UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended March 31, 2004
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 000-24435
MICROSTRATEGY INCORPORATED
(Exact name of registrant as specified in its charter)
Delaware
(State of incorporation)
1861 International Drive, McLean, VA
(Address of Principal Executive Offices)
22102
(Zip Code)
51-0323571
(I.R.S. Employer
Identification Number)
Registrants telephone number, including area code: (703) 848-8600
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 reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
The number of shares of the registrants class A common stock and class B common stock outstanding on May 1, 2004 was 12,441,598 and 3,603,730, respectively.
MICROSTRATEGY INCORPORATED
FORM 10-Q
Page | ||||
PART I. |
FINANCIAL INFORMATION | |||
Item 1. |
Financial Statements | |||
Consolidated Balance Sheets as of March 31, 2004 (unaudited) and December 31, 2003 | 1 | |||
Consolidated Statements of Operations For the Three Months Ended March 31, 2004 (unaudited) and 2003 (unaudited) | 2 | |||
Consolidated Statements of Cash Flows For the Three Months Ended March 31, 2004 (unaudited) and 2003 (unaudited) | 3 | |||
Notes to Consolidated Financial Statements (unaudited) | 4 | |||
Item 2. |
Managements Discussion and Analysis of Financial Condition and Results of Operations | 10 | ||
Item 3. |
Quantitative and Qualitative Disclosures About Market Risk | 27 | ||
Item 4. |
Controls and Procedures | 27 | ||
PART II. |
OTHER INFORMATION | |||
Item 1. |
Legal Proceedings | 28 | ||
Item 6. |
Exhibits and Reports on Form 8-K | 29 |
PART I. FINANCIAL INFORMATION
ITEM 1. | FINANCIAL STATEMENTS |
MICROSTRATEGY INCORPORATED
(in thousands, except per share data)
March 31, 2004 |
December 31, 2003 |
|||||||
(unaudited) | ||||||||
Assets |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 76,321 | $ | 51,882 | ||||
Restricted cash |
726 | 747 | ||||||
Accounts receivable, net |
23,144 | 30,993 | ||||||
Prepaid expenses and other current assets |
3,398 | 3,888 | ||||||
Deferred tax assets, net |
1,873 | 1,807 | ||||||
Total current assets |
105,462 | 89,317 | ||||||
Property and equipment, net |
16,636 | 16,113 | ||||||
Goodwill and intangible assets, net |
586 | 604 | ||||||
Capitalized software development costs, net |
3,551 | 3,693 | ||||||
Deposits and other assets |
1,236 | 1,380 | ||||||
Deferred tax assets, net |
3,371 | 3,686 | ||||||
Total assets |
$ | 130,842 | $ | 114,793 | ||||
Liabilities and Stockholders Equity |
||||||||
Current liabilities: |
||||||||
Accounts payable and accrued expenses |
$ | 14,235 | $ | 12,768 | ||||
Accrued compensation and employee benefits |
12,477 | 17,968 | ||||||
Accrued restructuring costs |
2,431 | 2,599 | ||||||
Deferred revenue and advance payments |
37,017 | 28,374 | ||||||
Total current liabilities |
66,160 | 61,709 | ||||||
Deferred revenue and advance payments |
3,267 | 2,750 | ||||||
Other long-term liabilities |
2,426 | 2,443 | ||||||
Accrued restructuring costs |
3,106 | 3,544 | ||||||
Total liabilities |
74,959 | 70,446 | ||||||
Commitments and Contingencies |
||||||||
Stockholders Equity: |
||||||||
Preferred stock undesignated, par value $0.001 per share, 4,971 shares authorized, no shares issued or outstanding |
| | ||||||
Class A common stock, par value $0.001 per share, 330,000 shares authorized, 12,441 and 12,362 shares issued and outstanding, respectively |
12 | 12 | ||||||
Class B common stock, par value $0.001 per share, 165,000 shares authorized, 3,604 and 3,604 shares issued and outstanding, respectively |
4 | 4 | ||||||
Additional paid-in capital |
389,529 | 387,625 | ||||||
Accumulated other comprehensive income |
1,872 | 2,619 | ||||||
Accumulated deficit |
(335,534 | ) | (345,913 | ) | ||||
Total stockholders equity |
55,883 | 44,347 | ||||||
Total liabilities and stockholders equity |
$ | 130,842 | $ | 114,793 | ||||
The accompanying notes are an integral part of these Consolidated Financial Statements.
1
MICROSTRATEGY INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three Months Ended March 31, |
||||||||
2004 |
2003 |
|||||||
Revenues: |
||||||||
Product licenses |
$ | 18,811 | $ | 16,529 | ||||
Product support and other services |
30,295 | 20,906 | ||||||
Total revenues |
49,106 | 37,435 | ||||||
Cost of revenues: |
||||||||
Product licenses |
844 | 790 | ||||||
Product support and other services |
6,911 | 5,958 | ||||||
Total cost of revenues |
7,755 | 6,748 | ||||||
Gross profit |
41,351 | 30,687 | ||||||
Operating expenses: |
||||||||
Sales and marketing |
16,406 | 12,683 | ||||||
Research and development |
6,730 | 6,933 | ||||||
General and administrative |
7,953 | 7,184 | ||||||
Amortization of intangible assets |
18 | 130 | ||||||
Total operating expenses |
31,107 | 26,930 | ||||||
Income from operations |
10,244 | 3,757 | ||||||
Financing and other income (expense): |
||||||||
Interest income |
115 | 90 | ||||||
Interest expense, including discount amortization expense on notes payable of $0 and $973, respectively |
(14 | ) | (2,298 | ) | ||||
Gain on early extinguishment of notes payable |
| 18 | ||||||
Other income (expense), net |
806 | (38 | ) | |||||
Total financing and other income (expense) |
907 | (2,228 | ) | |||||
Income before income taxes |
11,151 | 1,529 | ||||||
Provision for income taxes |
772 | 864 | ||||||
Net income |
$ | 10,379 | $ | 665 | ||||
Basic earnings per share |
$ | 0.65 | $ | 0.05 | ||||
Diluted earnings per share |
$ | 0.60 | $ | 0.05 | ||||
Basic weighted average shares outstanding |
16,010 | 13,788 | ||||||
Diluted weighted average shares outstanding |
17,253 | 14,056 | ||||||
The accompanying notes are an integral part of these Consolidated Financial Statements.
2
MICROSTRATEGY INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Three months ended March 31, |
||||||||
2004 |
2003 |
|||||||
Operating activities: |
||||||||
Income from continuing operations |
$ | 10,379 | $ | 665 | ||||
Adjustments to reconcile income from continuing operations to net cash provided by operating activities: |
||||||||
Depreciation and amortization |
2,061 | 2,477 | ||||||
Bad debt expense (recovery) |
306 | (144 | ) | |||||
Discount amortization expense on notes payable |
| 973 | ||||||
Other, net |
8 | (30 | ) | |||||
Changes in operating assets and liabilities: |
||||||||
Accounts receivable |
7,268 | 4,560 | ||||||
Prepaid expenses and other current assets |
423 | 173 | ||||||
Deferred tax assets, net |
248 | 320 | ||||||
Deposits and other assets |
152 | 2 | ||||||
Accounts payable and accrued expenses, compensation and employee benefits, accrued interest |
(3,966 | ) | (2,895 | ) | ||||
Accrued restructuring costs |
(610 | ) | (1,305 | ) | ||||
Deferred revenue and advance payments |
8,809 | 2,912 | ||||||
Other long-term liabilities |
(17 | ) | (250 | ) | ||||
Net cash provided by operating activities |
25,061 | 7,458 | ||||||
Investing activities: |
||||||||
Purchases of property and equipment, net |
(2,019 | ) | (682 | ) | ||||
Capitalized software development costs |
(418 | ) | | |||||
Increase in restricted cash |
(1 | ) | (1 | ) | ||||
Net cash used in investing activities |
(2,438 | ) | (683 | ) | ||||
Financing activities: |
||||||||
Proceeds from sale of class A common stock under employee stock purchase plan and exercise of employee stock options |
1,904 | 97 | ||||||
Net cash provided by financing activities |
1,904 | 97 | ||||||
Effect of foreign exchange rate changes on cash and cash equivalents |
(123 | ) | 93 | |||||
Net increase in cash and cash equivalents from continuing operations |
24,404 | 6,965 | ||||||
Net cash received from (advanced to) discontinued operations |
35 | (72 | ) | |||||
Net increase in cash and cash equivalents |
24,439 | 6,893 | ||||||
Cash and cash equivalents, beginning of period |
51,882 | 15,036 | ||||||
Cash and cash equivalents, end of period |
$ | 76,321 | $ | 21,929 | ||||
Supplemental disclosure of noncash investing and financing activities: |
||||||||
Early extinguishment of notes payable |
$ | | $ | (1,276 | ) | |||
Issuance of class A common stock in connection with early extinguishment of notes payable |
$ | | $ | 1,293 | ||||
The accompanying notes are an integral part of these Consolidated Financial Statements.
3
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(1) Basis of Presentation
Except for the consolidated balance sheet of MicroStrategy Incorporated (MicroStrategy or the Company) as of December 31, 2003, which is derived from audited financial statements, the accompanying consolidated financial statements are unaudited. In the opinion of management, all adjustments (consisting of normal recurring items) necessary for a fair presentation of such financial statements have been included. Interim results are not necessarily indicative of results for a full year.
The consolidated financial statements and notes are presented as required by Form 10-Q and do not contain certain information included in the Companys annual financial statements and notes. These financial statements should be read in conjunction with the Companys audited financial statements and the notes thereto filed with the Securities and Exchange Commission (SEC) in the Companys Annual Report on Form 10-K for the year ended December 31, 2003.
Certain prior year amounts in the consolidated financial statements have been reclassified to conform to the current year presentation.
