fiscal year 1998 the Company plans significant enhancements to these new products as well as significant enhancements to the MortgageWare Loan Management System and MortgageWare Entre. Accordingly, the Company anticipates a significant increase in capitalized development expenditures and a decrease in product development expense for fiscal year 1998. Sales and marketing expenses include salaries, sales commissions, travel, and facility costs for the Company's sales and marketing personnel. Sales and marketing expenses also includes advertising, telemarketing, and trade shows. As a percentage of net revenues, sales and marketing expenses decreased from 32% to 28% for fiscal year 1997 compared to fiscal year 1996 and decreased from 39% to 32% for fiscal year 1996 compared to fiscal year 1995. The decrease for fiscal year 1997 compared to fiscal year 1996 was primarily due to revenue increasing and sales and marketing expenses decreasing. The decrease in sales and marketing expenses was primarily due to the elimination of outsourced telemarketing fees during the quarter ended March 31, 1996. The decrease, as a percentage of revenues, for fiscal year 1996 compared to fiscal year 1995 was primarily due to the benefit of expense and staff reduction measures during the quarters ended September 30, 1995 and December 31, 1995, and to revenue increasing faster than sales and marketing expenses, which was somewhat offset by increased sales commission expense. The Company expects sales and marketing expenses to increase both on a dollar basis and as a percentage of revenue for fiscal year 1998 compared to fiscal year 1997, due to substantial marketing, promotional, and sales efforts planned to increase sales of the new products released during fiscal year 1997. General and administrative expenses include costs associated with finance, accounting, purchasing, order fulfillment, administration and facilities, as well as the amortization of certain LoanStar Systems assets, subsequent to their acquisition during the quarter ended March 31, 1994, and discontinuing with the write-off of their remaining net book value during the quarter ended March 31, 1995, as discussed below. As a percentage of net revenues, general and administrative expenses decreased from 23% to 22% for fiscal 1997 compared to fiscal year 1996, and decreased from 31% to 23% for fiscal year 1996 compared to fiscal year 1995. The decrease for fiscal year 1997 compared to fiscal year 1996 was primarily due to revenue increasing more than general and administrative expense. The decrease for fiscal year 1996 compared to fiscal year 1995 is primarily due to a combination of the elimination of the ongoing amortization of certain LoanStar Systems assets subsequent to their write-off during the quarter ended March 31, 1995, a lower bad debt provision and reduced professional services expense. The Company expects general and administrative expenses on a dollar basis to increase somewhat for fiscal year 1998 compared to fiscal year 1997, but hold steady or decrease slightly as a percentage of net revenues. Other general expenses - nonrecurring, consists of the write-off of capitalized software costs associated with purchased software code originally intended for use in the development of one of the Company's new products ($391,000) during the quarter ended June 30, 1995, the write-off of the remaining net book value of the acquired assets of LoanStar Systems, Inc. ($331,000), and costs associated with departed executives ($230,000) during the quarter ended March 31, 1995. 20 21 NET INTEREST AND OTHER INCOME (EXPENSE)
(In thousands) 1997 Decrease 1996 Increase 1995 - ---------------------------------------- ------ ---------- ----- --------- ----- Net interest and other income (expense) $719 (11)% $811 20% $676 Percentage of net revenues 5% -- 6% -- 6%
Interest income was $747,000, $801,000, and $728,000 for the fiscal years ended June 30, 1997, 1996, and 1995, respectively. The decrease for fiscal year 1997 was primarily due to a combination of a slightly lower average portfolio balance and a lower average rate of return on the portfolio. The increase for fiscal year 1996 was primarily due to earning a higher average interest rate on the investment portfolio. As of June 30, 1997, 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 (expense) for the foreseeable future to reflect net interest income. INCOME TAXES
(In thousands) 1997 Increase 1996 Increase 1995 - -------------------------- ------ -------- ------ --------- ------- Income taxes $627 151% $250 n/m $(779) Effective income tax rate 36% -- 37% -- (41)%
The provision for income taxes includes federal and state income taxes currently payable, and deferred taxes arising from temporary differences in determining income for financial statement and tax purposes. The effective income tax rate for fiscal year 1995 reflects a higher benefit due to certain tax-free interest income combined with a net loss. LIQUIDITY AND CAPITAL RESOURCES Working capital, which consists principally of cash, cash equivalents, and short-term investments, was $11,623,000 as of June 30, 1997, compared to $12,823,000 at June 30, 1996. Cash and cash equivalents increased by $1,283,000 for fiscal year 1997. There was $4,155,000 added to cash and cash equivalents by operating activities. Principal uses of cash and cash equivalents included the repurchase of $2,859,000 of Company common stock, the purchase of $547,000 of furniture and equipment, and $877,000 of capitalized software costs. The Company's capital expenditures for fiscal years 1997 and 1996 were $547,000 and $690,000, respectively. Although the Company currently has no material commitment for additional capital expenditures, it expects to spend approximately $500,000 during the fiscal year ending 1998, primarily for computer software and hardware, furniture, and fixtures. The Company expects these additional capital expenditures to be funded through cash from operations. 