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, 2001
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.Identification Number)
Registrant's 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 [_]
The number of shares of the registrant's Class A common stock and Class B
common stock outstanding on May 1, 2001 was 31,100,485 and 50,975,624,
respectively.
MICROSTRATEGY INCORPORATED
FORM 10-Q
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2001 (unaudited) and December 31, 2000......... 1
Consolidated Statements of Operations For the Three Months Ended March 31, 2001 and
2000 (unaudited)........................................................................... 2
Consolidated Statements of Cash Flows For the Three Months Ended March 31, 2001 and
2000 (unaudited)........................................................................... 3
Notes to Consolidated Financial Statements (unaudited)..................................... 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations...... 13
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................. 35
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.......................................................................... 37
Item 6. Exhibits and Reports on Form 8-K........................................................... 38
ii
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MICROSTRATEGY INCORPORATED
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
March 31, December 31,
2001 2000
--------------- -----------------
(unaudited)
Assets
Current assets:
Cash and cash equivalents............................................... $ 86,825 $ 67,685
Restricted cash......................................................... 400 25,884
Short-term investments.................................................. 4,208 1,085
Accounts receivable, net................................................ 35,129 49,061
Prepaid expenses and other current assets............................... 11,122 11,158
--------------- ----------------
Total current assets................................................. 137,684 154,873
--------------- ----------------
Property and equipment, net................................................ 59,251 61,409
Long-term investments...................................................... 250 5,271
Goodwill and intangible assets, net of accumulated amortization
of $22,419 and $18,170 respectively..................................... 30,051 34,300
Deposits and other assets.................................................. 3,810 3,234
--------------- ----------------
Total assets......................................................... $ 231,046 $ 259,087
=============== ================
Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
Accounts payable and accrued expenses................................... $ 29,655 $ 35,025
Accrued compensation and employee benefits.............................. 18,588 26,929
Deferred revenue and advance payments................................... 50,036 50,303
Working capital line of credit.......................................... 291 -
Current portion of long-term debt....................................... 3,047 -
--------------- ----------------
Total current liabilities............................................ 101,617 112,257
--------------- ----------------
Deferred revenue and advance payments...................................... 25,400 31,260
Accrued litigation settlement.............................................. 89,819 99,484
Term loan.................................................................. 5,884 -
Other long-term liabilities................................................ 1,509 1,509
--------------- ----------------
Total liabilities.................................................... 224,229 244,510
--------------- ----------------
Commitments and contingencies
Series A redeemable convertible preferred stock, par value $0.001
per share, 18 shares authorized, and 13 shares issued and
outstanding............................................................. 120,126 119,585
Mandatorily redeemable convertible preferred stock of consolidated
subsidiary, par value $0.001 per share, 47,884 shares authorized,
16,536 and 13,401 shares issued and outstanding, respectively........... 51,678 40,530
Stockholders' equity (deficit):
Preferred stock undesignated, par value $0.001 per share, 4,982
shares authorized, no shares issued or outstanding................... - -
Class A common stock, par value $0.001 per share, 330,000 shares
authorized, 30,655 and 28,736 shares issued and outstanding,
respectively......................................................... 31 29
Class B common stock, par value $0.001 per share, 165,000 shares
authorized, 50,976 and 52,033 shares issued and outstanding,
respectively......................................................... 51 52
Additional paid-in capital.............................................. 154,605 152,821
Deferred compensation................................................... (557) (624)
Accumulated other comprehensive income.................................. 713 1,443
Accumulated deficit..................................................... (319,830) (299,259)
--------------- ----------------
Total Stockholders' Equity (Deficit)................................. (164,987) (145,538)
--------------- ----------------
Total Liabilities and Stockholders' Equity (Deficit)................. $ 231,046 $ 259,087
=============== ================
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,
----------------------------
2001 2000
------------- -------------
Revenues:
Product licenses........................................................... $ 19,552 $ 26,011
Product support and other services......................................... 31,832 24,604
------------- -------------
Total revenues.......................................................... 51,384 50,615
------------- -------------
Cost of revenues:
Product licenses........................................................... 1,435 605
Product support and other services......................................... 18,614 15,761
------------- -------------
Total cost of revenues.................................................. 20,049 16,366
------------- -------------
Gross profit.................................................................... 31,335 34,249
------------- -------------
Operating expenses:
Sales and marketing........................................................ 28,464 41,512
Research and development................................................... 14,012 16,200
General and administrative................................................. 13,316 12,118
Amortization of intangible assets.......................................... 4,249 3,906
------------- -------------
Total operating expenses................................................ 60,041 73,736
------------- -------------
Loss from operations............................................................ (28,706) (39,487)
Financing and other income (expenses):
Interest income............................................................ 1,378 460
Interest expense........................................................... (284) (3)
(Loss) gain on investments................................................. (1,097) 6,430
Provision for litigation settlement........................................ 9,665 -
Minority interest.......................................................... (1,148) -
Other...................................................................... (90) -
------------- -------------
Total financing and other (expenses) income............................. 8,424 6,887
------------- -------------
Loss before income taxes........................................................ (20,282) (32,600)
Provision for income taxes...................................................... 289 250
------------- -------------
Net loss........................................................................ (20,571) (32,850)
------------- -------------
Preferred stock dividends....................................................... (2,158) -
------------- -------------
Net loss attributable to common stockholders.................................... $ (22,729) $ (32,850)
============= =============
Basic and diluted net loss per share............................................ $ (0.28) $ (0.42)
============= =============
Weighted average shares outstanding used in computing basic
and diluted net loss per share............................................. 81,269 78,926
============= =============
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,
---------------------------------
2001 2000
-------------- --------------
Operating activities:
Net loss............................................................................... $ (20,571) $ (32,850)
Adjustments to reconcile net loss to net cash from operating activities:
Depreciation and amortization..................................................... 9,588 6,131
Provision for doubtful accounts................................................... 2,511 507
Amortization of deferred stock option compensation................................ 67 67
Realized loss (gain) on sale and write-down of short-term investments............. 1,097 (6,430)
Loss on disposals of property and equipment....................................... 127 -
Non-cash reduction in provision for litigation settlement......................... (9,665) -
Amortization of loan costs and other.............................................. 53 -
Minority interest................................................................. 1,148 -
Changes in operating assets and liabilities:
Accounts receivable............................................................... 10,434 1,370
Prepaid expenses and other current assets......................................... 432 3,106
Deposits and other assets......................................................... (314) (1,368)
Accounts payable and accrued expenses, compensation and employee benefits......... (14,977) 9,928
Deferred revenue and advance payments............................................. (6,411) (1,898)
-------------- --------------
Net cash used in operating activities........................................ (26,481) (21,437)
-------------- --------------
Investing activities:
Purchases of property and equipment.................................................... (3,351) (9,937)
Proceeds from sales of property and equipment.......................................... 38 -
Purchases of intangible assets......................................................... - (2,313)
Purchases of short-term investments.................................................... (1,599) (1,496)
Maturities of short-term investments................................................... - 5,500
Proceeds from sales of short-term investments.......................................... - 17,204
Proceeds from exchange of short-term investment........................................ 2,166 -
Decrease in restricted cash............................................................ 25,484 -
-------------- --------------
Net cash provided by investing activities.................................... 22,738 8,958
-------------- --------------
Financing activities:
Proceeds from sale of Class A common stock and exercise of stock options, net
of offering costs................................................................. 3,471 4,379
Proceeds from sale of redeemable convertible preferred stock of consolidated
subsidiary, net of offering costs................................................. 10,000 -
Borrowings under term loan in connection with the Credit Facility...................... 10,000 -
-------------- --------------
Net cash provided by financing activities.................................... 23,471 4,379
-------------- --------------
Effect on foreign exchange rate changes on cash and cash equivalents......... (588) (307)
-------------- --------------
Net increase (decrease) in cash and cash equivalents......................................... 19,140 (8,407)
Cash and cash equivalents, beginning of period............................................... 67,685 25,941
-------------- --------------
Cash and cash equivalents, end of period..................................................... $ 86,825 $ 17,534
============== ==============
Supplemental disclosure of noncash investing and financing activities:
Stock received in exchange for product and services.................................... $ 762 $ -
============== ==============
Payment of preferred stock dividends through the issuance of Class A common
stock............................................................................. $ (599) $ -
============== ==============
Issuance of warrants in connection with the Credit Facility............................ $ (414) $ -
============== ==============
Repayment of term loan through use of line of credit................................... $ (278) $ -
============== ==============
The accompanying notes are an integral part of these Consolidated
Financial Statements.
3
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(1) Basis of Presentation
The consolidated balance sheet of MicroStrategy Incorporated
("MicroStrategy" or the "Company") as of March 31, 2001, the related
consolidated statements of operations for the three months ended March 31, 2001
and 2000 and the consolidated statements of cash flows for the three months
ended March 31, 2001 and 2000 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 Company's
annual financial statements and notes. These financial statements should be read
in conjunction with the Company's audited financial statements and the notes
thereto filed with the Securities and Exchange Commission ("SEC") in the
Company's Annual Report on Form 10-K for the year ended December 31, 2000.
The Company has incurred substantial losses for the three months ended
March 31, 2001 and each of the three years in the period ended December 31,
2000. For the three months ended March 31, 2001, the Company incurred a loss
from operations of $28.7 million and negative cash flows from operations of
$26.5 million. As of March 31, 2001, the Company had an accumulated deficit of
$319.8 million. The Company has taken several actions to reduce operating
expenses, including reducing headcount and curtailing discretionary expenses.
Additionally, the Company is exploring alternative financing arrangements, which
include credit facilities, the sale of equity in MicroStrategy or in
Strategy.com or alternative finance sources for Strategy.com (including the
potential sale of its operations). Concurrently, the Company has entered into an
agreement to refinance its Series A redeemable convertible preferred stock.
Alternative debt or equity financing may not be available on acceptable terms.
If the Company does not achieve revenues at acceptable levels, it will need to
take further measures to reduce costs in order to reduce its losses from
operations. Management believes that existing cash, cash generated internally by
operations and the new credit facility agreement entered into in February 2001
(see Note 5) will meet working capital requirements and anticipated capital
expenditures for the remainder of 2001.
Certain amounts in the prior year consolidated financial statements have
been reclassified to conform to the current year presentations.
(2) Recent Accounting Standards
In June 1999, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 137, which delays the
effective date of SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," which is effective for the fiscal year 2001. This statement
establishes accounting and reporting standards requiring that every derivative
instrument, including certain derivative instruments embedded in other
contracts, be recorded in the balance sheet as either an asset or liability
measured at its fair value. The statement also requires that changes in the
derivative's fair value be recognized in earnings unless specific hedge
accounting criteria are met. In June 2000, the FASB issued SFAS No. 138, which
amends certain accounting and reporting standards of SFAS No. 133. The Company
adopted SFAS No. 133 as of January 1, 2001, and through March 31, 2001, the
adoption of this statement did not have a material effect on the financial
position or results of operations of the Company.
(3) Investments
The following summarizes by major security type the fair market value and
cost of the Company's investments as of, (in thousands):
4
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(unaudited)
March 31, December 31,
--------- ------------
2001 2000
---- ----
Fair Fair
---- ----
Value Cost Value Cost
----- ---- ----- ----
Short-term obligations................................ $ 1,599 $ 1,599 $ - $ -
Marketable equity securities.......................... 2,609 2,935 1,085 1,118
Equity securities held in escrow...................... 334 484 - -
Non-publicly traded equity securities................. 250 250 5,271 5,271
-------------- ---------- ---------- ----------
$ 4,792 $ 5,268 $ 6,356 $ 6,389
============== ========== ========== ==========
Classified as:
Short-term investments......................... $ 4,208 $ 1,085
Prepaid expenses and other current assets...... 334 -
Long-term investments.......................... 250 5,271
-------------- ----------
$ 4,792 $ 6,356
============== ==========
During 2000, the Company received 805,800 shares of Xchange, Inc. common
stock, originally valued at $13.1 million, in consideration for the sale of
MicroStrategy software, technical support and consulting services. Due to a
significant decrease in the market value of Xchange's stock, the timing and
amount of future recovery, if any, of this asset is uncertain and the Company
does not consider the decline in value to be temporary. Accordingly, the Company
wrote down the investment to its fair value at December 31, 2000, and recognized
a loss of $12.1 million during 2000. During the first quarter of 2001, the
Company sold 161,300 of these shares for a gain of $24,000.
