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 September 30, 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.R.S. Employer
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 November 1, 2001 was 43,192,074 and 49,421,262,
respectively.
MICROSTRATEGY INCORPORATED
FORM 10-Q
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2001 (unaudited) and December 31, 2000. 1
Consolidated Statements of Operations For the Three Months Ended September 30, 2001 and
2000 (unaudited)....................................................................... 2
Consolidated Statements of Operations For the Nine Months Ended September 30, 2001 and
2000 (unaudited)....................................................................... 3
Consolidated Statements of Cash Flows For the Nine Months Ended September 30, 2001 and
2000 (unaudited)....................................................................... 4
Notes to Consolidated Financial Statements (unaudited)................................. 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.. 24
Item 3. Quantitative and Qualitative Disclosures About Market Risk............................. 47
PART II. OTHER INFORMATION
Item 1. Legal Proceedings...................................................................... 48
Item 2. Changes in Securities and Use of Proceeds.............................................. 49
Item 4. Submission of Matters to a Vote of Security Holders.................................... 49
Item 6. Exhibits and Reports on Form 8-K....................................................... 49
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MICROSTRATEGY INCORPORATED
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
September 30, December 31,
2001 2000
------------- -------------
(unaudited)
Assets
Current assets:
Cash and cash equivalents .............................................. $ 42,166 $ 67,685
Restricted cash ........................................................ 603 25,884
Short-term investments ................................................. 361 1,085
Accounts receivable, net ............................................... 24,043 49,061
Prepaid expenses and other current assets .............................. 7,548 11,158
--------- ---------
Total current assets ................................................ 74,721 154,873
--------- ---------
Property and equipment, net ............................................... 28,860 61,409
Long-term investments ..................................................... 250 5,271
Goodwill and intangible assets, net of accumulated amortization
of $30,916 and $18,170, respectively ................................... 21,542 34,300
Deposits and other assets ................................................. 3,268 3,234
--------- ---------
Total assets ........................................................ $ 128,641 $ 259,087
========= =========
Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
Accounts payable and accrued expenses .................................. $ 30,804 $ 35,025
Accrued restructuring costs ............................................ 11,134 --
Accrued compensation and employee benefits ............................. 13,662 26,929
Deferred revenue and advance payments .................................. 42,032 50,303
Working capital line of credit ......................................... 1,097 --
--------- ---------
Total current liabilities ........................................... 98,729 112,257
--------- ---------
Deferred revenue and advance payments ..................................... 16,351 31,260
Accrued litigation settlement ............................................. 57,082 99,484
Other long-term liabilities ............................................... 3,560 1,509
Accrued restructuring costs ............................................... 3,338 --
--------- ---------
Total liabilities ................................................... 179,060 244,510
--------- ---------
Commitments and contingencies
Series A redeemable convertible preferred stock, par value $0.001 per
share, 18 shares authorized, 1 and 13 shares issued and
outstanding, respectively .............................................. 6,322 119,585
Series B redeemable convertible preferred stock, par value $0.001
per share, 3 shares authorized, 3 and 0 shares issued and
outstanding, respectively .............................................. 32,263 --
Series C redeemable convertible preferred stock, par value $0.001
per share, 3 shares authorized, 3 and 0 shares issued and
outstanding, respectively .............................................. 25,745 --
Series D convertible preferred stock, par value $0.001 per share,
2 shares authorized, 2 and 0 shares issued and outstanding,
respectively ........................................................... 4,332 --
Mandatorily redeemable convertible preferred stock of consolidated
subsidiary, par value $0.001 per share, 47,884 shares authorized, 0
and 13,401 shares issued and outstanding, respectively ................. -- 40,530
Stockholders' Equity (Deficit):
Preferred stock undesignated, par value $0.001 per share, 4,973 shares
authorized, no shares issued or outstanding ......................... -- --
Class A common stock, par value $0.001 per share, 330,000 shares
authorized, 42,672 and 28,736 shares issued and outstanding,
respectively ........................................................ 43 29
Class B common stock, par value $0.001 per share, 165,000 shares
authorized, 49,421 and 52,033 shares issued and outstanding,
respectively ........................................................ 49 52
Additional paid-in capital ............................................. 239,892 152,821
Deferred compensation .................................................. (121) (624)
Accumulated other comprehensive income ................................. 183 1,443
Accumulated deficit .................................................... (359,127) (299,259)
--------- ---------
Total stockholders' equity (deficit) ................................ (119,081) (145,538)
--------- ---------
Total liabilities and stockholders' equity (deficit) ................ $ 128,641 $ 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)
Three Months Ended
September 30,
----------------------------
2001 2000
------------- -------------
(unaudited)
Revenues:
Product licenses............................................................... $ 16,559 $ 28,124
Product support and other services............................................. 27,639 36,731
------------- -------------
Total revenues.............................................................. 44,198 64,855
------------- -------------
Cost of revenues:
Product licenses............................................................... 1,145 120
Product support and other services............................................. 11,736 26,153
------------- -------------
Total cost of revenues...................................................... 12,881 26,273
------------- -------------
Gross profit........................................................................ 31,317 38,582
------------- -------------
Operating expenses:
Sales and marketing............................................................ 16,001 36,419
Research and development....................................................... 8,814 16,031
General and administrative..................................................... 9,252 17,108
Restructuring and impairment charges........................................... 2,907 10,835
Amortization of goodwill and intangible assets................................. 4,248 4,798
------------- -------------
Total operating expenses.................................................... 41,222 85,191
------------- -------------
Loss from operations................................................................ (9,905) (46,609)
Financing and other income (expense):
Interest income................................................................ 805 1,378
Interest expense............................................................... (1,794) (18)
Loss on investments............................................................ (923) (8,985)
Reduction in (provision for) estimated cost of litigation settlement........... 7,046 (113,700)
Minority interest.............................................................. (779) -
Other income, net.............................................................. 554 56
------------- -------------
Total financing and other income (expense).................................. 4,909 (121,269)
------------- -------------
Loss before income taxes............................................................ (4,996) (167,878)
Provision for income taxes..................................................... 1,003 350
------------- -------------
Net loss............................................................................ (5,999) (168,228)
------------- -------------
Dividends on and accretion of series A, B, C, D and E convertible preferred
stock....................................................................... (2,789) (2,188)
Gain on early redemption of mandatorily redeemable convertible preferred
stock of consolidated subsidiary............................................ 44,923 -
------------- -------------
Net income (loss) attributable to common stockholders............................... $ 36,135 $ (170,416)
============= =============
Basic earnings (loss) per share..................................................... $ 0.38 $ (2.13)
============= =============
Diluted earnings (loss) per share................................................... $ 0.37 $ (2.13)
============= =============
Basic weighted average shares outstanding........................................... 96,935 79,975
============= =============
Diluted weighted average shares outstanding......................................... 99,097 79,975
============= =============
The accompanying notes are an integral part of these Consolidated Financial
Statements.
2
MICROSTRATEGY INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Nine Months Ended
September 30,
----------------------------
2001 2000
------------- -------------
(unaudited)
Revenues:
Product licenses............................................................... $ 57,335 $ 75,964
Product support and other services............................................. 87,456 89,850
------------- -------------
Total revenues.............................................................. 144,791 165,814
------------- -------------
Cost of revenues:
Product licenses............................................................... 3,443 1,117
Product support and other services............................................. 44,493 63,690
------------- -------------
Total cost of revenues...................................................... 47,936 64,807
------------- -------------
Gross profit........................................................................ 96,855 101,007
------------- -------------
Operating expenses:
Sales and marketing............................................................ 65,539 116,274
Research and development....................................................... 32,539 48,044
General and administrative..................................................... 34,339 46,611
Restructuring and impairment charges........................................... 46,010 10,835
Amortization of goodwill and intangible assets................................. 12,746 12,946
------------- -------------
Total operating expenses.................................................... 191,173 234,710
------------- -------------
Loss from operations................................................................ (94,318) (133,703)
Financing and other income (expense):
Interest income................................................................ 3,019 2,279
Interest expense............................................................... (3,565) (28)
Loss on investments............................................................ (2,253) (7,629)
Reduction in (provision for) estimated cost of litigation settlement........... 41,652 (113,700)
Minority interest.............................................................. (3,108) -
Other income, net.............................................................. 45 161
------------- -------------
Total financing and other income (expense).................................. 35,790 (118,917)
------------- -------------
Loss before income taxes............................................................ (58,528) (252,620)
Provision for income taxes..................................................... 1,340 600
------------- -------------
Net loss............................................................................ (59,868) (253,220)
------------- -------------
Dividends on and accretion of series A, B, C, D and E convertible
preferred stock............................................................. (7,311) (2,500)
Net gain on refinancing of series A redeemable convertible preferred
stock....................................................................... 29,370 -
Gain on early redemption of mandatorily redeemable convertible preferred
stock of consolidated subsidiary............................................ 44,923 -
Preferred stock beneficial conversion feature.................................. - (19,375)
------------- -------------
Net income (loss) attributable to common stockholders............................... $ 7,114 $ (275,095)
============= =============
Basic and diluted loss per share.................................................... $ (0.21) $ (3.46)
============= =============
Basic and diluted weighted average shares outstanding............................... 87,874 79,546
============= =============
The accompanying notes are an integral part of these Consolidated Financial
Statements.