(2) Recent Accounting Standards
In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. In December 2003, the FASB revised FIN 46 to reflect decisions it made regarding a number of implementation issues. FIN 46, as revised, requires that the primary beneficiary of a variable interest entity consolidate the entity even if the primary beneficiary does not have a majority voting interest. This interpretation applies to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. This interpretation also identifies those situations where a controlling financial interest may be achieved through arrangements that do not involve voting interests. The interpretation also establishes additional disclosures which are required regarding an enterprises involvement with a variable interest entity when it is not the primary beneficiary. The requirements of this interpretation are required to be applied for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions must be applied for the first interim or annual period ending after December 15, 2003. The Company does not have any controlling interest, contractual relationships or other business relationships with unconsolidated variable interest entities and therefore the adoption of this standard did not have any effect on the Companys financial position and results of operations.
(3) Accounts Receivable
Accounts receivable, net of allowances, consist of the following, as of (in thousands):
March 31, 2004 |
December 31, 2003 |
|||||||
Billed and billable |
$ | 46,951 | $ | 61,118 | ||||
Less: billed and unpaid deferred revenue |
(21,189 | ) | (27,621 | ) | ||||
25,762 | 33,497 | |||||||
Less: allowance for doubtful accounts |
(2,618 | ) | (2,504 | ) | ||||
$ | 23,144 | $ | 30,993 | |||||
The Company offsets its accounts receivable and deferred revenue for any billed and unpaid items included in deferred revenue and advance payments.
4
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(4) Deferred Revenue and Advance Payments
Deferred revenue and advance payments from customers consist of the following, as of (in thousands):
March 31, 2004 |
December 31, 2003 |
|||||||
Current: |
||||||||
Deferred product revenue |
$ | 3,295 | $ | 4,490 | ||||
Deferred product support and other services revenue |
54,705 | 50,497 | ||||||
58,000 | 54,987 | |||||||
Less: billed and unpaid deferred revenue |
(20,983 | ) | (26,613 | ) | ||||
$ | 37,017 | $ | 28,374 | |||||
Non-current: |
||||||||
Deferred product revenue |
$ | 211 | $ | 378 | ||||
Deferred product support and other services revenue |
3,262 | 3,380 | ||||||
3,473 | 3,758 | |||||||
Less: billed and unpaid deferred revenue |
(206 | ) | (1,008 | ) | ||||
$ | 3,267 | $ | 2,750 | |||||
The Company offsets its accounts receivable and deferred revenue for any billed and unpaid items included in deferred revenue and advance payments.
(5) Litigation
(a) Business Objects Litigation
On October 2, 2001, the Company filed a lawsuit in the Virginia Circuit Court for Fairfax County against two field employees of Business Objects, S.A. This lawsuit alleged that these employees, who previously worked for the Company, breached their fiduciary and contractual obligations to the Company by, among other things, misappropriating its trade secrets and confidential information and soliciting its employees and customers. The complaint sought injunctive relief and damages. On October 17, 2001, Business Objects filed suit against the Company in the United States District Court for the Northern District of California, claiming that the Companys software infringes a patent issued to Business Objects relating to relational database access (the 403 patent). The suit sought injunctive relief and monetary damages. On August 29, 2003, the Court granted the Companys motion for summary judgment and dismissed the lawsuit, ruling as a matter of law that MicroStrategys products do not infringe the 403 patent. Business Objects has filed an appeal.
On October 31, 2001, the Company filed suit against Business Objects, S.A. and its subsidiary, Business Objects Americas, Inc., in the United States District Court for the Eastern District of Virginia, claiming that Business Objects software infringes two patents held by the Company relating to asynchronous control of report generation using a web browser (the 033 patent) and a system and method of adapting automatic output of OLAP reports to disparate user output devices (the 050 patent). On March 13, 2002, the Company voluntarily dismissed without prejudice its lawsuit pending in the Virginia Circuit Court for Fairfax County against the two field employees of Business Objects. The complaint against Business Objects was amended to add claims for violations of the federal Computer Fraud and Abuse Act, misappropriation of trade secrets, tortious interference with contractual relations, and violations of the Virginia Conspiracy Act. As a result of pre-trial rulings, certain of these claims were dismissed. The Companys claims for tortious interference and misappropriation of trade secrets proceeded to trial on October 20, 2003. On October 28, 2003, the Court dismissed the tortious interference claim. The Court
5
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
has yet to issue a ruling on the merits of the misappropriation of trade secrets claim, for which the Company is seeking various equitable remedies against Business Objects. In July 2003, the United States Patent & Trademark Office confirmed the validity of all the claims in the 033 and 050 patents and terminated reexamination proceedings that Business Objects had requested as to those patents. The Company agreed to dismissal of the 033 patent claims without prejudice. The Companys 050 patent claims are currently scheduled to proceed to trial on June 15, 2004. The Company is seeking monetary damages and injunctive relief. The outcome of this litigation is not presently determinable, and as such, the Company is currently unable to estimate a potential range of gain or loss, if any, relating to these actions. Accordingly, no provision for these matters has been made in the accompanying consolidated financial statements.
(b) ePlus Legal Matter
On February 2, 2004, ePlus Group, Inc. (ePlus) filed suit against the Company claiming breach of contract relating to the master lease agreement that the companies had entered into on November 1, 1999, under which the Company leased equipment from ePlus. ePlus claims that equipment returned by the Company upon expiration of the lease term was not in satisfactory condition and seeks damages of approximately $2.0 million plus interest, taxes and attorneys fees. The Company intends to vigorously defend the case. Although the ultimate outcome of this litigation is uncertain, the Company does not believe that the litigation will have a material adverse effect on the Companys financial position or results of operations.
(c) Other Matters
The Company is also involved in other legal proceedings through the normal course of business. Management believes that any unfavorable outcome related to these other proceedings will not have a material effect on the Companys financial position, results of operations or cash flows.
(6) Borrowings
On May 19, 2003, the Company entered into a $10 million secured credit facility (the Credit Facility) with Bank of America, N.A. The Credit Facility consists of a $10 million revolving line of credit subject to borrowing base limitations based on accounts receivable, as defined in the agreement. The Credit Facility, which matures in May 2004, includes a letter of credit sub-limit of $10 million and is secured by substantially all of the assets of the Company. The Company and Bank of America are currently discussing an extension and modification of the Credit Facility. During the three months ended March 31, 2004, the Company had not drawn any cash against the Credit Facility and had no amounts outstanding under the Credit Facility as of March 31, 2004. After consideration of outstanding letters of credit of $5.1 million and borrowing base limitations applicable to the Credit Facility, the Company had $4.9 million of borrowing capacity as of March 31, 2004.
At the Companys option, borrowings under the Credit Facility bear interest at a variable rate equal to LIBOR plus 2.5% to 3.0%, depending on the outstanding balance, or the prime rate plus 1.0%. The Credit Facility also includes a 2.0% letter of credit fee.
Under the terms of the Credit Facility, the Company is required to maintain compliance with certain financial covenants, the most restrictive of which include achieving certain minimum earnings amounts and maximum debt to earnings ratios, maintaining minimum liquidity amounts and limiting the ability to invest further in subsidiaries. As of March 31, 2004, the Company was in compliance with all covenants contained in the Credit Facility.
(7) Comprehensive Income
Comprehensive income includes foreign currency translation adjustments and unrealized gains and losses
6
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
on short-term investments, net of related tax effects, that have been excluded from net income and reflected in stockholders equity as accumulated other comprehensive income.
Comprehensive income for the three months ended March 31, 2004 and 2003, respectively, is calculated as follows (in thousands):
Three Months Ended March 31, | |||||||
2004 |
2003 | ||||||
Net income |
$ | 10,379 | $ | 665 | |||
Foreign currency translation adjustment |
(746 | ) | 565 | ||||
Comprehensive income |
$ | 9,633 | $ | 1,230 | |||
(8) Earnings per Share and Pro Forma Earnings (Loss) per Share
(a) Basic and diluted earnings per share
Basic earnings per share is determined by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share is determined by dividing net income by the weighted average number of common shares and potential common shares outstanding during the period. Potential common shares are included in the diluted earnings per share calculation when dilutive. Potential common shares consisting of common stock issuable upon exercise of outstanding employee stock options and warrants are computed using the treasury stock method.
(b) Pro forma basic and diluted earnings (loss) per share
In December 2002, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 148, Accounting for Stock-Based Compensation Transition and Disclosure. SFAS No. 148 provides for alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. The Company continues to account for its stock-based employee compensation plans under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. APB No. 25 provides that compensation expense relative to a companys employee stock options is measured based on the intrinsic value of the stock options at the measurement date. Effective for interim periods beginning after December 15, 2002, SFAS No. 148 also requires disclosure of pro-forma results on a quarterly basis as if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation.
7
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
As all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date of grant, no stock-based employee compensation cost is reflected in net income. If compensation expense had been recorded based on the fair value of awards under the stock option and purchase plans as set forth in SFAS No. 123, as amended, the Companys net income would have been adjusted to the pro forma amounts presented below, for the three months ended March 31, 2004 and 2003, respectively (in thousands, except per share data):
Three Months Ended March 31, |
||||||||
2004 |
2003 |
|||||||
Net income, as reported |
$ | 10,379 | $ | 665 | ||||
Stock-based employee compensation expense under fair value |
(3,139 | ) | (3,496 | ) | ||||
Pro forma net income (loss) |
$ | 7,240 | $ | (2,831 | ) | |||
Basic earnings per share, as reported |
$ | 0.65 | $ | 0.05 | ||||
Diluted earnings per share, as reported |
$ | 0.60 | $ | 0.05 | ||||
Basic earnings (loss) per share, pro forma |
$ | 0.45 | $ | (0.21 | ) | |||
Diluted earnings (loss) per share, pro forma |
$ | 0.42 | $ | (0.21 | ) | |||
The fair value of each option is estimated using the Black-Scholes option-pricing model with the following assumptions used for option grants issued during the three months ended March 31, 2004 and 2003, respectively, under MicroStrategys stock option plans: volatility factors of 50% and 97%, risk-free interest rates of 3% and 3%, weighted-average expected life of 5 years, and no dividend yields.