In March 2001, the Company received an additional of 320,733 shares of
Xchange's stock, originally valued at $762,000, in consideration for the sale of
MicroStrategy software, technical support and consulting services. Due to a
subsequent decrease in the market value of Xchange's stock, the timing and
amount of future recovery, if any, of this asset is uncertain and the Company
does not consider the decline in value to be temporary. Accordingly, the Company
has written down this investment to its fair value at March 31, 2001 and
recognized a loss of $281,000 during the three months ended March 31, 2001.
In August 2000, the Company invested $5.0 million in exchange for an
approximate 5% interest in a private voice portal technology company. In
February 2001, this voice portal technology company was acquired by a
publicly-traded company for cash and common stock of approximately $91.4
million. In consideration for its interest in the voice portal technology
company, MicroStrategy received $2.2 million in cash and 454,503 shares of
common stock valued at $2.0 million, of which 109,056 shares are held in escrow
for a twelve-month period following the date of the transaction. The fair value
of the shares held in escrow are included in prepaid expenses and other current
assets in the accompanying consolidated balance sheet as of March 31, 2001. In
connection with the transaction, MicroStrategy recorded a loss of $840,000 based
on the difference between its original basis in its investment and the fair
value of the consideration received.
At March 31, 2001, the Company had net unrealized losses of $476,000
included in accumulated other comprehensive loss.
(4) Accounts Receivable
Accounts receivable, net of allowances, consist of the following, as of (in
thousands):
5
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(unaudited)
March 31, December 31,
2001 2000
--------------- -----------------
Billed and billable................................. $ 65,158 $ 84,833
Less: billed and unpaid deferred revenue............ (19,637) (26,128)
--------------- -----------------
45,521 58,705
Less: allowance for doubtful accounts............... (10,392) (9,644)
--------------- -----------------
$ 35,129 $ 49,061
=============== =================
The Company offsets its accounts receivable and deferred revenue for any
billed and unpaid items included in deferred revenue and advance payments.
(5) Borrowings
On February 9, 2001, the Company entered into a loan and security agreement
which provides for aggregate borrowing capacity of up to $30.0 million to be
used for general working capital purposes (the "Credit Facility"). The Credit
Facility consists of a $10.0 million term loan and a revolving line of credit
for up to $20.0 million, subject to specified borrowing base limitations. The
Credit Facility matures in February 2004 and is collateralized by substantially
all of the Company's assets. The Credit Facility replaced the previous line of
credit agreement, which had provided for a $25.0 million revolving line of
credit and which was secured by cash and cash equivalents of $25.9 million
classified as restricted cash in the accompanying consolidated balance sheet as
of December 31, 2000. The cash was restricted through February 2001, at which
time the previous line of credit agreement was terminated upon the closing of
the new credit facility.
At the Company's option, borrowings under the revolving line of credit will bear
interest at a variable rate equal to LIBOR (4.71% at March 31, 2001) plus 3.25%
or 3.75% or at a variable rate equal to the prime rate (8.00% at March 31, 2001)
plus 1.50% or 2.00%, in each case depending on the outstanding balance. The
Credit Facility also includes a 1.50% unused letter of credit fee and requires
monthly payments of interest and other fees beginning on the first day of the
month following the execution of the agreement. Borrowings under the term loan
are based upon certain levels of maintenance revenue and bear interest at a
variable rate equal to the prime rate plus 3.00%. Under the terms of the Credit
Facility, the Company is required to maintain certain financial covenants, the
most restrictive of which are achieving certain minimum earnings amounts, as
defined in the agreement, limitations on capital expenditures, minimizing the
ability to invest further in subsidiaries, and limitations on incurring
additional indebtedness. On May 15, 2001, the Credit Facility was amended to,
among other things, extend the time to satisfy certain administrative covenants
through June 15, 2001. In April and May 2001, the Company did not meet these
administrative covenants but believes it will comply with these requirements
prior to June 15, 2001. In addition to the interest and other fees on borrowings
under the Credit Facility, the lender has been granted warrants to purchase
50,000 shares of the Company's Class A common stock at an exercise price of
$14.825 per share, subject to adjustment as set forth therein.
In connection with obtaining the Credit Facility, the Company incurred loan
origination costs of $417,000 for professional and other origination fees. The
Company accounted for the loan origination costs as a discount on the term loan.
The loan origination costs will be amortized to interest expense using the
straight-line method over the term of the Credit Facility of three years.
Additional interest expense related to the amortization of the loan origination
costs was $17,000 for the three months ended March 31, 2001.
As of March 31, 2001, the Company had $5.4 million of borrowing capacity
under the revolving line of credit. The remaining $14.6 million under the
revolving line of credit may be available for future drawdowns upon completion
of specified reporting requirements and other events defined within the
agreement and subject to borrowing base limitations. At March 31, 2001, the
Company has $8.9 million outstanding under the term loan and $291,000
outstanding under the line of credit. There were no borrowings outstanding at
December 31, 2000.
(6) Deferred Revenue and Advance Payments
Deferred revenue and advance payments from customers consist of the
following, as of (in thousands):
6
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(unaudited)
March 31, December 31,
2001 2000
---------------- -----------------
Current:
Deferred product revenue................................. $ 18,015 $ 21,399
Deferred product support and other services revenue...... 48,540 48,278
---------------- -----------------
66,555 69,677
Less: billed and unpaid deferred revenue................. (16,519) (19,374)
---------------- -----------------
$ 50,036 $ 50,303
================ =================
Non-current:
Deferred product revenue................................. $ 9,440 $ 13,267
Deferred product support and other services revenue...... 19,078 24,747
---------------- -----------------
28,518 38,014
Less: billed and unpaid deferred revenue................. (3,118) (6,754)
---------------- -----------------
$ 25,400 $ 31,260
================ =================
The Company offsets its accounts receivable and deferred revenue for any
billed and unpaid items included in deferred revenue and advance payments.
(7) Litigation
The Company and certain of its officers and directors were named as
defendants in a private securities class action lawsuit alleging that they have
violated Section 10(b) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), Rule 10b-5 promulgated thereunder, and Section 20(a) and
Section 20A of the Exchange Act in connection with various statements that were
made with respect to the 1999, 1998 and 1997 financial results. The action was
consolidated in the United States District Court for the Eastern District of
Virginia. In June 2000, purported holders of the Company's common stock filed a
shareholder derivative lawsuit in the Delaware Court of Chancery seeking
recovery for various alleged breaches of fiduciary duties by certain directors
and officers of the Company relating to the restatement of financial results for
1999, 1998 and 1997.
In October 2000, the Company entered into agreements to settle these
lawsuits. On January 19, 2001, the United States District Court authorized
notice of the proposed class action settlement sent to all putative class
members. The notice informs class members of their rights including their rights
to object to the proposed settlement and to pursue their claims separately. On
April 2, 2001, the United States District Court approved the class action
settlement. Any appeals from the ruling of the court must be filed in May 2001
and the settlement is subject to various closing conditions. The derivative
settlement is subject to confirmatory discovery, final documentation, court
approval and other conditions. The Company expects to file the settlement
agreements with the Delaware Court of Chancery in May 2001 and for the Chancery
Court subsequently to authorize notice of the proposed settlement to be sent to
shareholders. The Chancery Court would then be expected to schedule a hearing on
the fairness of the proposed settlement approximately 60 days after the sending
of the notice to shareholders.
Under the class action settlement agreements, class members will receive:
1) five-year unsecured subordinated promissory notes issued by the Company
having an aggregate principal amount of $80.5 million and bearing interest at
7.5% per year; 2) 2,777,778 shares of the Company's Class A common stock; and 3)
warrants issued by the Company to purchase 1,900,000 shares of the Company's
Class A common stock at an exercise price of $40 per share, with the warrants
expiring five years from the date they are issued.
The Company will have the right, at any time, to prepay the promissory
notes, or to mandatorily convert the promissory notes into shares of the
Company's Class A common stock at a conversion price equal to 80% of the dollar
weighted average trading price per share for all round lot transactions in the
Company's stock on the Nasdaq National Market for the ten trading days ending
two days prior to the date that written notice of conversion has been given. The
warrants may be exercised for cash or by tendering promissory notes valued for
the purpose of warrant
7
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(unaudited)
exercise at 133% of their principal amount plus accrued interest.
Under the derivative settlement agreement, the Company will add a new,
independent director with finance experience to the audit committee of its Board
of Directors and will ensure continued adherence with applicable legal and
regulatory requirements regarding the independence of audit committee members
and trading by insiders. In addition, certain officers of the Company will
contribute a portion of the shares of the Company's Class A common stock that is
to be issued to class members in settlement of the class action lawsuit.
Specifically, Michael J. Saylor, the Chairman of the Board of Directors and
Chief Executive Officer, Sanju K. Bansal, the Vice Chairman, Executive Vice
President and Chief Operating Officer, and Mark S. Lynch, the former Chief
Financial Officer, will contribute to the class action settlement an aggregate
of 1,683,502 shares of Class A common stock held by them.
Based on the terms of the settlement agreements, the Company determined
that a liability related to these actions was probable and that the value was
reasonably estimable. Accordingly, the Company separately evaluated the
individual components of the settlement agreements in consideration of existing
market conditions and established an estimate for the cost of the litigation
settlement. The details of the accrued litigation settlement at March 31,
2001 are as follows (in thousands):
Issuance of debt securities................. $ 69,200
Issuance of Class A common stock............ 16,500
Issuance of warrants........................ 3,119
Pending loss on additional settlement....... 250
Legal fees.................................. 1,037
Administration costs........................ 750
--------------
Accrued litigation settlement......... $ 90,856
==============
The fair value of the debt securities was based on the present value of
future cash flows discounted at borrowing rates currently available for debt
with similar terms and maturities. Utilizing a market borrowing rate of 12%, a
discount of $11.3 million was computed on the debt securities to be issued. Upon
the issuance of the debt securities, the discount will be amortized to interest
expense over the term of the debt securities.
The fair value of the warrants to be issued in connection with the
litigation settlement was computed utilizing the Black-Scholes pricing model
with the following assumptions used for the calculation: volatility factor of
119%, risk free interest rate of 5.5%, expected life of 5 years, and no dividend
yield. Upon issuance of the warrants, the Company expects to revalue the
warrants on a quarterly basis in accordance with SFAS No. 133.
The Company has recorded the unpaid amounts of $89.8 million in the
accompanying consolidated balance sheet as a long-term liability pending final
approval by the courts and satisfaction of certain other conditions and $1.1
million in accounts payable and accrued expenses related to amounts due
currently. Upon issuance of the debt and equity securities, the Company will
record such amounts as liabilities or stockholders' equity based on the nature
of the individual securities.
The final value of the settlements may differ significantly from the
estimates currently recorded depending on a variety of factors including the
market value of the Company's stock when issued and potential changes in market
conditions affecting the valuation of the other securities. Accordingly, the
Company will revalue the estimate of the settlement on a quarterly basis and at
the time the securities are issued. Due to a decline in the market value of the
Company's Class A common stock, the Company recorded a reduction in the
provision for the litigation settlement of $9.9 million during the three months
ended March 31, 2001 based on a revaluation of the warrants to be issued in
connection with the litigation settlement. This reduction was partially offset
by an increase in the provision of $250,000 during the first quarter of 2001 for
additional costs to be incurred for settling the litigation.
8
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(unaudited)
On March 20, 2001, NCR Corporation asked the Company to consider licensing
certain technology which NCR alleges is covered under patents that they hold.
NCR has implied that if the Company is unwilling to license this technology they
may seek to enforce their patents against the Company. Management has not yet
had an opportunity to fully review these matters. In the event NCR seeks to
enforce any of these patents and if such patents are found to be valid and
enforceable against the Company, the Company's business, operating results and
financial condition may be materially adversely affected. The Company is not
currently able to estimate the potential range of loss and the outcome of the
uncertainty is unknown. Accordingly, no provision for this matter has been made
in the accompanying consolidated financial statements.
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 Company's
financial position, results of operations or cash flows.
(8) Series A Redeemable Convertible Preferred Stock
For the three months ended March 31, 2001, the Company paid dividends on
its Series A redeemable convertible preferred stock of $599,000 through the
issuance of 63,146 shares of Class A common stock in lieu of cash. As of March
31, 2001, the Company has accrued dividends of $2.2 million which are included
in accounts payable and accrued expenses in the accompanying consolidated
balance sheet. All accrued dividends were paid subsequent to March 31, 2001
through the issuance of 646,238 shares of Class A common stock in lieu of cash.
Additionally, for the three months ended March 31, 2001, the Company accreted
preferred stock offering costs of $541,000. The Company is accreting the
preferred stock offering costs of $5.4 million using the straight-line method
over the term of the preferred stock of thirty months.
