<PAGE>   1
--------------------------------------------------------------------------------

                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON D.C. 20549
                               Amendment  No. 2
                                      to
                                   FORM 10-Q

(Mark One)
[X]  Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
     Act of 1934 
     For the period ended DECEMBER 31, 1998
                                       OR
[ ]  Transition report pursuant to Section 13 or 15(d) of the Securities 
     Exchange Act of 1934

                         COMMISSION FILE NUMBER 0-21402


                         INTERLINQ SOFTWARE CORPORATION
             (Exact name of registrant as specified in its charter)

                 WASHINGTON                                    91-1187540
       (State or other jurisdiction of                      (I.R.S. Employer
       incorporation or organization)                     Identification No.)

                             11980 N.E. 24TH STREET
                               BELLEVUE, WA 98005
                    (Address of principal executive offices)

                                 (425) 827-1112
              (Registrant's telephone number, including area code)

                               11255 KIRKLAND WAY
                               KIRKLAND, WA 98033
                 (Former address, if changed since last report)


Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such report), and (2) has been subject to such filing
requirements for the past 90 days.

                              Yes [X]       No [ ]


As of January 21, 1999, there were 5,128,662 shares of the Registrant's Common
Stock outstanding.

<PAGE>   2

PART I.   FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS

                              INTERLINQ SOFTWARE CORPORATION
                                 CONDENSED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                         DECEMBER 31,      JUNE 30,
                                                            1998             1998
                                                         ------------     -----------
                                                         (restated)       (restated)
ASSETS                                                   (unaudited)
<S>                                                      <C>              <C>        
CURRENT ASSETS:
     Cash and cash equivalents                           $ 2,707,270      $ 7,233,826
     Short-term investments                                6,703,116        6,673,923
     Accounts receivable, net                              3,797,274        3,400,194
     Inventory, prepaid expenses and
      other current assets                                 1,211,355          732,273
                                                         -----------      -----------
            Total current assets                          14,419,015       18,040,216
                                                         -----------      -----------

Property and equipment, at cost                            7,817,547        6,434,017
     Less accumulated depreciation and amortization        5,907,257        5,434,285
                                                         -----------      -----------
            Net property and equipment                     1,910,290          999,732
                                                         -----------      -----------

Capitalized software costs, net                            4,434,224        4,421,806
Goodwill and other intangible assets, net                  2,814,038        3,198,021
Other assets                                                 115,992          110,102
                                                         -----------      -----------
                                                         $23,693,559      $26,769,877
                                                         ===========      ===========

LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
     Accounts payable                                    $   846,424      $   690,138
     Accrued compensation and benefits                     1,051,682        1,745,908
     Other accrued liabilities                               227,581          670,800
     Purchase consideration payable                               --        2,600,000
     Customer deposits                                       534,342          374,151
     Deferred software support fees                        4,205,486        3,434,092
                                                         -----------      -----------
            Total current liabilities                      6,865,515        9,515,089
                                                         -----------      -----------

NONCURRENT LIABILITIES                                       111,436           99,864

SHAREHOLDERS' EQUITY:
     Common stock                                             51,262           53,506
     Additional paid-in capital                            9,211,669       10,442,835
     Retained earnings                                     7,453,677        6,658,583
                                                         -----------      -----------
            Total shareholders' equity                    16,716,608       17,154,924
                                                         -----------      -----------
                                                         $23,693,559      $26,769,877
                                                         ===========      ===========
</TABLE>

See accompanying notes to condensed financial statements.



                                       2
<PAGE>   3

                         INTERLINQ SOFTWARE CORPORATION
                            STATEMENTS OF OPERATIONS
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                               THREE MONTHS ENDED                SIX MONTHS ENDED
                                                   DECEMBER 31,                     DECEMBER 31,
                                             1998             1997            1998              1997
                                         -----------      -----------      -----------      -----------
                                         (restated)                         (restated)
<S>                                      <C>              <C>              <C>              <C>        
NET REVENUES:
     Software license fees               $ 3,158,612      $ 2,153,376      $ 6,505,717      $ 3,699,535
     Software support fees                 2,086,439        1,734,390        4,067,714        3,427,976
     Other                                   559,935          480,829        1,039,622          882,923
                                         -----------      -----------      -----------      -----------
        Total net revenues                 5,804,986        4,368,595       11,613,053        8,010,434
                                         -----------      -----------      -----------      -----------

COST OF REVENUES:
     Software license fees                   611,290          398,336        1,151,124          815,211
     Software support fees                   631,035          604,531        1,269,847        1,127,118
     Other                                   280,353          207,877          542,605          451,446
                                         -----------      -----------      -----------      -----------
        Total cost of revenues             1,522,678        1,210,744        2,963,576        2,393,775
                                         -----------      -----------      -----------      -----------
        Gross profit                       4,282,308        3,157,851        8,649,477        5,616,659
                                         -----------      -----------      -----------      -----------

OPERATING EXPENSES:
     Product development                     836,020          450,741        1,601,832          774,205
     Sales and marketing                   1,420,183        1,377,091        2,868,805        2,578,151
     General and administrative            1,623,183          947,786        2,778,374        1,716,744
     Amortization of goodwill and
        other intangible assets              214,833               --          429,666               --
                                         -----------      -----------      -----------      -----------
        Total operating expenses           4,094,219        2,775,618        7,678,677        5,069,100
                                         -----------      -----------      -----------      -----------
        Operating income                     188,089          382,233          970,800          547,559
Net interest and other income                136,746          183,716          291,253          375,487
                                         -----------      -----------      -----------      -----------
        Income before income taxes           324,835          565,949        1,262,053          923,046
Income tax expense                           120,189          209,401          466,959          357,284
                                         -----------      -----------      -----------      -----------
        Net income                       $   204,646      $   356,548      $   795,094      $   565,762
                                         ===========      ===========      ===========      ===========


Net income per share - basic             $       .04      $       .07      $       .15      $       .11
Net income per share - diluted           $       .04      $       .07      $       .14      $       .11

Share used to calculate net income
    per share - basic                      5,124,097        5,225,237        5,217,008        5,215,224
Shares used to calculate net income
     per share - diluted                   5,431,071        5,345,289        5,497,773        5,328,099
</TABLE>

See accompanying notes to condensed financial statements.



                                       3
<PAGE>   4

                         INTERLINQ SOFTWARE CORPORATION
                       CONDENSED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                      SIX MONTHS ENDED
                                                                        DECEMBER 31,
                                                                   1998             1997
                                                               -----------       -----------
                                                                (restated)
<S>                                                            <C>               <C>        
CASH FLOWS FROM OPERATING ACTIVITIES:
   Net income                                                  $   795,094       $   565,762
      Adjustments to reconcile net income to net cash
        provided by operating activities:
           Depreciation and amortization                           901,660           572,033
           Amortization of capitalized software costs            1,032,920           724,933
           Change in operating assets and liabilities:
             Accounts receivable                                  (397,080)         (754,447)
             Inventory and prepaid expenses                       (454,495)          (64,464)
             Other assets                                           (5,890)           15,696
             Accounts payable                                      268,666           (37,574)
             Accrued compensation and benefits,
                and other accrued liabilities                   (1,162,032)          (70,220)
             Customer deposits                                     160,191            23,703
             Deferred software support fees                        738,261           170,296
                                                               -----------       -----------
                Net cash provided by operating activities        1,877,295         1,145,718
                                                               -----------       -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
   Purchases of property and equipment                          (1,383,530)         (223,856)
   Capitalized software costs                                   (1,045,338)         (752,786)
   Proceeds from sales and maturities of short-term
      investments                                                  (29,193)        2,819,471
   Cash paid for acquisition                                    (2,712,380)               --
                                                               -----------       -----------
                Net cash (used in) provided by investing
                      activities                                (5,170,441)        1,842,829
                                                               -----------       -----------