3
MICROSTRATEGY INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Nine Months Ended
September 30,
---------------------------------
2001 2000
--------------- ---------------
(unaudited)
Operating activities:
Net loss ................................................................................. $ (59,868) $(253,220)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization ....................................................... 26,866 23,732
Bad debt expense .................................................................... 3,774 4,022
Net realized loss on sale and write-down of short-term investments .................. 2,253 7,629
Non-cash portion of restructuring and impairment charges ............................ 23,796 4,846
(Decrease) increase in estimated cost of litigation settlement ...................... (41,652) 113,700
Minority interest ................................................................... 3,108 --
Other, net .......................................................................... 685 203
Changes in operating assets and liabilities:
Accounts receivable ................................................................. 21,247 (7,076)
Prepaid expenses and other current assets ........................................... 2,792 1,968
Deposits and other assets ........................................................... (179) (1,576)
Accounts payable and accrued expenses, compensation and employee benefits ........... (18,979) 29,588
Accrued restructuring costs ......................................................... 14,472 --
Deferred revenue and advance payments ............................................... (23,420) (7,480)
Other long-term liabilities ......................................................... 2,051 1,508
--------- ---------
Net cash used in operating activities .......................................... (43,054) (82,156)
--------- ---------
Investing activities:
Purchases of property and equipment ...................................................... (3,959) (41,924)
Purchases of intangible assets ........................................................... -- (2,443)
Purchases of short-term investments ...................................................... (1,935) (1,496)
Purchases of long-term investments ....................................................... -- (5,011)
Maturities of short-term investments ..................................................... 1,935 5,500
Proceeds from sales of short-term investments ............................................ 2,800 39,763
Decrease (increase) in restricted cash ................................................... 25,281 (26,220)
--------- ---------
Net cash provided by (used in) investing activities ............................ 24,122 (31,831)
--------- ---------
Financing activities:
Proceeds from sale of class A common stock and exercise of stock options ................. 3,967 7,792
Proceeds from issuance of series A redeemable convertible preferred stock, net of offering
costs ............................................................................... -- 119,667
Proceeds from sale of mandatorily redeemable convertible preferred stock of consolidated
subsidiary .......................................................................... 10,000 --
Proceeds from term loan in connection with the New Credit Facility ....................... 10,000 --
Cash repayment of term loan .............................................................. (10,000) --
Net cash advances under the Modified Credit Facility ..................................... 866 --
Debt issuance costs ...................................................................... (765) --
Redemption of series A redeemable convertible preferred stock, including offering costs
of $513 ............................................................................. (13,013) --
Redemption of series E redeemable convertible preferred stock ............................ (6,770) --
Cash dividends for series E redeemable convertible preferred stockholders ................ (192) --
--------- ---------
Net cash (used in) provided by financing activities ............................ (5,907) 127,459
--------- ---------
Effect of foreign exchange rate changes on cash and cash equivalents ........... (680) (709)
--------- ---------
Net (decrease) increase in cash and cash equivalents ........................................... (25,519) 12,763
Cash and cash equivalents, beginning of period ................................................. 67,685 25,941
--------- ---------
Cash and cash equivalents, end of period ....................................................... $ 42,166 $ 38,704
========= =========
Supplemental disclosure of noncash investing and financing activities:
Stock received in exchange for products and services ..................................... $ 1,153 $ 12,556
========= =========
Public stock received in exchange for stock in private company ........................... $ 2,017 $ --
========= =========
Issuance of class A common stock related to consulting services agreement ................ $ -- $ 1,600
========= =========
Payment of series A redeemable convertible preferred stock dividends through the
issuance of class A common stock and series D convertible preferred stock ........... $ 5,198 $ 2,500
========= =========
Issuance of warrants in connection with the New Credit Facility .......................... $ 414 $ --
========= =========
Fair value of class A common stock and series B, series C, series D, and
series E redeemable convertible preferred stock issued in connection
with refinancing transaction ........................................................ $ 90,385 $ --
========= =========
Carrying value of series A redeemable convertible preferred stock redeemed and
exchanged in connection with refinancing transaction ................................ $(113,880) $ --
========= =========
Exchange of mandatorily redeemable convertible preferred stock of consolidated
subsidiary for class A common stock ................................................. $ 53,638 $ --
========= =========
Issuance of class A common stock exchanged for mandatorily redeemable
convertible preferred stock of consolidated subsidiary .............................. $ 8,715 $ --
========= =========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
4
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(1) Basis of Presentation
The consolidated balance sheet of MicroStrategy Incorporated (the "Company" or
"MicroStrategy") as of September 30, 2001, the consolidated statements of
operations for the three and nine months ended September 30, 2001 and 2000, and
the consolidated statements of cash flows for the nine months ended September
30, 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 preparation of the consolidated financial statements, in conformity with
accounting principles generally accepted in the United States, requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
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 nine months ended September
30, 2001 and for each of the three years in the period ended December 31, 2000.
For the nine months ended September 30, 2001, the Company incurred a loss from
operations of $94.3 million and incurred negative cash flows from operations of
$43.1 million. As of September 30, 2001, the Company had an accumulated deficit
of $359.1 million. The Company has taken several actions to reduce operating
expenses, including reducing headcount and substantially curtailing operations
in Strategy.com and overall Company discretionary expenses. Additionally, the
Company is exploring alternative financing arrangements, which include credit
facilities, the sale of equity in MicroStrategy or other alternative financing
sources for the Company. Alternative debt or equity financing may not be
available on acceptable terms. If the Company does not achieve sufficient
revenues, 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, if any, and the modified credit facility
entered into in June 2001 (Note 6) will be sufficient to meet the Company's
working capital requirements and anticipated capital expenditures for the next
twelve months.
Due to a change in the way management reviews its operating results, the Company
changed its basis of segmentation during the third quarter of 2001 (Note 13).
The new operating segments, referred to as Core and Non-Core, separate the
Company's core business intelligence business from other unrelated business
activities.
Certain amounts in the prior year consolidated financial statements have been
reclassified to conform to the current year presentation.
(2) Recent Accounting Pronouncements
The Company adopted Statement of Financial Accounting Standards ("SFAS") SFAS
No. 133 as of January 1, 2001. Through September 30, 2001, the adoption of SFAS
No. 133 did not have a material effect on the financial position or results of
operations of the Company.
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
142, "Goodwill and Other Intangible Assets," which is effective for the Company
beginning in fiscal year 2002. This statement addresses
5
financial accounting and reporting for intangible assets acquired individually
or with a group of other assets at acquisition. This statement also addresses
financial accounting and reporting for goodwill and other intangible assets
subsequent to their acquisition. Under SFAS No. 142, goodwill will not be
amortized. Instead, the statement requires that entities perform an initial
impairment assessment upon adoption and then again on at least an annual basis
or upon the occurrence of triggering events, if earlier, to identify potential
goodwill impairment and measure the amount of goodwill impairment loss to be
recognized, if any. An impairment loss is recognized when the carrying amount of
reporting unit goodwill exceeds the implied fair value of that goodwill. After a
goodwill impairment loss is recognized, the adjusted carrying amount of the
goodwill shall be its new accounting basis. The Company is currently assessing
the impact that the adoption of this statement will have on its consolidated
financial statements.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which is effective for the Company beginning in
fiscal year 2002. SFAS No. 144 supersedes previous guidance for financial
accounting and reporting for the impairment or disposal of long-lived assets and
for segments of a business to be disposed of. SFAS No. 144 retains the
fundamental provisions of existing generally accepted accounting principles with
respect to recognition and measurement of long-lived asset impairment contained
in SFAS No. 121, " Accounting for the Impairment of Long Lived Assets and for
Long-Lived Assets to be Disposed Of." However, SFAS No. 144 provides new
guidance intended to address certain significant implementation issues
associated with SFAS No. 121, including expanded guidance with respect to
appropriate cash flows to be used, whether recognition of any long-lived asset
impairment is required, and if required, how to measure the amount of
impairment. SFAS No. 144 also requires that any net assets to be disposed of by
sale be reported at the lower of carrying value or fair market value less costs
to sell, and expands the reporting of discontinued operations to include any
component of an entity with operations and cash flows that can be clearly
distinguished from the rest of the Company. The Company is currently assessing
the impact that the adoption of this statement will have on its consolidated
financial statements.
(3) Restructuring and Impairment Charges
(a) 2001 Restructuring Plans
During the second quarter of 2001, the Company adopted a restructuring plan
designed to focus its commercial activities. The restructuring plan includes a
strategic decision to focus operations 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 597
domestic, international, and Strategy.com employees throughout all functional
areas, or approximately 33% of the Company's worldwide headcount. As a result of
the reduction in headcount, the Company consolidated its multiple Northern
Virginia facilities into a single location in McLean, Virginia. In April and May
2001, Strategy.com adopted similar restructuring plans pursuant to which it
substantially curtailed operations and reduced its workforce to approximately 40
employees. This reduction in Strategy.com's workforce is included in the
Company's worldwide workforce reduction of 597 employees described above.
During the third quarter of 2001, the Company adopted an additional
restructuring plan to effect a further reduction in its workforce as part of its
ongoing measures to better align operating expenses with revenues and further
focus on its core business intelligence software business. The restructuring
plan adopted during the third quarter of 2001 resulted in a reduction of the
Company's workforce by 229 additional domestic and international employees
throughout all functional areas. Independent of this additional restructuring
plan, during the third quarter of 2001, the Company further reduced the
Strategy.com workforce to approximately 6 employees and is currently negotiating
to terminate Strategy.com's remaining customer contracts.
As a result of these restructuring plans, the Company recorded restructuring and
impairment charges during the second quarter and third quarter of 2001 for
severance costs and other benefits for terminated employees, costs associated
with exiting facilities, and fees incurred for professional services directly
related to the restructuring. Costs associated with exiting facilities included
estimated sublease losses, representing the excess of lease costs over sublease
income, estimated sublease commissions and concessions, and other facility
closing costs including rent expense while the office space is vacant.
The Company reviews long-lived assets, including goodwill and other intangible
assets, for impairment whenever events or changes in business circumstances
indicate that the carrying amount of the assets may not be fully
6
recoverable or that the useful lives of these assets are no longer appropriate.
Each impairment test is based on a comparison of the undiscounted cash flows to
the recorded value of the asset. If impairment is indicated, the asset is
written down by the amount in which the carrying value of the asset exceeds the
related fair value of the asset. In connection with the restructuring plan
adopted during the second quarter of 2001, the Company analyzed its property and
equipment and other long-lived assets, primarily consisting of furniture and
fixtures, computer equipment and software, leasehold improvements, and
internally developed software for such impairment. Certain assets to be disposed
of were written down to fair value which was estimated based on current market
values less disposal costs. Certain other assets to be held and used by the
Company were also written down to fair value based upon current market values
and certain other estimates of fair value such as discounting estimated future
cash flows. As a result, certain long-lived assets were deemed to be impaired, a
summary of which is as follows (in thousands):
Core Non-Core
----------------------------------------------- ---------------------------------------
Internally
Leasehold Furniture and Computers and Developed Software Computers and
Improvements Fixtures Equipment and Other Equipment Total
------------ -------- --------- --------- --------- -----
Net book value of assets
impaired before impairment $ 1,887 $ 5,002 $ 206 $ 11,590 $ 6,385 $ 25,070
Impairment charge (1,887) (4,474) (82) (11,590) (5,895) (23,928)
Disposals during the
third quarter of 2001....... - (246) - - (6) (252)
----------- ---------- ---------- ------------ ---------- -----------
Adjusted net book value at
September 30, 2001........ $ - $ 282 $ 124 $ - $ 484 $ 890
=========== ========== ========== ============ ========== ===========
Certain assets to be held and used in the Company's ongoing business were
written down to their estimated fair value of $330,000, continue to be
classified as property and equipment and will be depreciated over their
remaining useful lives. Certain other assets held for sale, which are classified
in prepaid expenses and other current assets in the accompanying consolidated
balance sheet, were written down to their fair value of $812,000 as of June 30,
2001. During the third quarter of 2001, the Company sold approximately $252,000
of these assets held for sale. The Company expects to dispose of the remaining
assets held for sale within the next three months.
The following table sets forth a summary of the restructuring and impairment
charges for 2001 (in thousands):
Charge for Charge for Consolidated Consolidated Accrued
Core Non-Core Charge for the Charge for the 2001 2001 Restructuring
Second Quarter Second Quarter Second Quarter Third Quarter Non-cash Cash Costs at
of 2001 of 2001 of 2001 of 2001 Charges Payments September 30, 2001
------- ------- ------- ------- ------- -------- ------------------
Severance and other employee
termination benefits.......... $ 2,862 $ 1,505 $ 4,367 $ 1,837 $ - $ (4,900) $ 1,304
Write-down of impaired assets... 6,443 17,485 23,928 - (23,928) - -
Estimated sublease losses and
other facility closing costs.. 13,008 - 13,008 1,040 132 (2,031) 12,149
Terminations of computer and
equipment leases............. 712 590 1,302 - - (489) 813
Accrual for professional fees... 393 105 498 30 - (322) 206
--------- -------- --------- --------- -------- -------- --------
Total restructuring and
impairment charges........ $ 23,418 $ 19,685 $ 43,103 $ 2,907 $(23,796) S (7,742) $ 14,472
========= ======== ======== ========= ======== ======== ========
All restructuring and impairment charges recorded during the third quarter of
2001 were recorded to Core operations. As of September 30, 2001, unpaid amounts
of $11.1 million and $3.3 million have been classified as current and long-term
accrued restructuring costs, respectively, in the accompanying consolidated
balance sheet. Remaining cash expenditures relating to severance costs and fees
incurred for professional services will be substantially paid during the fourth
quarter of 2001. Amounts related to the estimated sublease losses associated
with exiting facilities and terminations of computer and equipment leases will
be paid over the respective lease terms through February 2009. As a result of
the restructuring, the Company has approximately 179,000 square feet of vacant
office space as of September 30, 2001, all of which is currently being marketed
for sublease. Total future
7
aggregate lease commitments related to the vacant office space, before any
sublease income, are $27.8 million. The Company is also considering terminating
certain leases early. The Company estimated its sublease losses based upon
current information supplied by a third-party real estate broker. Final
estimates could differ from current estimates once all vacant office space is
sublet. Except for its estimated sublease losses and other facility closing
costs, the Company expects that its restructuring plan will be substantially
completed by December 2001.