The following assumptions were used for shares issued during the three months ended March 31, 2004 and 2003, respectively, under MicroStrategys employee stock purchase plan: volatility factors of 50% and 97%, risk-free interest rates of 3% and 3%, weighted-average expected life of 6 months, and no dividend yields.
The weighted average fair value of grants made under MicroStrategys stock option plans during the three months ended March 31, 2004 and 2003 were $28.64 and $18.18 per share, respectively.
(9) Segment Information
The Company operates in one significant business segment business intelligence. The following summary discloses total revenues and long-lived assets, excluding long-term deferred tax assets, according to geographic region (in thousands):
Domestic |
International |
Consolidated | |||||||
Three Months Ended March 31, 2004 |
|||||||||
Total license and service revenues |
$ | 28,128 | $ | 20,978 | $ | 49,106 | |||
Long-lived assets |
19,240 | 2,769 | 22,009 | ||||||
Three Months Ended March 31, 2003 |
|||||||||
Total license and service revenues |
$ | 24,051 | $ | 13,384 | $ | 37,435 | |||
Long-lived assets |
21,028 | 2,043 | 23,071 |
The domestic region includes operations in the U.S. and Canada. The international region includes operations in all other foreign countries. For the three months ended March 31, 2004, the United Kingdom accounted for 16.3% of total consolidated revenues. No other individual foreign country accounted for 10% or more of total consolidated revenues.
Transfers relating to intercompany software fees from international to domestic operations of $10.3 million and $5.0 million for the three months ended March 31, 2004 and 2003, respectively, have been excluded from the above tables and eliminated in the consolidated financial statements.
8
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
For the three months ended March 31, 2004, one large retail customer in the United Kingdom accounted for approximately 10% of the Companys total consolidated revenues. For the three months ended March 31, 2003, no individual customer accounted for 10% or more of total consolidated revenues.
(10) Restructuring and Impairment Charges
During 2001, the Company adopted restructuring plans which included a strategic decision to focus operations on the business intelligence market, the elimination or reduction of speculative technology initiatives, a reduction of the Companys workforce and a consolidation of its multiple Northern Virginia facilities into a single location in McLean, Virginia.
The following table sets forth a summary of the accrued restructuring costs as of March 31, 2004 (in thousands):
Accrued Restructuring Costs at December 31, 2003 |
Q1 2004 Cash Payments |
Accrued Restructuring Costs at March 31, 2004 | ||||||||
Estimated sublease losses and other facility closing costs |
$ | 6,054 | $ | (596 | ) | $ | 5,458 | |||
Terminations of equipment leases |
89 | (10 | ) | 79 | ||||||
Total accrued restructuring costs |
$ | 6,143 | $ | (606 | ) | $ | 5,537 | |||
As of March 31, 2004, unpaid amounts of $2.4 million and $3.1 million have been classified as current and long-term accrued restructuring costs, respectively, in the accompanying consolidated balance sheet. Amounts related to the estimated sublease losses associated with exiting facilities and terminations of equipment leases will be paid over the respective lease terms through February 2009. As a result of the restructuring, the Company has approximately 77,000 square feet of office space that is not occupied by the Company with the following expiration dates: 46,000 square feet expire in August 2006 and 31,000 square feet expire in February 2009. Of the 77,000 square feet of office space that is not occupied by the Company, 66,000 square feet has been subleased as of March 31, 2004. At March 31, 2004, the Company had $8.7 million in gross lease obligations and $1.2 million in estimated commissions, concessions and other costs, partially offset by $4.4 million in estimated gross sublease income recoveries during the remaining lease terms. The Company estimated its sublease losses based upon current information available relating to sublease commission costs, sub-tenant concession costs, sublease rental income and the length of time expected to sublease excess space. Final amounts could differ from current estimates if the Company is unable to sublet the remaining unoccupied office space on the estimated terms. The Company may also continue to seek to terminate certain leases early; however, the Companys landlords may not be willing to terminate such lease arrangements under terms and conditions that are acceptable to the Company. Except for estimated sublease losses and other facility closing costs and equipment leases, the restructuring plans have been substantially completed.
9
ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. For this purpose, any statements contained herein that are not statements of historical fact, including without limitation, certain statements regarding industry prospects and our results of operations or financial position, may be deemed to be forward-looking statements. Without limiting the foregoing, the words believes, anticipates, plans, expects, and similar expressions are intended to identify forward-looking statements. The important factors discussed below under the caption Risk Factors, among others, could cause actual results to differ materially from those indicated by forward-looking statements made herein and presented elsewhere by management from time to time. Such forward-looking statements represent managements current expectations and are inherently uncertain. Investors are warned that actual results may differ from managements expectations.
Overview
We are a leading worldwide provider of business intelligence software that enables companies to analyze the raw data stored across their enterprise to reveal the trends and insights needed to develop solutions to manage their business effectively. Our software delivers this critical information to workgroups, the enterprise and extranet communities via e-mail, web, fax, wireless and voice communication channels. Businesses can use our software platform to develop user-friendly solutions, proactively refine revenue-generating strategies, enhance cost-efficiency and productivity and improve customer relationships.
Our software platform, MicroStrategy 7i, enables users to query and analyze the most detailed, transaction-level databases, turning data into business intelligence and delivering boardroom quality reports and alerts about the users business processes. Our web-based architecture provides reporting, security, performance and standards that are critical for web deployment. With intranet deployments, our products provide employees with information to enable them to make better, more cost-effective business decisions. With extranet deployments, enterprises can use MicroStrategy 7i to build stronger relationships by linking customers and suppliers via the Internet. We also offer a comprehensive set of consulting, education, technical support and technical advisory services for our customers and strategic partners.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. MicroStrategy does not have any ownership interest in any special purpose entities that are not wholly-owned and consolidated subsidiaries of MicroStrategy. Additionally, MicroStrategy does not have any material related party transactions as defined under Statement of Financial Accounting Standards (SFAS) No. 57, Related Party Disclosures.
The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and equity 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. These estimates, particularly estimates relating to revenue recognition, restructuring and impairment charges and litigation and contingencies, have a material impact on our financial statements and are discussed in detail throughout our analysis of the results of operations as discussed below.
In addition to evaluating estimates relating to the items discussed above, we also consider other estimates, including, but not limited to, those related to allowance for doubtful accounts, software development costs, intangible assets, income taxes, and financing operations. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets, liabilities and equity that are not readily apparent from other sources. Actual results and outcomes could differ from these estimates and assumptions. For a more detailed explanation of the judgments made in these areas and a discussion of our
10
accounting policies, refer to Critical Accounting Policies included in Item 7 and Summary of Significant Accounting Policies (Note 2) included in Item 15 of our Annual Report on Form 10-K for the year ended December 31, 2003. Since December 31, 2003, there have been no significant changes to our critical accounting policies.
Results of Operations
The following table sets forth for the periods indicated the percentage of total revenues represented by certain items reflected in our consolidated statements of operations:
Three Months Ended March 31, |
||||||
2004 |
2003 |
|||||
Statements of Operations Data |
||||||
Revenues: |
||||||
Product licenses |
38.3 | % | 44.2 | % | ||
Product support and other services |
61.7 | 55.8 | ||||
Total revenues |
100.0 | 100.0 | ||||
Cost of revenues: |
||||||
Product licenses |
1.7 | 2.1 | ||||
Product support and other services |
14.1 | 15.9 | ||||
Total cost of revenues |
15.8 | 18.0 | ||||
Gross profit |
84.2 | 82.0 | ||||
Operating expenses: |
||||||
Sales and marketing |
33.4 | 33.9 | ||||
Research and development |
13.7 | 18.5 | ||||
General and administrative |
16.2 | 19.2 | ||||
Amortization of intangible assets |
| 0.3 | ||||
Total operating expenses |
63.3 | 71.9 | ||||
Income from operations |
20.9 | 10.1 | ||||
Financing and other income (expense): |
||||||
Interest income |
0.2 | 0.2 | ||||
Interest expense |
| (6.1 | ) | |||
Gain on early extinguishment of notes payable |
| | ||||
Other income (expense), net |
1.6 | (0.1 | ) | |||
Total financing and other income (expense) |
1.8 | (6.0 | ) | |||
Income before income taxes |
22.7 | 4.1 | ||||
Provision for income taxes |
1.6 | 2.3 | ||||
Net income |
21.1 | % | 1.8 | % | ||
Comparison of the three months ended March 31, 2004 and 2003
Revenues
Revenues. Total revenues consist of revenues derived from sales of product licenses and product support and other services, including technical support, education and consulting services.
11
The following table sets forth revenues (in thousands) and percentage changes in revenues for the periods indicated:
Three Months Ended March 31, |
|||||||||
2004 |
2003 |
% Change |
|||||||
Revenues: |
|||||||||
Product licenses |
$ | 18,811 | $ | 16,529 | 13.8 | % | |||
Product support and other services |
30,295 | 20,906 | 44.9 | % | |||||
Total revenues |
$ | 49,106 | $ | 37,435 | 31.2 | % | |||
Product Licenses Revenues. The increase in product licenses revenues was primarily attributable to an increase in the size of our sales force to further our presence in the business intelligence market and the impact of favorable foreign currency fluctuations. In addition, during late 2003, we introduced several new products that complement our business intelligence platform, which we believe have been well accepted by our customers and industry analysts. During the first quarter of 2004, we had three product license transactions in excess of $500,000, including one international transaction that generated $3.5 million of product licenses revenues, discussed further below. In the same period in 2003, we had six product license transactions in excess of $500,000. Although the average size of our product license transactions decreased slightly in the first quarter of 2004, as compared to the first quarter of 2003, the number of product license transactions increased. Product licenses revenues as a percentage of total revenues were 38.3% and 44.2% for the three months ended March 31, 2004 and 2003, respectively. The average size of our product license transactions and the number of high-dollar transactions may fluctuate on a period-to-period basis. Additionally, product licenses revenues as a percentage of total revenues may fluctuate on a period-to-period basis and may vary significantly from the percentage of total revenues achieved in prior years.