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; and the possible acquisition of other software products, technologies and 21 22 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 fiscal year 1998. FORWARD-LOOKING STATEMENTS When used in this discussion, the words "believes," "anticipates," and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. 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. 22 23 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Page # ------------------ Independent Auditors' Report 24 Balance Sheets as of June 30, 1997 and 1996 25 Statements of Operations for the years ended June 30, 1997, 1996 and 1995 26 Statements of Shareholders' Equity for the years ended June 30, 1997,1996 and 1995 27 Statements of Cash Flows for the years ended June 30, 1997, 1996 and 1995 28 Notes to Financial Statements 29 - 36 Schedule II - Valuation and Qualifying Accounts 39
23 24 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders INTERLINQ Software Corporation: We have audited the accompanying financial statements of INTERLINQ Software Corporation as listed in the accompanying index. In connection with our audits of these financial statements, we have also audited the financial statement schedule as listed in the accompanying index. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of INTERLINQ Software Corporation as of June 30, 1997 and 1996, and the results of its operations and its cash flows for each of the years in the three-year period ended June 30, 1997 in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ KPMG Peat Marwick LLP Seattle, Washington August 1, 1997 24 25 INTERLINQ SOFTWARE CORPORATION BALANCE SHEETS
As of June 30, 1997 1996 ----------- ----------- ASSETS Current assets: Cash and cash equivalents $ 7,793,761 $ 6,511,041 Investments available-for-sale, at fair value 4,024,651 3,909,917 Investments held-to-maturity, at amortized cost 2,012,894 3,796,929 Accounts receivable, less allowance for doubtful accounts of $176,000 in 1997 and $187,007 in 1996 1,602,220 1,971,507 Inventory 55,246 72,644 Prepaid expenses 408,909 331,026 Deferred income taxes 267,660 172,041 ----------- ----------- Total current assets 16,165,341 16,765,105 ----------- ----------- Property and equipment, at cost 5,836,895 5,289,836 Less accumulated depreciation and amortization 4,364,628 3,253,190 ----------- ----------- Net property and equipment 1,472,267 2,036,646 ----------- ----------- Capitalized software costs, less accumulated amortization of $1,718,683 in 1997 and $1,509,305 in 1996 3,358,016 3,493,563 Other assets 70,899 26,021 ----------- ----------- $21,066,523 $22,321,335 =========== ============ LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 235,895 $ 158,226 Accrued compensation and benefits 555,402 402,701 Other accrued liabilities 498,276 380,435 Customer deposits 199,636 363,703 Deferred software support fees 3,052,822 2,637,500 ----------- ----------- Total current liabilities 4,542,031 3,942,565 ----------- ----------- Noncurrent liabilities, excluding current installments: Deferred rent and other lease obligations 160,443 383,750 Deferred software support fees 6,746 10,233 Deferred income taxes 306,950 213,548 ----------- ----------- Total noncurrent liabilities 474,139 607,531 ----------- ----------- Shareholders' equity: Series A convertible preferred stock, $.01 par value -- -- Authorized 5,000,000 shares; no shares issued and outstanding in 1997 and 1996 -- -- Common stock, $.01 par value. Authorized 30,000,000 shares; issued and outstanding 5,416,512 shares in 1997 and 6,038,550 shares in 1996 54,165 60,386 Additional paid-in capital 10,343,087 13,167,629 Retained earnings 5,653,101 4,543,224 ----------- ----------- Total shareholders' equity 16,050,353 17,771,239 Commitments ----------- ----------- $21,066,523 $22,321,335 =========== ============
See accompanying notes to financial statements. 25 26 INTERLINQ SOFTWARE CORPORATION STATEMENTS OF OPERATIONS
Years Ended June 30, 1997 1996 1995 ------------ ------------ ----------- Net revenues: Software license fees $ 7,055,457 $ 6,232,011 $ 4,314,189 Software support fees 6,072,544 5,772,791 5,482,938 Other 1,239,045 1,087,613 1,196,321 ------------ ------------ ----------- Total net revenues 14,367,046 13,092,415 10,993,448 ------------ ------------ ----------- Cost of revenues: Software license fees 1,499,645 1,652,627 1,423,772 Software support fees 1,856,486 1,678,255 1,788,177 Other 682,666 588,987 641,700 ------------ ------------ ----------- Total cost of revenues 4,038,797 3,919,869 3,853,649 ------------ ------------ ----------- Gross profit 10,328,249 9,172,546 7,139,799 ------------ ------------ ----------- Operating expenses: Product development 2,147,546 2,060,427 1,123,093 Sales and marketing 4,011,440 4,229,994 4,244,444 General and administrative 3,151,761 3,010,223 3,403,827 Other general expenses - nonrecurring -- -- 952,043 ------------ ------------ ----------- Total operating expenses 9,310,747 9,300,644 9,723,407 ------------ ------------ ----------- Operating income (loss) 1,017,502 (128,098) (2,583,608) Net interest and other income 719,275 811,272 675,786 ------------ ------------ ----------- Income (loss) before income tax expense (benefit) 1,736,777 683,174 (1,907,822) Income tax expense (benefit) 626,900 250,398 (779,326) ------------ ------------ ----------- Net income (loss) $ 1,109,877 $ 432,776 $ (1,128,496) ============ ============ ============ Net income (loss) per share $ .19 $ .07 $ (.19) Weighted average number of common and common equivalent shares outstanding 5,841,764 6,171,210 5,830,842
See accompanying notes to financial statements. 26 27 INTERLINQ SOFTWARE CORPORATION STATEMENTS OF SHAREHOLDERS' EQUITY