(b) 2000 Restructuring Plan
In the third quarter of 2000, the Company adopted a restructuring plan designed
to bring costs more in line with revenues and strengthen the financial
performance of its business. The restructuring plan included a reduction of the
Company's workforce by 231 or approximately 10% of the worldwide headcount and
the cancellation of a number of new jobs for which candidates had not yet
commenced employment with the Company. All of these actions were completed prior
to September 30, 2000. As a result of the reduction in headcount, the Company
consolidated certain of its operations in the vicinity of its Northern Virginia
headquarters. In addition, the Company reduced or eliminated certain corporate
events. Finally, the Company reduced expenditures on external consultants and
contractors across all functional areas.
In connection with this restructuring plan, the Company incurred severance costs
for terminated employees and costs for rescinded offers of employment,
accelerated the vesting provisions of certain stock option grants, wrote-off
certain assets that were no longer of service, and accrued related professional
fees. In addition, Michael J. Saylor, the chairman and CEO of the Company, made
grants of the Company's class A common stock to terminated employees from his
personal stock holdings. As Mr. Saylor is a principal shareholder of the
Company, his actions were deemed to be an action undertaken on behalf of the
Company for accounting purposes. Accordingly, the Company recognized an expense
and a capital contribution by Mr. Saylor of approximately $3.0 million, which
represented the fair value of the stock on the date of grant.
The following table sets forth a summary of these restructuring and impairment
charges recorded during the third quarter of 2000 (in thousands):
Consolidated
Charge for the
Non-cash Cash Third Quarter
Charges Payments of 2000
------- -------- -------
Severance and rescinded employment offers....................... $ - $ 2,854 $ 2,854
Stock grant and applicable payroll taxes........................ 3,003 189 3,192
Compensation expense on accelerated stock options............... 1,483 - 1,483
Elimination of corporate events................................. - 2,838 2,838
Write-off of impaired assets.................................... 360 - 360
Accrual for professional fees................................... - 108 108
----------- ---------- -----------
Total restructuring and impairment charges...................... $ 4,846 $ 5,989 $ 10,835
=========== ========== ===========
Substantially all cash payments relating to the restructuring during the third
quarter of 2000 were made by December 31, 2000.
(4) Investments
On a quarterly basis, as of the end of the quarter, the Company determines
whether a decline in fair value of a marketable security is other than
temporary. Unrealized gains and losses on marketable securities are included in
other comprehensive income in shareholders' equity, net of related tax effects.
If a decline in the fair value of a marketable security below the Company's cost
basis is determined to be other than temporary, such marketable security is
written down to its estimated fair value with a charge to current earnings. The
following summarizes by major security type the fair market value and cost of
the Company's investments as of the dates indicated (in thousands):
8
September 30, December 31,
--------------------- --------------------
2001 2000
--------------------- --------------------
Fair Fair
Value Cost Value Cost
----- ---- ----- ----
Marketable equity securities..................... $ 361 $ 2,242 $ 1,085 $ 1,118
Non-publicly traded equity securities............ 250 250 5,271 5,271
---------- --------- --------- ---------
$ 611 $ 2,492 $ 6,356 $ 6,389
========== ========= ========= =========
Classified as:
Short-term investments.................... $ 361 $ 1,085
Long-term investments..................... 250 5,271
---------- ---------
$ 611 $ 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 and because the
timing and amount of future recovery, if any, is uncertain, the Company wrote
down the investment to its fair value at December 31, 2000 and recognized a loss
of $12.1 million during 2000.
In March and June 2001, the Company separately received 320,733 shares of
Xchange's stock, originally valued at $762,000 and $391,000, respectively,
pursuant to the arrangement discussed above. Due to a subsequent decrease in the
market value of Xchange's stock and because the timing and amount of future
recovery, if any, is uncertain, the Company wrote down the investment to its
fair value at March 31, 2001, at June 30, 2001, and again at September 30, 2001.
Consequently, the Company recognized losses of $923,000 and $1.4 million during
the three months and nine months ended September 30, 2001, respectively.
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 a
combination of cash and common stock. 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. In connection with the
transaction, MicroStrategy recorded a loss of $840,000 during the first quarter
of 2001 based on the difference between its original basis in its investment and
the fair value of the consideration received. Any additional changes in the fair
value of the common stock during the second and third quarters of 2001 were
deemed to be temporary.
The Company has concluded that all unrealized losses on marketable equity
securities at September 30, 2001 are temporary in nature. Should any portion of
these unrealized losses subsequently be determined to be other than temporary,
the Company would be required to record the related amount as a charge to
current earnings. As a result of temporary declines in the fair value of certain
marketable equity securities, the Company had net unrealized losses of $1.9
million at September 30, 2001 included in accumulated other comprehensive income
in the accompanying consolidated balance sheet.
(5) Accounts Receivable
Accounts receivable, net of allowances, consist of the following, as of the
dates indicated (in thousands):
9
September 30, December 31,
----------------- -----------------
2001 2000
----------------- -----------------
Billed and billable.................................... $ 41,963 $ 84,833
Less: billed and unpaid deferred revenue............... (10,087) (26,128)
----------------- -----------------
31,876 58,705
Less: allowance for doubtful accounts.................. (7,833) (9,644)
----------------- -----------------
$ 24,043 $ 49,061
================= =================
The Company offsets its accounts receivable and deferred revenue for any billed
and unpaid items included in deferred revenue and advance payments.
(6) Borrowings
On February 9, 2001, the Company entered into a loan and security agreement (the
"New Credit Facility") which provided for aggregate borrowing capacity of up to
$30.0 million to be used for general working capital purposes. The New Credit
Facility consisted 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
New Credit Facility replaced a 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. During the
first and second quarters of 2001, the Company repaid $1.1 million of the term
loan under the New Credit Facility through the use of the revolving line of
credit.
On June 14, 2001, the Company entered into an Amended and Restated Loan and
Security Agreement (the "Modified Credit Facility"), which replaced the New
Credit Facility. The Modified Credit Facility provides for aggregate borrowing
capacity of up to $30 million, including a $5 million maintenance receivables
backed sub-facility, subject to specified borrowing base limitations based on
eligible maintenance receivables. The maximum amount available under the
maintenance receivables backed sub-facility decreases by $278,000 per month
until March 2002, at which time the then remaining balance of $2.5 million may
remain outstanding until maturity. Upon the closing of the Modified Credit
Facility, the Company also repaid $8.9 million of the term loan under the New
Credit Facility and drew $5.0 million under the Modified Credit Facility. During
the third quarter of 2001, the Company repaid $5.2 million of the balance under
the Modified Credit Facility.
Borrowings under the Modified Credit Facility bear interest at a variable rate.
The Company's borrowing rate in effect at September 30, 2001 was 7.50%. The
Modified Credit Facility also includes an annual 1.50% unused letter of credit
fee. Monthly principal payments are due to the extent that the balance
outstanding exceeds the borrowing base limitations or the maintenance
receivables backed sub-facility exceeds the maximum month-end amount available.
The Modified Credit Facility matures in February 2004 and is collateralized by
substantially all of the Company's domestic assets. Under the terms of the
Modified Credit Facility, the Company is required to maintain compliance with
various covenants, including certain financial covenants, the most restrictive
of which are achieving certain minimum earnings amounts, maintaining certain
cash balances domestically, and limiting the amount of additional indebtedness
that the Company may incur. At September 30, 2001, the Company was in compliance
with all covenants.
In addition to the interest and other fees on borrowings under the New Credit
Facility, the Company granted the lender 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. The fair value of the warrants of
$414,000 was accounted for as debt issuance costs and will be amortized to
interest expense through the expiration of the Modified Credit Facility.
Interest expense related to the amortization of the initial value of the warrant
was $35,000 and $87,000, respectively, during the three and nine months ended
September 30, 2001. The warrants may be exercised by tendering cash, executing a
cashless exercise using the value of the warrants, or by tendering principal
outstanding under the Modified Credit Facility. Because the warrants meet the
definition of a derivative under SFAS No. 133, the value of the warrants will be
adjusted for subsequent changes in fair value on a quarterly basis with the
change being
10
recorded as interest expense. During the second quarter of 2001,
fair value was determined using the Black-Scholes pricing model with the
following assumptions used for the calculation: volatility factor of 120%, risk
free interest rate of 4.9%, expected life of 5 years, and no dividend yield. The
estimated value of the warrants was updated again during the third quarter of
2001 using the same methodology as in the second quarter of 2001. As a result of
a decline in the fair value of the warrants as of June 30, 2001 and again as of
September 30, 2001, the Company recorded reductions in the carrying value of its
warrant liability and a decrease in interest expense in the amount of $315,000
during the second quarter of 2001 and $71,000 during the third quarter of 2001.
Because the fair value of the warrants was substantially the same upon issuance
and as of March 31, 2001, there was no charge to interest expense in the first
quarter of 2001.
At September 30, 2001, the Company had $1.1 million outstanding under the
Modified Credit Facility. After consideration of outstanding letters of credit
of $5.8 million, the Company has $23.1 million available for future drawdowns,
subject to borrowing base limitations. As a result of the borrowing base
limitations, $3.8 million of additional borrowing capacity under the Modified
Credit Facility was available at September 30, 2001.
(7) Deferred Revenue and Advance Payments
Deferred revenue and advance payments from customers consist of the following,
as of the dates indicated (in thousands):
September 30, December 31,
2001 2000
----------------- -------------
Current:
Deferred product revenue................................... $ 9,410 $ 21,399
Deferred product support and other services revenue........
41,468 48,278
------------- -------------
50,878 69,677
Less: billed and unpaid deferred revenue................... (8,846) (19,374)
------------- -------------
$ 42,032 $ 50,303
============= =============
Non-current:
Deferred product revenue............................... $ 3,620 $ 13,267
Deferred product support and other services revenue.........
13,972 24,747
------------- -------------
17,592 38,014
Less: billed and unpaid deferred revenue......................
(1,241) (6,754)
------------- -------------
$ 16,351 $ 31,260
============= =============
The Company offsets its accounts receivable and deferred revenue for any billed
and unpaid items included in deferred revenue and advance payments.
Strategy.com is currently negotiating to terminate its remaining customer
contracts. As of September 30, 2001, Strategy.com had $7.8 million of deferred
revenue remaining associated with these contracts. A significant portion of this
deferred revenue may not ultimately be recognized as revenue in the event that
the contracts are terminated early.
(8) Litigation
(a) Securities Litigation
The Company and certain of its officers and directors were named as defendants
in a private securities class action lawsuit alleging that they 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 its 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
11
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 that was sent to all putative class members.