Product Support and Other Services Revenues. The increase in product support and other services revenues was primarily the result of a 45.7% increase in revenues from technical support services and a 41.6% increase in revenues from consulting and education services. Revenues from technical support services have increased as a result of an ongoing increase in our installed base of software licenses under technical support contracts, an increase in the average rate charged for technical support, our high renewal rates for such contracts, an increase in technical support fees from customers that were underlicensed in prior periods and the impact of favorable foreign currency fluctuations. Revenues from consulting and education services have increased as a result of increased marketing initiatives and higher sales of our new services packages. Additionally, fluctuations in foreign currencies have positively influenced revenues from consulting and education services. Product support and other services revenues as a percentage of total revenues were 61.7% and 55.8% for the three months ended March 31, 2004 and 2003, respectively. As a result of possible fluctuations in product licenses revenues discussed above, product support and other services revenues as a percentage of total revenues may fluctuate on a period-to-period basis and may vary significantly from the percentage of total revenues achieved in prior years.
The following table sets forth international revenues (in thousands) and percentage changes in international revenues for the periods indicated:
Three Months Ended March 31, |
|||||||||
2004 |
2003 |
% Change |
|||||||
International revenues: |
|||||||||
Product licenses |
$ | 10,069 | $ | 5,394 | 86.7 | % | |||
Product support and other services |
10,906 | 7,992 | 36.5 | % | |||||
Total international revenues |
$ | 20,975 | $ | 13,386 | 56.7 | % | |||
International Revenues. International revenues are included in the amounts discussed above for product licenses and product support and other services revenues and also are discussed separately within this paragraph. The increase in international product licenses revenues was the result of a 64.4% increase in revenues, after adjusting for foreign currency fluctuations, and a 22.3% positive foreign currency impact. In the first quarter of 2004, we completed a transaction in the United Kingdom with a large retail customer that generated $3.5 million of product licenses revenues. In addition, the average size of our international
12
product licenses revenue transactions increased in the first quarter of 2004 as compared to the first quarter of 2003. Product support and other services revenues increased as a result of an 18.9% increase in revenues, after adjusting for foreign currency fluctuations, and a 17.6% positive foreign currency impact. The increase was attributable to a 58.4% increase in revenues from technical support services, which included a 20.0% positive foreign currency impact, and a 4.2% increase in revenues from consulting and education services. As a percentage of total revenues, international revenues were 42.7% and 35.8% for the three months ended March 31, 2004 and 2003, respectively. Foreign currency impacts generally fluctuate over time, and accordingly, the same volume of license transactions and support services in a future period may result in lower reported earnings if future foreign currency impacts are less favorable than those experienced in previous periods. We anticipate that international revenues will continue to account for a significant portion of total revenues, and management expects to continue to commit significant time and financial resources to the maintenance and ongoing development of direct and indirect international sales and support channels.
Costs and Expenses
The following table sets forth total cost of revenues (in thousands) and percentage changes in cost of revenues for the periods indicated:
Three Months Ended March 31, |
|||||||||
2004 |
2003 |
% Change |
|||||||
Cost of Revenues: |
|||||||||
Product licenses |
$ | 844 | $ | 790 | 6.8 | % | |||
Product support and other services |
6,911 | 5,958 | 16.0 | % | |||||
Total cost of revenues |
$ | 7,755 | $ | 6,748 | 14.9 | % | |||
Cost of Product Licenses Revenues. Cost of product licenses revenues consists primarily of the costs of product manuals, media, amortization of capitalized software development costs and royalties paid to third-party software vendors. As a percentage of product licenses revenues, cost of product licenses revenues were 4.5% and 4.8% for the three months ended March 31, 2004 and 2003, respectively. Cost of product licenses revenues increased in the first quarter of 2004, as compared to the first quarter of 2003, due to the amortization of capitalized software development costs associated with the release of our new enterprise reporting product, MicroStrategy Report ServicesTM, in late 2003. Cost of product licenses revenues, however, decreased as a percentage of product licenses revenues because of the increase in product licenses revenues during the three months ended March 31, 2004. Our cost of product licenses revenues could increase further with the development and addition of new products to our product line.
Cost of Product Support and Other Services. Cost of product support and other services consists of the costs of providing consulting services to customers and partners, technical advisory services, technical support and education. The increase in cost of product support and other services was attributable to an 8% increase in staffing levels and a 5.8% unfavorable impact from foreign currency fluctuations. Cost of product support and other services as a percentage of product support and other services revenues decreased from 28.5% in the first quarter of 2003 to 22.8% in the first quarter of 2004. The decrease was primarily due to the increase in product support and other services revenues. Additionally, the decrease was attributable to an increase in technical support revenues as a percentage of total product support and other services revenues, which result in higher profit margins than our consulting and education services, improved utilization of consulting personnel and a decrease in the use of third parties to perform consulting services.
13
The following table sets forth operating expenses (in thousands) and percentage changes in operating expenses for the periods indicated:
Three Months Ended March 31, |
|||||||||
2004 |
2003 |
% Change |
|||||||
Operating expenses: |
|||||||||
Sales and marketing |
$ | 16,406 | $ | 12,683 | 29.4 | % | |||
Research and development |
6,730 | 6,933 | -2.9 | % | |||||
General and administrative |
7,953 | 7,184 | 10.7 | % | |||||
Amortization of intangible assets |
18 | 130 | -86.2 | % | |||||
Total operating expenses |
$ | 31,107 | $ | 26,930 | 15.5 | % | |||
Sales and Marketing Expenses. Sales and marketing expenses include personnel costs, commissions, office facilities, travel, advertising, public relations programs and promotional events, such as trade shows, seminars and technical conferences. As a percentage of total revenues, sales and marketing expenses were 33.4% and 33.9% for the three months ended March 31, 2004 and 2003, respectively. The increase in sales and marketing expenses in the first quarter of 2004, as compared to the same period in 2003, related to a 22.7% increase in costs and a 6.7% unfavorable impact from foreign currency fluctuations. Staffing levels for our sales and marketing personnel increased by approximately 10% in the first quarter of 2004, as compared to the first quarter of 2003, which in conjunction with the increase in product licenses revenues described above, have caused salary and commission costs to increase. Sales and marketing expenses may continue to increase in 2004 if we continue to expand our sales force and as we market new product offerings.
Research and Development Expenses. Research and development expenses consist primarily of salaries and benefits of software engineering personnel, depreciation of equipment and other related costs. As a percentage of total revenues, research and development expenses were 13.7% in the first quarter of 2004 and 18.5% in the first quarter of 2003. The decrease in research and development expenses in the first quarter of 2004, as compared to the first quarter of 2003, was due to a $418,000 increase in the capitalization of software development costs associated with the development of certain products. The decrease in research and development expenses was partially offset by an increase in personnel costs. Although staffing levels of our research and development personnel were lower by approximately 3% in the first quarter of 2004, as compared to the first quarter of 2003, costs increased due to higher variable incentive compensation costs as a result of our improved financial performance.
The following table summarizes research and development expenses and amortization of capitalized software development costs activity for the periods indicated (in thousands):
Three Months Ended March 31, | |||||||
2004 |
2003 | ||||||
Gross research and development expenses: |
|||||||
Core research and development activities |
$ | 6,736 | $ | 6,436 | |||
Non-core research and development activities |
412 | 497 | |||||
Capitalized software development costs |
(418 | ) | | ||||
Research and development expenses |
$ | 6,730 | $ | 6,933 | |||
Amortization of capitalized software development costs included in cost of product licenses revenues |
$ | 560 | $ | 462 | |||
During the three months ended March 31, 2004, in accordance with SFAS No. 86, Accounting for the Costs of Computer Equipment to be Sold, Leased, or Otherwise Marketed, we capitalized $418,000 of software development costs associated with the development of Intelligence Server Universal, which allows our products to function on Unix platforms. We did not capitalize any software development costs during the three months ended March 31, 2003. Software development costs for a product are capitalized from the time that technological feasibility is reached until
14
the general release of that product. We consider technological feasibility to be achieved when a product design and working model of the software product have been completed. These capitalized software costs are amortized over their respective useful lives of approximately three years. We expect that Intelligence Server Universal will be available for general release during mid-2004. Based on current development plans and allocated resources, we currently expect to capitalize an additional $800,000 of costs during the second quarter of 2004 associated with the development of this new product; however as project development efforts continue, the amount of capitalized costs and the date of general availability could change.
As of March 31, 2004, our research and development engineering resources were allocated to the following major projects: 30% to our MicroStrategy 7i product, 20% to our Unix products, 11% to our non-core research and development projects, Angel.com and Alarm.com, and 39% to on-going support of existing products and other research and development efforts. The allocation of our research and development resources is expected to change as project development efforts require, as current projects are completed and as new projects commence.
General and Administrative Expenses. General and administrative expenses include personnel and other costs of our finance, human resources, information systems, administrative and executive departments as well as third-party consulting, legal and other professional fees. The increase in general and administrative expenses in the first quarter of 2004, as compared to the same period in 2003, related to a 7.9% increase in costs and a 2.8% unfavorable foreign currency impact. The increase in costs was due to a 9% increase in staffing levels of our general and administrative personnel and higher variable compensation costs as a result of improved financial performance. The increase in costs was partially offset by a decline in external legal and professional fees. As a percentage of total revenues, general and administrative expenses were 16.2% and 19.2% for the three months ended March 31, 2004 and 2003, respectively.
The following table sets forth interest expense and changes in interest expense for the periods indicated (in thousands):
Three Months Ended March 31, |
||||||||||
2004 |
2003 |
$ Change |
||||||||
7 1/2% series A unsecured notes: |
||||||||||
Stated interest expense |
$ | | $ | 1,186 | $ | (1,186 | ) | |||
Discount amortization expense |
| 847 | (847 | ) | ||||||
Promissory notes issued to former preferred stockholders: |
||||||||||
Stated interest expense |
| 91 | (91 | ) | ||||||
Discount amortization expense |
| 126 | (126 | ) | ||||||
Other debt and interest expense |
14 | 48 | (34 | ) | ||||||
Total interest expense |
$ | 14 | $ | 2,298 | $ | (2,284 | ) | |||
Interest Expense. The decline in interest expense was attributable to the conversion of our 7 ½% series A unsecured notes into class A common stock on July 30, 2003 and the repayment in full of our promissory notes issued to former preferred stockholders on July 31, 2003. Upon conversion of the 7 ½% series A notes and repayment of the promissory notes issued to former preferred stockholders, we ceased accruing interest and incurring discount amortization expense on these instruments.