CASH FLOWS FROM FINANCING ACTIVITIES:
   Proceeds from issuance of common stock                           19,340             8,488
   Repurchase of common stock                                   (1,252,750)       (1,311,687)
                                                               -----------       -----------
                Net cash used in financing activities           (1,233,410)       (1,303,199)
                                                               -----------       -----------
                Net (decrease) increase in cash and
                      cash equivalents                          (4,526,556)        1,685,348
   Cash and cash equivalents at beginning of period              7,233,826         7,793,761
                                                               ===========       ===========
   Cash and cash equivalents at end of period                  $ 2,707,270       $ 9,479,109
                                                               ===========       ===========
</TABLE>

See accompanying notes to condensed financial statements.



                                        4
<PAGE>   5

                         INTERLINQ SOFTWARE CORPORATION
                     NOTES TO CONDENSED FINANCIAL STATEMENTS
                                DECEMBER 31, 1998
                                   (UNAUDITED)

1.      BASIS OF PRESENTATION

The accompanying unaudited financial statements have been prepared in accordance
with generally accepted accounting principles for interim financial information
pursuant to the rules and regulations of the Securities and Exchange Commission.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.

In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three-month period ended December 31, 1998, are not
necessarily indicative of the results for the year ending June 30, 1999. The
financial statements should be read in conjunction with the financial statements
and notes thereto included in the Company's Annual Report on Form 10-K for the
fiscal year ended June 30, 1998, as amended by Form 10-K/A on March 9, 1999.

2.      RESTATEMENT

The management of the Company and the Staff of the Securities and Exchange
Commission have had discussions with respect to the methods used to value
acquired in-process research and development recorded and written off at the
date of acquisition of Logical Software Solutions Corporation (LSS). As a result
of these discussions, the Company has modified the method used to determine the
value of in-process R&D acquired in connection with the Company's June 1998
acquisition of LSS. Initial calculations of the value of the in-process R&D were
based on the cost required to complete the project, the after-tax cash flows
attributable to the project, and selection of an appropriate rate of return to
reflect the risk associated with the project. Revised calculations are based on
adjusted after-tax cash flows that give explicit consideration to the Staff's
views on in-process R&D as set forth in its September 15, 1998 letter to the
AICPA, and the Staff's comments for the Company to consider the stage of
completion of the in-process technology at the date of acquisition. As a result
of this modification the Company decreased the amount of the purchase price
allocated to in-process research and development in the LSS acquisition from
$3,615,304 to $1,349,616. This resulted in a corresponding increase to goodwill,
which is being amortized over its useful life of four years on a straight-line
basis. As a result of the significant decrease in the amount of acquired
in-process research and development, there was also a significant decrease in
the corresponding deferred tax asset. Given this decrease, the Company has
determined that a valuation allowance is no longer necessary.



                                       5
<PAGE>   6

The effects of the restatement resulted in the following impact on the Company's
results of operations for the quarter and the six months ended December 31,
1998, respectively.

<TABLE>
<CAPTION>
                                                                                 December 31, 1998
                                                                            Quarter           Six Months
                                                                             Ended              Ended
                                                                           -----------       -----------
<S>                                                                        <C>               <C>        
    Income before income taxes as previously reported                      $   466,441       $ 1,545,265
    Restatement adjustment to record additional goodwill amortization         (141,606)         (283,212)
                                                                           -----------       -----------
    Income before income taxes as restated                                 $   324,835       $ 1,262,053
                                                                           -----------       -----------

    Net income as previously reported                                      $   305,520       $ 1,012,150
    Restatement adjustment to record additional goodwill amortization
    (net of income taxes)                                                     (100,874)         (217,056)
                                                                           -----------       -----------
    Net income as restated                                                 $   204,646       $   795,094
                                                                           -----------       -----------

    Net income per diluted share as previously reported                    $       .06       $       .18
    Restatement adjustment to record additional goodwill amortization
    (net of income taxes)                                                         (.02)             (.04)
                                                                           -----------       -----------
    Net income per diluted share as restated                               $       .04       $       .14
                                                                           -----------       -----------
</TABLE>


The effect of the restatement resulted in the following impact on the Company's
financial position at December 31, 1998, and June 30, 1998:


<TABLE>
<CAPTION>
                                                                             December 31,       June 30,
                                                                                1998             1998
                                                                             -----------      -----------
<S>                                                                          <C>              <C>        
    Total assets as previously reported                                      $21,269,340      $24,153,189
    Restatement adjustment to reduce in-process R&D, net                       2,424,219        2,616,688
                                                                             -----------      -----------
    Total assets as restated                                                 $23,693,559      $26,769,877
                                                                             -----------      -----------

    Total liabilities as previously reported                                 $ 6,891,951      $ 9,554,540
    Restatement adjustment to record current and deferred tax liability           85,000           60,413
                                                                             -----------      -----------
    Total liabilities as restated                                            $ 6,976,951      $ 9,614,953
                                                                             -----------      -----------

    Retained earnings as previously reported                                 $ 5,114,458      $ 4,102,308
    Restatement adjustment to reduce in-process R&D                            1,982,476        2,265,688
    Restatement adjustment for income taxes                                      356,743          290,587
                                                                             -----------      -----------
    Retained earnings as restated                                            $ 7,453,677      $ 6,658,583
                                                                             -----------      -----------
</TABLE>


3.      EARNINGS PER SHARE

Basic earnings per share is computed using the weighted average number of common
shares outstanding during the period. Diluted earnings per share is computed
using the weighted average number of common and dilutive common equivalent
shares outstanding during the period.



                                       6
<PAGE>   7

The following table reconciles the shares used in calculating basic earnings per
share to the shares used in calculating diluted earnings per share:

<TABLE>
<CAPTION>
                                              THREE MONTHS ENDED              SIX MONTHS ENDED
                                                  DECEMBER 31,                  DECEMBER 31,
                                              1998           1997           1998           1997
                                            ---------      ---------      ---------      ---------
<S>                                         <C>            <C>            <C>            <C>      
Weighted average common shares              5,124,097      5,225,237      5,217,008      5,215,224
Dilutive effect of outstanding options        306,974        120,052        280,765        112,875
                                            ---------      ---------      ---------      ---------
Weighted average common and
     common equivalent shares               5,431,071      5,345,289      5,497,773      5,328,099
                                            =========      =========      =========      =========
</TABLE>


Certain options outstanding at the end of each period presented were excluded
from the computation of earnings per share because their inclusion would be
anti-dilutive as follows:

<TABLE>
<CAPTION>
                                         THREE MONTHS ENDED             SIX MONTHS ENDED
                                             DECEMBER 31,                  DECEMBER 31,
                                         1998            1997          1998            1997
                                       ---------      ---------      ---------      ---------
<S>                                    <C>            <C>            <C>            <C>      
Options excluded from computation          4,933        225,165         28,312        230,732
Weighted-average exercise price        $    7.55      $    5.83      $    7.08      $    5.83
</TABLE>

4.   REVENUE RECOGNITION

On July 1, 1998, the Company adopted the provisions of Statement of Position
97-2, Software Revenue Recognition ("SOP 97-2"), which provides specific
industry guidance and stipulates that revenue recognized from software
arrangements is to be allocated to each element of the arrangement based on the
relative fair values of the elements, such as software products, upgrades,
enhancements, post contract customer support, consulting and implementation
services, or training. Under SOP 97-2, the determination of fair value is based
on objective evidence that is specific to the vendor. If such evidence of fair
value for each element of the arrangement does not exist, all revenue from the
arrangement is deferred until such time that evidence of fair value does exist
or until all elements of the arrangement are delivered. The adoption of SOP 97-2
did not have a material effect on the Company's revenue recognition.