On April 3, 2001, the Company announced that it had entered into an
agreement to refinance its Series A redeemable convertible preferred stock. See
discussion of refinancing in Note 13 below.
(9) Mandatorily Redeemable Convertible Preferred Stock of Consolidated
Subsidiary
In October 2000, Strategy.com issued 13,401,253 shares of Series A
redeemable convertible preferred stock to a group of institutional and
accredited investors in exchange for $39.8 million, net of offering costs of
approximately $3.0 million, in an initial closing. In January 2001, Strategy.com
completed this round of financing in a second closing and issued an additional
3,134,796 shares for proceeds of $10.0 million. The offering costs are being
accreted using the straight-line method based on the mandatory redemption dates
and redemption portions of the preferred stock of Strategy.com. The investors
own approximately 16% of the economic interest in the outstanding equity of
Strategy.com on an as converted, diluted basis. The remaining 84% economic
interest continues to be owned by the Company and the Company maintains
approximately 98% of the voting interest in Strategy.com.
For the three months ended March 31, 2001, the Company accreted dividends
of $1.0 million on the preferred stock of its consolidated subsidiary,
Strategy.com. Additionally, during the three months ended March 31, 2001, the
Company accreted offering costs of $127,000 on the preferred stock of
Strategy.com. The accretion of dividends and offering costs on Strategy.com's
preferred stock are classified as minority interest in the accompanying
consolidated statements of operations. No other minority interest has been
recorded as all losses of Strategy.com are included in the consolidated
financial statements of the Company.
(10) Comprehensive Loss
Comprehensive loss includes foreign currency translation adjustments and
unrealized gains and losses on short-term investments, net of related tax
effects, that have been excluded from net loss and reflected in stockholders'
equity (deficit) as accumulated other comprehensive income.
Comprehensive loss for the three months ended March 31, 2001 and 2000 is
calculated as follows (in thousands):
9
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(unaudited)
Three Months Ended
March 31,
-----------------------------
2001 2000
------------- -------------
Net loss.......................................................................... $ (20,571) $ (32,850)
Foreign currency translation adjustment........................................... (287) (379)
Unrealized (loss) gain on short-term investments, net of applicable taxes......... (443) 9,571
---------- ----------
Comprehensive loss........................................................... $ (21,301) $ (23,658)
========== ==========
(11) Basic and Diluted Net Loss Per Share
Basic net loss per share is determined by dividing the net loss applicable
to common stockholders by the weighted average number of common shares
outstanding during the period. Diluted net loss per share is determined by
dividing the net loss applicable to common stockholders by the weighted average
number of common shares and potential common shares outstanding during the
period. Potential common shares are included in the diluted net loss per share
calculation when dilutive. Potential common shares consisting of common stock
issuable upon exercise of outstanding common stock options, convertible
preferred stock and warrants are computed using the treasury stock method. The
Company's net loss per share calculation for basic and diluted is based on the
weighted average common shares outstanding. There are no reconciling items in
the numerator and denominator of the Company's net loss per share calculation.
Employee stock options of 16,052,253 and 12,688,504 and warrants of 128,334 and
100,000 for the three months ended March 31, 2001 and 2000, respectively, have
been excluded from the net loss per share calculation because their effect would
be anti-dilutive. Additionally, Series A redeemable convertible preferred stock,
which is currently convertible into 3,744,152 shares of Class A common stock,
was excluded from the net loss per share calculation for the three ended March
31, 2001 because their effect would be anti-dilutive.
(12) Segment Information
The Company has two operating segments, MicroStrategy Platform and
Strategy.com. MicroStrategy Platform enables users to query and analyze the most
detailed, transaction-level databases, turning data into business intelligence.
Revenues are derived from sales of product licenses and product support and
other services, including technical support, education and consulting services.
Strategy.com's hosted one-to-one messaging platform enables third-party content
providers to offer their customers highly personalized, timely information
services through a wide variety of delivery methods including the web, wireless
applications protocol-enabled devices, e-mail, mobile phone, fax, pager and
regular telephone. Revenues are derived from license fees, programming services,
and subscriber and messaging services. The Company began operating its business
as two segments in the latter part of 1999. Prior years' segment information has
been restated to reflect the operations of Strategy.com.
The accounting policies of both segments are the same as those described in
the summary of significant accounting policies in the Company's Annual Report on
Form 10-K for the year ended December 31, 2000. Prior to the establishment of
Strategy.com as a stand-alone subsidiary in October 2000, certain corporate
support costs were allocated to Strategy.com based on factors such as headcount,
gross asset value and the specific level of activity directly related to such
costs. Upon completion of the reorganization which resulted in the establishment
of Strategy.com as a stand-alone subsidiary, the Company entered into various
intercompany agreements whereby consulting services, sales and marketing
activities and administrative services are provided by MicroStrategy to
Strategy.com for a fee based on rates and factors specified in the agreements.
These rates and factors for determining fees are based upon the same allocations
utilized prior to the reorganization and include factors such as headcount,
gross asset value and specific level of activity directly related to such
services.
The following summary discloses certain financial information regarding the
Company's operating segments (in thousands):
10
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(unaudited)
Microstrategy
-------------
Platform Strategy.com Consolidated
-------- ------------ ------------
Three Months Ended March 31, 2001
Total license and service revenues............ $ 48,949 $ 2,435 $ 51,384
Gross profit (loss)........................... 33,018 (1,683) 31,335
Depreciation and amortization................. 7,368 2,220 9,588
Operating expenses............................ 53,070 6,971 60,041
Loss from operations.......................... (20,052) (8,654) (28,706)
Total assets.................................. 173,737 57,309 231,046
Three Months Ended March 31, 2000
Total license and service revenues............ $ 50,502 $ 113 $ 50,615
Gross profit (loss)........................... 34,343 (94) 34,249
Depreciation and amortization................. 5,360 771 6,131
Operating expenses............................ 62,352 11,384 73,736
Loss from operations.......................... (28,009) (11,478) (39,487)
Total assets.................................. 182,608 10,614 193,222
The following summary discloses total revenues and long-lived assets,
excluding long-term deferred tax assets and long-term investments, relating to
the Company's geographic regions (in thousands):
Domestic International Consolidated
-------- ------------- ------------
Three Months Ended March 31, 2001
Total license and service revenues............ $ 34,605 $ 16,779 $ 51,384
Long-lived assets............................. 89,412 3,700 93,112
Three Months Ended March 31, 2000
Total license and service revenues............ $ 39,185 $ 11,430 $ 50,615
Long-lived assets............................. 85,615 3,423 89,038
Transfers of $4.6 million and $2.4 million for the three months ended
March 31, 2001 and 2000, respectively, from international to domestic operations
have been excluded from the above table and eliminated in the consolidated
financial statements.
(13) Subsequent Events
On April 3, 2001, MicroStrategy announced a restructuring plan designed to
focus its commercial activities. The restructuring plan includes a refocus on
the business intelligence market, the elimination or reduction of speculative
technology initiatives, a greater emphasis on indirect sales, and a reduction of
the Company's workforce by approximately 600 employees or approximately 33% of
the worldwide headcount. As a result of the reduction in headcount, the Company
will consolidate its multiple Northern Virginia facilities into a single
location in McLean, Virginia. On April 3, 2001 and May 4, 2001, Strategy.com
adopted restructuring plans in which its workforce will be reduced to
approximately 40 employees.
The Company will record a special charge during the second quarter of 2001
including severance costs for terminated employees, the write-off of certain
property and equipment that will be no longer of service, costs associated with
exiting and consolidating facilities, fees for professional services and certain
other charges.
On April 3, 2001, the Company announced that it entered into an agreement
to refinance its Series A redeemable convertible preferred stock. The
refinancing is expected to close on June 4, 2001, subject to the satisfaction of
various closing conditions including the consent of the holder of its new Credit
Facility. As a result of the refinancing, the Company will have the option to
redeem for cash $5.3 million face value of its outstanding Series A redeemable
convertible preferred stock and will redeem or exchange all remaining
outstanding Series A redeemable convertible preferred stock as follows:
11
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(continued)
(unaudited)
. $25 million stated value of the Series A redeemable convertible preferred
stock will be redeemed for $25 million in cash;
. $33.75 million stated value of the Series A redeemable convertible
preferred stock will be exchanged for a combination of Class A common stock
and Series D redeemable convertible preferred stock with a fixed conversion
price of $5 per share so that the number of shares of Class A common stock
issued in exchange for the Series A redeemable convertible preferred stock
and the number of shares of the Class A common stock issuable upon
conversion of the Series D convertible preferred stock will equal 7,355,978
shares in aggregate;
. $33.125 million stated value of the Series A redeemable convertible
preferred stock will be exchanged for an equivalent face amount of Series B
redeemable convertible preferred stock, with a fixed conversion price of
$12.50 per share, subject to adjustment at maturity if the Company elects
to mandatorily convert these shares into Class A common stock; and
. $27.825 million stated value of the Series A redeemable convertible
preferred stock will be exchanged for an equivalent face amount of Series C
redeemable convertible preferred stock, with a fixed conversion price of
$17.50 per share, subject to adjustment at maturity if the Company elects
to mandatorily convert these shares into Class A common stock.
The Series B redeemable convertible preferred stock and the Series C
redeemable convertible preferred stock will mature three years after the date of
issuance and accrue dividends at a rate of 12.5% per annum, payable in cash or
shares of Class A common stock, subject to satisfaction of certain conditions.
At the option of the Company, the Series B and Series C preferred stock may be
redeemed at maturity at par value plus accrued dividends or mandatorily
converted into Class A common stock at the lower of their respective fixed
conversion prices or 95% of the average of the dollar volume-weighted average
price of the Class A common stock during the 30 consecutive trading days
immediately preceding the maturity date. The Series D preferred stock will
mature three years after the date of issuance, will not pay dividends, and will
have a fixed conversion price of $5 per share. At maturity, the Series D
preferred stock mandatorily converts into Class A common stock at the fixed
conversion price of $5 per share. The Company has not yet determined the
potential impact of this refinancing transaction on its consolidated financial
position and results of operations.
12
ITEM 2. MANAGEMENT'S 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 management's
current expectations and are inherently uncertain. Investors are warned that
actual results may differ from management's expectations.
Overview
We are a leading worldwide provider of business intelligence software and
related services that enable the transaction of one-to-one electronic business
through web, wireless and communication channels. Our product line enables both
proactive and interactive delivery of information from large-scale databases.
Our objective is to provide businesses with a software platform to develop
solutions that deliver insight and intelligence to their enterprises, customers
and supply-chain partners. Our software platform enables users to query and
analyze the most detailed, transaction-level databases, turning data into
business intelligence. We offer a comprehensive set of business intelligence
software, consulting, education and technical support services for our customers
and partners.
In July 1999, we launched a new business unit called Strategy.com. Third
party content providers use Strategy.com's hosted one-to-one messaging platform
to offer their customers highly personalized, timely information services. These
services are delivered on a scheduled or event-driven basis through a wide
variety of delivery methods, including e-mail, telephone and wireless devices.
As of March 31, 2001, syndicated programming hosted by Strategy.com includes
Finance, News, Weather, Sports and Traffic "channels." Strategy.com syndicates
its channels through companies it refers to as Strategy.com affiliates, such as
Earthlink and Ameritrade. MicroStrategy owns approximately 84% of the economic
interest in the outstanding equity of Strategy.com on an as converted, diluted
basis. In April and Many 2001, Strategy.com adopted restructuring plans in which
it will reduce its workforce to approximately 40 employees and will explore
strategic alternatives for the Strategy.com business, including the potential
sale of its operations.
13
Recognizing the need to bring operating expenses in line with revenue
expectations in order to achieve our goal of making our MicroStrategy platform
business profitable on an operating basis by the end of 2001, excluding special
charges, we developed a restructuring plan to be implemented during the second
quarter of 2001. The restructuring plan includes a refocus on the business
intelligence market, the elimination or reduction of speculative technology
initiatives, a greater emphasis on indirect sales, and a reduction of our
workforce by approximately 600 employees or approximately 33% of the worldwide
headcount. As a result of the reduction in headcount, we will consolidate our
multiple Northern Virginia facilities into a single location in McLean,
Virginia. Additionally, Strategy.com adopted restructuring plans in which it
will reduce its workforce to approximately 40 employees and will explore
strategic alternatives for the Strategy.com business, including the potential
sale of its operations. As a result of these actions, we will record a special
during the second quarter of 2001 including severance costs for terminated
employees, the write-off of certain property and equipment that will be no
longer of service, costs associated with exiting and consolidating facilities,
professional services and certain other charges. We anticipate annualized
savings to be between $70 million and $85 million as a result of these actions.