Gain on Early Extinguishment of Notes Payable. During the first quarter of 2003, we repurchased promissory notes with an aggregate principal amount of $1.8 million in exchange for 56,053 shares of class A common stock. The carrying value of the extinguished promissory notes plus accrued and unpaid interest of $1.3 million in aggregate was substantially equal to the fair value of the consideration transferred to the holders of such promissory notes.
15
Other Income (Expense), net. Other income (expense), net includes gains and losses on foreign currency transactions primarily resulting from the strengthening of the British pound sterling against the U.S. dollar and minority interest in our subsidiary, Alarm.com.
Provision for Income Taxes. During the three months ended March 31, 2004 and 2003, we recorded income tax expense of $772,000 and $864,000, respectively. The provision for income taxes was primarily related to foreign jurisdictions where we are profitable and withholding taxes on intercompany software fees and other intercompany transactions with our foreign subsidiaries. During the three months ended March 31, 2004, we utilized net operating loss carryforwards in the United States which had the effect of reducing our effective tax rate and related tax expense. During the three months ended March 31, 2003, we utilized net operating loss carryforwards in the United States and in certain foreign subsidiaries which had the effect of reducing our effective tax rate and related tax expense. If we become more profitable in certain foreign jurisdictions where we have limited or no net operating losses to offset taxable income, we would expect to incur increased tax expense in those jurisdictions.
As of March 31, 2004, we had net operating loss carryforwards of approximately $309.3 million and other temporary differences, which resulted in net deferred tax assets of approximately $148.7 million. Also as of March 31, 2004, we had a valuation allowance of $143.5 million on our deferred tax assets. If our operations, and particularly our domestic operations, continue to demonstrate profitability in 2004, after excluding permanent differences and certain non-recurring items, we may reduce a substantial amount of our valuation allowance at the end of 2004. During the period of any such substantial reduction in our domestic valuation allowance, we would expect a corresponding tax benefit and increase in net income, and thereafter our effective tax rate would increase to, approximately, 36% - 40%. We may not be able to sustain profitability and as a result any release of the valuation allowance and our future effective tax rate is uncertain. In determining net deferred tax assets and valuation allowances, management is required to make judgments and estimates related to projections of domestic and foreign profitability, the timing and extent of the utilization of net operating loss carryforwards, applicable tax rates, transfer pricing methodologies and prudent and feasible tax planning strategies.
On February 21, 2004, we received notification from the Internal Revenue Service that our calendar year 2000 corporate income tax return has been selected for audit. Management believes that adequate provision has been made for any adjustments that may result from the audit. However, the outcome of this tax audit cannot be predicted with certainty. Should any issues addressed in our tax audit be resolved in a manner not consistent with managements expectations, we could be required to adjust our provision for income taxes in the period such resolution occurs.
Legal Proceedings and Contingencies
We are involved in lawsuits with Business Objects, S.A. and Business Objects Americas, Inc. relating to claims involving patent infringement and other intellectual property claims. The outcome of this litigation is not presently determinable, and as such, we are currently unable to estimate the potential range of gain or loss, if any, relating to these actions. Accordingly, no provision for these matters has been made in the accompanying consolidated financial statements. Additional information regarding these matters is included below under Risk Factors.
We are also involved in a lawsuit with ePlus Group, Inc. relating to a claim involving breach of contract relating to the master lease agreement that we entered into with them on November 1, 1999, under which we leased equipment from ePlus. ePlus claims that equipment returned by us upon expiration of the lease term was not in satisfactory condition and seeks damages of approximately $2.0 million plus interest, taxes and attorneys fees. We intend to vigorously defend the case. Although the ultimate outcome of this litigation is uncertain, we believe that the litigation will not have a material adverse effect on our financial position or results of operations.
We are also involved in other legal proceedings through the normal course of business. Management believes that any unfavorable outcome related to these other proceedings will not have a material effect on our financial position, results of operations or cash flows.
16
Accrued Restructuring Costs
During 2001, we adopted restructuring plans which included a strategic decision to focus operations on the business intelligence market, the elimination or reduction of speculative technology initiatives, a reduction of our workforce and a consolidation of our multiple Northern Virginia facilities into a single location in McLean, Virginia.
The following table sets forth a summary of the accrued restructuring costs as of March 31, 2004 (in thousands):
Accrued Restructuring Costs at December 31, 2003 |
Q1 2004 Cash Payments |
Accrued Restructuring Costs at March 31, 2004 | ||||||||
Estimated sublease losses and other facility closing costs |
$ | 6,054 | $ | (596 | ) | $ | 5,458 | |||
Terminations of equipment leases |
89 | (10 | ) | 79 | ||||||
Total accrued restructuring costs |
$ | 6,143 | $ | (606 | ) | $ | 5,537 | |||
As of March 31, 2004, unpaid amounts of $2.4 million and $3.1 million have been classified as current and long-term accrued restructuring costs, respectively, in the accompanying consolidated balance sheet. Amounts related to the estimated sublease losses associated with exiting facilities and terminations of equipment leases will be paid over the respective lease terms through February 2009. As a result of the restructuring, we have approximately 77,000 square feet of office space that is not occupied by us with the following expiration dates: 46,000 square feet expire in August 2006 and 31,000 square feet expire in February 2009. Of the 77,000 square feet of office space that is not occupied by us, 66,000 square feet has been subleased as of March 31, 2004. The remaining unoccupied office space continues to be marketed for sublease. At March 31, 2004, we had $8.7 million in gross lease obligations and $1.2 million in estimated commissions, concessions and other costs, partially offset by $4.4 million in estimated gross sublease income recoveries during the remaining lease terms. We estimated our sublease losses based upon current information available relating to sublease commission costs, sub-tenant concession costs, sublease rental income and the length of time expected to sublease excess space. Final amounts could differ from current estimates if we are unable to sublet the remaining unoccupied office space on the estimated terms. For example, if our estimates relating to sublease income and costs to sublease differ from current estimates by 10%, our final restructuring costs could be approximately $550,000 higher. We may also continue to seek to terminate certain leases early; however, our landlords may not be willing to terminate such lease arrangements under terms and conditions that are acceptable to us. Except for estimated sublease losses and other facility closing costs and equipment leases, the restructuring plans have been substantially completed.
Deferred Revenue and Advance Payments
Deferred revenue and advance payments primarily represent product support and other services fees that are collected in advance and recognized over the contract service period and product license and product support and other services fees relating to multiple element software arrangements that include future deliverables. Current and non-current deferred revenue and advance payments totaled $40.3 million as of March 31, 2004 compared to $31.1 million as of March 31, 2003. The increase in deferred revenue and advance payments was primarily attributable to an ongoing increase in our installed base of software licenses under technical support contracts, an increase in the average rate charged for technical support during 2004 and our high renewal rates of such contracts. The increase was partially offset by a reduction of deferred revenue and advance payment balances due to the recognition of revenues on existing license and technical support contracts. We expect to recognize approximately $37.0 million of this deferred revenue and advance payments over the next 12 months; however, the timing and ultimate recognition of our deferred revenue and advance payments depend on our performance of various service obligations, and the amount of deferred revenue and advance payments at any date should not be considered indicative of revenues for any succeeding period.
17
Deferred revenue and advance payments from customers consist of the following, as of (in thousands):
March 31, 2004 |
December 31, 2003 |
|||||||
Current: |
||||||||
Deferred product revenue |
$ | 3,295 | $ | 4,490 | ||||
Deferred product support and other services revenue |
54,705 | 50,497 | ||||||
58,000 | 54,987 | |||||||
Less: billed and unpaid deferred revenue |
(20,983 | ) | (26,613 | ) | ||||
$ | 37,017 | $ | 28,374 | |||||
Non-current: |
||||||||
Deferred product revenue |
$ | 211 | $ | 378 | ||||
Deferred product support and other services revenue |
3,262 | 3,380 | ||||||
3,473 | 3,758 | |||||||
Less: billed and unpaid deferred revenue |
(206 | ) | (1,008 | ) | ||||
$ | 3,267 | $ | 2,750 | |||||
We offset our accounts receivable and deferred revenue for any billed and unpaid items included in deferred revenue and advance payments.
Liquidity and Capital Resources
Our principal source of liquidity is our cash, cash equivalents, on-going collection of our accounts receivable and a revolving line of credit subject to borrowing base limitations based on accounts receivable. On March 31, 2004 and December 31, 2003, we had $77.0 million and $52.6 million, respectively, of cash and cash equivalents, of which $726,000 and $747,000, respectively, was restricted cash. As of March 31, 2004, we had $4.9 million of borrowing capacity under our revolving line of credit based on the borrowing base limitation applicable to the facility.
The following are our contractual obligations associated with our restructuring plans and lease commitments (in thousands):
Twelve months ending March 31, |
|||||||||||||||||||||
2005 |
2006 |
2007 |
2008 |
2009 |
Thereafter |
Total | |||||||||||||||
Restructuring-related obligations, net (1) |
$ | 2,431 | $ | 1,574 | $ | 769 | $ | 398 | $ | 365 | $ | | $ | 5,537 | |||||||
Operating leases |
9,978 | 9,114 | 7,643 | 6,918 | 6,773 | 8,962 | 49,388 | ||||||||||||||
Total contractual cash obligations |
$ | 12,409 | $ | 10,688 | $ | 8,412 | $ | 7,316 | $ | 7,138 | $ | 8,962 | $ | 54,925 | |||||||
(1) | Restructuring-related lease obligations include estimated sublease concessions, commission payments and other costs associated with marketing our idle space for sublease of $1.2 million and are reflected net of estimated sublease income recoveries of $4.4 million. Total gross restructuring-related lease obligations are $8.7 million. We may incur additional charges and expend more cash than currently expected if we are unable to sublet our idle space on the estimated terms. |
Operating Activities
Net cash provided by operating activities was $25.1 million and $7.5 million for the three months ended March 31, 2004 and 2003, respectively. The increase in cash provided by operating activities was primarily attributable to an improvement in operating results, a reduction in accounts receivable resulting
18
from improved cash collections from customers and an increase in deferred revenue balances. If we continue to generate income from operations and increases in deferred revenues, we expect to continue to generate positive cash flows from operations.