The notice informed 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, and the period from which an appeal could have been taken has
expired. The settlement is subject to various closing conditions. At a hearing
on August 7, 2001, the Chancery Court approved the derivative settlement.
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. Prior to the issuance of these
securities, certain officers of the Company will tender 1,683,502 shares of
class A common stock to the Company for no consideration as part of the
derivative settlement agreement described below, resulting in a net issuance of
1,094,276 shares of class A common stock.
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 volume-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 the related unsecured subordinated
promissory notes valued for the purpose of warrant exercise at 133% of their
principal amount plus accrued interest.
Under the derivative settlement agreement, the Company was required to add a new
independent director with finance experience to the audit committee of its Board
of Directors and to ensure continued adherence with applicable legal and
regulatory requirements regarding the independence of audit committee members
and trading by insiders. On June 11, 2001, the Company announced the addition of
two new independent directors to the audit committee of its Board of Directors.
In addition, prior to the distribution of the securities to be issued as part of
the class action settlement, Michael J. Saylor, Chairman of the Board of
Directors and Chief Executive Officer, Sanju K. Bansal, Vice Chairman, Executive
Vice President and Chief Operating Officer, and Mark S. Lynch, former Chief
Financial Officer and current Vice President of Business Affairs, will tender to
the Company for no consideration an aggregate of 1,683,502 shares of class A
common stock.
Based on the terms of the settlement agreements, during the third quarter of
2000, the Company determined that a liability related to these actions was
probable and that the value was reasonably estimable. Accordingly, during the
third quarter of 2000, the Company established an estimate for the cost of the
litigation settlement of $113.7 million, net of insurance recoveries of $13.1
million. Subsequently, the Company has updated the estimated value of the
settlement during each of the successive quarterly financial reporting periods
based upon valuation assumptions stemming from the settlement. During the second
quarter of 2001, the Company updated the estimated value assigned to the notes
and warrants to be issued based upon an independent third-party valuation. The
estimated value of the warrants was updated again during the third quarter of
2001 using the same methodology as in the second quarter of 2001, and the other
individual components of the settlement agreements were separately evaluated.
The details of the accrued litigation settlement at September 30, 2001 are as
follows (in thousands):
12
Accounts Accrued Total
Payable and Litigation Accrual at
Accrued Expenses Settlement September 30, 2001
---------------- ---------- ------------------
Promissory notes to be issued................ $ - $ 52,500 $ 52,500
Class A common stock to be issued............ - 3,139 3,139
Warrants to be issued........................ - 1,193 1,193
Pending loss on additional settlement........ - 250 250
Legal fees................................... 799 - 799
Administration costs......................... 530 - 530
---------- -------- --------
Total accrual.......................... $ 1,329 $ 57,082 $ 58,411
========== ======== ========
The fair value of the promissory notes was based on the present value of future
cash flows discounted at borrowing rates currently assumed to be available for
debt with similar terms and maturities. Based on the terms of the debt
instrument and the market conditions in existence at the time, the fair value of
the promissory notes was initially estimated during the third quarter of 2000
assuming a market borrowing rate of 12%. Due to changes in market conditions
since the settlement and based upon the third-party valuation during the second
quarter of 2001, the fair value of the promissory notes was revalued utilizing
an estimated market borrowing rate of 20%. Based on an estimated market
borrowing rate of 20%, the expected discount on the unsecured subordinated
promissory notes was increased to $28.0 million. As a result of the change in
the estimated fair value of the promissory notes, the Company recorded a $16.7
million reduction in the provision for the litigation settlement during the
second quarter of 2001. As market conditions and assumptions remained similar,
no change in the estimated fair value of the promissory notes was recorded
during the third quarter of 2001. Upon the issuance of these promissory notes,
the discount will be amortized to interest expense over the term of the
promissory notes.
Prior to the approval of the United States District Court on April 2, 2001, the
Company was obligated to issue the greater of 550,000 shares of common stock or
a number of shares of common stock with a value of $16.5 million based upon the
per share price of the stock on the date of the settlement hearing. Because the
number of shares and share price were not fixed, the Company recorded the full
amount of the $16.5 million value of the common stock portion of the settlement.
As a result of the court's approval during the second quarter of 2001, the
number of shares of common stock was fixed at 2,777,778 shares based upon a per
share price of $5.94. As a result of a decline in the Company's class A common
stock price to $1.13 per share as of September 30, 2001, the value of the common
stock to be issued under the settlement agreement was reduced by $4.6 million to
$3.1 million during the third quarter of 2001 and by $13.4 million for the nine
month period in 2001.
The fair value of the warrants to be issued in connection with the litigation
settlement of $3.6 million was computed utilizing the Black-Scholes pricing
model with the following assumptions used for the calculation: volatility factor
of 120%, risk free interest rate of 4.9%, expected life of 5 years, and no
dividend yield. As a result of changes in the estimated fair value of the
warrants, the Company recorded reductions in the provision for the litigation
settlement of $2.4 million and $11.8 million, respectively, during the three and
nine months ended September 30, 2001.
As a result of the changes in the estimated value of each element of the
securities litigation settlement discussed above, the Company recorded an
aggregate reduction in the provision for the litigation settlement of $7.0
million and $41.7 million during the three and nine months ended September 30,
2001, respectively. This reduction was comprised of the following (in
thousands):
Three Nine
Months Ended Months Ended
September 30, 2001 September 30, 2001
------------------ ------------------
Promissory notes to be issued................ $ - $ (16,700)
Class A common stock to be issued............ (4,639) (13,360)
Warrants to be issued........................ (2,407) (11,842)
Pending loss on additional settlement........ - 250
--------- ---------
Reduction in estimated value of
provision................................ $(7,046) $ (41,652)
========= ==========
13
The final value of the overall settlement and each of its components may differ
significantly from the estimates currently recorded depending on a variety of
factors including the market value of the Company's class A common 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. 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. Because of the rights of the holders of the promissory notes to
tender the notes in satisfaction of the exercise price upon exercising the
warrants, the warrants meet the definition of a derivative under SFAS No. 133
and, accordingly, will be revalued through earnings on a quarterly basis after
issuance.
(b) Business Objects Litigation
On October 2, 2001, the Company filed a lawsuit in the Virginia Circuit Court
for Fairfax County against two field employees of Business Objects, S.A. ("BO").
The lawsuit alleges that these employees, who previously worked for the Company,
have breached their fiduciary and contractual obligations to the Company by,
among other things, misappropriating the Company's trade secrets and
confidential information and soliciting the Company's employees and customers.
The Company's complaint seeks injunctive relief and damages of at least $3
million. On October 17, 2001, BO filed suit against the Company in the United
States District Court for the Northern District of California, claiming that the
Company's software infringes a patent issued to BO relating to relational
database access. The suit seeks injunctive relief and unspecified monetary
damages. The Company intends to vigorously defend the case. On October 31, 2001,
the Company filed suit against BO in the United States District Court for the
Eastern District of Virginia, claiming that BO's software infringes two patents
held by the Company relating to asynchronous control of report generation using
a web browser and a system and method of adapting automatic output of OLAP
reports to disparate user output devices. The Company is seeking monetary
damages and injunctive relief. As these actions are in a very preliminary stage,
the Company is currently unable to estimate the potential range of gain or
loss, and the outcome of this uncertainty is not presently determinable.
Accordingly, no provision for these matters has been made in the accompanying
consolidated financial statements.
(c) Other Matters
The Company is also involved in other legal proceedings through the normal
course of business. Management believes that any unfavorable outcome related to
these other proceedings will not have a material effect on the Company's
financial position, results of operations, or cash flows.
(9) Redeemable Convertible Preferred Stock
On June 19, 2000, the Company issued 12,500 shares of its series A redeemable
convertible preferred stock in a private placement to institutional investors
for $119.6 million, net of offering costs of $5.4 million. In connection with
the transaction, the Company recorded a $19.4 million charge to additional
paid-in capital attributable to the beneficial conversion feature of the series
A redeemable convertible preferred stock. On June 14, 2001, the Company
refinanced its series A redeemable convertible preferred stock. As a result of
the refinancing, 650 shares of the series A redeemable convertible stock with a
$6.5 million stated value remain outstanding. The Company redeemed or exchanged
the remaining 11,850 shares of its series A redeemable convertible preferred
stock, in connection with the refinancing, as follows:
o $12.5 million stated value of the series A redeemable convertible preferred
stock, or 1,250 shares, were redeemed for $12.5 million in cash;
o $38.75 million stated value of the series A redeemable convertible
preferred stock and accrued dividends of $1.7 million on all series A
redeemable convertible preferred stock redeemed or exchanged were exchanged
for 5,568,466 shares of class A common stock and $16.3 million stated value
of series D convertible preferred stock, or 1,626.1 shares, with a fixed
conversion price of $5.00 per share;
o $33.125 million stated value of the series A redeemable convertible
preferred stock were exchanged for an equivalent stated value of series B
redeemable convertible preferred stock, or 3,312.5 shares, 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;
o $27.825 million stated value of the series A redeemable convertible
preferred stock were exchanged for an equivalent stated value of series C
redeemable convertible preferred stock, or 2,782.5 shares, with a fixed
14
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; and
o $6.3 million stated value of the series A redeemable convertible preferred
stock were exchanged for an equivalent stated value of series E redeemable
convertible preferred stock, or 630 shares.
The series B preferred stock and the series C preferred stock mature three years
after the date of issuance and accrue cumulative dividends at a rate of 12.5%
per annum, payable in cash or shares of class A common stock at the option of
the Company, subject to satisfaction of certain conditions. Prior to maturity,
holders have the right to convert their series B preferred stock and series C
preferred stock into shares of the Company's class A common stock. At the option
of the Company, the series B and series C preferred stock may be redeemed at
maturity at stated value plus accrued dividends or mandatorily converted into
class A common stock at a conversion price of 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 matures three years after the date of issuance,
does not carry any dividend rate, and has 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. In addition, prior
to maturity, holders have the right to convert their series D preferred stock
into shares of the Company's class A common stock.
The Company had the right to redeem the series E preferred stock prior to
December 11, 2001 for 105% of the stated value plus accrued and unpaid dividends
if redeemed on or before October 27, 2001, 110% of the stated value plus accrued
and unpaid dividends if redeemed from October 28, 2001 through December 11,
2001, and at 120% of the stated value plus accrued dividends if redeemed
thereafter. In addition, the holders of the series E preferred stock had the
right to require the Company to redeem the series E preferred stock at specified
prices upon specified financing transactions or other events. Upon the closing
of the Exchange Agreement pursuant to which the Company acquired the outstanding
series A preferred stock of Strategy.com (Note 10), the holders exercised this
right, and on September 10, 2001 the Company paid $6.8 million in cash to redeem
all 630 shares of the series E preferred stock for 105% of the stated value of
$6.3 million plus accrued and unpaid dividends of $155,000. The cash redemption
payment was substantially equal to the carrying value of the series E preferred
stock on the date of redemption.