14
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,
-------------------------------------
2001 2000
----------- -----------
Statements of Operations Data
Revenues:
Product licenses...................................................... 38.1% 51.4%
Product support and other services.................................... 61.9 48.6
---------- ----------
Total revenues..................................................... 100.0 100.0
---------- ----------
Cost of revenues:
Product licenses...................................................... 2.8 1.2
Product support and other services.................................... 36.2 31.1
---------- ----------
Total cost of revenues............................................. 39.0 32.3
---------- ----------
Gross profit............................................................... 61.0 67.7
---------- ----------
Operating expenses:
Sales and marketing................................................... 55.4 82.0
Research and development.............................................. 27.3 32.0
General and administrative............................................ 25.9 24.0
Amortization of intangible assets..................................... 8.2 7.7
---------- ----------
Total operating expenses........................................... 116.8 145.7
---------- ----------
Loss from operations....................................................... (55.8) (78.0)
Financing and other income (expenses):
Interest income....................................................... 2.7 0.9
Interest expense...................................................... (0.6) -
(Loss) gain on investments............................................ (2.1) 12.7
Provision for litigation settlement................................... 18.8 -
Minority interest..................................................... (2.2) -
Other (expense) income, net........................................... (0.2) -
---------- ----------
Total financing and other (expenses) income........................ 16.4 13.6
---------- ----------
Loss before income taxes................................................... (39.4) (64.4)
Provision for income taxes................................................. 0.6 0.5
---------- ----------
Net loss................................................................... (40.0) (64.9)
---------- ----------
Preferred stock dividends.................................................. (4.2) -
---------- ----------
Net loss attributable to common stockholders............................... (44.2)% (64.9)%
========== ==========
Comparison of the Three Months Ended March 31, 2001 and 2000
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. Total revenues increased from $50.6 million to $51.4
million for the three months ended March 31, 2000 and 2001, respectively,
resulting in an increase of 1.5%.
15
Product License Revenues. Product license revenues decreased from $26.0
million to $19.6 million for the three months ended March 31, 2000 and 2001,
respectively, resulting in a decrease of 24.8%. Product license revenues
included revenues related to Strategy.com of $0 and $916,000 during the three
months ended March 31, 2000 and 2001, respectively. The overall decrease in
product license revenues was primarily due to the economic slowdown domestically
in the first quarter of 2001 which led to decreased corporate spending in
information technology. As discussed further below, the decline in domestic
product license revenues was offset by an increase in international product
license revenues. Additionally, the decrease may have been caused, in part, by
concerns of potential new customers over our restatement of our 1999, 1998, and
1997 financial results and the related shareholder class action litigation and
SEC proceedings during 2000. We believe the resolution of these matters may help
alleviate some of these concerns. We expect product license revenues as a
percentage of total revenues to fluctuate on a period-to-period basis and vary
significantly from the percentage of total revenues achieved in prior years.
There can be no assurance that we will be able to maintain or increase market
acceptance for our family of products.
Product Support and Other Services Revenues. Product support and other
services revenues increased from $24.6 million to $31.8 million for the three
months ended March 31, 2000 and 2001, respectively, resulting in an increase of
29.4%. Product support and other services revenues included revenues related to
Strategy.com of $113,000 and $1.5 million during the three months ended March
31, 2000 and 2001, respectively. The increase in product support and other
services revenues was primarily due to an increase technical support services
resulting from an increase in the size of our installed product base covered
under our software support contracts with new and existing customers. As a
result of possible fluctuations in product license revenues discussed above,
product support and other services revenues as a percentage of total revenues
may fluctuate on a period-to-period basis and vary significantly from the
percentage of total revenues achieved in prior years.
International Revenues. International revenues are included in the amounts
discussed above and are discussed separately within this paragraph. Total
international revenues increased from $11.4 million to $16.8 million for the
three months ended March 31, 2000 and 2001, respectively, resulting in an
increase of 46.8%. International product license revenues increased from $6.9
million to $8.2 million for the three months ended March 31, 2000 and 2001,
respectively, resulting in an increase of 18.8%. International product support
and other services revenues increased from $4.5 million to $8.6 million for the
three months ended March 31, 2001, respectively, resulting in an increase of
91.1%. The increase in these revenues is due to the expansion of our
international operations, new product offerings and growing international market
acceptance of our software products. In addition, we opened new sales offices in
Argentina, Switzerland, Mexico, Korea, and Australia in the latter half of 2000.
As a percentage of total revenues, international revenues were 32.7% and 22.6%
for the three months ended March 31, 2001 and 2000, respectively. We anticipate
that international revenues will continue to account for a significant amount 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
Cost of Product License Revenues. Cost of product license revenues consists
primarily of the costs of product manuals, media, amortization of capitalized
software expenses and royalties paid to third party software vendors. Cost of
product license revenues increased from $605,000 to $1.4 million for the three
months ended March 31, 2000 and 2001, respectively. As a percentage of product
license revenues, cost of product license revenues increased from 2.3% to 7.3%
for the three months ended March 31, 2000 and 2001, respectively. The increase
in cost of product license revenues as a percentage of product license revenues
was primarily due to increased royalty obligations to third party software
vendors resulting from an increase in royalty arrangements with strategic
partners. In the event that we increase indirect sales and enter into additional
royalty arrangements with strategic partners in the future, cost of product
license revenues as a percentage of total product license revenues may increase.
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 support and education. Cost of product support
16
and other services increased from $15.8 million to $18.6 million for the three
months ended March 31, 2000 and 2001, respectively. As a percentage of product
support and other services revenues, however, cost of product support and other
services revenues decreased from 64.1% to 58.5% for the three months ended March
31, 2000 and 2001, respectively. The increase in cost of product support and
other services was primarily due to consulting, technical support and other
costs, including costs associated with Strategy.com. The decrease in cost of
product support and other services as a percentage of product support and other
services revenues ("services margin") was primarily due to a decrease in the use
of third parties to perform consulting services and an increase in maintenance
revenues as a percentage of total product support and other services revenues,
which are at higher margins than other product support revenues.
As discussed above, we developed a restructuring plan to be implemented
during the second quarter of 2001, under which we have reduced our consulting,
education and technical support staffing levels in our core business and
Strategy.com. To the extent that we do not achieve anticipated levels of product
support and other services revenues, our services margin may not improve without
further lowering costs of product support and other services.
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. Sales and marketing expenses decreased from $41.5 million
to $28.5 million for the three months ended March 31, 2000 and 2001,
respectively. As a percentage of total revenues, sales and marketing expenses
decreased from 82.0% to 55.4% for the three months ended March 31, 2000 and
2001, respectively. The decrease in sales and marketing expenses was primarily
due to decreased staffing levels in the sales force as a result of our
restructuring in the third quarter of 2000, decreased commissions earned,
relating to product license revenues and decreased promotional activities and
advertising. During the first quarter of 2000, we invested heavily in
advertising, including a national television and print advertising campaign and
other marketing efforts in order to create better market awareness of the value-
added potential of our product suite and Strategy.com and to seek to acquire
market share. These advertising programs were not continued in the latter half
of 2000 and in the first quarter of 2001. We intend to continue to market our
MicroStrategy 7 software and other technology in our suite of products; however,
we expect to continue to reduce our overall advertising and marketing efforts
going forward in order to better align our costs with anticipated revenues.
Research and Development Expenses. Research and development expenses
consist primarily of salaries and benefits of software engineering personnel,
depreciation of equipment and other costs. Research and development expenses
decreased from $16.2 million to $14.0 million for the three months ended March
31, 2000 and 2001, respectively. As a percentage of total revenues, research and
development expenses decreased from to 32.0% to 27.3% for the three months ended
March 31, 2000 and 2001, respectively. The decrease in research and development
expenses was due to a reduction in spending, a decrease in the use of third
party consultants to develop new products and product releases, and a
curtailment of spending on the Strategy.com network. Research and development
expenses related to Strategy.com decreased from $4.3 million to $3.5 million for
the three months ended March 31, 2000 and 2001, respectively. We expect that
research and development expenses may decrease in future periods in view of
staff reductions, reductions in the use of external consultants and reductions
in spending on technology projects that are unrelated to our primary market.
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 outside consulting,
legal and other professional fees. General and administrative expenses increased
from $12.1 million to $13.3 million for the three months ended March 31, 2000
and 2001, respectively. As a percentage of total revenues, general and
administrative expenses increased from 24.0% to 25.9% for the three months ended
March 31, 2000 and 2001, respectively. The increase in general and
administrative expenses was primarily the result of increased staffing levels
through our international expansion and additional Strategy.com personnel. The
increase in international and Strategy.com general and administrative expenses
was offset by decreased staffing levels in
17
domestic core business operations and a reduction in legal and other
consultancy fees. We expect that general and administrative expenses may
decrease in future periods in view of staff reductions, facilities
consolidation, and reductions in the use of external consultants.
Amortization of Goodwill and Other Intangible Assets. We have recorded $3.9
million and $4.2 million in amortization expense for the three months ended
March 31, 2000 and 2001, respectively. We expect our rate of amortization
expense to be substantially the same over the next two years, to the extent no
additional intangible assets are acquired.
(Loss) Gain on Investments. In March 2000, we sold 412,372 of Xchange, Inc.
common shares received in consideration for the sale of software, for a realized
gain of $6.4 million.
During the first quarter of 2001, we received additional shares of
Xchange's stock in consideration for the sale of MicroStrategy software,
technical support and consulting services. Due to a subsequent decrease in the
market value of Xchange's stock, the timing and amount of future recovery of our
aggregate investment in Xchange's stock was determined to be uncertain and the
decline in value was deemed to be other than temporary. Accordingly, we wrote
down the investment to its fair value at March 31, 2001 and recognized a loss of
$281,000 during the three months ended March 31, 2001.
18
The remaining amount of the loss on investments incurred during the first
quarter of 2001 was attributable to an $840,000 loss related to a 5% interest we
held in a voice portal company that was purchased by another company, in
exchange for approximately 50% in cash and 50% in publicly-traded common stock
of the acquiring entity.
Provision for Litigation Settlement. We and certain of our officers and
directors were named as defendants in a private securities class action lawsuit
alleging that we had violated Section 10(b) of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), Rule 10b-5 promulgated thereunder, and
Section 20(a) and Section 20A of the Exchange Act in connection with various
statements that were made with respect to our 1999, 1998 and 1997 financial
results. The action was consolidated in the United States District Court for the
Eastern District of Virginia. In June 2000, purported holders of our common
stock filed a shareholder derivative lawsuit in the Delaware Court of Chancery
seeking recovery for various alleged breaches of fiduciary duties by certain of
our directors and officers relating to the restatement of our financial results
for 1999, 1998 and 1997.
In October 2000, we entered into agreements to settle these lawsuits. On
January 19, 2001, the United States District Court authorized notice of the
proposed class action settlement sent to all putative class members. The notice
informs class members of their rights including their rights to object to the
proposed settlement and to pursue their claims separately. On April 2, 2001, the
United States District Court held a hearing and approved the class action
settlement. Any appeals from the ruling of the court must be filed in May 2001
and the settlement is subject to various closing conditions. The derivative
settlement is still subject to confirmatory discovery, final documentation,
court approval and certain other conditions. We expects to file the settlement
agreements with the Delaware Court of Chancery in May 2001 and for the Chancery
Court subsequently to authorize notice of the proposed settlement to be sent to
shareholders. The Chancery Court would then be expected to schedule a hearing on
the fairness of the proposed settlement approximately 60 days after the sending
of the notice to shareholders.
Under the class action settlement agreements, class members will receive:
1) five-year unsecured subordinated promissory notes issued by the Company
having an aggregate principal amount of $80.5 million and bearing interest at
7.5% per year; 2) 2,777,778 shares of our Class A common stock; and 3) warrants
issued by the Company to purchase 1,900,000 shares of our Class A common stock
at an exercise price of $40 per share, with the warrants expiring five years
from the date they are issued.
Based on the terms of the settlement agreements, we determined that a
liability related to these actions was probable and that the value was
reasonably estimable. Accordingly, we separately evaluated the individual
components of the settlement agreements in consideration of existing market
conditions and recorded an estimated charge during 2000 of $89.7 million for the
cost of the litigation settlement, net of insurance proceeds of approximately
$13.0 million.