5.   ACQUISITION

On June 30, 1998, the Company acquired substantially all of the assets and
business of Logical Software Solutions Corporation ("LSS"). LSS is an enterprise
application integration developer and service provider. The purchase price
consisted of 233,334 shares of common stock valued at approximately $1,400,000,
cash in the amount of $3,600,000, and $379,000 in direct acquisition costs. The
233,334 shares of common stock issued in the acquisition were placed in escrow
and will vest with time over a six-year period. Vesting of the shares will be
accelerated if annual performance goals to be determined by mutual agreement
among the Company and the former LSS shareholders are met. If all performance
goals are met, the shares will fully vest in three years. The specific
performance goals have not yet been determined.

The acquisition was accounted for using the purchase method of accounting.
Accordingly, the results of operations of the acquired business and the fair
market values of the acquired assets and 



                                       7
<PAGE>   8

assumed liabilities were included in the Company's financial statements as of
the date of acquisition. The purchase price was allocated to the acquired assets
and assumed liabilities based on fair values.

A portion of the purchase price represents purchased in-process research and
development that has not yet reached technological feasibility and has no
alternative future use. The value assigned to purchased in-process research and
development was determined by identifying research projects in areas for which
technological feasibility has not been established; estimating the costs to
develop the purchased in-process research and development into commercially
viable products; estimating the resulting net cash flows from such projects;
discounting the net cash flows back to the time of acquisition; and applying an
attribution rate based on the estimated percent complete.

The following table presents pro forma results of operations as if the
acquisition had occurred on July 1, 1997, excluding all nonrecurring
acquisition-related charges. The table includes the impact of certain
adjustments such as goodwill amortization and related tax effects. The pro forma
information is not necessarily indicative of the combined results that would
have occurred had the acquisition been in effect for the entire period
presented, nor is it necessarily indicative of results that may occur in the
future.

<TABLE>
<CAPTION>
                                                   Quarter Ended      Six Months Ended
                                                  December 31, 1997   December 31, 1997
                                                  -----------------   -----------------
<S>                                               <C>                 <C>       
   Total net revenues                                $4,504,000          $8,504,000
   Net income                                           125,000             209,000
   Net income per share - basic and diluted                 .02                 .04
</TABLE>

5.   NEW ACCOUNTING STANDARDS

In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 130, Reporting Comprehensive Income ("SFAS
No. 130"). SFAS No. 130 establishes standards for reporting and disclosure of
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general-purpose financial statements. SFAS No. 130, which is
effective for fiscal years beginning after December 15, 1997, requires
reclassification of financial statements for earlier periods to be provided for
comparative purposes. The Company currently has no components of accumulated
other comprehensive income and has not determined the manner in which it will
present the information required by SFAS No. 130 in its annual financial
statements for the year ending June 30, 1999.

In June 1997, the FASB issued SFAS No. 131, Disclosure About Segments of an
Enterprise and Related Information ("SFAS No. 131"). SFAS No. 131 establishes
standards for the way public business enterprises report information about
operating segments. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. SFAS No. 131 is
effective for fiscal years beginning after December 15, 1997. In the initial
year of application, comparative information for earlier years must be restated.
The Company has not determined the manner in which it will present the
information required by SFAS No. 131 in its annual financial statements for the
year ending June 30, 1999.

On December 22, 1998, the AICPA Accounting Standards Executive Committee issued
Statement of Position (SOP) 98-9. SOP 98-9 amends paragraphs 11 and 12 of SOP
97-2 to require recognition of revenue using the "residual method" when (1)
there is vendor-specific objective evidence of the fair values of all
undelivered elements in a multiple-element arrangement that is not accounted for
using long-term contract accounting, (2) vendor-specific objective evidence of
fair value does not exist for one or more of the delivered elements in the
arrangement, and (3) all revenue-recognition criteria in SOP 97-2 other than the
requirement for vendor-specific objective evidence of the fair value of each
delivered 



                                       8
<PAGE>   9

element of the arrangement are satisfied. Under the residual method, the
arrangement fee is recognized as follows: (1) the total fair value of the
undelivered elements, as indicated by vendor-specific objective evidence, is
deferred and subsequently recognized in accordance with the relevant sections of
SOP 97-2 and (2) the difference between the total arrangement fee and the amount
deferred for the undelivered elements is recognized as revenue related to the
delivered elements. The "residual method" established by SOP 98-9 is effective
for fiscal years beginning after March 15, 1999. The Company believes that the
adoption of SOP 98-9 will not have a material effect on the Company's revenue
recognition.



                                       9
<PAGE>   10

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following Management's Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements that have been made
under the provisions of the Private Securities Litigation Reform Act of 1995.
Such forward-looking statements are based on current expectations, estimates and
projections about the Company's industry, management's beliefs and certain
assumptions made by management. When used throughout this discussion, words such
as "anticipates," "expects," "intends," "plans," "believes," "seeks,"
"estimates" and similar expressions are intended to identify such
forward-looking statements. These statements are not guarantees of future
performance and are subject to certain risks, uncertainties and assumptions that
are difficult to predict. The Company's actual actions or results may differ
materially from those discussed in the forward-looking statements. Factors which
could affect the Company's financial results and cause such results to differ
materially from quarter to quarter include, but are not limited to, fluctuations
in quarterly performance and in interest rates, competition, timing and customer
acceptance of new products, the Company's ability to manage growth and integrate
acquired technology, changes in governmental regulations and tax laws, and
general economic conditions and concerns raised by the Year 2000 computer
problem. Additional information regarding these and other risks and
uncertainties is described in the Company's Annual Report on Form 10-K for the
fiscal year ended June 30, 1998, and in other reports filed by the Company from
time to time with the Securities and Exchange Commission. Readers are cautioned
not to place undue reliance on these forward-looking statements, which speak
only as of the date hereof. The Company undertakes no obligation to update
publicly any forward-looking statements, whether as a result of new information,
future events or otherwise.

OVERVIEW

INTERLINQ Software Corporation, established in 1982, is a leading provider of
technology that helps organizations effectively manage complex,
information-intensive business transactions.

On June 30, 1998, the Company acquired substantially all of the assets and
business of Logical Software Solutions Corporation ("LSS"). This acquisition
included the LSS technology and specifically FlowMan(R) version 3.2. As a result
of the acquisition, the Company formed two operating divisions - the Mortgage
Technology Division and the Enterprise Technology Division. The operations of
the acquired company are included in the Company's financial statements
beginning on June 30, 1998.

The Mortgage Technology Division provides business solutions to approximately
2,000 banks, savings institutions, mortgage banks, mortgage brokers and credit
unions. The Enterprise Technology Division provides process-centered, enterprise
application integration ("EAI") solutions through third-party application
developers, OEMs and system integrators.