Total Common Additional Retained Shareholders' Years Ended June 30, 1997, 1996, 1995 Stock Paid-in Capital Earnings Equity - ------------------------------------- ------- --------------- ----------- ----------- Balances at June 30, 1994 $57,937 $13,406,325 $5,238,944 $18,703,206 Issuance of 313,790 shares of common stock 3,138 41,042 -- 44,180 Tax benefit realized upon exercise of stock options -- 366,604 -- 366,604 Repurchase of 139,500 shares of common stock (1,395) (645,980) -- (647,375) Net loss for the year ended June 30, 1995 -- -- (1,128,496) (1,128,496) ------- ---------- ----------- ----------- Balances at June 30, 1995 59,680 13,167,991 4,110,448 17,338,119 Issuance of 170,550 shares of common stock 1,706 214,487 -- 216,193 Tax benefit realized upon exercise of stock options -- 96,651 -- 96,651 Repurchase of 100,000 shares of common stock (1,000) (311,500) -- (312,500) Net income for the year ended June 30, 1996 -- -- 432,776 432,776 ------- ---------- ----------- ----------- Balances at June 30, 1996 60,386 13,167,629 4,543,224 17,771,239 Issuance of 19,962 shares of common stock 199 17,321 -- 17,520 Tax benefit realized upon exercise of stock options -- 10,967 -- 10,967 Repurchase of 642,000 shares of common stock (6,420) (2,852,830) -- (2,859,250) Net income for the year ended June 30, 1997 -- -- 1,109,877 1,109,877 ------- ----------- ----------- ----------- Balances at June 30, 1997 $54,165 $10,343,087 $5,653,101 $16,050,353 ======= =========== =========== ===========
See accompanying notes to financial statements. 27 28 INTERLINQ SOFTWARE CORPORATION STATEMENTS OF CASH FLOWS
Years Ended June 30, 1997 1996 1995 - -------------------- ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ 1,109,877 $ 432,776 $ (1,128,496) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization of property and equipment 1,111,438 1,014,452 1,180,679 Amortization of capitalized software costs 1,287,881 1,430,111 1,249,849 Write-off of purchased software -- -- 391,518 Amortization of other assets -- -- 221,073 Write-off of LoanStar acquisition costs -- -- 330,817 Loss (gain) on disposition of equipment -- (1,473) 4,041 Deferred income tax expense (benefit) (2,217) (156,727) 31,388 Tax benefit realized upon exercise of stock options 10,967 96,651 366,604 Change in certain assets and liabilities: Accounts receivable 369,287 (745,365) 1,047,738 Income taxes refundable -- 987,429 (603,346) Inventory and prepaid expenses (60,485) (88,508) 79,859 Other assets (44,878) 9,613 128,924 Accounts payable 77,669 34,971 (230,958) Accrued compensation and benefits, other accrued liabilities and deferred rent and other lease obligations 47,235 51,136 45,445 Customer deposits (164,067) 256,613 (167,983) Deferred software support fees 411,835 93,400 (430,452) ------------ ------------ ------------ Net cash provided by operating activities 4,154,542 3,415,079 2,516,700 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (547,059) (689,857) (338,381) Capitalized software costs (877,334) (789,792) (1,793,182) Purchase of source code (275,000) (2,000,000) -- Purchases of investments (14,511,012) (18,734,310) (4,496,002) Proceeds from sales and maturities of investments 16,180,313 12,498,246 10,671,287 Proceeds from sale of equipment -- 5,435 6,865 ------------ ------------ ------------ Net cash provided by (used in) investing activities (30,092) (9,710,278) 4,050,587 ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock 17,520 216,193 44,180 Repurchase of common stock (2,859,250) (312,500) (647,375) ------------ ------------ ------------ Net cash used in financing activities (2,841,730) (96,307) (603,195) ------------ ------------ ------------ Net increase (decrease) in cash & cash equivalents 1,282,720 (6,391,506) 5,964,092 ------------ ------------ ------------ Cash and cash equivalents at beginning of year 6,511,041 12,902,547 6,938,455 ------------ ------------ ------------ Cash and cash equivalents at end of year $ 7,793,761 $ 6,511,041 $ 12,902,547 ============ ============ ============ Supplemental disclosure of cash flow information - net cash paid (received) during the year for income taxes $ 615,891 $ (691,880) $ (623,362) See accompanying notes to financial statements
28 29 INTERLINQ SOFTWARE CORPORATION NOTES TO FINANCIAL STATEMENTS JUNE 30, 1997 AND 1996 (1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) DESCRIPTION OF BUSINESS INTERLINQ Software Corporation (Company) develops, markets, and supports personal computer ("PC")-based software products, both stand-alone and networked, for mortgage brokers and bankers, banks, credit unions, and savings institutions located primarily throughout the United States. Credit is extended to such customers in the Company's normal course of business. The Company's product line encompasses all major components of the mortgage loan production process, secondary marketing activities, mortgage loan servicing, and construction loan servicing. The Company's business strategy is to provide easy-to-use, PC-based software solutions marketed through a direct sales force and to maintain long-term customer relationships which generate recurring revenues. (b) CASH EQUIVALENTS All highly liquid investments purchased with a maturity of three months or less are considered to be cash equivalents. (c) INVESTMENTS Investments at June 30, 1997 and 1996 consist principally of investment-grade, interest-bearing securities. The Company classifies investment securities as either available-for-sale or held-to-maturity depending upon its intentions at the time the securities are acquired. Investments available- for-sale are carried at fair value, with any unrealized holding gains and losses reported as a separate component of shareholders' equity. Investments held-to-maturity are carried at amortized cost. At June 30, 1997 and 1996, the fair value of all securities approximated amortized cost and there were no material unrealized holding gains or losses. Investments held-to-maturity have contractual maturities