The final value of the settlements may differ significantly from the
estimates currently recorded depending on a variety of factors including the
market value of the stock when issued and potential changes in market conditions
affecting the valuation of the other securities. Accordingly, we will revalue
the estimate of the settlement on a quarterly basis and at the time the debt and
equity securities are issued. Due to a decline in the market value of our Class
A common stock, we recorded a reduction in the provision for the litigation
settlement of $9.9 million for three months ended March 31, 2001 based on a
revaluation of the warrants to be issued in connection with the litigation
settlement. This reduction was partially offset by an increase in the provision
of $250,000 for the three months ended March 31, 2001 for additional costs to be
incurred for settling the litigation. Upon issuance of the warrants, the Company
expects to revalue the warrants on a quarterly basis in accordance with SFAS No.
133.
Minority Interest. During the three months ended March 31, 2001, we
accreted dividends and offering costs of $1.1 million on the preferred stock of
Strategy.com which was issued in October 2000 and January 2001.
Provision for Income Taxes. During the three months ended March 31, 2001
and 2000, we recorded income
19
tax expense of $289,000 and $250,000, respectively, primarily related to foreign
jurisdictions where we are profitable. The provision for income taxes may
increase as we become more profitable in certain foreign jurisdictions.
Preferred Stock Dividends. During the three months ended March 31, 2001, we
recorded preferred stock dividends of $2.2 million which are included in
accounts payable and accrued expenses in the accompanying consolidated balance
sheet. All accrued dividends were paid subsequent to March 31, 2001 through the
issuance of 646,238 share of Class A common stock in lieu of cash.
Deferred Revenue
Deferred revenue represents product support and other services fees that
are collected in advance for product license and product support and other
services fees relating to multiple element software arrangements for which the
fair value of each element cannot be established. Deferred revenue also includes
product license and product support and other services fees relating to
arrangements which required implementation-related services that are significant
to the functionality of features of the software product, including arrangements
with subsequent hosting services. Aggregate deferred revenue was $75.4 million
as of March 31, 2001 compared to $81.6 million as of December 31, 2000. We
expect to recognize approximately $50.0 million of this deferred revenue over
the next twelve months; however, the timing and ultimate recognition of our
deferred revenue depends 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 and other services, deferred revenue as of any particular date
may not be representative of actual revenue for any succeeding period.
Liquidity and Capital Resources
On March 31, 2001 and December 31, 2000, we had $91.4 million and $94.7
million of cash, cash equivalents, and short-term investments, respectively, of
which $400,000 and $25.9 million was restricted cash as of March 31, 2001 and
December 31, 2000, respectively and $32.1 million and $34.5 million was cash of
Strategy.com as of March 31, 2001 and December 31, 2000, respectively.
Cash used in operations was $26.5 million and $21.4 million for the three
months ended March 31, 2001 and 2000, respectively. The increase in cash used in
operations from 2000 to 2001 was primarily attributable to an increase in cash
used for working capital items such as accounts payable and accrued expenses
offset by a decrease in sales and marketing and other operating expenses. During
the latter part of 2000 and subsequent to the first quarter of 2001, we have
taken several actions to curtail our operating expenses including a reduction in
headcount, consolidation of facilities and discontinuation of various company
sponsored events. We have also implemented actions to reduce the use of outside
consultants and contractors and other sales and marketing expenses. These
actions were taken to achieve our goal of making our business, excluding
Strategy.com, profitable on an operating basis by the end of 2001, excluding
amortization, preferred dividends and other non-operating expenses.
Cash provided by investing activities was $22.7 million and $9.0 million
for the three months ended March 31, 2001 and 2000, respectively. As discussed
further below, cash provided by investing activities consisted primarily of the
$25.9 million in restricted cash that was released in connection with the
termination of our prior credit facility. Additionally, as discussed above, we
received $2.2 million in cash relating to the sale of a 5% interest we held in a
voice portal company that was purchased by another company, in exchange for
approximately 50% in cash and 50% in publicly-traded common stock of the
acquiring entity. The remaining increase in cash provided by investing
activities from 2000 to 2001 is attributable to a reduction in capital
expenditures.
Our financing activities provided cash of $23.5 million and $4.4 million
for the three months ended March 31, 2001 and 2000, respectively. In January
2001, we issued an additional 3,134,796 million shares for $10.0 million, in a
second and final closing of convertible preferred stock of Strategy.com.
20
On February 9, 2001, we entered into a loan and security agreement which
provides for aggregate borrowing capacity of up to $30.0 million to be used for
general working capital purposes (the "Credit Facility"). The Credit Facility
consists of a $10.0 million term loan and a revolving line of credit for up to
$20.0 million, subject to specified borrowing base limitations. The Credit
Facility matures in February 2004 and is collateralized by substantially all of
our assets. The Credit Facility replaced the previous line of credit agreement,
which provided for a $25.0 million revolving line of credit and was secured by
cash and cash equivalents of $25.9 million classified as restricted cash in the
accompanying consolidated balance sheet at December 31, 2000. The cash was
restricted through February 2001, at which time the previous line of credit
agreement was terminated upon the closing of the new credit facility. At March
31, 2001, we had $5.4 million of borrowing capacity under the revolving line of
credit. The remaining $14.6 million under the revolving line of credit may be
available for future drawdowns upon completion of specified reporting
requirements and other events defined in the agreement and subject to borrowing
base limitations.
At our option, borrowings under the revolving line of credit will bear interest
at a variable rate equal to LIBOR plus 3.25% or 3.75% or at a variable rate
equal to the prime rate plus 1.50% or 2.00%, depending on the outstanding
balance. The Credit Facility also includes a 1.50% unused letter of credit fee
and requires monthly payments of interest and other fees beginning on the first
day of the month following the execution of the agreement. Borrowings under the
term loan are based upon certain levels of maintenance revenue and bear interest
at a variable rate equal to the prime rate plus 3.00%. Under the terms of the
Credit Facility, we are required to maintain certain financial covenants, the
most restrictive of which are achieving certain minimum earnings amounts, as
defined in the agreement, limitations on capital expenditures, minimizing the
ability to invest further in subsidiaries, and limitations on incurring
additional indebtedness. On May 15, 2001, the Credit Facility was amended to,
among other things, extend the time to satisfy certain administrative covenants
through June 15, 2001. In April and May 2001, we did not meet these
administrative covenants but believe we will comply with these requirements
prior to June 15, 2001. In addition to the interest and other fees on borrowings
under the Credit Facility, the lender has been granted warrants to purchase
50,000 shares of our Class A common stock at an exercise price of $14.825 per
share, subject to adjustment as set forth therein.
In connection with obtaining the Credit Facility, we incurred loan
origination costs of $417,000 for professional and other origination fees. The
loan origination costs were accounted for as a discount on the term loan. The
loan origination costs will be amortized to interest expense using the
straight-line method over the term of the Credit Facility of three years.
Additional interest expense related to the amortization of the loan origination
costs was $17,000 for the three months ended March 31, 2001.
As part of the class action litigation settlement agreement, in addition to
issuing Class A common stock, we will issue five-year unsecured subordinated
promissory notes having an aggregate principal amount of $80.5 million and
bearing interest at 7.5% per year and warrants to purchase 1,900,000 shares of
Class A common stock at an exercise price of $40 per share, with the warrants
expiring five years from the date they are issued. In connection with this
arrangement, we expect to pay approximately $6.0 million per year in interest
charges commencing upon the settlement hearing date of April 2, 2001.
In November 1999, we signed a three-year master lease agreement to lease up
to $40.0 million of computer equipment, of which we leased approximately $17.8
million as of March 31, 2001. The lease bears interest at a rate equal to
interest on three-year U.S. treasury notes plus 1.5% to 2.0%. Future drawdowns
and interest rates under the lease agreement are subject to our credit
worthiness. Currently, we are unable to draw down additional amounts under the
lease agreement.
We have recently taken actions to realign our cost structure to better
match our expected revenues by reducing our workforce, limiting discretionary
operating expenses and reducing capital expenditures. If we do not achieve
revenues at anticipated levels, and we are not able to promptly adjust our cost
structure, we will need to take further measures to reduce costs or will require
additional external financing through credit facilities, sale of additional
equity in MicroStrategy or in our Strategy.com subsidiary, or by obtaining other
financing facilities to support our current cost structure. Financing facilities
may not be available on acceptable terms. We believe that our existing cash,
cash generated internally by operations and the new credit facility agreement
entered into in February 2001 will meet our working capital requirements and
anticipated capital expenditures for the remainder of 2001.
21
In connection with the restructuring plan, we announced, on April 3, 2001,
that we had entered into an agreement to refinance our Series A redeemable
convertible preferred stock. The refinancing is expected to close on June 4,
2001, subject to the satisfaction of various closing conditions including the
consent of the holders of our new credit facility. As a result of the
refinancing, we will have the option to redeem for cash $5.3 million face value
of our outstanding Series A redeemable convertible preferred stock and will
redeem or exchange all remaining outstanding Series A redeemable convertible
preferred stock as follows:
. $25 million stated value of the Series A redeemable convertible preferred
stock will be redeemed for $25 million in cash;
. $33.75 million stated value of the Series A redeemable convertible
preferred stock will be exchanged for a combination of Class A common stock
and Series D redeemable convertible preferred stock with a fixed conversion
price of $5 per share;
. $33.125 million stated value of the Series A redeemable convertible
preferred stock will be exchanged for an equivalent face amount of Series B
redeemable convertible preferred stock, with a fixed conversion price of
$12.50 per share, subject to adjustment at maturity if the Company elects
to mandatorily convert these shares into Class A common stock; and
. $27.825 million stated value of the Series A redeemable convertible
preferred stock will be exchanged for an equivalent face amount of Series C
redeemable convertible preferred stock, with a fixed conversion price of
$17.50 per share, subject to adjustment at maturity if the Company elects
to mandatorily convert these shares into Class A common stock.
The Series B redeemable convertible preferred stock and the Series C
redeemable convertible preferred stock will mature three years after the date of
issuance and accrue dividends at a rate of 12.5% per annum, payable in cash or
shares of Class A common stock, subject to satisfaction of certain conditions.
At our option, the Series B and Series C preferred stock may be redeemed at
maturity at par value plus accrued dividends or mandatorily converted into Class
A common stock at the lower of their respective fixed conversion prices or 95%
of the average of the dollar volume-weighted average price of the Class A common
stock during the 30 consecutive trading days immediately preceding the maturity
date. The Series D preferred stock will mature three years after the date of
issuance, will not pay dividends, and will have a fixed conversion price of $5
per share. At maturity, the Series D preferred stock mandatorily converts into
Class A common stock at the fixed conversion price of $5 per share. We have not
yet determined the potential impact of this refinancing transaction on our
consolidated financial position and results of operations.
Our operations and prospects have been and will be significantly affected
by the developments relating to the revision of our 1999, 1998 and 1997
financial statements. We and certain of our officers and directors were named as
defendants in a class action lawsuit alleging violations of various securities
laws and certain of our officers and directors are defendants in a shareholder
derivative lawsuit alleging that they breached their fiduciary duties related to
our restated financial statements. In October 2000, we entered into agreements
to settle the class action and shareholder derivative lawsuits. On January 19,
2001, the United States District Court authorized notice of the proposed class
action settlement sent to all putative class members. The notice informs class
members of their rights including their rights to object to the proposed
settlement and to pursue their claims separately. On April 2, 2001, the United
States District Court held a hearing and approved the class action settlement.
Any appeals from the ruling of the court must be filed in May 2001 and the
settlement is subject to various closing conditions. The derivative settlement
is still subject to confirmatory discovery, final documentation, court approval
and certain other conditions. We expect to file the settlement agreements with
the Delaware Court of Chancery in May 2001 and for the Chancery Court
subsequently to authorize notice of the proposed settlement to be sent to
shareholders. The Chancery Court would then be expected to schedule a hearing on
the fairness of the proposed settlement approximately 60 days after the sending
of the notice to shareholders.
22
Recent Accounting Standards
In June 1999, the FASB issued SFAS No. 137, which delays the effective date
of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities,"
which is effective for the fiscal year 2001. This statement establishes
accounting and reporting standards requiring that every derivative instrument,
including certain derivative instruments embedded in other contracts, be
recorded in the balance sheet as either an asset or liability measured at its
fair value. The statement also requires that changes in the derivative's fair
value be recognized in earnings unless specific hedge accounting criteria are
met. In June 2000, the FASB issued SFAS No. 138, which amends certain accounting
and reporting standards of SFAS No. 133. We adopted SFAS No. 133 as of January
1, 2001 and through March 31, 2001, the adoption of this statement did not have
a material effect on our financial position or results of operations.