MORTGAGE TECHNOLOGY DIVISION: Through its Mortgage Technology Division, the
Company works closely with clients to provide comprehensive software
applications and business 



                                       10
<PAGE>   11

solutions for the residential mortgage and construction lending industry,
offering a suite of products, MortgageWare(R) Enterprise, that manages the
entire life cycle of a mortgage loan.

Prior to the mid-1980s, mortgage loans in the United States were originated in a
manual and paper-intensive process. Beginning in the mid-1980s and running
through the mid-1990s, the mortgage lending industry implemented its first wave
of automation with PC-based software solutions for mortgage originations. During
this period, the Company experienced rapid revenue and customer growth by
providing its MortgageWare Loan Management System - designed as a robust,
full-featured and cost-effective PC-based software solution for mortgage
originations.

This first wave of automation accelerated and amplified beginning in 1992, as
mortgage interest rates reached historically low levels and mortgage refinance
volumes soared. In early 1994, the Federal Reserve raised interest rates, which
immediately caused mortgage refinance volumes to decline substantially. As a
result, lenders found themselves with excess labor and mortgage processing
capacity. Consequently, the Company believes, the industry was focused more on
staff reduction and cost-cutting than on adding new automated loan management
systems.

From 1996 through 1998, mortgage-lending rates have reflected a lending
environment that has experienced a high degree of volatility. In spite of this
volatility, overall lending conditions have been considered favorable for the
borrower compared to most historical measures. The Company believes that this
overall favorable lending environment for mortgage-lending activity is driving
an increase in financing of home sales and refinancing of existing mortgages.
During the latter half of fiscal year 1997, the Company observed a shift in the
mortgage origination business, which it attributes to excess production capacity
coupled with a reduced profit margin. Currently, most of this excess production
capacity appears to have been fulfilled, yet profit margins in mortgage loan
origination continue to be low.

During the quarter ended December 31, 1998, the Company saw an increase in
software license fees, compared to the same quarter in the prior year, due to
demand for the MortgageWare Enterprise product suite and the continuing
favorable lending environment. The Company believes that due to intense
competition in the mortgage lending industry and the related lower profit
margins, its customers will continue to shift their long-term purchasing
decisions from solutions that solely increase production capacity to solutions
that will help to reduce unit costs and, consequently, increase profit margins.
Accordingly, during fiscal years 1996 and 1997, the Company sought to diversify
its product offerings by developing an integrated "enterprise" solution for the
mortgage lending industry. The Company believes that this broader enterprise
solution has contributed to the increases in software license revenues over the
last few quarters, and will allow the Company to respond advantageously to the
recent changes in the mortgage lending industry. This broader product offering
is designed to reduce the cost of originating, processing, and servicing a
mortgage, rather than just increasing production capacity.

ENTERPRISE TECHNOLOGY DIVISION: Through its Enterprise Technology Division, the
Company intends to enter the EAI market by marketing 



                                       11
<PAGE>   12

FlowMan, a software product that integrates disparate systems and applications
to facilitate ongoing process knowledge management by applying its business
process and rules technology across an entire enterprise. FlowMan is designed to
coordinate the execution and timing of all tasks, events and decisions for key
business processes across legacy systems, enterprise applications, client-server
systems and Internet technologies.

Upon acquisition of LSS, the Company developed a two-prong strategy to leverage
the FlowMan technology. This two-prong strategy is expected to provide growth
and diversification for the Company, while allowing it to continue to expand and
excel in its core market of mortgage technology.

In the first prong, the Company is in the process of integrating the FlowMan
technology with the Company's MortgageWare Enterprise product suite. This is
expected to further broaden the capabilities and the appeal of the Mortgage
Technology Division's product offerings and strengthen the commitment of the
Company to enterprise solutions. In the second prong, the Company has entered
the EAI market by marketing FlowMan on a stand-alone basis, primarily through
OEMs, system integrators, and third-party application developers. The Company
believes that the product can be successfully marketed as an application package
in other vertical markets and as a tool kit for use by other application
providers. The Company views the EAI market as being in its early stages of
development and expects this market to grow over the next few years.



CERTAIN DEVELOPMENTS: On December 29, 1998, the Company entered into an
agreement with Terlin, Inc., an affiliate of W.R. Hambrecht + Co., LLC ("WRH")
relating to a leveraged recapitalization of the Company. Under the agreement,
the Company will merge with Terlin, Inc. If approved by shareholders, the merger
may result in the Company ceasing to be publicly traded. In the merger, each of
approximately 2,150,000 shares of Terlin Inc. will convert into one share of the
Company's common stock. In addition, 1,250,000 shares of the Company's common
stock will remain outstanding and all other outstanding shares will be converted
into the right to receive cash in the amount of $9.25 per share. Each
shareholder will be given the opportunity to elect as to all or a part of his or
her shares, to retain such shares. To the extent that the shareholders elect to
retain more or less than 1,250,000 shares, the shareholders will receive
additional shares or cash on a pro rata basis. Additionally, a reverse stock
split may take place following the merger to reduce the number of shareholders
to less than 300 to facilitate taking the Company private.

NET REVENUES

<TABLE>
<CAPTION>
Three months ended December 31,
(In thousands)                1998          1997         Change
---------------------------------------------------------------
<S>                          <C>           <C>           <C>
Software license fees        $3,159        $2,153            47%

Software support fees         2,086         1,734            20%

Other                           560           481            16%
---------------------------------------------------------------
Total net revenues           $5,805        $4,368            33%
---------------------------------------------------------------
</TABLE>

Net revenues consist of software license fees, software support fees and other
revenues (which include training, consulting fees, document fees, and other
miscellaneous sales), net of discounts and sales returns.



                                       12
<PAGE>   13

Software license fees were $3,159,000 for the quarter ended December 31, 1998,
an increase of 47% from $2,153,000 in the comparable quarter of the prior year.
Software license fees were $6,506,000 for the six months ended December 31,
1998, an increase of 76% from $3,700,000 in the comparable period of the prior
year. These increases were due primarily to demand from new and existing
customers for the Company's MortgageWare Enterprise product suite, resulting in
a combination of a net increase in sales of MortgageWare TC/MortgageWare Loan
Management System (as lenders added production capacity), an increase in sales
of MortgageWare Loan Servicing and to a lesser extent, increased sales of the
Company's other products.

Software support fees were $2,086,000 for the quarter ended December 31, 1998,
an increase of 20% from $1,734,000 in the comparable quarter of the prior year.
Software support fees were $4,068,000 for the six months ended December 31,
1998, an increase of 19% from $3,428,000 in the comparable period of the prior
year. These period-to-period increases were due primarily to higher software
sales volume and a relatively low customer attrition rate. Due in part to
changes, from time to time, in government regulations relating to documentation
required for residential mortgage lending, the vast majority of the Company's
customers purchase annual software support agreements. Because software support
fees are recognized ratably over the term of the annual support agreement (while
software license fees are recognized on product shipment), the percentage
increase in software support fees compared to software license fees is not
directly proportional. The Company believes software support fees are likely to
continue to increase at a modest rate for the rest of fiscal year 1999.

Other revenues were $560,000 for the quarter ended December 31, 1998, an
increase of 16% from $481,000 in the comparable quarter of the prior year. Other
revenues were $1,040,000 for the six months ended December 31, 1998, an increase
of 18% from $883,000 in the comparable period of the prior year. These increases
were due primarily to an increase in demand for the Company's training services
and VMP referral fees earned by the Company on document sales, partially offset
by a decrease in consulting services. The Company expects its other revenues to
continue to increase during the remainder of fiscal year 1999, compared to
fiscal year 1998, due to the related increase in software license fee revenue as
well as increased demand for consulting services associated with implementation
of MortgageWare Loan Servicing.