Investing Activities
Net cash used in investing activities was $2.4 million and $683,000 for the three months ended March 31, 2004 and 2003, respectively. The increase in net cash used in investing activities was attributable to an increase in capital expenditures and an increase in capitalized software developments costs. We expect to continue to invest in property and equipment to appropriately support our future growth and to continue to maintain and enhance our current infrastructure.
Financing Activities
Net cash provided by financing activities was $1.9 million and $97,000 for the three months ended March 31, 2004 and 2003, respectively. The change was attributable to an increase in proceeds from the sale of our class A common stock under our employee stock purchase plan and the exercise of employee stock options.
Management believes that existing cash, cash anticipated to be generated internally by operations and the Companys credit facility will be sufficient to meet working capital requirements and anticipated capital expenditures for at least the next twelve months. Based upon our cash position, we do not currently expect to borrow money to finance our operations. Our liquidity and capital resources and ability to generate revenues are subject to various business and economic risks discussed below under Risk Factors.
Recent Accounting Standards
In January 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. In December 2003, the FASB revised FIN 46 to reflect decisions it made regarding a number of implementation issues. FIN 46, as revised, requires that the primary beneficiary of a variable interest entity consolidate the entity even if the primary beneficiary does not have a majority voting interest. This interpretation applies to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. This interpretation also identifies those situations where a controlling financial interest may be achieved through arrangements that do not involve voting interests. The interpretation also establishes additional disclosures which are required regarding an enterprises involvement with a variable interest entity when it is not the primary beneficiary. The requirements of this interpretation are required to be applied for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions must be applied for the first interim or annual period ending after December 15, 2003. We do not have any controlling interest, contractual relationships or other business relationships with unconsolidated variable interest entities and therefore the adoption of this standard did not have any effect on our financial position and results of operations.
Risk Factors
You should carefully consider the risks described below before making an investment decision. The risks and uncertainties described below are not the only ones facing MicroStrategy. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations.
If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected. In such case, the trading price of our class A common stock could decline and you may lose all or part of your investment.
19
We may not be able to sustain or increase profitability in the future
We generated net income for the three months ended March 31, 2004; however, we may not be able to sustain or increase profitability on a quarterly or annual basis in the future. As of March 31, 2004, our accumulated deficit was $335.5 million. If operating expenses exceed our expectations or cannot be adjusted accordingly, our business, results of operations and financial condition will be materially and adversely affected.
Our quarterly operating results, revenues and expenses may fluctuate significantly, which could have an adverse effect on the market price of our stock
For a number of reasons, including those described below, our operating results, revenues and expenses have in the past varied and may in the future vary significantly from quarter to quarter. These fluctuations could have an adverse effect on the market price of our class A common stock.
Fluctuations in Quarterly Operating Results. Our quarterly operating results may fluctuate as a result of:
| the size, timing, volume and execution of significant orders and shipments; |
| the mix of products and services of customer orders, which can affect whether we recognize revenue upon the signing and delivery of our software products or whether revenue must be recognized as work progresses or over the entire contract period; |
| the timing of new product announcements; |
| changes in our pricing policies or those of our competitors; |
| market acceptance of business intelligence software generally and of new and enhanced versions of our products in particular; |
| the length of our sales cycles; |
| changes in our operating expenses; |
| personnel changes; |
| our success in adding to our indirect distribution channels; |
| utilization of our consulting personnel, which can be affected by delays or deferrals of customer implementation of our software products and consulting, education and support services; |
| changes in foreign currency exchange rates, which had a positive impact on our results for the three months ended March 31, 2004; and |
| seasonal factors, such as our traditionally lower pace of new sales in the summer. |
Limited Ability to Adjust Expenses. We base our operating expense budgets on expected revenue trends. Many of our expenses, such as office and equipment leases and certain personnel costs, are relatively fixed. We may be unable to adjust spending quickly enough to offset any unexpected revenue shortfall. Accordingly, any shortfall in revenue may cause significant variation in operating results in any quarter.
Based on the above factors, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. It is possible that in one or more future quarters, our operating results may be below the expectations of public market analysts and investors. In that event, the trading price of our class A common stock may fall.
We use strategic channel partners and if we are unable to maintain successful relationships with them, our business, operating results and financial condition could be materially adversely affected
In addition to our direct sales force, we use strategic channel partners such as value-added resellers, system integrators and original equipment manufacturers to license and support our products in the United States and internationally. For the three months ended March 31, 2004 and the years ended December 31, 2003, 2002 and 2001, channel partners accounted for, directly or indirectly, approximately 15.7%, 24.6%, 27.3% and 35.4% of our total product licenses revenues, respectively. Our channel partners generally offer customers the products of several different companies, including some products that compete with ours. Although we believe that direct sales will continue to account for a majority of product license revenues, we seek to maintain a significant level of indirect sales activities through our strategic channel partners; however, we may not be successful in those efforts. Our ability to achieve revenue growth in the future will depend in part on our success in maintaining successful relationships with those strategic partners. If we are unable to maintain our relationships with these strategic partners, our business, operating results and financial condition could be materially adversely affected.
Our recognition of deferred revenue and advance payments is subject to future performance obligations and may not be representative of revenues for succeeding periods
Our deferred revenue and advance payments were $40.3 million as of March 31, 2004. The timing and ultimate recognition of our deferred revenue and advance payments depend on our performance of various service obligations. Because of the possibility of customer changes in development schedules, delays in implementation and development efforts and the need to satisfactorily perform product support services,
20
deferred revenue and advance payments at any particular date may not be representative of actual revenue for any succeeding period.
Managing our international operations is complex and our failure to do so successfully or in a cost-effective manner would have a material adverse effect on our business, operating results and financial condition
International sales accounted for 42.7% and 35.8% of our total revenues for the three months ended March 31, 2004 and 2003, respectively. Our international operations require significant management attention and financial resources.
There are certain risks inherent in our international business activities including:
| changes in foreign currency exchange rates; |
| unexpected changes in regulatory requirements; |
| tariffs and other trade barriers; |
| costs of localizing products for foreign countries; |
| lack of acceptance of localized products in foreign countries; |
| longer accounts receivable payment cycles; |
| difficulties in managing international operations; |
| tax issues, including restrictions on repatriating earnings; |
| weaker intellectual property protection in other countries; |
| economic weakness or currency related crises that may arise in different countries or geographic regions; and |
| the burden of complying with a wide variety of foreign laws. |
These factors may have a material adverse effect on our future international sales and, consequently, on our business, operating results and financial condition.
We may lose sales, or sales may be delayed, due to the long sales and implementation cycles for our products, which would reduce our revenues
To date, our customers have typically invested substantial time, money and other resources and involved many people in the decision to license our software products and purchase our consulting and other services. As a result, we may wait nine months or more after the first contact with a customer for that customer to place an order while they seek internal approval for the purchase of our products and/or services. During this long sales cycle, events may occur that affect the size or timing of the order or even cause it to be canceled. For example, our competitors may introduce new products, or the customers own budget and purchasing priorities may change.
Even after an order is placed, the time it takes to deploy our products and complete consulting engagements varies widely from one customer to the next. Implementing our product can sometimes last several months, depending on the customers needs and may begin only with a pilot program. It may be difficult to deploy our products if the customer has complicated deployment requirements, which typically involve integrating databases, hardware and software from different vendors. If a customer hires a third party to deploy our products, we cannot be sure that our products will be deployed successfully.
21
We face intense competition, which may lead to lower prices for our products, reduced gross margins, loss of market share and reduced revenue
The markets for business intelligence software, analytical applications and information delivery are intensely competitive and subject to rapidly changing technology. In addition, many companies in these markets are offering, or may soon offer, products and services that may compete with MicroStrategy products.
MicroStrategys most direct competitors include providers of:
| Business intelligence software; |
| OLAP tools; |
| Ad-hoc Query tools; |
| Web-based reporting tools; and |
| Report delivery and proactive alerting. |
Each of these markets is discussed more fully below.
Business Intelligence Software. Makers of business intelligence software provide business intelligence capabilities designed for integration, customization and application development. Companies such as Microsoft, Oracle, Hyperion Solutions, SAP AG, Computer Associates and SAS provide business intelligence software.
OLAP Tools. Companies that build software to perform online analytical processing (OLAP) provide offerings competitive with the core MicroStrategy 7i platform. Whether web-based or client-server, these tools give end users the ability to analyze underlying data sources without having to hand code structured query language queries. Most OLAP tools allow users to build their own calculations and specify report layouts and other options. Additionally, OLAP tools provide users the ability to navigate throughout the underlying data in an easy, graphical style, often referred to as drilling. Additional OLAP capabilities include pivoting and filtering. Providers of OLAP tools include Cognos, Hyperion Solutions, IBM, SAP and Microsoft.
Ad-hoc Query Tools. Ad-hoc query tools allow large numbers of end users to gain access to pre-defined reports and queries for simple analysis. Often each end user is able to specify some personalized run-time criteria that customize the result set for that particular person. Some limited drilling is also provided. Some ad-hoc query tools allow users to access databases and create their own database queries using structured query language. Users are then able to export the resulting data into other formats such as Microsoft Excel for their own use. Companies that produce query and reporting tools include Business Objects, Cognos, Oracle, Hyperion Solutions and Information Builders.