Each series of preferred stock is also redeemable upon certain triggering events
as defined in the respective Certificate of Designations, Preferences and Rights
of each series. In the event of redemption upon a triggering event, the
preferred stock is redeemable, with respect to each series of preferred stock,
at the greater of 125% of the stated value of such shares of preferred stock
plus accrued and unpaid dividends or the product of the number of shares of
class A common stock into which each series of preferred stock is convertible
multiplied by the closing sale price of the Company's class A common stock on
the day immediately before the triggering event occurs, except for the series D
preferred stock which is redeemable at the greater of its stated value or such
product. As of September 30, 2001, none of these triggering events have
occurred. In addition, upon a change of control of the Company, each holder of
series A, series B, and series C preferred stock shall have the right, at the
holder's option, to require the Company to redeem all or a portion of the
preferred stock at 125% of the stated value of such shares of preferred stock
plus accrued and unpaid dividends. Holders of series D preferred stock shall
have the right, at the holder's option, to require the Company to redeem all or
a portion of the preferred stock at the stated value of such shares of preferred
stock plus accrued and unpaid dividends upon a change of control.
Other than as required by law, holders of each series of preferred stock have no
voting rights, except that the consent of at least two-thirds of the outstanding
shares of the applicable series of preferred stock would be required to effect
any change in either the Company's Amended and Restated Certificate of
Incorporation or Certificates of Designation that would change any of the rights
of the applicable series of preferred stock or to issue any other additional
shares of such series of preferred stock. Each series of preferred stock ranks
senior to common stock with respect to distribution and payments upon the
liquidation or dissolution of the Company and to resolutions made by the Board
of Directors. Each series of preferred stock has a liquidation preference of
$10,000 per share plus accrued and unpaid dividends. Additionally, holders of
each series of preferred stock are entitled to participate in dividends and
distributions on common stock, if any, to the same extent as if they held shares
of common stock on the record date for such dividends and distributions.
In connection with the June 2001 refinancing of the Company's series A
redeemable convertible preferred stock, the Company obtained an independent
third-party valuation of the fair value of each series of the preferred stock.
Based
15
upon the independent third-party valuation, the total fair value of the
new series of preferred stock and the actual value of the common stock issued at
closing were determined to be lower than the carrying value of the series A
securities being refinanced. Accordingly, the Company recorded a net gain
attributable to common stockholders on the refinancing of the series A preferred
stock of $29.4 million during the second quarter of 2001. This net gain
represents the excess of the fair value of the consideration transferred to the
holders of the series A preferred stock over the carrying value of those
preferred securities, equal to $11.0 million, plus the amount of the previously
recognized beneficial conversion feature equivalent to the pro-rata portion of
the shares redeemed of $18.4 million. The net gain of $29.4 million was
recognized as a reduction to net loss attributable to common stockholders in the
accompanying consolidated statement of operations for the nine months ended
September 30, 2001.
Based on the valuation of the series D preferred stock, the Company determined
that the effective conversion price of the series D preferred stock was less
than the fair value of the Company's class A common stock on the date of
issuance. As a result, the Company recorded a beneficial conversion feature in
the amount of $3.8 million based on the difference between the fair market value
of the Company's class A common stock on the closing date and the effective
conversion price of the series D preferred stock. The beneficial conversion
feature has been recorded as a discount on the value of the series D preferred
stock and an increase in additional paid-in capital and will be accreted using
the effective interest method over the three-year term of the series D preferred
stock. For the three and nine months ended September 30, 2001, accretion to the
carrying value of the beneficial conversion feature was $231,000 and $268,000,
respectively.
The remaining 650 shares of series A preferred stock with a $6.5 million stated
value accrue dividends at a rate of 7% per annum, payable in cash or shares of
class A common stock at the election of the Company. Following a conversion
price reset adjustment on July 5, 2001, the conversion price of the series A
preferred stock was adjusted downward to $3.08 per share based on the average of
the dollar-volume weighted average price of the Company's class A common stock
during the ten trading day immediately preceding July 5, 2001. Prior to this
adjustment, the conversion price was $33.39 per share. As a result of this
adjustment to the conversion price, the series A preferred stock is convertible,
as of September 30, 2001, at the option of the holders, into 2,108,247 shares of
class A common stock, not including shares of class A common stock that may be
issuable as dividends on the series A preferred stock. The Company has the right
to redeem 120 shares of the series A preferred stock with a $1.2 million stated
value on or prior to December 11, 2001. At the option of the Company, the series
A preferred stock may be redeemed at its June 19, 2002 maturity at stated value
plus accrued dividends or mandatorily converted into class A common stock equal
to 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. Additionally, the Company, at its option, may extend the maturity
of the series A preferred stock for up to an additional two years. If the
Company elects to extend the maturity of the series A preferred stock, the
conversion price may be adjusted based on the average of the dollar-volume
weighted average price the Company's class A common stock on each trading day
during the ten days immediately following each anniversary of the original
maturity, if such adjustment would result in a lower conversion price. The
preferred stock is also redeemable upon certain triggering events as defined in
the Certificate of Designations, Preferences and Rights of the series A
Redeemable Convertible Preferred Stock. In the event of redemption upon a
triggering event, the series A preferred stock is redeemable at the greater of
125% of the conversion amount or an agreed upon formula. As of September 30,
2001, none of these triggering events have occurred.
The Company has recorded each series of preferred stock issued in June 2001 at
its fair value, net of offering costs of $513,000. The offering costs were
allocated ratably to each series of preferred stock based on the respective fair
value of each series. The Company is accreting the carrying value of the series
B and series C preferred stock to its stated value over the three-year term of
each series of preferred stock. For the three and nine months ended September
30, 2001, accretion to the carrying value of the preferred stock was $397,000
and $1.1 million, respectively. Because the series D preferred stock requires
share settlement at maturity and does not have a mandatory cash redemption
requirement, except upon a triggering event, the Company will not accrete the
carrying value of the series D preferred stock to its stated value.
For the three and nine months ended September 30, 2001, the Company accrued
total dividends of $2.2 million and $6.5 million, respectively, on all of its
series of preferred stock. During the nine months ended September 30, 2001, the
Company paid aggregate dividends of $5.2 million through the issuance of
1,336,479 shares of class A common stock and 175.6 shares of series D preferred
stock in lieu of cash. The 175.6 shares of series D preferred stock were
16
deemed to have been distributed as consideration for a portion of the dividends
that had accrued on the series A preferred stock prior to the refinancing
transaction. As of September 30, 2001, the Company has accrued dividends of $1.8
million which are included in accounts payable and accrued expenses in the
accompanying consolidated balance sheet.
(10) Mandatorily Redeemable Convertible Preferred Stock of Consolidated
Subsidiary
In an initial closing 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 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.
On August 29, 2001, the Company entered into an exchange agreement (the
"Exchange Agreement") whereby MicroStrategy acquired all 16,536,049 shares of
Strategy.com's series A preferred stock in exchange for 3,500,000 shares of
MicroStrategy's class A common stock. Based on the closing price of the
Company's class A common stock of $2.49 per share on the date of the closing and
the carrying value of Strategy.com's series A preferred stock of $53.6 million
on that same date, the early redemption resulted in a consolidated gain of $44.9
million. This gain represents the excess of the carrying value of Strategy.com's
preferred stock over the fair value of the Company's class A common stock
exchanged in the transaction. The gain of $44.9 million was recognized as an
increase to net income attributable to common stockholders in the accompanying
consolidated statement of operations.
Prior to entering into the Exchange Agreement, offering costs were being
accreted using the straight-line method based on the mandatory redemption dates
and redemption portions of the preferred stock of Strategy.com. During the three
months and nine months ended September 30, 2001, the Company accreted offering
costs of $85,000 and $341,000, respectively, on the preferred stock of
Strategy.com. Additionally, for the three months and nine months ended September
30, 2001, the Company accreted dividends of $694,000 and $2.8 million,
respectively, on the preferred stock of Strategy.com. The accretion of dividends
and offering costs on Strategy.com's preferred stock until the date of
redemption is 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.
(11) Comprehensive Loss
Comprehensive loss includes foreign currency translation adjustments and
unrealized gains and losses on short-term investments that have been excluded
from net loss and reflected in stockholders' equity (deficit) as accumulated
other comprehensive income.
Comprehensive loss for the three and nine months ended September 30, 2001 and
2000 is calculated as follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- ---------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
Net loss.......................................... $ (5,999) $(168,228) $ (59,868) $(253,220)
Foreign currency translation adjustment........... 1,188 (601) 588 (722)
Unrealized loss on short-term investments......... (2,104) (70) (1,848) (1,336)
------------ ------------ ------------ ------------
Comprehensive loss........................... $ (6,915) $(168,899) $ (61,128) $(255,278)
============ ============ ============ ============
(12) Basic and Diluted Earnings (Loss) Per Share
The Company computes basic and diluted earnings (loss) per share in accordance
with SFAS No. 128, "Earnings per Share" and EITF Topic D-72, "Effect of
Contracts That May Be Settled in Stock or Cash on the Computation of Diluted
Earnings per Share". Additionally, in accordance with EITF Topic D-95, "Effect
of Participating Convertible Securities in the Computation of Basic Earnings per
Share," participating securities that are convertible into common stock must be
included in the computation of basic earnings (loss) per share if their effect
is dilutive.
17
Because each series of the Company's preferred stock has participation rights in
the undistributed earnings of the Company equivalent to those of common
shareholders, each series of preferred stock is considered a participating
convertible security and is therefore included in the computation of basic
earnings per share to the extent they are dilutive.
18
The following table sets forth the computation of basic and diluted earnings
(loss) per share for the three months ended September 30, 2001 and 2000,
respectively (in thousands, except per share data):
Three months ended Three months ended
September 30, 2001 September 30, 2000
------------------------------------------------- ------------------------------------------
Income Shares Per Share Income Shares Per Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------- ------------- ------ ----------- ------------- ------
Net loss $ (5,999) $ (168,228)
Dividends on and accretion of
series A, B, C, D and E
convertible preferred stock (2,789) (2,188)
Gain on early redemption of
mandatorily redeemable
convertible preferred stock
of consolidated subsidiary 44,923 -
--------------- --------------
Net income (loss) attributable
to common stockholders 36,135 (170,416)
Effect of common stock:
Weighted average shares of
class A common stock 40,031 55,147
Weighted average shares of
class B common stock 49,421 24,828
Effect of dilutive participating
convertible securities:
Series D preferred stock 231 3,252
Series A preferred stock 186 2,384
Series E preferred stock 178 1,847
--------------- ------------------- -------------- ---------
Basic earnings (loss) per share 36,730 96,935 $ 0.38 (170,416) 79,975 $(2.13)
============ ==========
Effect of dilutive securities:
Employee stock options 2,162
--------------- ------------------- -------------- --------- ----------
Diluted earnings (loss) per share $ 36,730 99,097 $ 0.37 $ (170,416) 79,975 $(2.13)
=============== =================== ============ ============== ========= ==========
The diluted earnings (loss) per share calculation for the three months ended
September 30, 2001 excludes 4,355,584 weighted average shares of Series B and C
preferred stock because their effect would have been anti-dilutive. Employee
stock options of 9,598,688 and 5,119,667 and warrants of 128,334 and 78,334 for
the three months ended September 30, 2001 and 2000, respectively, have also been
excluded from the diluted earnings (loss) per share calculation because their
effect would be anti-dilutive. In addition, series A convertible preferred
stock, which was convertible into 3,744,152 shares of class A common stock, was
excluded from the diluted earnings (loss) per share calculation for the three
months ended September 30, 2000 because its effect would be anti-dilutive.