Risk Factors
The following important factors, among others, could cause actual results
to differ materially from those contained in forward-looking statements made in
this Quarterly Report on Form 10-Q or presented elsewhere by management from
time to time. The risks and uncertainties described below are not the only ones
facing our company. 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 events described in 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.
We have experienced losses in the past and expect future losses through at least
the end of 2001
We have not achieved profitability and have incurred significant operating
losses in each of the last five years. We incurred net losses since becoming a
public company of $20.6 million in the three months ended March 31, 2001 and
$261.3 million, $33.7 million and $2.3 million in the years ended December 31,
2000, 1999 and 1998, respectively. As of March 31, 2001, our accumulated deficit
was $319.8 million. We expect our gross revenue to decline from the fiscal year
ended December 31, 2000 to the fiscal year ended December 31, 2001.
We expect that we will not achieve sufficient revenue to become
profitable through at least the end of 2001. Even if we do achieve
profitability, we cannot assure you that we can sustain or increase
profitability on a quarterly or annual basis in the future. If revenue grows
more slowly than we anticipate, or 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 may 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 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;
23
. 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; 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, particularly personnel costs
and rent, 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 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 customer's 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 products can sometimes last several months, depending on the
customer's 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.
Our employees, investors, customers, vendors and lenders may react adversely to
the revision of our 1999, 1998 and 1997 revenues and operating results
Our future success depends in large part on the support of our key
employees, investors, customers, vendors and lenders, some of whom have reacted
adversely to the revision of our 1999, 1998 and 1997 revenues and operating
results. The revision of our 1999, 1998 and 1997 revenues and operating results
has resulted in substantial amounts of negative publicity about us and we
believe that this publicity has caused some of our potential customers to defer
24
purchases of our software or to do business with other vendors. We may not be
able to retain key employees and customers if they lose confidence in us, and
our vendors and lenders may reexamine their willingness to do business with us.
In addition, investors may lose confidence, which may cause the trading price of
our class A common stock to decrease. We believe that adverse reaction to our
revision of our financial statements and the loss of confidence in MicroStrategy
by some employees, investors, customers, vendors and lenders due to the revision
contributed to the substantial decline in our stock price over the last year. If
we lose the services of our key employees or are unable to retain and attract
our existing and new customers, vendors and lenders, our business, operating
results and financial condition could be materially and adversely affected.
Our recognition of deferred revenue is subject to future performance obligations
and may not be representative of actual revenues for succeeding periods
Our deferred revenue was approximately $75.4 million as of March 31, 2001.
The timing and ultimate recognition of our deferred revenue depends 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, deferred revenue at any particular date may not be representative of
actual revenue for any succeeding period.
We may need additional financing which could be difficult to obtain
We may require additional external financing through credit facilities,
sale of additional debt or equity securities in MicroStrategy or by obtaining
other financing facilities to support our operations, as we expect to incur
operating losses through at least the third quarter of 2001 and possibly longer.
Obtaining additional financing will be subject to a number of factors,
including:
. market conditions;
. our operating performance; and
. investor sentiment.
These factors may make the timing, amount, terms and conditions of
additional financing unattractive to us. If we are unable to raise capital to
fund our operations, our business, operating results and financial condition may
be materially and adversely affected.
We face litigation that could have a material adverse effect on our business,
financial condition and results of operations
We and certain of our directors and executive officers are named as
defendants in a private securities class action lawsuit and a shareholder
derivative lawsuit relating to the restatement of our 1999, 1998 and 1997
financial results. Although we have entered into agreements to settle such
lawsuits and the securities class action settlement has received district court
approval, the securities class action settlement may be appealed prior to June
2001, the shareholder derivative lawsuit is subject to court approval and both
settlements are subject to various closing conditions. If the agreed upon
settlements are not consummated, it is possible that we may be required to pay
substantial damages or settlement costs which could have a material adverse
effect on our financial condition or results of operation. Regardless of the
outcome of these matters, it is likely that we will incur substantial defense
costs and that these actions may cause a diversion of management time and
attention.
The issuance of class A common stock as part of the proposed settlement of class
action litigation and the exercise of warrants or conversion of notes issued as
part of the litigation settlement could result in a substantial number of
additional shares of class A common stock being issued
The agreements we entered into to settle the private securities class
action lawsuit and the derivative suit relating to the restatement of our 1999,
1998 and 1997 financial results require us to issue to members of the class
2,777,778 shares of class A common stock. At the time of that issuance, some of
our officers will tender to us for no
25
consideration 1,683,502 shares of class A common stock for cancellation,
resulting in a net issuance of 1,094,276 additional shares of class A common
stock. In addition, the number of shares of class A common stock to be issued to
class members will be increased based on a dollar-weighted anti-dilution formula
in the event we issue or sell any equity securities or equity linked securities
to any person on or before June 2, 2001, with some exceptions, for an effective
price per share of class A common stock that is less than $5.94 per share. In
addition, the settlement agreements require the issuance of warrants to purchase
1,900,000 shares of common stock and five-year unsecured subordinated promissory
notes having an aggregate principal amount of $80.5 million. We would have the
option at any time prior to the expiration of the five year term of the notes to
convert the notes into a number of shares of class A common stock equal to the
principal amount of the notes being converted divided by 80% of the weighted
average trading price of the class A common stock over a 10 day period preceding
our delivery of a notice of conversion, which could result in a substantial
number of shares of class A common stock being issued. For example, if the
conversion price of notes were the based on the weighted average trading price
of the Class A common stock during the 10 trading days ending May 1, 2001, we
would be obligated to issue 22,183,642 shares of class A common stock if we
elected to convert the notes. The issuance of a substantial number of shares of
class A common stock as part of the litigation settlement and future exercises
or conversions of securities issued in the litigation settlement may result in
substantial dilution to the interests of holders of class A common stock and may
result in downward pressure on the price of our class A common stock.
We are currently unable to borrow additional amounts under our master equipment
lease agreement
We signed a three-year master lease agreement to lease up to $40.0 million
of computer equipment, of which we have leased approximately $17.8 million as of
March 31, 2001. Future drawdowns and interest rates under the lease agreement
are subject to our credit worthiness. Currently, we are not able to draw down
additional amounts under the lease agreement.
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, customer relationship
management applications, portals and narrowcast messaging technologies are
intensely competitive and subject to rapidly changing technology. In addition,
many of our competitors in these markets are offering, or may soon offer,
products and services that may compete with MicroStrategy products and those of
Strategy.com.
MicroStrategy's most direct competitors provide:
. business intelligence software;
. online analytical processing, or OLAP, tools;
. query and reporting tools;
. web-based static reporting tools;
. information delivery and proactive reporting;
. analytical customer relationship management products;
. web traffic analysis applications; and
. marketing automation.
Each of these markets are discussed more fully below.
Business Intelligence Software. Makers of business intelligence software
provide business intelligence capabilities designed for integration,
customization and application development. Leading industry analysts classify
26
companies such as Microsoft, Oracle, Hyperion, SAP and SAS to be leading
providers of business intelligence software.
OLAP Tools. Companies that build software to perform OLAP provide offerings
competitive with the core MicroStrategy 7 platform. Whether web-based or
client-server, these tools give end users the ability to query 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 mode, often referred to as
drilling. Providers of OLAP tools include Cognos, Microsoft, Hyperion, Brio,
IBM, Seagate and Microsoft.
Query and Reporting Tools. Query and reporting tools allow large numbers of
end users to gain access to pre-defined reports for simple analysis. Often the
end users are able to specify some sort of run-time criteria that customizes the
result set for that particular person. Some limited `drilling' is also provided.
Companies that produce query and reporting tools include Business Objects,
Cognos, Oracle, Seagate, and Brio.
Web-based Static Reporting Tools. Companies that offer software to deliver
pre-built reports for end user viewing and consumption can also compete with
MicroStrategy. These applications often lack the sophistication, robustness and
scalability of MicroStrategy, but can be attractive for small, departmental
applications. Vendors in this category include Actuate, Business Objects,
Seagate, Microsoft, Computer Associates and SAS.
Information Delivery and Proactive Reporting. Companies that focus on the
proactive delivery of information via e-mail, website, or other medium can
compete with MicroStrategy's offerings. Typically these tools serve to push out
compiled reports on a scheduled basis to sets of users based on job type.
MicroStrategy software has this technology integrated into its core platforms.
Vendors of such technology include Actuate, nQuire, Information Builders and
Business Objects.
Analytical Customer Relationship Management Products. Companies that
deliver customer relationship management products alone or in conjunction with
e-commerce applications, such as Broadbase, BroadVision, E.piphany and Vignette,
compete with our analytical customer relationship management applications. In
contrast with providers of operational customer relationship management vendors,
such as Vantive and Oracle, analytical customer relationship management deals
more with customer segmentation, analysis and interaction as opposed to
infrastructure and call centers.
Web Traffic Analysis Applications. Reporting and analysis tools can be
specialized to analyze visitors to a company's website. Typically this involves
extracting data from a web-log file and importing it into a usable format, often
in a relational database. A set of analysis, sometimes customer-centric in
nature, is performed, and limited ad-hoc reporting is permitted. Advanced
applications in this space merge data from the web-logs with other customer
centric attributes to help provide a complete view of the customer base. Vendors
in this space include Accrue, Net.Genesis and WebTrends.
Marketing Automation. Applications focused on the automation and execution
of marketing tasks, such as campaign management and delivery, compete with our
customer relationship management products and our Narrowcast Server platform.
Leading vendors in this space include E.piphany, Xchange, Chordiant and
Broadbase.
Strategy.com's most direct competitors provide:
. web portal and information networks;
. vertical internet portals and information networks; and,
. wireless communications and wireless access protocol enabled products.
Each of these market segments are discussed more fully below.
Web Portals and Information Networks. Web portals and information networks,
such as Microsoft Network, Yahoo, Lycos, Excite, America Online and
InfoSpace.com, offer an array of information that is similar to
27
information provided by Strategy.com.
Vertical Internet Portals and Information Networks. Expedia, Weather.com,
CNBC.com, ABC.com, ESPN.com, Microsoft Investor, StockBoss, Microsoft CarPoint,
InfoBeat, Internet Travel Network and others have developed custom applications
and products to commercialize, analyze and deliver specific information over the
Internet. These systems are usually tailored to one application, such as
providing news, sports or weather, but in the aggregate, they offer applications
similar to those provided by Strategy.com. Any one of these companies could
expand their offerings to more closely compete with Strategy.com.
Wireless Communications and Wireless Access Protocol Enabled Products.
Wireless communications providers, such as AT&T, Sprint, MCI WorldCom, Nextel
Communications, British Telecom, Deutsche Telekom, PageNet, Nokia, Ericsson,
3COM and Palm offer a variety of mobile phones and wireless devices over which
Strategy.com delivers information. These companies may develop in-house
information services or partner with other companies to deliver information that
is competitive to that offered by Strategy.com.
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 cannot be sure that we will
be able to compete successfully against current and future competitors or that
the competitive pressures we face will not have a material adverse affect 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 harm our ability to obtain maintenance revenues for new
and existing product licenses on favorable terms.
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. In
April 2001, we implemented a corporate restructuring which included a reduction
in our worldwide workforce of approximately one-third. In April and May 2001,
Strategy.com adopted restructuring plans in which its workforce would be reduced
to approximately 40 employees. These reductions in force have had and could
continue to have an adverse impact on our employee morale and on our ability to
attract and retain employees. 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.
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:
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. 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, introductions of new competitive products or customer
requirements, nor can we be sure that our 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 MicroStrategy products. Although the core database component
of our business intelligence solutions is compatible with nearly all enterprise
server hardware and operating system combinations, such as OS/390, AS/400, Unix
and Windows, our application server component runs only on the Windows NT
operating system. Therefore, our ability to increase sales currently depends on
the continued acceptance of the Windows NT operating system. We cannot market
many of our current business intelligence products to potential customers who
use Unix operating systems as their application server. We would have to invest
substantial resources to develop a Unix product and we cannot be sure that we
could introduce such a product on a timely or cost-effective basis, if at all.
The legal environment regarding collection and use of personal information is
uncertain and new laws or government regulations could have a material adverse
effect on our business, operating results and financial condition
Although some existing laws govern the collection and use of personal
information obtained through the Internet or other public data networks, it is
unclear whether they apply to our products and us. Most of these laws were
adopted before the widespread use and commercialization of the Internet and
other public data networks. As a result, the laws do not address the unique
issues presented by these media.