Web-based Reporting Tools. Companies that offer software to deliver pre-built reports for end user viewing and consumption can also compete with MicroStrategy. Extensive formatting capabilities ensure that users can easily consume the information contained in the reports. There is limited user interactivity with these reports generated by reporting tools. Reporting applications built with these tools often lack the sophistication, robustness and scalability of the MicroStrategy platform, but can be attractive for small departments. Vendors in this category include Actuate, Business Objects, Microsoft and SAS.
Report Delivery and Proactive Alerting. Companies that focus on the proactive delivery of information, via e-mail, website, or other medium can compete with MicroStrategys offerings. Typically, these tools serve to push out compiled reports on a scheduled basis to sets of users based on job type. MicroStrategy
22
software has integrated this technology into the MicroStrategy 7i platform. Vendors of such technology include Actuate and Business Objects.
Many of our competitors have longer operating histories, significantly greater financial, technical, marketing or other resources, and greater name recognition than we do. In addition, many of our competitors have strong relationships with current and potential customers and extensive knowledge of the business intelligence industry. As a result, they may be able to respond more quickly to new or emerging technologies and changes in customer requirements or devote greater resources to the development, promotion and sale of their products than we can. Increased competition may lead to price cuts, reduced gross margins and loss of market share. We may not be able to compete successfully against current and future competitors and the failure to meet the competitive pressures we face may have a material adverse effect on our business, operating results and financial condition.
Current and future competitors may also make strategic acquisitions or establish cooperative relationships among themselves or with others. By doing so, they may increase their ability to meet the needs of our potential customers. Our current or prospective indirect channel partners may establish cooperative relationships with our current or future competitors. These relationships may limit our ability to sell our products through specific distribution channels. Accordingly, new competitors or alliances among current and future competitors may emerge and rapidly gain significant market share. These developments could limit our ability to obtain revenues from new customers and to maintain technical support revenues from our installed customer base.
Our inability to develop and release product enhancements and new products to respond to rapid technological change in a timely and cost-effective manner would have a material adverse effect on our business, operating results and financial condition
The market for our products is characterized by rapid technological change, frequent new product introductions and enhancements, changing customer demands and evolving industry standards. The introduction of products embodying new technologies can quickly make existing products obsolete and unmarketable. We believe that our future success depends largely on three factors:
| our ability to continue to support a number of popular operating systems and databases; |
| our ability to maintain and improve our current product line; and |
| our ability to rapidly develop new products that achieve market acceptance, maintain technological competitiveness and meet an expanding range of customer requirements. |
Business intelligence applications are inherently complex, and it can take a long time to develop and test major new products and product enhancements. In addition, customers may delay their purchasing decisions because they anticipate that new or enhanced versions of our products will soon become available. We cannot be sure that we will succeed in developing and marketing, on a timely and cost-effective basis, product enhancements or new products that respond to technological change or new customer requirements, nor can we be sure that any new products and product enhancements will achieve market acceptance.
The emergence of new industry standards may adversely affect our ability to market our existing products
The emergence of new industry standards in related fields may adversely affect the demand for our existing products. This could happen, for example, if new web standards and technologies emerged that were incompatible with customer deployments of our products. Although the core database component of our business intelligence solutions is compatible with nearly all major enterprise server hardware and operating system combinations, such as OS/390, AS/400, Unix, Linux and Windows, certain of our application server components run only on the Windows NT, Server 2000 and Server 2003 operating systems. Therefore, our ability to increase sales currently depends in part on the continued acceptance of the Windows NT and
23
Windows Server operating systems and in part on our ability to port certain components of our software to non-Windows based operating systems.
The nature of our products makes them particularly vulnerable to undetected errors, or bugs, which could cause problems with how the products perform and which could in turn reduce demand for our products, reduce our revenue and lead to product liability claims against us
Software products as complex as ours may contain errors or defects. Although we test our products extensively, we have in the past discovered software errors in new products after their introduction. Despite testing by us and by our current and potential customers, errors may be found in new products or releases after commercial shipments begin. This could result in lost revenue or delays in market acceptance, which could have a material adverse effect upon our business, operating results and financial condition.
Our license agreements with customers typically contain provisions designed to limit our exposure to product liability claims. It is possible, however, that these provisions may not be effective under the laws of certain domestic or international jurisdictions. Although there have been no product liability claims against us to date, our license and support of products may involve the risk of these claims. A successful product liability claim against us could have a material adverse effect on our business, operating results and financial condition.
If we are unable to recruit or retain skilled personnel, or if we lose the services of any of our key management personnel, our business, operating results and financial condition would be materially adversely affected
Our future success depends on our continuing ability to attract, train, assimilate and retain highly skilled personnel. Competition for these employees is intense. We may not be able to retain our current key employees or attract, train, assimilate or retain other highly skilled personnel in the future. Our future success also depends in large part on the continued service of key management personnel, particularly Michael J. Saylor, our Chairman and Chief Executive Officer, and Sanju K. Bansal, our Vice Chairman, Executive Vice President and Chief Operating Officer. If we lose the services of one or both of these individuals or other key personnel, or if we are unable to attract, train, assimilate and retain the highly skilled personnel we need, our business, operating results and financial condition could be materially adversely affected.
Because of the rights of our two classes of common stock, and because we are controlled by our existing holders of class B common stock, these stockholders could transfer control of MicroStrategy to a third party without anyone elses approval or prevent a third party from acquiring MicroStrategy
We have two classes of common stock: class A common stock and class B common stock. Holders of our class A common stock generally have the same rights as holders of our class B common stock, except that holders of class A common stock have one vote per share while holders of class B common stock have ten votes per share. As of May 1, 2004, holders of our class B common stock owned 3,603,730 shares of class B common stock, or 74.3% of the total voting power. Michael J. Saylor, our Chairman and Chief Executive Officer, beneficially owned 82,882 shares of class A common stock and 2,849,700 shares of class B common stock, or 59.0% of the total voting power, as of May 1, 2004. Accordingly, Mr. Saylor is able to control MicroStrategy through his ability to determine the outcome of elections of our directors, amend our certificate of incorporation and by-laws and take other actions requiring the vote or consent of stockholders, including mergers, going-private transactions and other extraordinary transactions and their terms.
Our certificate of incorporation allows holders of class B common stock, almost all of whom are current employees or former employees of our company or related parties, to transfer shares of class B common stock, subject to the approval of stockholders possessing a majority of the outstanding class B common stock. Mr. Saylor or a group of stockholders possessing a majority of the outstanding class B common
24
stock could, without seeking anyone elses approval, transfer voting control of MicroStrategy to a third party. Such a transfer of control could have a material adverse effect on our business, operating results and financial condition. Mr. Saylor will also be able to prevent a change of control of MicroStrategy, regardless of whether holders of class A common stock might otherwise receive a premium for their shares over the then current market price.
We have only limited protection for our proprietary rights in our software, which makes it difficult to prevent third parties from infringing upon our rights
We rely primarily on a combination of copyright, patent, trademark and trade secret laws, customer licensing agreements, employee and third-party nondisclosure agreements and other methods to protect our proprietary rights. However, these laws and contractual provisions provide only limited protection. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Policing such unauthorized use is difficult, and we cannot be certain that we can prevent it, particularly in countries where the laws may not protect our proprietary rights as fully as in the United States.
Our products may be susceptible to claims by other companies that our products infringe upon their proprietary rights, which could adversely affect our business, operating results and financial condition
As the number of software products in our target markets increases and the functionality of these products further overlaps, we may become increasingly subject to claims by a third party that our technology infringes such partys proprietary rights. Regardless of their merit, any such claims could be time consuming and expensive to defend, may divert managements attention and resources, could cause product shipment delays and could require us to enter into costly royalty or licensing agreements. If successful, a claim of infringement against us and our inability to license the infringed or similar technology could have a material adverse effect on our business, operating results and financial condition.
On October 17, 2001, Business Objects filed suit against us in the United States District Court for the Northern District of California, claiming that our software infringes a patent issued to Business Objects relating to relational database access (the 403 patent). The suit sought injunctive relief and monetary damages. On August 29, 2003, the Court granted our motion for summary judgment and dismissed the lawsuit, ruling as a matter of law that our products do not infringe the 403 patent. Business Objects has filed an appeal.
On October 31, 2001, we filed suit against Business Objects, S.A. and its subsidiary, Business Objects Americas, Inc., in the United States District Court for the Eastern District of Virginia, claiming that Business Objects software infringes two patents held by us relating to asynchronous control of report generation using a web browser (the 033 patent) and a system and method of adapting automatic output of OLAP reports to disparate user output devices (the 050 patent). The complaint against Business Objects was amended to add claims for violations of the federal Computer Fraud and Abuse Act, misappropriation of trade secrets, tortious interference with contractual relations, and violations of the Virginia Conspiracy Act. As a result of pre-trial rulings, certain of these claims were dismissed. Our claims for tortious interference and misappropriation of trade secrets proceeded to trial on October 20, 2003. On October 28, 2003, the Court dismissed the tortious interference claim. The Court has yet to issue a ruling on the merits of the misappropriation of trade secrets claim, for which we are seeking various equitable remedies against Business Objects. In July 2003, the United States Patent & Trademark Office confirmed the validity of all the claims in the 033 and 050 patents and terminated reexamination proceedings that Business Objects had requested as to those patents. We agreed to dismissal of the 033 patent claims without prejudice. Our 050 patent claims are currently scheduled to proceed to trial on June 15, 2004. We are seeking monetary damages and injunctive relief.
On December 10, 2003, we filed a complaint for patent infringement against Crystal Decisions, Inc. in the United States District Court for the District of Delaware. The lawsuit alleges that Crystal Decisions willfully infringes three patents issued to us relating to: (i) asynchronous control of report generation using
25
a web browser (the 033 patent); (ii) management of an automatic OLAP report broadcast system (the 796 patent); and (iii) providing business intelligence web content with reduced client-side processing (the 432 patent). We are seeking monetary damages and injunctive relief. Following the filing of the complaint, Crystal Decisions was acquired by Business Objects Americas, Inc. Business Objects Americas, Inc. has answered the complaint, denying infringement and seeking a declaration that the patents in suit are invalid and not infringed by Business Objects Americas, Inc. The case is in its earliest stages. Trial is scheduled for November 2005.