of less than one year. Investments available-for-sale have contractual maturities ranging from two years to thirty-two years and carry adjustable rates of interest with periodic reset dates. (d) INVENTORY Inventory is stated at the lower of cost (first-in, first-out) or replacement market. (e) PROPERTY AND EQUIPMENT Depreciation and amortization of property and equipment are provided on the straight-line method over the estimated useful lives of the assets or respective lease terms if shorter. Management periodically evaluates property and equipment for impairment whenever events or circumstances indicate that the carrying amount may not be recoverable. (f) PRODUCT DEVELOPMENT AND CAPITALIZED SOFTWARE COSTS Software development costs incurred in conjunction with product development are charged to product development expense in the period the cost is incurred until technological feasibility is established. Thereafter, all software product development costs are capitalized and reported at the lower of unamortized cost or net realizable value. Software costs incurred in conjunc tion with acquisition of technologically feasible products developed externally are capitalized and reported at the lower of unamortized cost or net realizable value. 29 30 Amortization of capitalized software costs begins when the related software is available for general release to customers and is provided for each software product based on the greater of (i) the ratio of current gross revenues to total current and anticipated future gross revenues for the related software or (ii) the straight-line method over two to five years, based on the remaining economic life of the software. The estimates of anticipated future gross revenues and remaining economic life of the Company's products are subject to risks inherent in the software industry, such as changes in technology and customer perceptions. Management regularly reviews these estimates and makes adjustments as appropriate. (g) REVENUE RECOGNITION Net revenues consist of software license fees, software support fees, and other revenues. Software license fees are earned under three different types of licensing agreements. Under the purchase option, a one-time license fee is recognized when the goods are shipped if no significant obligations remain on the part of the Company, and collection of any resulting receivables is deemed probable. Under the Partnership Plan option, revenues are recognized each month based on the monthly volume of loan transactions processed by the customer using the Company's software. Under the software rental option, revenues are recognized each month based on the monthly license fee. Software support fees relate only to licensing agreements under the purchase option and are charged separately, on an annual or quarterly basis, and are recognized over the life of the related service contracts. Deferred software support fees represent fees charged to customers but not yet recognized as revenue. Other revenues include training fees and custom document fees. Training fees are recognized when related training is completed. Custom document fees are recognized when the goods are shipped. (h) COST OF REVENUES Cost of software license fees includes costs related to sales of licenses such as disks and supplies, amortization of capitalized software costs, depreciation of hardware under the Partnership Plan, and other direct costs. Cost of software support fees includes salaries and other costs related to providing telephone support and the costs of disks and supplies related to product enhancements provided under support contracts. Cost of other revenues includes direct costs related to training, custom document fees and other revenue. (i) STOCK-BASED COMPENSATION The Company accounts for its stock option plans using the intrinsic value method. As such, compensation expense is recorded only if, on the date of grant, the current market price of the underlying stock exceeded the exercise price. (j) INCOME TAXES The Company records income taxes under the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Management evaluates the need to establish valuation allowances for deferred tax assets based upon the amount of existing temporary differences, the period in which they are expected to be recovered, and expected levels of taxable income. 30 31 (k) EARNINGS PER SHARE Earnings per share amounts are based on the weighted average number of common and dilutive common equivalent shares outstanding assuming exercise of all common stock options using the treasury stock method. For the year ended June 30, 1995, earnings per share amounts are based on weighted average shares outstanding only, since using the treasury stock method would be antidilutive in periods where the Company has a net loss. (l) USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (m) CONCENTRATION OF MARKET RISK The Company markets its products primarily to businesses involved in the residential loan production process. Changes in mortgage lending rates and other economic factors could affect the economic stability of these businesses and their ability, as a group, to purchase the Company's products. As a result, the Company's success in marketing its products may fluctuate in accordance with these economic factors. (n) RECLASSIFICATIONS Certain reclassifications have been made to the prior period financial statements to conform with the current year presentation. (o) NEW ACCOUNTING STANDARD In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 128, Earnings Per Share. SFAS No. 128 establishes standards for the computation, presentation, and disclosure of earnings per share (EPS), replacing the presentation of currently required Primary EPS with a presentation of Basic EPS. It also requires dual presentation of Basic EPS and Diluted EPS on the face of the income statement for entities with complex capital structures. Basic EPS excludes all dilution, while Diluted EPS reflects the potential dilution that could occur from the exercise or conversion of securities into common stock or from other contracts to issue common stock. SFAS No. 128 is effective for financial statements for periods ending after December 15, 1997, including interim periods, and earlier application is not permitted. When adopted, the Company will be required to restate its EPS data for all prior periods presented. The Company is in the process of evaluating this statement and its impact on the Company's reported EPS amounts. (2) PROPERTY AND EQUIPMENT Major classes of property and equipment as of June 30 are as follows:
1997 1996 ---------- ---------- Leasehold improvements $1,501,349 $1,501,349 Furniture and fixtures 1,044,088 1,016,490 Computer equipment 2,919,194 2,399,733 Office equipment 372,264 372,264 ---------- ---------- $5,836,895 $5,289,836 ========== ==========
31 32 (3) OTHER GENERAL EXPENSES -- NONRECURRING Other general expenses -- nonrecurring represents three separate charges recorded in 1995 consisting of the write off of unamortized intangible assets acquired in 1994, the write off of certain capitalized software costs, and costs associated with the 1995 departure of two executives, as more fully described below. In March 1994, the Company signed an agreement to acquire certain assets of LoanStar Systems (LoanStar), a provider of loan processing software located in California. The purchase agreement included a noncompete agreement, the source code of LoanStar's software, and a list of active LoanStar customers. The cost of the assets acquired was $649,510. Amortization of the cost of these assets amounted to $221,073 for the year ended June 30, 1995, and is included in general and administrative expense. During the year ended June 30, 1995, the level of conversions of LoanStar customers to the Company's software was significantly below management's expectations. As a result, the Company determined that the LoanStar assets had no continuing value and wrote off the remaining net book value of $330,817 at March 31, 1995. Other general expenses -- nonrecurring also includes $391,518 representing primarily the cost of purchased software acquired in a prior year. The software was previously intended for use in one of the Company's products. In connection with management's ongoing review of its development plans and consideration of alternative future uses of the acquired software, the Company determined that this software was of no further value in the ongoing development of the Company's product and charged off such capitalized costs during the fourth quarter of 1995. During the third quarter of 1995, the Company incurred $229,708 of costs in connection with the departure of its President and Chief Executive Officer and its Vice President of Product Development. (4) COMMITMENTS (a) LEASES In March 1994, the Company moved into its current premises which it leases under a noncancelable operating lease expiring in November 1998. The total of the scheduled lease payments is being charged to expense on the straight-line method over the life of the lease. The lease for the Company's previous premises, into which the Company moved in October 1992, remains in effect until its expiration in October 1998. The Company negotiated a sublease to another tenant for the remaining lease term beginning in March 1994. Included in deferred rent payable and other lease obligations is $142,568 and $322,978 which represents the Company's remaining obligation under this lease, net of amounts to be received under the sublease at June 30, 1997 and 1996, respectively. Accrued liabilities at June 30, 1997 and 1996 include $223,307 and $67,842, respectively, representing the current portion of deferred rent payable. Future minimum lease payments under noncancelable operating leases are as follows:
Net Minimum minimum lease Sublease lease payments receipts payments --------- --------- --------- Year ending June 30: 1998 874,974 (248,598) 626,376 1999 327,020 (5,257) 321,763 --------- --------- --------- 1,201,994 (253,855) 948,139 ========= ========= =========
Total rent expense amounted to $379,994, $381,447 and $382,505 for the years ended June 30, 1997, 1996, and 1995, respectively. 32 33 (b) 401(K) PLAN The Company sponsors a 401(k) plan that covers substantially all employees. At its own discretion, the Company may make contributions to the plan based on a percentage of participants' contributions. No contributions were made for the years ended June 30, 1997, 1996 and 1995. The Company has no other postemployment or postretirement benefit plans. (5) INCOME TAXES Components of income taxes are summarized as follows:
1997 1996 1995 ----------- ----------- ----------- Current: Federal $ 580,601 $ 291,906 $(1,173,047) State 37,549 18,568 (4,271) ----------- ----------- ----------- Total current 618,150 310,474 (1,177,318) ----------- ----------- ----------- Deferred: Federal (2,032) (151,137) 31,741 State (185) (5,590) (353) ----------- ----------- ----------- Total deferred (2,217) (156,727) 31,388 ----------- ----------- ----------- Charge in lieu of taxes from employee stock options 10,967 96,651 366,604 ----------- ----------- ----------- $ 626,900 $ 250,398 $ (779,326) =========== =========== ===========
Income tax expense (benefit) differs from "expected" income tax expense (benefit) (computed by applying the U.S. Federal income tax rate of 34%) as follows:
1997 1996 1995 --------- --------- --------- Computed "expected" tax expense $ 590,504 $ 232,279 $(648,659) (benefit) Tax exempt interest -- (574) (129,196) State income taxes, net of Federal 24,660 8,565 (3,052) benefit Other 11,736 10,128 1,581 --------- --------- --------- $ 626,900 $ 250,398 $(779,326) --------- --------- ---------
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities are as follows:
1997 1996 --------- --------- Deferred tax assets: Allowance for doubtful accounts receivable $ 62,112 $ 65,776 Deferred software support fees 59,254 36,662 Deferred rent 110,646 131,580 Accrued expenses 78,775 69,603 Property and equipment 461,183 299,324 --------- --------- Total deferred tax assets 771,970 602,945 Deferred tax liabilities - capitalized software (811,260) (644,452) --------- --------- Net deferred tax liability $ (39,290) $ (41,507) ========= =========
33 34 (6) SHAREHOLDERS' EQUITY (a) PREFERRED STOCK Preferred stock authorized consists of 5,000,000 shares of Series A preferred stock. The Series A preferred stock is convertible at any time into two times the number of shares of common stock and has the same voting rights as its common stock equivalent. However, Series A preferred stock has preferential treatment with respect to any payment of dividends and any distributions of assets upon liquidation. (b) STOCK OPTION PLANS The Company has three stock option plans: the 1985 Restated Stock Option Plan (1985 Plan), the 1993 Stock Option Plan (1993 Plan) and the 1993 Stock Option Plan for Nonemployee Directors (Directors Plan). The Company accounts for its option plans in accordance with the provisions of Accounting Principles Board Opinion No. 25 and no compensation cost has been recognized related to its stock options. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's net income would have decreased to the pro forma amounts indicated below:
1997 1996 ----------- ---------- Net income: As reported $1,109,877 $432,776 Pro forma 821,572 265,341 Net income per share: As reported $ .19 $ .07 Pro forma $ .14 $ .04
Pro forma net income and net income per share reflect only options granted in the years ended June 30, 1997 and 1996. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma net income and net income per share amounts presented above because compensation cost is reflected over the options' vesting period and compensation cost for options granted prior to July 1, 1995, is not considered. The per share weighted-average fair value of stock options granted during the years ended June 30, 1997 and 1996 was $3.28 and $2.05, respectively, on the date of grant using the Black Scholes option-pricing model with the following weighted-average assumptions: 1997 expected dividend yield of 0.0%, risk-free interest rate of 6.02%, expected volatility of 65%, and an expected life of 5 years; 1996 - expected dividend yield of 0.0%, risk-free interest rate of 5.11%, expected volatility of 65%, and an expected life of 5 years. The 1985 and 1993 Plans provide for both incentive stock options and other stock options that may be issued to attract and retain the services of employees. The incentive stock options vest over a four-year period and may be exercised during continued employment or within one month of terminating employment for the 1985 Plan and within three months for the 1993 Plan. All options expire ten years from the date of grant. The 1985 Plan has been suspended in regard to future grants, and stock options are currently granted pursuant to the 1993 Plan. The Company has authorized 900,000 shares of common stock to be reserved for grants pursuant to the 1993 Plan. The Directors Plan provides for stock options that may be issued to attract and retain services of the members of the Board of Directors who are not otherwise employees of the Company. The stock options vest six months from the date of grant and may be exercised during the director's term or within three months of the date the option holder ceases to be a director. All options expire five years from the date of grant. The Company has authorized 215,000 shares of common stock to be reserved for grants pursuant to the Directors Plan. 34 35 (b) STOCK OPTION PLANS (CONTINUED) A summary of stock option activity under the stock option plans follows:
Outstanding options -------------------------------------------- Number of shares Weighted Options ------------------------------- average available 1985 1993 Directors exercise for grant Plan Plan Plan price --------- -------- -------- -------- --------- Balances at June 30, 1994 308,392 661,208 54,608 12,000 $ 1.30 Options granted (276,900) -- 214,900 62,000 4.00 Options exercised -- (313,790) -- -- .14 Options canceled 104,547 (17,150) (104,547) -- 4.72 -------- -------- -------- -------- Balances at June 30, 1995 136,039 330,268 164,961 74,000 2.52 Increase in shares reserved under 1993 Plan 600,000 -- -- -- -- Options granted (472,275) -- 417,275 55,000 3.45 Options exercised -- (164,050) (6,500) -- 1.27 Options canceled 118,774 (3,800) (68,774) (50,000) 3.84 -------- -------- -------- -------- Balances at June 30, 1996 382,538 162,418 506,962 79,000 3.17 Increase in shares reserved under Directors Plan 140,000 -- -- -- -- Options granted (228,180) -- 219,180 9,000 5.46 Options exercised -- (19,650) (312) -- .88 Options canceled 59,476 (19,150) (37,476) (22,000) 4.11 -------- -------- -------- -------- Balances at June 30, 1997 353,834 123,618 688,354 66,000 3.73 ======== ======== ======== ========
Additional information regarding options outstanding as of June 30, 1997 is as follows:
Options outstanding Options exercisable -------------------------------------------------------------------------- ---------------------------------- Weighted- average Weighted- Weighted- remaining average average Range of Number contractual exercise Number exercise exercise prices outstanding life (yrs) price exercisable price --------------- ----------- --------- -------- ----------- --------- $ .100 - .500 98,918 3.83 $ .37 98,918 $ .37 2.500-3.875 530,976 8.25 3.41 173,960 3.30 4.031-5.844 217,278 9.19 5.56 32,828 4.48 7.000-8.375 30,800 6.30 7.27 26,066 7.30 --------------- --------- --------- -------- --------- --------- $ .100-8.375 877,972 7.92 $3.73 331,772 $2.86 --------------- --------- --------- -------- --------- ---------