Due to increasing use of the Internet and the dramatically increased
access to personal information made possible by technologies like ours, the U.S.
federal and various state and foreign governments have recently proposed
limitations on the collection and use of personal information of users of the
Internet and other public data networks.
Although we attempt to obtain permission from users prior to collecting or
processing their personal data, new laws or regulations governing personal
privacy may change the ways in which we and our customers and affiliates may
gather this personal information. There may be significant costs and delays
involved with adapting our products to any change in regulations.
Our business, and in particular the Strategy.com network, depends upon our
receiving detailed personal information about subscribers in order to provide
them with the services they select. Privacy concerns may cause some potential
subscribers to forego subscribing to our service. If new laws or regulations
prohibit us from using information in the ways that we currently do or plan to
do, or if users opt out of making their personal preferences and information
available to us and Strategy.com affiliates, the utility of our products will
decrease, which could have a material adverse effect on our business, operating
results and financial condition. If our customers, our network or Strategy.com
affiliates misuse personal information, our legal liability may be increased and
our growth may be limited.
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The Federal Trade Commission has recently launched investigations of the
data collection practices of various Internet companies. In addition, numerous
individuals and privacy groups have filed lawsuits or administrative complaints
against other companies asserting that they were harmed by the misuse of their
personal information. If comparable legal proceedings were commenced against us,
regardless of the merits of the claim, we could be required to spend significant
amounts on legal defense and our senior management's time and attention could be
diverted from our business. In addition, demand for our products could be
reduced if companies are not permitted to use clickstream data derived from
their websites. This could materially and adversely affect our business,
operating results and financial condition.
In Europe, the European Union Directive on Data Protection requires member
countries to implement legislation that prohibits any European entity from
sharing personal data collected from EU persons with entities in any country
that is not deemed to have adequate data protection laws. Currently, the United
States' data protection laws are not deemed to be adequate, and some data
transfers from European entities to us may be prohibited unless explicit consent
is obtained from EU data subjects, we agree to specified contractual privacy
safeguards that are approved by EU authorities, or we comply with the
requirements of the so-called Safe Harbor program between the United States and
the EU. It may not be feasible for us to obtain the required consent or to make
the necessary contractual commitments. Currently, we have not sought to be
certified under the Safe Harbor program, and our data collection and handling
practices may not qualify under this program. Although enforcement of EU data
protection laws against U.S. companies is currently subject to a standstill,
this standstill will expire in June 2001, and some countries, including France,
are currently attempting to enforce data protection laws with respect to data
exports to the United States, notwithstanding the existence of the standstill.
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 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.
Our relationship with Strategy.com could create the potential for conflicts of
interest
We hold an approximately 84% economic interest in the equity of
Strategy.com. Conflicts may arise between us and other investors in
Strategy.com, including: the allocation of business opportunities, the sharing
of rights, technologies, facilities, personnel and other resources, and the
fiduciary duties owed by officers, directors and other personnel who provide
services to both us and Strategy.com.
Strategy.com is expected to incur significant losses for the foreseeable future
and we are exploring strategic alternatives for this business
Strategy.com is expected to incur significant losses for the foreseeable
future. In April and May 2001, Strategy.com adopted restructuring plans in which
it will reduce its workforce to approximately 40 employees and will explore
strategic alternatives for the Strategy.com business, including a sale of the
Strategy.com business. It may not be possible to sell the Strategy.com business
on acceptable terms.
Because of the rights of our two classes of common stock, and because we are
controlled by our existing stockholders, these stockholders could transfer
control of MicroStrategy to a third party without anyone else's approval or
prevent a third party from acquiring MicroStrategy
30
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, 2001, holders of our class B common stock owned or
controlled 50,975,624 shares of class B common stock, or 94.2% of the total
voting power. Michael J. Saylor, our Chairman and Chief Executive Officer,
controlled 3,100,155 shares of class A common stock and 39,467,110 shares of
class B common stock, or 73.5% of total voting power, as of May 1, 2001.
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 bylaws 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 who are employees of our company or related parties, to transfer
shares of class B common stock, subject to the approval of a majority of the
holders of outstanding class B common stock. Mr. Saylor or a group of
stockholders possessing a majority of the outstanding class B common stock
could, without seeking anyone else's 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.
The conversion of the shares of our preferred stock could result in substantial
numbers of additional shares of class A common stock being issued if our market
price declines during periods in which the conversion price of the preferred
stock may adjust
The holders of 11,970 shares of our series A redeemable convertible
preferred stock have entered into an agreement with us in which they have agreed
to exchange their preferred stock for cash and shares of our class A common
stock, series B redeemable convertible preferred stock, series C redeemable
convertible preferred stock and series D redeemable convertible preferred stock
subject to the satisfaction of various closing conditions. The transaction is
expected to close on June 4, 2001. The series B redeemable convertible preferred
stock, series C redeemable convertible preferred stock and series D redeemable
convertible preferred are convertible into shares of our class A common stock at
conversion prices currently equal to $12.50, $17.50 and $5.00 per share,
respectively. If the transaction closes and the series A redeemable convertible
preferred stock is exchanged, the shares of series B redeemable convertible
preferred stock and series C redeemable convertible preferred stock that we
would issue in the exchange would currently convert into 4,240,000 shares of
class A common stock, plus a number of shares reflecting accrued but unpaid
dividends as of the conversion date. However, if the holders of the series B
redeemable convertible preferred stock and series C redeemable convertible
preferred stock do not convert their shares into shares of class A common stock
prior to their maturity three years from the date of issuance, and if we do not
redeem their outstanding shares of series B redeemable convertible preferred
stock and series C redeemable convertible preferred stock at maturity, the
conversion price for such shares will be reset to a price equal to 95% of the
dollar weighted average price of our class A common stock for the 30 trading
days prior to the maturity date. If the market price of our class A common stock
is less than the applicable conversion price at maturity, the number of shares
of class A common stock that we could be required to issue upon conversion of
the series B redeemable convertible preferred stock and series C redeemable
convertible preferred stock would increase. For instance, if the market price of
our class A common stock on the maturity date of our series B redeemable
convertible preferred stock and series C redeemable convertible preferred stock
were the same as the market price of our class A common stock as of May 1, 2001,
the holders of the series B redeemable convertible preferred stock and series C
redeemable convertible preferred stock did not elect to convert any of their
shares prior to the maturity date and we did not redeem such shares on the
maturity date, we would be required to issue a total of 10,883,929 shares of our
class A common stock upon conversion of such shares at maturity.
After the exchange of shares of our series A convertible preferred stock
for shares of our class A common stock, series B redeemable convertible
preferred stock, series C redeemable convertible preferred stock and series D
redeemable convertible preferred stock as described above, there would be 530
shares of our series A redeemable convertible preferred stock outstanding if we
do not elect to redeem such shares in connection with the refinancing of the
series A redeemable convertible preferred stock. If the refinancing transaction
does not close, all 12,500
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shares of the series A redeemable convertible preferred stock would remain
outstanding. As of March 31, 2001, shares of series A redeemable convertible
preferred stock are convertible into class A common stock at a conversion price
equal to $33.39 per share. This conversion price may be adjusted based on the
market price of our class A common stock if the series A redeemable convertible
preferred stock remains outstanding on June 19, 2001 and on each subsequent
anniversary of such date, if such adjustment would result in a lower conversion
price. The conversion price may also be adjusted upon the occurrence of various
events, including the failure to maintain the effectiveness of the registration
statement to which these shares relate and the issuance of certain equity
securities. As a result, the lower the price of our class A common stock at
these intervals, the greater the number of shares the holder will receive upon
conversion after any such adjustment. For example, the number of shares of class
A common stock that we would be required to issue upon conversion of all 12,500
shares of series A redeemable convertible preferred stock, excluding shares
issued as accrued dividends would increase from approximately 3,744,151 shares,
based on the applicable conversion price of $33.39 per share as of March 31,
2001, to approximately 22,321,428 shares based on the $5.60 closing price of our
class A common Stock as of May 1, 2001. If the refinancing transaction were to
close, the number of shares of class A common stock that we would be required to
issue upon conversion of the 530 shares of series A redeemable convertible
preferred stock, excluding shares issued as accrued dividends, would increase
from approximately 158,752 shares, based on the applicable conversion price of
$33.39 per share as of March 31, 2001, to approximately 946,429 shares based on
the closing price of our class A common stock as of May 1, 2001.
To the extent the shares of our preferred stock are converted or dividends
on these shares are paid in shares of class A common stock rather than cash, a
significant number of shares of class A common stock may be sold into the
market, which could decrease the price of our class A common stock and encourage
short sales. Short sales could place further downward pressure on the price of
our class A common stock. In that case, we could be required to issue an
increasingly greater number of shares of our class A common stock upon future
conversions of the preferred stock as a result of the annual and other
adjustments described above, sales of which could further depress the price of
our class A common stock.
The conversion of and the payment of dividends in shares of class A common
stock in lieu of cash on the preferred stock may result in substantial dilution
to the interests of other holders of our class A common stock. No selling
stockholder may convert its preferred stock if upon such conversion the selling
stockholder together with its affiliates would have acquired a number of shares
of class A common stock during the 60-day period ending on the date of
conversion which, when added to the number of shares of class A common stock
held at the beginning of such 60-day period, would exceed 9.99% of our then
outstanding class A common stock, excluding for purposes of such determination
shares of class A common stock issuable upon conversion of shares of preferred
stock which have not been converted. Nevertheless, a selling stockholder may
still sell a substantial number of shares in the market. By periodically selling
shares into the market, an individual selling stockholder could eventually sell
more than 9.99% of our outstanding class A common stock while never holding more
than 9.99% at any specific time.
We may be required to pay substantial penalties to the holders of the preferred
shares if specific events occur
In accordance with the terms of the agreements relating to the issuance of
the series A redeemable convertible preferred stock and in connection with the
transactions relating to the proposed issuance of the series B redeemable
convertible preferred stock, the series C redeemable convertible preferred stock
and the series D redeemable convertible preferred stock, we are required to pay
substantial penalties to a holder of preferred stock under specified
circumstances, including, among others:
. nonpayment of dividends on the series A redeemable convertible preferred
stock, series B redeemable convertible preferred stock and series C
redeemable convertible preferred stock in a timely manner;
. failure to deliver shares of our class A common stock upon conversion of
the preferred shares after a proper request;
. nonpayment of the redemption price at maturity of any remaining series A
redeemable convertible preferred stock, series B redeemable convertible
preferred stock and series C redeemable convertible preferred stock; or
32
. the unavailability of the registration statement relating to the shares of
class A common stock issuable upon conversion of and in lieu of cash
dividends on the preferred stock to cover the resale of such shares for
more than brief intervals.
Such penalties are generally paid in the form of interest payments,
subject to any restrictions imposed by applicable law. In the third quarter of
2000, we incurred $578,000 in penalties as a result of a 14-day delay in the
filing of a registration statement registering the shares of class A common
stock issuable upon conversion of and in lieu of dividends on the series A
redeemable convertible preferred stock.
We rely on our strategic channel partners and if we are unable to develop or
maintain successful relationships with them, our business, operating results and
financial condition will suffer
In addition to our direct sales force, we rely on strategic channel
partners, such as original equipment manufacturers, system integrators and
value-added resellers, to license and support our products in the United States
and internationally. In particular, for the three months ended March 31, 2001
and the years ended December 31, 2000, 1999 and 1998, channel partners accounted
for, directly or indirectly, approximately 34.0%, 44.4%, 39.2% and 33.6% of our
total product license 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 intend to
increase the level of indirect sales activities through our strategic channel
partners. However, we may not be successful in our efforts to continue to expand
indirect sales in this manner. We may not be able to attract strategic partners
who will market our products effectively and who will be qualified to provide
timely and cost-effective customer support and service. Our ability to achieve
revenue growth in the future will depend in part on our success in developing
and maintaining successful relationships with those strategic partners. If we
are unable to develop or maintain our relationships with these strategic
partners, our business, operating results and financial condition will suffer.
Strategy.com affiliates will rely on Strategy.com to maintain the infrastructure
of the network and any problems with that infrastructure could expose
Strategy.com to liability from its Strategy.com affiliates and their customers
Strategy.com affiliates depend on Strategy.com to maintain the software
and hardware infrastructure of the Strategy.com network. If this infrastructure
fails or Strategy.com affiliates or their customers otherwise experience
difficulties or delays in accessing the network, Strategy.com could face
liability claims from them. Strategy.com expects to include contractual
provisions limiting its liability to its Strategy.com affiliates for system
failures and delays, but these limits may not be enforceable and may not be
sufficient to shield Strategy.com from liability. Strategy.com will seek to
obtain liability insurance to cover problems of this sort, but insurance may not
be available and the amounts of its coverage may not be sufficient to cover all
potential claims.