The Company anticipates an increasing contribution to software license fees, and
related increases to software support fees and other revenues, from MortgageWare
Loan Servicing, MortgageWare InfoLINQ, MortgageWare MarketLINQ, MortgageWare
InvestorLINQ and FlowMan for the remainder of fiscal 1999. As discussed above,
the Company believes the overall lending environment to be favorable as of
December 31, 1998. Nonetheless, there can be no assurance that mortgage-lending
rates will not increase or continue to experience a high amount of volatility.
Such increases or continued volatility could have a material adverse effect on
the Company's business, financial condition and results of operations. Even if
lending rates stabilize, if homeowners and potential 



                                       13
<PAGE>   14

homeowners perceive such rates as too high, mortgage lending transactions may be
delayed. Such delays may have an adverse effect on the Company's customers,
which could result in an adverse effect on the Company and its results of
operations.

The Company has just entered the relatively new EAI market, which is subject to
constant change and intense competition. In addition, many of the Company's
competitors in this market have longer operating histories, greater name
recognition, and significantly greater financial, technical and marketing
resources than the Company. There is no assurance that the Company's products
will be accepted by the market or that the Company will be competitive within
the market, which would have a material adverse effect on the Company's
business, financial condition and results of operations.

COST OF REVENUES

<TABLE>
<CAPTION>
Three months ended December 31,
(In thousands)                     1998           1997          Change
----------------------------------------------------------------------
<S>                               <C>            <C>            <C>
Software license fees             $  611         $  398             54%

Percentage of software
  license fees                        19%            18%
----------------------------------------------------------------------

Software support fees             $  631         $  605              4%

Percentage of software
   support fees                       30%            35%
----------------------------------------------------------------------

Other                             $  280         $  208             35%
Percentage of other                   50%            43%
----------------------------------------------------------------------
Total cost of revenues            $1,522         $1,211             26%

Percentage of net revenues            26%            28%
----------------------------------------------------------------------
</TABLE>

Cost of software license fees primarily consists of the amortization of
capitalized software development costs and, to a lesser extent, the purchase and
duplication of disks and product documentation. As a percentage of software
license fees, cost of software license fees increased to 19% for the quarter
ended December 31, 1998, from 18% in the comparable quarter of the prior year.
As a percentage of software license fees, cost of software license fees
decreased to 18% for the six months ended December 31, 1998, from 22% in the
comparable period of the prior year. The increase for the quarter is due
primarily to a change in the product mix and lower gross margins on certain
interface products. The decrease for the six-month period is due primarily to
software license fees increasing at a substantially higher rate than the cost of
software license fees that contain the relatively fixed component of
amortization of capitalized software development costs. Amortization of
capitalized software development costs increased to $530,000 for the quarter
ended December 31, 1998, compared to $369,000 in the comparable quarter of the
prior year, and increased to $1,033,000 for the six-month period ended December
31, 1998, compared to $725,000 in the comparable period of the prior year. The
Company expects the dollar amount of its amortization of capitalized software
development costs to increase for the remainder of fiscal year 1999.

Cost of software support fees includes salaries and other costs related to
providing telephone support, and the purchase, duplication and shipping of disks
associated with software updates. As a percentage of software support fees, cost
of software support fees decreased to 30% for the quarter ended December 31,
1998, from 35% in the comparable quarter of the prior year. As a percentage of
software support fees, cost of software support fees decreased to 31% for the
six-month period ended December 31, 1998, from 



                                       14
<PAGE>   15

33% in the comparable period of the prior year. These decreases were primarily
due to software support fee revenue increasing at a rate higher than the cost of
software support fees. Payroll costs have increased since the prior year as the
customer support group has grown; however, these increases have been offset by
decreases in the supplies expense associated with delivering software updates.
The Company expects the dollar cost of software support fees to continue to
increase due to the increased staffing that will be required to support a higher
installed base of the Company's products and in order to support the FlowMan
product. The Company expects that these factors will not lead to a significant
increase in the ratio of the cost of software support fees to software support
fees.

Cost of other revenue includes the salaries and reimbursable expenses for the
employees who provide training and consulting services and the net cost of the
Company's annual MortgageWare software users' group meeting. As a percentage of
other revenue, cost of other revenue increased to 50% for the quarter ended
December 31, 1998, from 43% in the comparable quarter of the prior year. As a
percentage of other revenue, cost of other revenue remained relatively
consistent increasing to 52% for the six-month period ended December 31, 1998,
from 51% in the comparable period of the prior year. These increases were
primarily due to a change in the product mix of other revenues and the
associated costs. The Company expects the margins earned on other revenues to
continue to vary with changes in the product mix.



OPERATING EXPENSES

<TABLE>
<CAPTION>
Three months ended December 31,
(In thousands)                         1998           1997          Change
--------------------------------------------------------------------------
<S>                                   <C>            <C>            <C>
Product development                   $  836         $  451             85%

Percentage of net revenues                14%            10%
--------------------------------------------------------------------------

Sales & marketing                     $1,420         $1,377              3%

Percentage of net revenues                24%            32%
--------------------------------------------------------------------------

General & administrative              $1,623         $  948             71%

Percentage of net revenues                28%            22%
--------------------------------------------------------------------------

Amortization of goodwill
   and other intangible assets        $  215             --             nm

Percentage of net revenues                 4%            --
--------------------------------------------------------------------------
</TABLE>

Product development expenses include salaries for software developers and
analysts, facility costs and expenses associated with computer equipment used in
software development, net of costs capitalized. As a percentage of net revenues,
product development expenses increased to 14% for the quarter ended December 31,
1998 from 10% in the comparable quarter of the prior year. As a percentage of
net revenues, product development expenses increased to 14% for the six-month
period ended December 31, 1998, from 10% in the comparable period of the prior
year. These increases were due primarily to the Company's efforts introduced in
the current fiscal year to develop FlowMan version 4.0 and to operate the
related remote development office. These efforts resulted in additional product
development expenses of approximately $295,000 for the quarter ended December
31, 1998, and $515,000 for the six-month period ended December 31, 1998. The
remainder of the increase resulted from increased headcount, salaries and
bonuses related to the Company's other product development efforts (due in part
to 



                                       15
<PAGE>   16

the tight market for technical skills). These increases were offset somewhat by
an increase in the amount of capitalized software development costs. The Company
capitalized $556,000 and $416,000 of development expenditures for the quarters
ended December 31, 1998, and 1997, respectively. The Company capitalized
$1,045,000 and $753,000 of development expenditures for the six months ended
December 31, 1998, and 1997, respectively. As a result of development expenses
associated with FlowMan 4.0, the integration of FlowMan with the Company's
existing products, as well as normal enhancements to existing products, the
Company expects overall development spending to continue to increase somewhat
during the remainder of the 1999 fiscal year. No development costs related to
FlowMan 4.0 will be capitalized until the product reaches technological
feasibility; therefore, the Company expects that the amount of capitalized
software development costs that are carried on its balance sheet will only
increase slightly or remain flat until that time.