(7) NET INTEREST AND OTHER INCOME (EXPENSE) Net interest and other income (expense) consist of:
1997 1996 1995 --------- --------- --------- Interest income $ 746,712 801,434 728,457 Interest expense (27,713) (27,579) (26,566) Other, net 276 37,417 (26,105) --------- --------- --------- $ 719,275 $ 811,272 $ 675,786 ========= ========= =========
35 36 (8) FINANCIAL INSTRUMENTS The Company's financial instruments consist primarily of investments, accounts receivable, accounts payable, and accrued liabilities. The financial instruments have a short term until maturity or settlement in cash and, therefore, the carrying value approximates fair value. (9) ACQUISITION OF PRODUCT SOURCE CODE On April 4, 1995, the Company entered into a marketing agreement with Tuttle & Co. (Tuttle), a California limited partnership to market and support its software product, Loan Officer Plus (LOP) for Windows. LOP is designed for use on laptop computers and enables loan officers to prequalify applications and originate loans in the field. The agreement provided that the Company pay Tuttle a license fee for each unit of LOP that it sold and certain amounts received by the Company for product support. In return, Tuttle provided all regulatory and regular enhancements of LOP to the Company. Pursuant to their right to terminate the marketing agreement for convenience, Tuttle delivered to the Company a notice of termination dated September 1, 1995. On October 31, 1995, the effective date of termination, the Company received a nonexclusive, perpetual license for the LOP source code in exchange for $2 million. With this license, the Company received the right to continue to market, develop, and support the LOP source code, with no further compensation to Tuttle. The Company currently markets this source code under the name MortgageWare Entre. (10) QUARTERLY FINANCIAL DATA (UNAUDITED) The following table summarizes the unaudited statements of operations for each quarter of fiscal 1997 and 1996 (in thousands, except per share amounts):
First Second Third Fourth --------- --------- --------- --------- 1997 Net revenues $3,579 $3,516 $3,534 $3,738 Gross profit 2,620 2,530 2,509 2,669 Operating income 318 246 86 368 Net earnings 326 271 161 352 Earnings per share $ .05 $ .05 $ .03 $ .06 1996 Net revenues $2,954 $3,109 $3,345 $3,684 Gross profit 1,980 2,113 2,450 2,629 Operating income (loss) (369) (311) 180 372 Net earnings (loss) (104) (76) 242 371 Earnings (loss) per share $ (.02) $ (.01) $ .04 $ .06
36 37 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Incorporated by reference to the information under the captions "Election of Directors," "Continuing Class I Directors, Terms Expiring in 1998," "Nominees for Election as Class II Directors, Terms Expiring in 1999," "Directors' Fees," and "Filing of Forms Pursuant to Section 16 of the Securities Exchange Act of 1934" in the Company's Proxy Statement relating to its 1997 Annual Meeting of Shareholders (the "Proxy Statement"). Certain information regarding the executive officers of the Company is set forth in Part I. ITEM 11. EXECUTIVE COMPENSATION Incorporated by reference to the information under the captions "Directors Fees," "Compensation of Officers," and "Employment Contracts, Termination of Employment and Change of Control Arrangements" in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Incorporated by reference to the information under the caption "Voting Securities and Principal Holders Thereof" in the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (A) THE FOLLOWING DOCUMENTS ARE FILED AS A PART OF THIS REPORT: 1. FINANCIAL STATEMENTS The Financial Statements, Notes thereto, and Independent Auditor's Report are included in Part II, Item 8 of this Report. 2. FINANCIAL STATEMENT SCHEDULES The following documents are filed as part of this report and should be read in conjunction with the Financial Statements of INTERLINQ Software Corporation. Schedule II - Valuation and Qualifying Accounts for the years ended June 30, 1997, 1996, and 1995 Schedules not listed above have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the Financial Statements or Notes thereto. 37 38 3. EXHIBITS. The Exhibits listed on the accompanying Index to Exhibits immediately following the financial statement schedules are filed as part of, or incorporated by reference into, this report.
Exhibit Number Description ------ ----------- 3.1(1) Restated Articles of Incorporation of INTERLINQ Software Corporation 3.2(1) Restated Bylaws of INTERLINQ Software Corporation 10.1(1)(2) 1985 Restated Stock Option Plan 10.2(1)(2) 1993 Stock Option Plan 10.3(1)(2) Stock Option Plan for Non-Employee Directors, as amended 10.4(1) Amended and Restated Registration Rights Agreement between INTERLINQ Software Corporation and the partners listed on Schedule A thereto dated as of March 12, 1993 10.6(1) Office Lease between Yarrow Bay Office III Limited Partnership and INTERLINQ Software Corporation dated as of July 31, 1992 10.7(1) Forms Remarketing Agreement between INTERLINQ Software Corporation and Great Lakes Business Forms, Inc. Dated as of April 10, 1989 10.8(1) Form of Indemnification Agreement for Directors and Officers 10.10(3) Co-Marketing Agreement between INTERLINQ Software Corporation and CMCI Corporation dated as of July 1, 1993 10.12(4) Office sublease between Halliburton Company and INTERLINQ Software Corporation dated January 21, 1994 10.15(2)(5) Letter dated August 25, 1995 regarding Jiri Nechleba Compensatory Arrangement 10.16(5) Appointment of Licensing Agent and Compliance Delegate Agreement between VMP's Electronic Laser Forms, Inc. A division of CBF Systems, Inc. And INTERLINQ Software Corporation dated October 2, 1995 10.17(5) Amendment of Co-marketing Agreement between INTERLINQ Software Corporation and CMCI Corporation dated October 1, 1995 23.1 Consent of KPMG Peat Marwick LLP 27.1 Financial data schedule