19
The following table sets forth the computation of basic and diluted earnings
(loss) per share for the nine months ended September 30, 2001 and 2000,
respectively (in thousands, except per share data):
Nine months ended Nine months ended
September 30, 2001 September 30, 2000
------------------------------------------- --------------------------------------------
Income Shares Per Share Income Shares Per Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------- ------------- ------ ----------- ------------ --------
Net loss $ (59,868) $ (253,220)
Dividends on and accretion of
series A, B, C, D and E
convertible preferred stock (7,311) (2,500)
Net gain on refinancing of
series A redeemable
convertible preferred stock 29,370 -
Gain on early redemption of
mandatorily redeemable
convertible preferred stock
of consolidated subsidiary 44,923 -
Preferred stock beneficial
conversion feature - (19,375)
--------------- --------------
Net income (loss) attributable
to common stockholders
7,114 (275,095)
Effect of common stock:
Weighted average shares of
class A common stock 35,272 55,147
Weighted average shares of
class B common stock 49,421 24,399
Effect of dilutive participating
convertible securities:
Series A preferred stock (25,227) 3,181
--------------- ---------- -------------- -----------
Basic and diluted loss per share $ (18,113) 87,874 $ (0.21) $ (275,095) 79,546 $ (3.46)
=============== ========== ========= ============== =========== =========
The numerator in the basic and diluted loss per share calculation for the nine
months ended September 30, 2001 has been adjusted to eliminate the $29.4 million
gain on the refinancing of the series A preferred stock and $4.2 million of
dividends and accretion as required by the if-converted method. As a result, the
Company has a loss per share of $0.21 for the nine months ended September 30,
2001 for both basic and diluted earnings (loss) per share.
The diluted earnings (loss) per share calculation for the nine months ended
September 30, 2001 excludes 3,699,164 incremental weighted shares of Series B,
C, D and E preferred stock because their effect would have been anti-dilutive.
Employee stock options of 13,707,443 and 2,761,314 and warrants of 128,334 and
78,334 for the nine months ended September 30, 2001 and 2000, respectively, have
also been excluded from the diluted earnings (loss) per share calculation
because their effect would be anti-dilutive. In addition, series A convertible
preferred stock, which was convertible into 3,744,152 shares of class A common
stock, was excluded from the diluted earnings (loss) per share calculation for
the nine months ended September 30, 2000 because its effect would be
anti-dilutive.
(13) Segment Information
Due to a change in the way management reviews its operating results, the Company
changed its basis of segmentation during the third quarter of 2001. Prior to the
change, the Company had two operating segments,
20
MicroStrategy Core and Strategy.com and had begun operating its business as
these two segments in the latter part of 1999. The new segments, referred to as
Core and Non-Core, separate the Company's core business intelligence business
from other unrelated business activities. Revenues in the Core segment are
derived from business intelligence sales of product licenses and product support
and other services, including technical support, education and consulting
services. The Non-Core segment consists of the operations of Strategy.com and
other similar non-core research and development activities. Strategy.com
delivers personalized information services to subscribers on a scheduled or
event-driven basis. Other non-core research and development activities consist
of speech and voice command services. Due to similarities in the financial
requirements, economic characteristics, and nature of the respective businesses,
the results of three separate business activities have been aggregated into the
Non-Core segment.
As previously discussed, during the second quarter of 2001, the Company
substantially curtailed operations of Strategy.com and reduced its workforce to
approximately 40 employees. During the third quarter 2001, the Company further
reduced the Strategy.com workforce to approximately 6 employees and is currently
negotiating to terminate Strategy.com's remaining customer contracts. Although
the curtailment of the business includes a substantial reduction in product,
software development and marketing expenditures, the Company expects to continue
to incur losses from its Strategy.com operations in the forseeable future. As a
result of the significant curtailment of the business and the uncertainty of
generating additional Strategy.com revenues, the Company recorded asset
impairment charges during the second quarter of 2001 related to the hardware and
software used in Strategy.com operations.
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. To be consistent with current
period presentation, the Company has restated the comparative financial segment
information of earlier periods. The following summary discloses certain
financial information regarding the Company's operating segments (in thousands):
21
Core Non-Core Consolidated
---- -------- ------------
Three Months Ended September 30, 2001
Total license and service revenues............. $ 41,072 $ 3,126 $ 44,198
Gross profit................................... 30,733 584 31,317
Depreciation and amortization.................. 7,207 211 7,418
Operating expenses............................. 39,128 2,094 41,222
Loss from operations........................... (8,395) (1,510) (9,905)
Total assets................................... 123,221 5,420 128,641
Three Months Ended September 30, 2000
Total license and service revenues............. $ 59,539 $ 5,316 $ 64,855
Gross profit (loss)............................ 39,295 (713) 38,582
Depreciation and amortization.................. 7,899 1,582 9,481
Operating expenses............................. 71,250 13,941 85,191
Loss from operations........................... (31,955) (14,654) (46,609)
Total assets................................... 218,880 23,183 242,063
Core Non-Core Consolidated
---- -------- ------------
Nine Months Ended September 30, 2001
Total license and service revenues............. $137,181 $ 7,610 $ 144,791
Gross profit (loss)............................ 99,561 (2,706) 96,855
Depreciation and amortization.................. 23,110 3,756 26,866
Operating expenses............................. 156,875 34,298 191,173
Loss from operations........................... (57,314) (37,004) (94,318)
Total assets................................... 123,221 5,420 128,641
Nine Months Ended September 30, 2000
Total license and service revenues............. $159,241 $ 6,573 $ 165,814
Gross profit (loss)............................ 101,852 (845) 101,007
Depreciation and amortization.................. 20,314 3,418 23,732
Operating expenses............................. 196,161 38,549 234,710
Loss from operations........................... (94,309) (39,394) (133,703)
Total assets................................... 218,880 23,183 242,063
Operating expenses and loss from operations for the three months ended September
30, 2001 include restructuring and impairment charges of $2.9 million for Core.
For the nine months ended September 30, 2001, those charges were $26.3 million
and $19.7 million for Core and Non-Core, respectively. For both the three and
nine months ended September 30, 2000, those charges were $9.3 million and $1.5
million for Core and Non-Core, respectively.
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):
22
Domestic International Consolidated
-------- ------------- ------------
Three Months Ended September 30, 2001
Total license and service revenues.......... $ 29,760 $ 14,438 $ 44,198
Long-lived assets........................... 50,431 3,239 53,670
Three Months Ended September 30, 2000
Total license and service revenues.......... $ 47,329 $ 17,526 $ 64,855
Long-lived assets........................... 112,601 3,300 115,901
Domestic International Consolidated
-------- ------------- ------------
Nine Months Ended September 30, 2001
Total license and service revenues.......... $ 98,577 $ 46,214 $ 144,791
Long-lived assets........................... 50,431 3,239 53,670
Nine Months Ended September 30, 2000
Total license and service revenues.......... $ 125,760 $ 40,054 $ 165,814
Long-lived assets........................... 112,601 3,300 115,901
Transfers relating to intercompany software license royalties from international
to domestic operations of $2.2 million for both the three months ended September
30, 2001 and 2000, respectively, and of $12.5 million and $6.5 million for the
nine months ended September 30, 2001 and 2000, respectively, have been excluded
from the above tables and eliminated in the consolidated financial statements.
23
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 cautioned that actual results may differ
from management's expectations.
Overview
We are a leading worldwide provider of business intelligence software that
enables companies to analyze the raw data stored across their enterprise to
reveal the trends and answers needed to manage their business effectively. Our
software delivers this critical insight to employees, customers, partners and
suppliers via e-mail, web, wireless and voice communication channels. Our
objective is to provide businesses with a software platform that enables them to
develop user-friendly solutions, proactively optimize revenue-generating
strategies, enhance cost-efficiency and productivity and improve their customer
relationships.
Our software platform enables users to query and analyze the most detailed,
transaction-level databases, turning data into business intelligence and
delivering reports and alerts in the context of the users' business processes.
Our web architecture provides reporting, security, performance and standards
that are critical for web deployment. Within intranets, our products provide
employees with information to enable them to make better, more cost-effective
business decisions. In extranets, enterprises can use our MicroStrategy 7
software to build stronger relationships by linking customers and suppliers via
the Internet. We offer a comprehensive set of consulting, education and
technical support services for our customers and partners.
Towards the end of 2000 and throughout 2001, we have been affected by the global
economic slowdown which has resulted in a decrease in corporate spending on
information technology. The terrorist attacks on September 11, 2001 magnified
this economic trend during the third quarter. These macro-economic factors have
had an adverse impact on the Company's results of operations as discussed below.
We developed a restructuring plan that was adopted during the second quarter of
2001 in order to better align operating expenses with revenue expectations to
help achieve our goal of making the MicroStrategy core business profitable on an
operating basis by the end of 2001, excluding certain charges. The restructuring
plan includes a strategic decision to focus 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 597 domestic,
international, and Strategy.com employees throughout all functional areas, or
approximately 33% of the worldwide headcount. As a result of the reduction in
headcount, we consolidated our multiple Northern Virginia facilities into a
single location in McLean, Virginia.
During the third quarter of 2001, we adopted an additional restructuring plan to
effect a further reduction in our workforce as part of our ongoing measures to
better align operating expenses with revenues and further focus on our core
business intelligence software business. The restructuring adopted during the
third quarter of 2001 resulted in a reduction of the Company's workforce by 229
additional domestic and international employees throughout all functional areas.
As a result of our restructuring plans, we recorded restructuring and impairment
charges of $2.9 million and $46.0 million during the three and nine months ended
September 30, 2001, respectively, for severance costs and other benefits for
terminated employees, costs associated with exiting facilities, and fees
incurred for
24
professional services directly related to the restructuring. We anticipate
overall annualized savings to be in the range of $86 million to $110 million as
a result of the restructuring plans adopted during 2001.
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 Nine Months Ended
--------------------------- -------------------------
September 30, September 30,
2001 2000 2001 2000
--------- ---------- --------- ----------
Statements of Operations Data
Revenues:
Product licenses.............................. 37.5% 43.4% 39.6% 45.8%
Product support and other
services................................... 62.5 56.6 60.4 54.2
--------- ---------- --------- ----------
Total revenues............................ 100.0 100.0 100.0 100.0
--------- ---------- --------- ----------
Cost of revenues:
Product licenses............................. 2.6 0.2 2.4 0.7
Product support and other services........... 26.6 40.3 30.7 38.4
--------- ---------- --------- ----------
Total cost of revenues.................... 29.2 40.5 33.1 39.1
--------- ---------- --------- ----------
Gross profit...................................... 70.8 59.5 66.9 60.9
--------- ---------- --------- ----------
Operating expenses:
Sales and marketing.......................... 36.2 56.2 45.3 70.1
Research and development..................... 19.9 24.7 22.5 29.0
General and administrative................... 20.9 26.4 23.7 28.1
Restructuring and impairment charges......... 6.6 16.7 31.8 6.5
Amortization of goodwill and intangible
assets.................................... 9.6 7.4 8.8 7.8
--------- ---------- --------- ----------
Total operating expenses.................. 93.2 131.4 132.1 141.5
--------- ---------- --------- ----------
Loss from operations.............................. (22.4) (71.9) (65.2) (80.6)
Financing and other income (expense):
Interest income.............................. 1.8 2.1 2.1 1.4
Interest expense............................ (4.0) - (2.5) -
Loss on investments.......................... (2.1) (13.9) (1.6) (4.6)
Reduction in (provision for) estimated cost of
litigation settlement..................... 15.9 (175.3) 28.8 (68.6)
Minority interest............................ (1.8) - (2.1) -
Other income, net............................ 1.3 0.1 - 0.1
--------- ---------- --------- ----------
Total financing and other income (expense). 11.1 (187.0) 24.7 (71.7)
--------- ---------- --------- ----------
Loss before income taxes............................ (11.3) (258.9) (40.5) (152.3)
Provision for income taxes.......................... 2.3 0.5 0.9 0.4
--------- ---------- --------- ----------
Net loss............................................ (13.6) (259.4) (41.4) (152.7)
--------- ---------- --------- ----------
Dividends on and accretion of series A, B, C, D
and E convertible preferred
stock.......................................... (6.3) (3.4) (5.0) (1.5)
Net gain on refinancing of series A redeemable
convertible preferred stock.................... - - 20.3 -
Gain on early redemption of mandatorily
redeemable convertible preferred stock of
consolidated subsidiary........................ 101.7 - 31.0 -
Preferred stock beneficial conversion
feature......................................... - - - (11.7)
--------- ---------- --------- ----------
Net income (loss) attributable to common
stockholders.................................... 81.8% (262.8)% 4.9% (165.9)%
========= ============ ========= ==========
25
Comparison of the Three and Nine Months Ended September 30, 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 decreased 31.9% from $64.9 million to $44.2
million for the three months ended September 30, 2000 and 2001, respectively,
and decreased 12.7% from $165.8 million to $144.8 million for the nine months
ended September 30, 2000 and 2001, respectively.