In connection with the acquisition of LSS, the Company acquired in-process
research and development related to the development of FlowMan 4.0. The Company
incurred approximately $240,000 and $390,000 of development costs during the
quarter ended December 31, 1998 and the six-months ended December 31, 1998,
respectively. The Company currently estimates the costs to complete the project
to be approximately $510,000. These cost estimates are consistent with those
estimated during the quarter ended September 30, 1998, but are higher than the
original estimate of $200,000. The Company has experienced unforeseen technical
complexities and other project management issues leading to the increase in
costs. The project is currently expected to be completed during the fourth
quarter of fiscal 1999.

At the time of the acquisition of LSS, revenues attributable to FlowMan 4.0 were
projected for purposes of valuing the acquired in-process R&D. The Company
continues to believe that FlowMan 4.0 will produce substantial revenues upon
successful completion. The Company originally expected to market both FlowMan
3.2 and 4.0 through its existing direct sales force and indirect distribution
channels. During the quarter ended September 30, 1998, the Company concluded
that a majority of sales will come through indirect channels that need to be
developed. The increased need to develop indirect distribution channels and the
one quarter delay in the expected completion date of FlowMan 4.0 from the third
quarter to the fourth quarter of fiscal 1999 have affected the amount and timing
of projected revenues. As a result, during the quarter ended September 30, 1998,
the Company revised its projected annual revenue ranges down to a range of $0.3
million to $6.5 million, as compared to the original projected annual revenue
ranges of $1.0 million to $10.3 million.

Though the Company currently expects that the acquired in process technology
will be successfully developed, there can be no assurance that commercial or
technical viability of the product will be achieved. If the project is not
successfully developed, the Company may not realize the value assigned to the
in-process R&D project. In addition, the value of goodwill and other acquired
intangible assets may also become impaired. Ongoing operations and financial
results for acquired businesses and the Company are subject to a variety of
factors which may or may not have been known or estimable at the time



                                       16
<PAGE>   17

of such acquisition, and the estimates discussed above are subject to change.

Sales and marketing expenses consist primarily of salaries, sales commissions,
travel and facility costs for the Company's sales and marketing personnel, and,
to a lesser extent, advertising, trade shows and other promotional activities.
As a percentage of net revenues, sales and marketing expenses decreased to 24%
for the quarter ended December 31, 1998, from 32% in the comparable quarter of
the prior year. As a percentage of net revenues, sales and marketing expenses
decreased to 25% for the six months ended December 31, 1998, from 32% in the
comparable period of the prior year. These decreases were primarily due to
revenues increasing at a faster rate than sales and marketing expenses. On a
dollar basis, sales and marketing expenses increased 3% to $1,420,000 for the
quarter ended December 31, 1998, from $1,377,000 in the comparable quarter of
the prior year. Sales and marketing expenses increased 11% to $2,869,000 for the
six-month period ended December 31, 1998, from $2,578,000 in the comparable
period of the prior year. At the same time, total net revenues increased by 33%
and 45% for the quarter and the six-month period ended December 31, 1998,
respectively (as discussed above). The Company expects sales and marketing
expenses to continue to increase on a dollar basis but to remain relatively
consistent on a percentage of revenue basis for the rest of fiscal year 1999,
since many sales and marketing expenses fluctuate with revenue.

General and administrative expenses include costs associated with finance,
accounting, purchasing, order fulfillment, administration and facilities. As a
percentage of net revenues, general and administrative expenses increased to 28%
for the quarter ended December 31, 1998, from 22% in the comparable quarter of
the prior year. As a percentage of net revenues, general and administrative
expenses increased to 24% for the six-month period ended December 31, 1998, from
21% in the comparable period of the prior year. On a dollar basis, general and
administrative expenses increased 71% to $1,623,000 for the quarter ended
December 31, 1998, from $948,000 in the comparable quarter of the prior year,
and increased 62% to $2,778,000 for the six months ended December 31, 1998, from
$1,717,000 in the comparable period of the prior year. These increases were due
primarily to approximately $360,000 of expenses incurred by the Company for the
potential leveraged recapitalization transaction (as discussed above), including
investment banking fees, legal and accounting fees. To a lesser extent, general
and administrative expenses increased during these periods due to increased
payroll for the department and non-recurring costs associated with the
relocation of the Company's headquarters during the quarter ended December 31,
1998. The Company expects general and administrative expenses to continue to
increase on a dollar basis as additional expenses are expected related to the
leveraged recapitalization. The Company expects this to translate into a modest
increase in general and administrative expenses as a percentage of net revenues.

Amortization of goodwill and other intangible assets consists of the
straight-line amortization of assets obtained by the Company as a result of its
acquisition of LSS on June 30, 1998. These assets include workforce-in-place,
customer lists, tradename, noncompete and employment agreements and goodwill,
which are being 



                                       17
<PAGE>   18

amortized over their estimated useful lives of three to four years.

NET INTEREST AND OTHER INCOME

<TABLE>
<CAPTION>
Three months ended December 31,
(In thousands)                     1998           1997          Change
----------------------------------------------------------------------
<S>                               <C>            <C>            <C>  
Net interest and other
    income                        $  137         $  184            (26%)
Percentage of net revenues             2%             4%
----------------------------------------------------------------------
</TABLE>

Net interest and other income, which consists primarily of interest income,
decreased 26% to $137,000 for the quarter ended December 31, 1998, from $184,000
in the comparable quarter of the prior year. Net interest and other income
decreased 22% to $291,000 for the six-month period ended December 31, 1998, from
$375,000 in the comparable period of the prior year. These decreases were due
primarily to the reduction in cash and investments resulting from the purchase
of LSS, significant purchases of property, equipment and leasehold improvements,
the repurchase of the Company's common stock and cash deposits made for federal
income tax. These uses of cash were offset somewhat by the cash generated by
operations.

If the leveraged recapitalization with WRH, is approved by shareholders (as
discussed above), the Company expects to incur net interest expense rather than
net interest income due to the use of cash and the related debt that would be
incurred.

INCOME TAXES

<TABLE>
<CAPTION>
Three months ended December 31,
(In thousands)             1998           1997          Change
--------------------------------------------------------------
<S>                       <C>            <C>            <C>  
Income taxes              $  120         $  209            (43%)

Effective tax rate            37%            37%
--------------------------------------------------------------
</TABLE>

Income taxes include federal and state income taxes currently payable and
deferred taxes arising from temporary differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. The effective tax rate for the quarter ended December 31,
1998, was consistent with that in the comparable quarter of the prior year. The
effective tax rate decreased to 37% for the six-month period ended December 31,
1998, from 39% in the comparable period of the prior year due primarily to
approximately $15,000 of additional income tax expense recognized during the
quarter ended September 30, 1997, for an IRS tax audit.

LIQUIDITY AND CAPITAL RESOURCES

Working capital, which consists principally of cash, cash equivalents and
short-term investments, was $7,554,000 as of December 31, 1998, compared to
$8,525,000 at June 30, 1998. Cash and cash equivalents decreased by $4,527,000
for the six months ended December 31, 1998. Additions to cash and cash
equivalents included $1,877,000 provided by operations. Principal uses of cash
and cash equivalents included $2,712,000 for the acquisition of LSS, $1,253,000
for the repurchase of common stock, $1,045,000 of capitalized software costs,
and $1,384,000 for the purchase of property and equipment.