(1) Incorporated by reference to the Company's Registration Statement on Form S-1, as amended (Registration No. 33-59502) filed with the Securities and Exchange Commission on March 15, 1993, as same exhibit number. (2) Management contract or compensatory plan or arrangement. (3) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1993, as same exhibit number. Confidential treatment has been requested as to portions of this document. (4) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1994, as same exhibit number. (5) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1996, as same exhibit number. (6) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1995, as same exhibit number. Confidential treatment has been requested as to portions of this document. (B) REPORTS ON FORM 8-K DURING THE FOURTH QUARTER ENDED JUNE 30, 1997 None 38 39 Schedule II INTERLINQ SOFTWARE CORPORATION VALUATION AND QUALIFYING ACCOUNTS Years ended June 30, 1997, 1996 and 1995
Additions ---------------------- Balance at Charged to Charged to beginning of costs and other Balance at Description year expenses accounts Deductions end of year ----------- ------------ ---------- ---------- ---------- ----------- Allowances for doubtful accounts: Year ended June 30, 1997: Accounts receivable $ 187,007 $ 396,986 -- $(407,993) $ 176,000 Year ended June 30, 1996: Accounts receivable 152,287 331,224 -- (296,504) 187,007 Year ended June 30, 1995: Accounts receivable 403,341 704,618 -- (955,672) 152,287
39 40 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Seattle, State of Washington, on the 26th day of September, 1997. INTERLINQ SOFTWARE CORPORATION By: /s/ JIRI M. NECHLEBA ------------------------------------- Jiri Nechleba President and Chief Executive Officer
Signature Title --------- ----- /s/ JIRI M. NECHLEBA Chairman of the Board, President and Chief - ------------------------------- Executive Officer Jiri M. Nechleba (Principal Executive Officer) /s/ STEPHEN A. YOUNT Vice President-Finance, Chief Financial Officer - ------------------------------- and Secretary Stephen A. Yount (Principal Accounting Officer) /s/ ROBERT W. O'REAR Director - ------------------------------- Robert W. O'Rear /s/ THEODORE M. WIGHT Director - ------------------------------- Theodore M. Wight /s/ ROBERT J. GALLAGHER Director - ------------------------------- Robert J. Gallagher
40 41 INTERLINQ SOFTWARE CORPORATION INDEX TO EXHIBITS
Exhibit # Description - ------------ ------------------------------------------------------------------------------------ 3.1(1) Restated Articles of Incorporation of INTERLINQ Software Corporation 3.2(1) Restated Bylaws of INTERLINQ Software Corporation 10.1(1)(2) 1985 Restated Stock Option Plan 10.2(1)(2) 1993 Stock Option Plan 10.3(1)(2) Stock Option Plan for Non-Employee Directors, as amended 10.4(1) Amended and Restated Registration Rights Agreement between INTERLINQ Software Corporation and the partners listed on Schedule A thereto dated as of March 12, 1993 10.6(1) Office Lease between Yarrow Bay Office III Limited Partnership and INTERLINQ Software Corporation dated as of July 31, 1992 10.7(1) Forms Remarketing Agreement between INTERLINQ Software Corporation and Great Lakes Business Forms, Inc. Dated as of April 10, 1989 10.8(1) Form of Indemnification Agreement for Directors and Officers 10.10(3) Co-Marketing Agreement between INTERLINQ Software Corporation and CMCI Corporation dated as of July 1, 1993 10.12(4) Office sublease between Halliburton Company and INTERLINQ Software Corporation dated January 21, 1994 10.15(2)(5) Letter dated August 25, 1995 regarding Jiri Nechleba Compensatory Arrangement 10.16(5) Appointment of Licensing Agent and Compliance Delegate Agreement between VMP's Electronic Laser Forms, Inc. A division of CBF Systems, Inc. And INTERLINQ Software Corporation dated October 2, 1995 10.17(5) Amendment of Co-marketing Agreement between INTERLINQ Software Corporation and CMCI Corporation dated October 1, 1995 23.1 Consent of KPMG Peat Marwick LLP 27.1 Financial data schedule
- ---------------------- (1) Incorporated by reference to the Company's Registration Statement on Form S-1, as amended (Registration No. 33-59502) filed with the Securities and Exchange Commission on March 15, 1993, as same exhibit number. (2) Management contract or compensatory plan or arrangement. (3) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1993, as same exhibit number. Confidential treatment has been requested as to portions of this document. (4) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1994, as same exhibit number. (5) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1996, as same exhibit number. (6) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarterly period ended September 30, 1995, as same exhibit number. Confidential treatment has been requested as to portions of this document. 41 EX-23.1 2 CONSENT OF KPMG PEAT MARWICK LLP 1 CONSENT OF INDEPENDENT AUDITORS The Board of Directors and Shareholders INTERLINQ Software Corporation: We consent to incorporation by reference in the registration statements (No. 33-63388 and 333-4558) on Form S-8 of INTERLINQ Software Corporation of our report dated August 1, 1997, relating to the balance sheets of INTERLINQ Software Corporation as of June 30, 1997 and 1996, and the related statements of operations, shareholders' equity, and cash flows and the related financial statement schedule for each of the years in the three-year period ended June 30, 1997, which report appears in the June 30, 1997 annual report on Form 10-K. /s/ KPMG Peat Marwick LLP Seattle, Washington September 26, 1997 42 EX-27.1 3 FINANCIAL DATA SCHEDULE
5 1000 12-MOS JUN-30-1997 JUL-01-1996 JUN-30-1997 7,794 6,038 1,602 0 55 16,165 5,837 4,365 21,067 4,542 0 0 0 54 15,996 21,067 7,055 14,367 1,500 4,039 9,311 0 0 1,737 627 1,110 0 0 0 1,110 .19 .19
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