If the market for business intelligence software fails to grow as we expect, or if businesses fail to adopt our products, our business, operating results and financial condition would be materially adversely affected
Nearly all of our revenues to date have come from sales of business intelligence software and related technical support, consulting and education services. We expect these sales to account for a large portion of our revenues for the foreseeable future. Although demand for business intelligence software has grown in recent years, the market for business intelligence software applications is still emerging. Resistance from consumer and privacy groups to increased commercial collection and use of data on spending patterns and other personal behavior and recent European Union restrictions on the collection and use of personal data may impair the further growth of this market, as may other developments. We cannot be sure that this market will continue to grow or, even if it does grow, that businesses will adopt our solutions. We have spent, and intend to keep spending, considerable resources to educate potential customers about business intelligence software in general and our solutions in particular. However, we cannot be sure that these expenditures will help our products achieve any additional market acceptance. If the market fails to grow or grows more slowly than we currently expect, our business, operating results and financial condition would be materially adversely affected.
The price of our stock may be extremely volatile
The market price for our class A common stock has historically been volatile and could fluctuate significantly for any of the following reasons:
| quarter-to-quarter variations in our operating results; |
| developments or disputes concerning proprietary rights; |
| technological innovations or new products; |
| governmental regulatory action; |
| general conditions in the software industry; |
| increased price competition; |
| changes in revenue or earnings estimates by analysts; or |
| other events or factors. |
Many of the above factors are beyond our control.
The stock market has recently experienced extreme price and volume fluctuations. These fluctuations have particularly affected the market price of many software companies, often without regard to their operating performance.
26
ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
The following discussion about our market risk disclosures involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements. We are exposed to the impact of interest rate changes and foreign currency fluctuations.
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily to our cash equivalents and short-term investments. We invest our excess cash in short-term, fixed income financial instruments. These fixed rate investments are subject to interest rate risk and may fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10% from the levels at March 31, 2004, the fair market value of the portfolio would decline by an immaterial amount. We have the ability to hold our fixed income investments until maturity and, therefore, we do not expect our operating results or cash flows to be materially affected by a sudden change in market interest rates on our investment portfolio.
Foreign Currency Risk
We face exposure to adverse movements in foreign currency exchange rates. Our international revenues and expenses are denominated in foreign currencies, principally the Euro and the British pound sterling. The functional currency of each of our foreign subsidiaries is the local currency. Our international business is subject to risks typical of an international business, including, but not limited to differing tax structures, other regulations and restrictions, and foreign exchange rate volatility. Based on our overall currency rate exposure at March 31, 2004, a 10% change in foreign exchange rates would have had an immaterial effect on our financial position, results of operations and cash flows. International revenues were 42.7% and 35.8% of total revenues for the three months ended March 31, 2004 and 2003, respectively. We anticipate that international revenues will continue to account for a significant amount of total revenues. To date, we have not hedged the risks associated with foreign exchange exposure. Although we may do so in the future, we cannot be sure that any hedging techniques we may implement will be successful or that our business, results of operations, financial condition and cash flows will not be materially adversely affected by exchange rate fluctuations.
ITEM 4. | CONTROLS AND PROCEDURES |
Evaluation of disclosure controls and procedures. Based on their evaluation of the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(3) under the Exchange Act) as of March 31, 2004, the Companys chief executive officer and chief financial officer have concluded that the Companys disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms and are operating in an effective manner.
Changes in internal controls. No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended March 31, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
27
PART II. OTHER INFORMATION
ITEM 1. | LEGAL PROCEEDINGS |
Business Objects Litigation
On October 2, 2001, we filed a lawsuit in the Virginia Circuit Court for Fairfax County against two field employees of Business Objects, S.A. This lawsuit alleged that these employees, who previously worked for us, breached their fiduciary and contractual obligations to us by, among other things, misappropriating our trade secrets and confidential information and soliciting our employees and customers. The complaint sought injunctive relief and damages. On October 17, 2001, Business Objects filed suit against us in the United States District Court for the Northern District of California, claiming that our software infringes a patent issued to Business Objects relating to relational database access (the 403 patent). The suit sought injunctive relief and monetary damages. On August 29, 2003, the Court granted our motion for summary judgment and dismissed the lawsuit, ruling as a matter of law that our products do not infringe the 403 patent. Business Objects has filed an appeal.
On October 31, 2001, we filed suit against Business Objects, S.A. and its subsidiary, Business Objects Americas, Inc., in the United States District Court for the Eastern District of Virginia, claiming that Business Objects software infringes two patents held by us relating to asynchronous control of report generation using a web browser (the 033 patent) and a system and method of adapting automatic output of OLAP reports to disparate user output devices (the 050 patent). On March 13, 2002, we voluntarily dismissed without prejudice our lawsuit pending in the Virginia Circuit Court for Fairfax County against the two field employees of Business Objects. The complaint against Business Objects was amended to add claims for violations of the federal Computer Fraud and Abuse Act, misappropriation of trade secrets, tortious interference with contractual relations and violations of the Virginia Conspiracy Act. As a result of pre-trial rulings, certain of these claims were dismissed. Our claims for tortious interference and misappropriation of trade secrets proceeded to trial on October 20, 2003. On October 28, 2003, the Court dismissed the tortious interference claim. The Court has yet to issue a ruling on the merits of the misappropriation of trade secrets claim, for which we are seeking various equitable remedies against Business Objects. In July 2003, the United States Patent & Trademark Office confirmed the validity of all the claims in the 033 and 050 patents and terminated reexamination proceedings that Business Objects had requested as to those patents. We agreed to dismissal of the 033 patent claims without prejudice. Our 050 patent claims are currently scheduled to proceed to trial on June 15, 2004. We are seeking monetary damages and injunctive relief.
On December 10, 2003, we filed a complaint for patent infringement against Crystal Decisions, Inc. in the United States District Court for the District of Delaware. The lawsuit alleges that Crystal Decisions willfully infringes three patents issued to us relating to: (i) asynchronous control of report generation using a web browser (the 033 patent); (ii) management of an automatic OLAP report broadcast system (the 796 patent); and (iii) providing business intelligence web content with reduced client-side processing (the 432 patent). We are seeking monetary damages and injunctive relief. Following the filing of the complaint, Crystal Decisions was acquired by Business Objects Americas, Inc. Business Objects Americas, Inc. has answered the complaint, denying infringement and seeking a declaration that the patents in suit are invalid and not infringed by Business Objects Americas, Inc. The case is in its earliest stages. Trial is scheduled for November 2005.
Other Proceedings
We are also involved in other legal proceedings through the normal course of business. Management believes that any unfavorable outcome related to these other proceedings will not have a material effect on our financial position, results of operations or cash flows.
28
ITEM 6. | EXHIBITS AND REPORTS ON FORM 8-K |
A. Exhibits
Exhibit Number |
Description | |
3.1 | Second Restated Certificate of Incorporation of the registrant (filed as Exhibit 3.1 to the registrants Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2003 (File No. 000-24435) and incorporated by reference herein). | |
3.2 | Amended and Restated By-Laws of the registrant (filed as Exhibit 3.2 to the registrants Annual Report on Form 10-K for the fiscal year ended December 31, 2003 (File No. 000-24435) and incorporated by reference herein). | |
4.1 | Form of Certificate of Class A Common Stock of the registrant (filed as Exhibit 4.1 to the registrants Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2003 (File No. 000-24435) and incorporated by reference herein). | |
4.2 | Warrant Agreement, dated as of January 11, 2001, by and between the registrant and American Stock Transfer & Trust Company, included as Exhibit E to the Stipulation of Settlement regarding the settlement of the class action lawsuit, dated as of January 11, 2001 (filed as Exhibit 10.29 to the registrants Annual Report on Form 10-K for the fiscal year ended December 31, 2000 (File No. 000-24435) and incorporated by reference herein). | |
10.1 | Secured Credit Agreement, dated May 19, 2003, by and between the registrant, MicroStrategy Services Corporation, MicroStrategy Management Corporation, MicroStrategy Administration Corporation and Strategy.com Incorporated; and Bank of America, N.A. (filed as Exhibit 10.1 to the registrants Current Report on Form 8-K dated May 19, 2003 (File No. 000-24435) and incorporated by reference herein). | |
10.2 | First Modification Agreement, dated November 4, 2003, by and between the registrant, MicroStrategy Services Corporation, MicroStrategy Management Corporation, MicroStrategy Administration Corporation and Strategy.com Incorporated; and Bank of America, N.A., modifying that certain Secured Credit Agreement dated May 19, 2003 (filed as Exhibit 10.21 to the registrants Annual Report on Form 10-K for the fiscal year ended December 31, 2003 (File No. 000-24435) and incorporated by reference herein). | |
10.3 | Second Modification Agreement, dated March 31, 2004, by and between the registrant, MicroStrategy Services Corporation, MicroStrategy Management Corporation, MicroStrategy Administration Corporation and Strategy.com Incorporated; and Bank of America, N.A., modifying that certain Secured Credit Agreement dated May 19, 2003. | |
31.1 | Certification pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Chairman of the Board of Directors and Chief Executive Officer. | |
31.2 | Certification pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the President and Chief Financial Officer. | |
32 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
29
B. Reports on Form 8-K
On January 29, 2004, the registrant filed a Current Report pursuant to Items 5 and 7 on Form 8-K dated January 29, 2004 to report that it had issued a press release announcing its financial results for the quarter ended December 31, 2003 and providing additional outlook and financial guidance information.
All other items included in a Quarterly Report of Form 10-Q are omitted because they are not applicable or the answers thereto are none.
30
SIGNATURES
Pursuant to the requirements 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.
MICROSTRATEGY INCORPORATED | ||
By: |
/s/ Michael J. Saylor | |
Michael J. Saylor Chairman of the Board of Directors and Chief Executive Officer | ||
By: |
/s/ Eric F. Brown | |
Eric F. Brown President and Chief Financial Officer |
Date: May 7, 2004
31