The Company expects to spend approximately $200,000 for capital expenditures
during the remainder of the fiscal year ending June 30, 1999. The Company's
facility lease expired in November 1998, and the Company entered into a
seven-year lease for a new facility. Net occupancy costs are not expected to
increase significantly as a result of this move; however, during the six months
ended December 31, 1998, the Company incurred approximately $815,000 of



                                       18
<PAGE>   19

tenant improvement costs and fixed asset purchases related to this move.

Long-term cash requirements, other than normal operating expenses, are
anticipated for development of new software products and enhancement of existing
products (including FlowMan version 4.0); financing anticipated growth; the
possible acquisition of other software products, technologies and businesses;
and the possible repurchase of the Company's common stock.

As of December 31, 1998, the Company had no interest-bearing debt outstanding.
If the shareholders approve the leveraged recapitalization of the Company,
pursuant to the agreement between the Company and Terlin, Inc., (as discussed
above) the Company expects such transaction to result in the origination of
long-term financing. The terms of such financing are not known at this time. In
addition, the transaction would result in a significant reduction of the cash
and investment balances held by the Company since these resources would be
partially used to finance the recapitalization. The remaining balance of cash
and investments will depend on the timing of the transaction and the cash
generated and/or used before the transaction closes. The Company believes the
use of cash will be significant but does not know the exact amount at this time.
If the transaction is not approved, the Company believes that no new debt
financing would be required and that its existing cash, cash equivalents,
short-term investments, and cash generated by operations will be sufficient to
satisfy its other currently anticipated cash requirements for fiscal year 1999.

YEAR 2000

The Year 2000 problem arose because many existing computer programs use only the
last two digits to refer to a year. Therefore, these computer programs do not
properly recognize a year that begins with "20" instead of the familiar "19." If
not corrected, many computer applications could fail or create erroneous
results.

The Company has initiated efforts to mitigate the impact of the Year 2000
problem on three levels: (i) the products that the Company uses internally to
conduct its business, (ii) the products that it sells, and (iii) the Year 2000
readiness of the Company's vendors.

(i) Internal Products

The Company has taken an inventory of all software and hardware systems used
internally to conduct its ongoing business. These systems include client/server
systems, LAN systems, PC systems and related software, security systems and
voice mail systems. The Company has been notified by its vendors that certain of
these systems are currently Year 2000-ready, while other systems are scheduled
for purchase or update during the remainder of the 1999 fiscal year. The Company
has performed limited testing to confirm Year 2000 readiness on certain of these
systems, and intends to complete such testing by June 30, 1999. The Company has
not retained any outside consultants to assist in the Year 2000 problem and
based on its review of its internal systems, the Company believes the aggregate
costs of completing Year 2000 readiness will not be material. The Company
believes that significant record-keeping and operational deficiencies could
occur should the Company's 



                                       19
<PAGE>   20

internal products not be made Year 2000-ready, which could have material adverse
effects on the Company's business, financial condition and results of
operations. However, because the Company believes that the majority of its
internal systems are Year 2000-ready, no formal contingency plans have been
developed to respond to such effects.

(ii) The Company's Products

A majority of the products that the Company sells in the operation of its
business have been made Year 2000-ready. All of the products have been evaluated
for the Year 2000 problem and significant steps have been taken to make each
product Year 2000-ready. The following products have been made Year 2000-ready
and have been subjected to testing for the Year 2000 problem: MortgageWare Loan
Servicing, MortgageWare Loan Management System, MortgageWare TC, MortgageWare
Entre, MortgageWare MarketLINQ, MortgageWare InvestorLINQ, Mortgageware InfoLINQ
and BuilderBlock$(TM). In addition to internal testing, the Company has
published recommendations to its customers with regard to the testing that they
should be performing in-house on these products to ensure Year 2000 readiness.

The Company believes that all of its products will be Year 2000-ready by the end
of the 1999 fiscal year. The Company has not calculated separately from its
product development costs, the costs of making its products Year 2000-ready. The
Company believes that any incremental Year 2000-related expense has been less
than $75,000 and any additional costs in achieving Year 2000 readiness are not
expected to be material. Year 2000 readiness has been and is continuing to be
addressed as a routine engineering exercise as successive versions or upgrades
of the Company's products are released. No third-party consulting firms or
Company personnel have been retained by the Company to specifically address Year
2000 issues relating to the Company's products. However, there can be no
assurances that the Company's products do not contain undetected errors relating
to the Year 2000 problem that may result in material additional cost or
liabilities of unknown magnitude, which could have a material adverse effect on
the Company's business, financial condition and results of operations. However,
because the Company believes that all of its products will be Year 2000-ready,
no formal contingency plans have been developed to respond to such effects. In
addition, the Company believes that the purchasing patterns of customers and
potential customers may be affected by the Year 2000 problem in a variety of
ways. The Company believes that certain industry groups and large financial
institutions have been making recommendations that mortgage lenders protect
themselves from further Year 2000 exposure by deferring purchase and
implementation of new software programs (whether or not they purport to be Year
2000-ready) until after January 1, 2000. Also, the Company believes that some
customers may defer purchasing the Company's products because those customers
will be diverting resources to address their own Year 2000



                                       20
<PAGE>   21

problems. In contrast, other customers may accelerate their decisions to
purchase the Company's products to replace non-Year 2000-ready applications. The
Company has not been able to directly measure any impact of these decisions for
the six months ended December 31, 1998, and believes that it is not possible to
predict the overall impact of these decisions.

(iii) The Company's Vendors

The Company has identified third-party vendors upon which it places significant
reliance and plans to ascertain their readiness for the Year 2000 problem during
the 1999 fiscal year. The Company does not expect to incur any material costs in
ascertaining the Year 2000 readiness of its significant vendors. Although the
Company believes it is prudent to assess its vendors' Year 2000 readiness, it is
unable to accurately predict the impact to the Company if certain vendors are
not Year 2000-ready. Significant disruption in the businesses of the Company's
customers and third-party vendors may have material adverse effects on the
Company's business, financial condition and results of operations. However,
because the Company expects that its significant third-party vendors are or will
be Year 2000-ready, no formal contingency plans have been developed to respond
to such effects.

CERTAIN ADDITIONAL FACTORS AFFECTING FUTURE RESULTS

If the proposed merger between the Company and Terlin Inc. is completed as
planned, the Company will have substantially more indebtedness than it has had
historically. Consequently, a portion of cash flow available from operations
will be dedicated to the payment of principal and interest on indebtedness,
thereby reducing the funds that would otherwise be available to the Company,
including for research and development, acquisitions and future business
opportunities. In addition, the Company's ability to obtain additional financing
in the future may be limited. Furthermore, certain of the borrowings may be at
variable rates of interest, which will cause the Company to be even more
vulnerable to increases in interest rates and the higher degree of leverage will
make the Company relatively more vulnerable to economic downturns and
competitive pressures. Each of these factors could materially adversely affect
the Company's operating results and financial condition.

If, on the other hand, the merger is abandoned, under certain circumstances and
depending on the reasons for the termination, the Company may be obligated to
either reimburse Terlin for all its reasonable out-of-pocket expenses and fees,
pay Terlin $625,000 plus reimbursements for all its reasonable out-of-pocket
expenses and fees, or pay Terlin $1,250,000 plus reimbursements for all its
reasonable out-of-pocket expenses and fees. There is no assurance that the
merger will be completed as planned, and any such termination payments could
materially adversely affect the Company's operating results and financial
condition.