During the third quarter of 2000, we and a significant customer, Deutsche Bank,
agreed to restructure our relationship, terminating the Strategy.com affiliation
and joint research and development agreement and replacing it with a standard
enterprise software license and maintenance agreement. While we had been
providing services to this customer over the previous six months, no revenue had
been recognized in accordance with our revenue recognition accounting polices.
In view of changes in the customer's goals, we entered into an agreement with
Deutsche Bank in which we agreed to cease further development efforts and
deliver all existing work product to Deutsche Bank. Since we had no future
obligations to Deutsche Bank, all payments had been made prior to the end of the
quarter, and all other revenue recognition criteria had been achieved, we
recorded revenues of $9.5 million during the third quarter of 2000, with $4.4
million and $5.1 million recorded as product license revenues and product
support and other services revenues, respectively, and deferred an additional
$1.5 million related to ongoing product support obligations.
Product License Revenues. Product license revenues decreased 41.1% from $28.1
million to $16.6 million for the three months ended September 30, 2000 and 2001,
respectively, and decreased 24.5% from $76.0 million to $57.3 million for the
nine months ended September 30, 2000 and 2001, respectively. Product license
revenues included revenues related to our non-core activities of $0 and $1.4
million during the three months ended September 30, 2000 and 2001, respectively,
and $778,000 and $3.3 million during the nine months ended September 30, 2000
and 2001, respectively. The overall decrease in product license revenues in the
period ending September 30, 2001 was primarily attributable to the economic
slowdown in the first three quarters of 2001, which led to decreased corporate
spending on information technology and, to a lesser extent, the effect of the
September 11, 2001 terrorist attacks, which had an adverse affect on sales
efforts at the end of the third quarter. Contributing to the decrease were
unusually high product licenses revenues in the third quarter of 2000 relating
to the restructuring of the Deutsche Bank relationship described above which
resulted in $4.4 million of product license revenues being recognized in the
third quarter of 2000. 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.
Product Support and Other Services Revenues. Product support and other services
revenues decreased 24.8% from $36.7 million to $27.6 million for the three
months ended September 30, 2000 and 2001, respectively, and decreased 2.7% from
$89.9 million to $87.5 million for the nine months ended September 30, 2000 and
2001, respectively. Product support and other services revenues related to our
non-core activities represented 40.7% of the overall decrease for the quarter,
declining from $5.4 million to $1.7 million for the three months ended September
30, 2000 and 2001, respectively. For the nine months ended September 30, 2000
and 2001, product support and other services revenues related to our non-core
activities declined from $5.8 million to $4.3 million, respectively. Also
contributing to the decrease in the period ending September 30, 2001 were
unusually high product support and other services revenues in the third quarter
of 2000 relating to the restructuring of the Deutsche Bank relationship
described above which resulted in $5.1 million of product support and other
services revenues being recognized in the third quarter of 2000. As a result of
possible fluctuations in product license revenues discussed above and other
factors, 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 decreased 17.6% from $17.5 million to $14.4 million for
the three months ended September 30, 2000 and 2001, respectively, and increased
15.4% from $40.1 million to $46.2 million for the nine months ended September
30, 2000 and 2001, respectively,. International product license revenues
decreased 36.3% from $10.2 million to $6.5 million for the three months ended
September 30, 2000 and 2001, respectively, and decreased 3.5% from $22.5 million
to $21.7 million for the nine months ended
26
September 30, 2000 and 2001, respectively. International product support and
other services revenues increased 8.2% from $7.3 million to $7.9 million for the
three months ended September 30, 2000 and 2001, respectively, and increased
39.2% from $17.6 million to $24.5 million for the nine months ended September
30, 2001, respectively. The decrease in international revenues in the period
ending September 30, 2001 was primarily due to the recognition of $4.4 million
of product license revenues resulting from the restructuring of the Deutsche
Bank relationship described above in the third quarter of 2000. Excluding the
impact of the Deutsche Bank transaction, international revenues increased
slightly due to the expansion of our international operations, new product
offerings and growing international market acceptance of our software products.
As a percentage of total revenues, international revenues were 32.7% and 27.0%
for the three months ended September 30, 2001 and 2000, respectively, and 31.9%
and 24.2% for the nine months ended September 30, 2001 and 2000, respectively.
We anticipate that international revenues will continue to account for a
significant portion of total revenues and management expects to continue to
commit significant time and financial resources to the maintenance and ongoing
development of direct and indirect international sales and support channels.
Costs and Expenses
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 $120,000 to $1.1 million for the three
months ended September 30, 2000 and 2001, respectively, and from $1.1 million to
$3.4 million for the nine months ended September 30, 2000 and 2001,
respectively. As a percentage of product license revenues, cost of product
license revenues increased from 0.4% to 6.9% for the three months ended
September 30, 2000 and 2001, respectively, and from 1.5% to 6.0% for the nine
months ended September 30, 2000 and 2001, respectively. The increase in cost of
product license revenues as a percentage of product license revenues was
primarily due to increased software royalty obligations to third-party software
vendors resulting from an increase in MicroStrategy software sold that included
third-party software. In the event that we enter into additional software
royalty arrangements with third-party software vendors 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 and other
services decreased from $26.2 million to $11.7 million for the three months
ended September 30, 2000 and 2001, respectively, and from $63.7 million to $44.5
million for the nine months ended September 30, 2000 and 2001, respectively. As
a percentage of product support and other services revenues, cost of product
support and other services revenues decreased from 71.2% to 42.5% for the three
months ended September 30, 2000 and 2001, respectively, and from 70.9% to 50.9%
for the nine months ended September 30, 2000 and 2001, respectively. As
discussed above, we implemented restructuring plans during the second and third
quarters of 2001, under which we have reduced our consulting, education and
technical support staffing levels in our core and non-core operations, which
contributed to the decrease in the cost of product support and other services as
a percentage of product support and other services revenues ("services cost").
The decrease in services cost was also attributable 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 result in higher profit margins than other product support revenues, such
as consulting and educational services. 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 domestic and
international 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 $36.4 million to $16.0 million for the three months ended
September 30, 2000 and 2001, respectively, and from $116.3 million to $65.5
million for the nine months ended September 30, 2000 and 2001, respectively. As
a percentage of total revenues, sales and marketing expenses decreased from
56.2% to 36.2% for the three months ended September 30, 2000 and 2001,
respectively, and from 70.1% to 45.3% for the nine months ended September 30,
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 plans implemented in the second and third quarter of 2001,
decreased commissions expense as a result of lower product licenses 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
27
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 or in 2001. As part of the restructuring plans in the second
and third quarter of 2001, we have reduced overall spending on marketing
initiatives and advertising and have focused our marketing efforts solely on our
core business intelligence product line. Sales and marketing expenses related to
our non-core activities decreased from $3.0 million to $504,000 for the three
months ended September 30, 2000 and 2001, respectively, and from $11.9 million
to $3.3 million for the nine months ended September 30, 2000 and 2001
respectively. While we intend to continue to market our MicroStrategy 7 software
and other technology in our suite of business intelligence products, 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 computer equipment and other related costs. Research and
development expenses decreased from $16.0 million to $8.8 million for the three
months ended September 30, 2000 and 2001, respectively, and from $48.0 million
to $32.5 million for the nine months ended September 30, 2000 and 2001,
respectively. As a percentage of total revenues, research and development
expenses decreased from 24.7% to 19.9% for the three months ended September 30,
2000 and 2001, respectively, and from 29.0% to 22.5% for the nine months ended
September 30, 2000 and 2001, respectively. During 2001, we focused our research
and development efforts on enhancing our core business intelligence product line
and limited our initiatives on new product development. As a result of this
change in focus and our restructuring plans, research and development expenses
declined due to a reduction in staffing levels, a decrease in the use of third-
party consultants, and a curtailment of spending on our non-core activities.
Research and development expenses related to our non-core activities decreased
from $6.0 million to $1.3 million for the three months ended September 30, 2000
and 2001, respectively, and from $16.1 million to $8.1 million for the nine
months ended September 30, 2000 and 2001, respectively.
For the three and nine months ended September 30, 2001, in accordance with SFAS
No. 86, "Accounting for the Costs of Computer Equipment to be Sold, Leased, or
Otherwise Marketed," we capitalized $0 and $606,000, respectively, of software
development costs associated with the release of the Narrowcaster 7.1 software.
During the three and nine months ended September 30, 2000, we capitalized $0 and
$1.0 million, respectively, of software development costs associated with the
release of the MicroStrategy 7.0 software. These amounts represent software
development costs incurred from the time that technological feasibility was
reached until the general release of the respective software products. These
capitalized software costs are amortized over their respective useful lives of
approximately three years.
General and Administrative Expenses. General and administrative expenses include
domestic and international personnel and other costs of our finance, human
resources, information systems, legal, administrative and executive departments
as well as third-party consulting, legal and other professional fees. General
and administrative expenses decreased from $17.1 million to $9.3 million for the
three months ended September 30, 2000 and 2001, respectively, and from $46.6
million to $34.3 million for the nine months ended September 30, 2000 and 2001,
respectively. As a percentage of total revenues, general and administrative
expenses decreased from 26.4% to 20.9% for the three months ended September 30,
2000 and 2001, respectively, and from 28.1% to 23.7% for the nine months ended
September 30, 2000 and 2001, respectively. The decrease in general and
administrative expenses was primarily due to a reduction in staff levels as a
result of the restructuring plans implemented during the second and third
quarters of 2001, a decrease in the use of external professional services, and a
reduction in recruiting efforts. General and administrative expenses related to
our non-core activities decreased from $3.5 million to $380,000 for the three
months ended September 30, 2000 and 2001, respectively, and from $9.1 million to
$3.1 million for the nine months ended September 30, 2000 and 2001,
respectively. We expect that general and administrative expenses may be further
reduced in future periods, if necessary, to better align expenses with
anticipated revenue levels.
Restructuring and Impairment Charges
(a) 2001 Restructuring Plans. During the second quarter of 2001, we adopted a
restructuring plan designed to focus our commercial activities. The
restructuring plan includes a strategic decision to focus our operations 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 597 domestic, international, and Strategy.com employees
throughout all functional areas, or approximately 33% of the worldwide
headcount. As a result of the reduction in
28
headcount, we consolidated our multiple Northern Virginia facilities into a
single location in McLean, Virginia. In April and May 2001, Strategy.com adopted
similar restructuring plans pursuant to which it substantially curtailed
operations and reduced its workforce to approximately 40 employees. This
reduction in Strategy.com's workforce is included in the Company's worldwide
workforce reduction of 597 employees described above.