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 party's
proprietary rights. Regardless of their merit, any such claims could be time
consuming and expensive to defend, may divert management's attention and
resources, could cause product shipment delays and could require us
33
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.
In late March 2001, NCR Corporation asked us to consider licensing certain
technology which NCR alleges is covered under patents that they hold. NCR has
implied that if we are unwilling to license this technology they may seek to
enforce their patents against us. We have not yet had an opportunity to fully
review these matters. In the event NCR seeks to enforce any of these patents and
if such patents are found to be valid and enforceable against MicroStrategy, our
business, operating results and financial condition may be materially adversely
affected. We are not currently able to estimate the potential range of loss and
the outcome of the uncertainty is unknown. Accordingly, no provision for this
matter has been made in our consolidated financial statements.
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 32.7%, 24.9%, 24.0% and 26.1% of our
total revenues for the three months ended March 31, 2001 and the years ended
December 31, 2000, 1999 and 1998, 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; 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, our business, operating results and
financial condition.
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,
especially when first or subsequent versions are released. 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.
34
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.
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;
. any change in the actual or expected amount of dilution attributable to
issuances of additional shares of class A common stock upon conversion of
our preferred stock or as a result of the litigation settlement; 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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 do not use derivative
financial instruments. 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, 2001, 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
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We face exposure to adverse movements in foreign currency exchange rates.
Our international revenues and expenses are denominated in foreign currencies.
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, 2001, a 10% change in foreign
exchange rates would have had an immaterial effect on our financial position,
results of operations and cash flows. 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.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Actions Arising under Federal Securities Laws
From March through May 2000, twenty-five class action complaints were filed
in federal courts in various jurisdictions alleging that we and certain of our
officers and directors violated section 10(b) of the Securities and Exchange Act
of 1934, as amended (the "Exchange Act"), Rule 10b-5 promulgated thereunder, and
section 20(a) and section 20A of the Exchange Act. Our outside auditor,
PricewaterhouseCoopers LLP, was also named in two of the suits. The complaints
contained varying allegations, including that we made materially false and
misleading statements with respect to our 1999, 1998 and 1997 financial results
in our filings with the SEC, analysts' reports, press releases and media
reports. In June 2000, these putative class action lawsuits were consolidated in
the United States District Court for the Eastern District of Virginia. On July
7, 2000, the lead plaintiffs filed an amended class action complaint naming us,
certain of our officers and directors, and PricewaterhouseCoopers LLP as
defendants. The amended class action complaint alleges claims under section
10(b), section 20(a) and section 20A of the Exchange Act. The amended class
action complaint does not specify the amount of damages sought.
On October 23, 2000, the Company, its officers and directors named as
defendants, and plaintiffs' counsel entered into a settlement agreement in the
consolidated class action. Under the settlement agreement, class members will
receive: (1) five-year unsecured subordinated promissory notes issued by
MicroStrategy having an aggregate principal amount of $80.5 million and bearing
interest at 7.5% per year; (2) 2,777,778 shares of our Class A common stock; and
(3) warrants to purchase 1.9 million shares of Class A common stock at an
exercise price of $40 per share. The settlement was made subject to confirmatory
discovery, final documentation, district court approval, and other conditions.
On January 19, 2001, the district court authorized notice of the proposed
settlement to be sent to all putative class members. The notice informs class
members of their rights including their rights to object to the proposed
settlement and to opt out of the proposed settlement and pursue their claims
separately. On April 2, 2001, the district court approved the settlement. Any
appeal from that order must be taken in May 2001.
Delaware Derivative Investigation
On June 30, 2000, a shareholder derivative action was filed in the Delaware
Court of Chancery seeking recovery for various alleged breaches of fiduciary
duties by certain of our directors and officers relating to our restatement of
financial results. On September 11, 2000, we filed a motion to dismiss the
derivative complaint for failure to make a demand. That motion remains pending.
On October 23, 2000, the Company, the directors and officers named as defendants
and the derivative plaintiff reached an agreement in principle settling the
derivative action. Under the derivative settlement agreement, we will add a new,
independent director with finance experience to the audit committee of our Board
of Directors and will ensure continued adherence with applicable legal and
regulatory requirements regarding the independence of audit committee members
and trading by insiders. In addition, certain of our officers will contribute a
portion of the Class A common stock held by them that is to be issued to class
members in settlement of the class action lawsuit. Specifically, Michael J.
Saylor, our Chairman of the Board of Directors and Chief Executive Officer,
Sanju K. Bansal, our Vice Chairman, Executive Vice President and Chief Operating
Officer, and Mark S. Lynch, our former Chief Financial Officer, will contribute
to the class action settlement an aggregate of 1,683,502 shares of Class A
common stock held by them. The settlement was made subject to confirmatory
discovery, final documentation, Chancery Court approval, and other conditions.
No hearing has been scheduled for the Chancery Court to review and, if
appropriate, approve the settlement.
SEC Investigation
In March 2000, we were notified that the SEC had issued a formal order of
private investigation in connection with matters relating to the restatement of
our financial results. On December 14, 2000, we consented, without
37
admitting or denying the SEC's findings, to the entry of an administrative cease
and desist order finding that we had violated certain provisions of the federal
securities laws. As part of the cease and desist order, we made a number of
undertakings pursuant to which we will implement various corporate governance
enhancements, hire additional staff and adopt policies and controls relating to
our contract administration and financial reporting functions. The cease and
desist order imposed no monetary fines or penalties on us.
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.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
3.1 Amended and Restated Certificate of Incorporation of the Company
(Filed as Exhibit 3.1 to the Company's Registration Statement on Form
S-1 (Registration No. 333-49899) and incorporated by reference
herein).
3.2 Certificate of Amendment to the Amended and Restated Certificate of
Incorporation of the Company (Filed as Exhibit 3.2 to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended June 30,
2000 (File No. 000-24435) and incorporated by reference herein).
3.3 Certificate of Designations, Preferences and Rights of the Series A
Convertible Preferred Stock (Filed as Exhibit 3.1 to the Company's
Current Report on Form 8-K (File No. 000-24435) filed on June 19, 2000
and incorporated by reference herein).
3.2 Restated Bylaws of the Company (Filed as Exhibit 3.2 to the Company's
Registration Statement on Form S-1 (Registration No. 333- 49899) and
incorporated by reference herein).
4.1 Form of Certificate of Class A Common Stock of the Company (Filed as
Exhibit 4.1 to the Company's Registration Statement on Form S-1
(Registration No. 333-49899) and incorporated by reference herein).
10.1 Amended and Restated 1997 Stock Option Plan for French Employees of
the Company.
10.2 Amended and Restated 1999 Stock Option Plan of the Company.
10.3 Stipulation of Settlement regarding the settlement of the class action
lawsuit, dated as of January 11, 2001. (Filed as Exhibit 10.29 to the
Company's Annual Report on Form 10-K (File No. 000-24435) filed on
April 2, 2001 and incorporated by reference herein).
10.4 Loan and Security Agreement by and among Foothill Capital Corporation,
the Company and MicroStrategy Services Corporation, dated as of
February 9, 2001 (Filed as Exhibit 10.1 to the Company's Current
Report of Form 8-K (File No. 000-24435) filed on February 15, 2001 and
incorporated by reference herein).
38
10.5 General Continuing Guaranty by and among the Company, Aventine
Incorporated, MicroStrategy Capital Corporation and MicroStrategy
Management Corporation, dated as of February 9, 2001 (Filed as Exhibit
10.2 to the Company's Current Report of Form 8-K (File No. 000-
24435) filed on February 15, 2001 and incorporated by reference
herein).
10.6 Security Agreement by and among the Company, Aventine Incorporated,
MicroStrategy Capital Corporation, MicroStrategy Management
Corporation and Foothill Capital Corporation, dated as of February 9,
2001 (Filed as Exhibit 10.3 to the Company's Current Report of Form
8-K (File No. 000-24435) filed on February 15, 2001 and incorporated
by reference herein).
10.7 Warrant to Purchase Class A Common Stock of the Company, dated
February 9, 2001, issued to Foothill Capital Corporation (Filed as
Exhibit 10.4 to the Company's Current Report of Form 8-K (File No.
000-24435) filed on February 15, 2001 and incorporated by reference
herein).
10.8 Registration Rights Agreement by and between the Company and
Foothill Capital Corporation, dated as of February 9, 2001 (Filed as
Exhibit 10.5 to the Company's Current Report of Form 8-K (File No.
000-24435) filed on February 15, 2001 and incorporated by reference
herein).
10.9 Redemption and Exchange Agreement, dated as of April 3, 2001, by and
among the Company, Fisher Capital Ltd. and Wingate Ltd. (Filed as
Exhibit 10.1 to the Company's Current Report on Form 8-K (File No.
000-24435) filed on April 4, 2001 and incorporated by reference
herein).
10.10 Redemption and Exchange Agreement, dated as of April 3, 2001, by and
between the Company and HFTP Investment L.L.C. (Filed as Exhibit 10.2
to the Company's Current Report on Form 8-K (File No. 000-24435) filed
on April 4, 2001 and incorporated by reference herein).
10.11 Redemption and Exchange Agreement, dated as of April 3, 2001, by and
between the Company and Leonardo, L.P. (Filed as Exhibit 10.3 to the
Company's Current Report on Form 8-K (File No. 000-24435) filed on
April 4, 2001 and incorporated by reference herein).
10.12 Form of Certificate of Designations, Preferences and Rights of the
Series B Convertible Preferred Stock (Exhibit A to Exhibits 10.9,
10.10 and 10.11 hereto) (Filed as Exhibit 10.4 to the Company's
Current Report on Form 8-K (File No. 000-24435) filed on April 4, 2001
and incorporated by reference herein).
10.13 Form of Certificate of Designations, Preferences and Rights of the
Series C Convertible Preferred Stock (Exhibit B to Exhibits 10.9 and
10.11 hereto) (Filed as Exhibit 10.5 to the Company's Current Report
on Form 8-K (File No. 000-24435) filed on April 4, 2001 and
incorporated by reference herein).
10.14 Form of Certificate of Designations, Preferences and Rights of the
Series D Convertible Preferred Stock (Exhibit C to Exhibits 10.9 and
10.11 hereto and Exhibit B to Exhibit 10.10 hereto) (Filed as Exhibit
10.6 to the Company's Current Report on Form 8-K (File No. 000-24435)
filed on April 4, 2001 and incorporated by reference herein).
10.15 Registration Rights Agreement, dated as of April 3, 2001, by and
among the Company, Fisher Capital Ltd. and Wingate Capital Ltd. (Filed
as Exhibit 10.7 to the Company's Current Report on Form 8-K (File No.
000-24435) filed on April 4, 2001 and incorporated by reference
herein).
10.16 Registration Rights Agreement, dated as of April 3, 2001, by and
between the Company and HFTP Investment L.L.C. (Filed as Exhibit 10.8
to the Company's Current Report on Form 8-K (File No. 000-24435) filed
on April 4, 2001 and incorporated by reference herein).
10.17 Registration Rights Agreement, dated as of April 3, 2001, by and
between the Company and Leonardo, L.P. (Filed as Exhibit 10.9 to the
Company's Current Report on Form 8-K (File No. 000-24435) filed on
April 4, 2001 and incorporated by reference herein).
B. Reports on Form 8-K
On February 7, 2001, the Company filed a Current Report on Form 8-K dated
February 6, 2001 to report that it had issued a press release announcing its
financial results for the three month period ended December 31, 2000, and
providing additional outlook and financial guidance information.
On February 15, 2001, the Company filed a Current Report on Form 8-K dated
February 13, 2001, announcing that (a) the Company had entered into a $30
million credit facility with Foothill Capital Corporation, (b) Foothill had been
issued a Warrant to purchase 50,000 shares of the Company's Class A common stock
and (c) the Company had entered into a Registration Rights Agreement, pursuant
to which the Company has agreed to register the resale of the shares of its
Class A common stock issued upon exercise of the Warrant under certain
circumstances.
On March 9, 2001, the Company filed a Current Report on Form 8-K dated
March 7, 2001 to report that it had issued a press release announcing that Sanju
K. Bansal, the Company's vice chairman, executive vice president and chief
operating officer, had adopted a new asset diversification plan in place of the
plan announced on February 6, 2001.
All other items included in a Quarterly Report of Form 10-Q are omitted
because they are not applicable or the answers are "none".
39
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 14, 2001
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