The Company's business divisions face intense competition at many levels. The
market for mortgage-related software products is highly competitive. Similarly,
the EAI software market is intensely competitive and subject to rapid change.
The Company believes that the main competitive factors in both markets include
price, operating platform compatibility, ease of



                                       21
<PAGE>   22

implementation and use, and customer support. Any change in such factors could
materially adversely affect the Company's business, operating results and
financial condition.

There is no assurance that the Company will be successful in attracting new
customers in the mortgage technology market, or that its existing customers will
continue to purchase its products and support services. In addition, there is no
assurance that the Company's new mortgage technology products and services will
be released in a timely fashion and that, if and when released, new products or
services or its efforts to integrate the FlowMan product, into its existing
mortgage software products will be well received by its target market or that
others will not successfully develop competing products and services. Each of
these events could have a material adverse effect upon the Company's revenues,
financial condition, and results of operations.

There is no assurance that the Company will be successful in attracting new
customers in the EAI market, or that its existing customers will continue to
purchase its products and support services. In addition, there is no assurance
that FlowMan 4.0 will be released in a timely fashion or that, if and when
released, it will be well received by its target market or that others will not
successfully develop competing products and services. Nor is there any assurance
that the Company will be successful in its efforts to develop the required new
indirect sales channels, given its plans to market FlowMan through third party
application developers, OEMs, and system integrators. Each of these events could
have a material adverse effect upon the Company's revenues, financial condition,
and results of operations.

Expansion of the Company's operations in the EAI software market will require
significant additional expenses and capital and could strain the Company's
management, financial and operational resources. There can be no assurance that
the Company's experience and leadership in the mortgage-related software market
will benefit the Company as it enters new markets, and gross margins
attributable to new business areas may be lower than those associated with the
Company's existing business activities. Nor can there be assurance that the
Company will be able to expand its operations in a cost-effective or timely
manner. Furthermore, any new business launched by the Company that is not
favorably received by consumers could damage the Company's reputation or the
INTERLINQ brand. The lack of market acceptance of such efforts or the Company's
inability to generate satisfactory revenues from such expanded services or
products to offset their cost could have a material adverse effect on the
Company's business, prospects, financial condition and results of operations.

The Company is unable to accurately estimate unit sales of its products and the
volume of annual support contracts that its customers will purchase due in
general to the nature of the software markets, and specifically to the cyclical
and volatile nature of the residential mortgage lending market, and the
development stage of the EAI market. Increases in interest rates, or changes in
tax laws or other governmental regulations relating to the mortgage industry
could have a material adverse effect on the Company's financial condition and
results of operations.



                                       22
<PAGE>   23

NEW ACCOUNTING STANDARDS

In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 130, Reporting Comprehensive Income ("SFAS
No. 130"). SFAS No. 130 establishes standards for reporting and disclosure of
comprehensive income and its components (revenues, expenses, gains and losses)
in a full set of general-purpose financial statements. SFAS No. 130, which is
effective for fiscal years beginning after December 15, 1997, requires
reclassification of financial statements for earlier periods to be provided for
comparative purposes. The Company currently has no other components of
comprehensive income and has not determined the manner in which it will present
the information required by SFAS No. 130 in its annual financial statements for
the year ending June 30, 1999.

In June 1997, the FASB issued SFAS No. 131, Disclosure About Segments of an
Enterprise and Related Information ("SFAS No. 131"). SFAS No. 131 establishes
standards for the way public business enterprises report information about
operating segments. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. SFAS No. 131 is
effective for fiscal years beginning after December 15, 1997. In the initial
year of application, comparative information for earlier years must be restated.
The Company has not determined the manner in which it will present the
information required by SFAS No. 131.

On December 22, 1998, the AICPA Accounting Standards Executive Committee issued
Statement of Position (SOP) 98-9. SOP 98-9 amends paragraphs 11 and 12 of SOP
97-2 to require recognition of revenue using the "residual method" when (1)
there is vendor-specific objective evidence of the fair values of all
undelivered elements in a multiple-element arrangement that is not accounted for
using long-term contract accounting, (2) vendor-specific objective evidence of
fair value does not exist for one or more of the delivered elements in the
arrangement, and (3) all revenue-recognition criteria in SOP 97-2 other than the
requirement for vendor-specific objective evidence of the fair value of each
delivered element of the arrangement are satisfied. Under the residual method,
the arrangement fee is recognized as follows: (1) the total fair value of the
undelivered elements, as indicated by vendor-specific objective evidence, is
deferred and subsequently recognized in accordance with the relevant sections of
SOP 97-2 and (2) the difference between the total arrangement fee and the amount
deferred for the undelivered elements is recognized as revenue related to the
delivered elements. The "residual method" established by SOP 98-9 is effective
for fiscal years beginning after March 15, 1999. The Company believes that the
adoption of SOP 98-9 will not have a material effect on the Company's revenue
recognition.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company's exposure to market risk associated with activities in financial
and commodity instruments, derivative or otherwise, is not material.



                                       23
<PAGE>   24

PART II.  OTHER INFORMATION



    ITEM 1.  LEGAL PROCEEDINGS

               None.

    ITEM 2.  CHANGES IN SECURITIES

               None.

    ITEM 3.   DEFAULTS UPON SENIOR SECURITIES

               None.

    ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

               At the Company's Annual Meeting of Shareholders held on November
               10, 1998:

               The following nominees were elected to the Board of Directors:


                                            Affirmative         Votes
                                               Votes           Withheld
                                            -------------    -------------
               Robert W. O'Rear                4,175,189          369,740
               Robert J. Gallagher             4,175,389          369,540

               Directors Jiri M. Nechleba and Theodore M. Wight will continue
               their current term as directors.

               A proposal to amend the Company's 1993 Stock Option Plan (the
               Plan) to increase the number of shares of Common Stock to be
               granted under the plan was approved as follows:


<TABLE>
<CAPTION>
             Affirmative         Votes 
                Votes           Against        Abstentions        Non-Votes
             -----------       ---------       -----------        ---------
<S>                            <C>             <C>                <C>
              3,742,158          781,215           21,156          577,248
</TABLE>

    ITEM 5.  OTHER INFORMATION

               None



                                       24
<PAGE>   25

    ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

          a)      EXHIBITS

                  27.1 Financial Data Schedule which is submitted electronically
                  to the Securities and Exchange Commission for information
                  purposes only and is not filed.

          b)      REPORTS ON FORM 8-K

                  The Company filed a Current Report on Form 8-K dated December
                  15, 1998, announcing that it had received a non-binding
                  proposal from W.R. Hambrecht + Co., LLC ("WRH") regarding a
                  leveraged recapitalization of the Company.

                  The Company filed a Current Report on Form 8-K dated December
                  29, 1998, announcing the Agreement and Plan of Merger, dated
                  December 29, 1998, between the Company and Terlin, Inc., an
                  affiliate of WRH relating to a leveraged recapitalization of
                  the Company.



                                       25
<PAGE>   26

SIGNATURES



Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.



DATED:  May 17, 1999



                                   INTERLINQ SOFTWARE CORPORATION
                                   (Registrant)



                                   /s/ Stephen A. Yount
                                   --------------------
                                   Stephen A. Yount
                                   Executive Vice President and Chief Financial
                                   Officer
                                   (Principal Financial and Accounting Officer)



                                       26
<PAGE>   27

                                  EXHIBIT INDEX

<TABLE>
<CAPTION>
          EXHIBIT NUMBER                      TITLE
     -------------------------    -------------------------------
<S>                               <C>
               27.1                  FINANCIAL DATA SCHEDULE
</TABLE>



                                       27