During the third quarter of 2001, we adopted an additional restructuring plan to
effect a further reduction in our workforce as part of our ongoing measures to
better align operating expenses with revenues and further focus on our core
business intelligence software business. The restructuring plan adopted during
the third quarter of 2001 resulted in a reduction of our workforce by 229
additional domestic and international employees throughout all functional areas.
As a result of our restructuring plans adopted in 2001, we recorded
restructuring and impairment charges of $2.9 million and $46.0 million during
the three and nine months ended September 30, 2001, respectively, for severance
costs and other benefits for terminated employees, costs associated with exiting
facilities, and fees incurred for professional services directly related to the
restructuring. As a result of the restructuring, we expect depreciation expense
to be reduced by approximately $22.0 million over the next four years. The
following table sets forth a summary of the restructuring and impairment charges
for 2001 (in thousands):
Charge for Charge for Consolidated Consoldiated Accrued
Core Non-Core Charge for the Charge for the 2001 2001 Restructuring
Second Quarter Second Quarter Second Quarter Third Quarter Non-cash Cash Costs at
of 2001 of 2001 of 2001 of 2001 Charges Payments September 30, 2001
------- ------- ------- ------- ------- -------- ------------------
Severance and other employee
termination benefits........... $ 2,862 $ 1,505 $ 4,367 $ 1,837 $ - $ (4,900) $ 1,304
Write-down of impaired assets... 6,443 17,485 (23,928) - $ (23,928) - -
Estimated sublease losses and
other facility closing costs... 13,008 - 13,008 1,040 132 (2,031) 12,149
Terminations of computer and
equipment leases............... 712 590 1,302 - - (489) 813
Accrual for professional fees... 393 105 498 30 - (322) 206
Total restructuring and ---------- --------- --------- -------- ----------- -------- ----------
Impairment charges........ $ 23,418 $ 19,685 $ 43,103 $ 2,907 $ (23,796) $ (7,742) $ 14,472
========== ========= ========= ======== =========== ======== ==========
All restructuring and impairment charges recorded during the third quarter of
2001 were recorded to Core operations.
(b) 2000 Restructuring Plan. In the third quarter of 2000, we adopted a
restructuring plan designed to bring costs more in line with revenues and
strengthen the financial performance of our business. The restructuring plan
included a reduction of our workforce by 231 or approximately 10% of the
worldwide headcount and the cancellation of a number of new jobs for which
candidates had not yet commenced employment with us. All of these actions were
completed prior to September 30, 2000. As a result of the reduction in
headcount, we consolidated certain of our facilities located in the vicinity of
our Northern Virginia headquarters. In addition, we eliminated or reduced
certain corporate events. Finally, we reduced expenditures on external
consultants and contractors across all functional areas.
In connection with the third quarter 2000 restructuring plan, we incurred
severance costs for terminated employees and costs for rescinded offers of
employment, accelerated the vesting provisions of certain stock option grants,
wrote-off certain assets that were no longer of service, and accrued related
professional fees. In addition, Michael J. Saylor, the chairman and CEO of the
Company, made grants of our class A common stock to terminated employees from
his personal stock holdings. As Mr. Saylor is a principal shareholder of the
Company, his actions were deemed to be an action undertaken on behalf of the
Company for accounting purposes. Accordingly, we recognized an expense and a
capital contribution by Mr. Saylor of approximately $3.0 million, which
represented the fair value of the stock on the date of grant. The following
table sets forth a summary of these restructuring and impairment charges
recorded during the third quarter of 2000 (in thousands):
29
Consolidated
Charge for the
Non-cash Cash Third Quarter
Charges Payments of 2000
------- -------- ---------
Severance and rescinded employment offers.......... $ - $ 2,854 $ 2,854
Stock grant and applicable payroll taxes........... 3,003 189 3,192
Compensation expense on accelerated stock options.. 1,483 - 1,483
Elimination of corporate events.................... - 2,838 2,838
Write-off of impaired assets....................... 360 - 360
Accrual for professional fees...................... - 108 108
----------- -------- ---------
Total restructuring and impairment charges......... $ 4,846 $ 5,989 $ 10,835
=========== ======== =========
Substantially all cash payments related to the restructuring plan adopted during
the third quarter of 2000 were made by December 31, 2000.
Amortization of Goodwill and Intangible Assets. We have recorded $4.8 million
and $4.2 million in amortization expense for the three months ended September
30, 2000 and 2001, respectively, and $12.9 million and $12.7 million in
amortization expense for the nine months ended September 30, 2000 and 2001,
respectively. We expect our level of amortization expense to be substantially
the same through the end of 2001, to the extent no additional intangible assets
are acquired. See "Recent Accounting Pronouncements" below regarding the
issuance of SFAS No. 142, "Goodwill and Other Intangible Assets."
Loss 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. In May 2000, we sold an additional 412,370 shares of Xchange,
Inc. common stock for a realized loss of $4.9 million. Also during the second
quarter of 2000, the Company sold certain other securities, which resulted in a
realized loss of $137,000. Due to a subsequent decrease in the market value of
Xchange's stock and because the timing and amount of future recovery, if any,
was determined to be uncertain, we wrote down the investment to its fair value
at September 30, 2000 and recognized a loss of $10.4 million during the third
quarter of 2000. This loss was partially offset by a transaction that resulted
in a gain of $1.4 million in the third quarter of 2000.
During the first and second quarters of 2001, we received additional shares of
Xchange's stock, pursuant to the arrangement discussed above. Due to a
subsequent decrease in the market value of Xchange's stock and because the
timing and amount of future recovery, if any, is uncertain, we wrote down the
investment to its fair value at March 31, 2001, at June 30, 2001, and then again
at September 30, 2001. Consequently, we recognized losses of $923,000 and $1.4
million during the three months and nine months ended September 30, 2001,
respectively.
Additionally, during the first quarter of 2001, we recognized a loss of $840,000
related to a 5% interest we held in a voice portal technology company that was
acquired by a publicly-traded company for a combination of cash and common
stock.
We have concluded that all unrealized losses on marketable equity securities at
September 30, 2001 are temporary in nature. Should any portion of these
unrealized losses subsequently be determined to be other than temporary, we
would be required to record the related amount as a charge to current earnings.
Reduction in (Provision for) Estimated Cost of Litigation Settlement. We and
certain of our officers and directors were named as defendants in a private
securities class action lawsuit alleging that they 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 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 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.
30
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 that was 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, and the
period from which an appeal could have been taken has expired. The settlement is
subject to various closing conditions. At a hearing on August 7, 2001, the
Chancery Court approved the derivative settlement.
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. Prior to the issuance of these securities, certain of our
officers will tender to us for no consideration 1,683,502 shares of class A
common stock as part of the derivative settlement described below, resulting in
a net issuance of 1,094,276 shares of class A common stock.
Based on the terms of the settlement agreements, during the third quarter of
2000, we determined that a liability related to these actions was probable and
that the value was reasonably estimable. Accordingly, during the third quarter
of 2000, we established an estimate for the cost of the litigation settlement of
$113.7 million, net of insurance recoveries of $13.1 million. Subsequently, we
have updated the estimated value of the settlement during each of the successive
quarterly financial reporting periods based upon valuation assumptions stemming
from the settlement. During the second quarter of 2001, we updated the estimated
value assigned to the notes and warrants to be issued based upon an independent
third-party valuation. The estimated value of the warrants was updated again
during the third quarter of 2001 using the same methodology as in the second
quarter of 2001, and the other individual components of the settlement
agreements were separately evaluated. As a result of the changes in the
estimated value of each element of the securities litigation settlement, we
recorded an aggregate reduction in the provision for the litigation settlement
of $7.0 million and $41.7 million during the three and nine months ended
September 30, 2001, respectively. This reduction was comprised of the following
(in thousands):
Three Nine
Months Ended Months Ended
September 30, 2001 September 30, 2001
------------------ ------------------
Promissory notes to be issued................... $ - $ (16,700)
Class A common stock to be issued............... (4,639) (13,360)
Warrants to be issued........................... (2,407) (11,842)
Pending loss on additional settlement........... - 250
----------- --------------
Reduction in estimated value of provision... $ (7,046) $ (41,652)
=========== ==============
The final value of the overall settlement and each of its components may differ
significantly from the estimates currently recorded depending on a variety of
factors including the market value of the class A common 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 securities are issued. Upon issuance of the
debt and equity securities, we will record such amounts as liabilities or
stockholders' equity based on the nature of the individual securities. Because
of the rights of the holders of the promissory notes to tender the notes in
satisfaction of the exercise price upon exercising the warrants, the warrants
meet the definition of a derivative under SFAS No. 133 and, accordingly, will be
revalued through earnings on a quarterly basis after issuance.
Minority Interest. For the three and nine months ended September 30, 2001, we
accreted dividends and offering costs of $779,000 and $3.1 million,
respectively, on the preferred stock of Strategy.com through the date of
redemption on August 29, 2001.
Other Income, net. Other income, net includes gains and losses on foreign
currency transactions and, in 2001, included gains on contract terminations.
During the third quarter of 2001, Strategy.com entered into an agreement with
two customers under which Strategy.com terminated its obligation to provide
future services to these customers. In connection with these arrangements, we
recorded a gain on the early termination of these contracts of
31
$1.5 million which is included in other income, net in the accompanying
consolidated statement of operations for the three months ended September 30,
2001. The gain on contract terminations was partially offset by foreign currency
transaction losses.
Provision for Income Taxes. We recorded income tax expense of $1.0 million and
$350,000 for the three months ended September 30, 2001 and 2000, respectively,
and $1.3 million and $600,000 of income tax expense for the nine months ended
September 30, 2001 and 2000, respectively. The provision for both quarters and
the nine months ended September 30 in each year relates to income taxes payable
in certain foreign jurisdictions in which we were profitable. The provision for
income taxes may increase as we become more profitable in certain foreign
jurisdictions where we have limited or no net operating losses to offset taxable
income.
Dividends on and Accretion of Series A, B, C, D and E Convertible Preferred
Stock. For the three and nine months ended September 30, 2001, we recorded
aggregate preferred stock dividends and accretion of $2.8 million and $7.3
million, respectively. During the nine months ended September 30, 2001, we paid
aggregate dividends of $5.2 million through the issuance of 1,336,479 shares of
class A common stock, respectively, and 175.6 shares of series D preferred stock
in lieu of cash. The 175.6 shares of series D preferred stock were deemed to
have been distributed as consideration for a portion of the dividends that had
accrued on the series A preferred stock prior to the refinancing transaction. As
of September 30, 2001, we had accrued dividends of $1.8 million which are
included in accounts payable and accrued expenses in the accompanying
consolidated balance sheet.
Net Gain on Refinancing of Series A Redeemable Convertible Preferred Stock. In
connection with the June 2001 refinancing of our series A redeemable convertible
preferred stock described below, we obtained an independent third-party
valuation of the fair value of each series of the preferred stock. Based upon
the independent third-party valuation, the total fair value of the new series of
preferred stock and the actual value of the common stock issued at closing were
determined to be lower than the carrying value of the series A securities being
refinanced. Accordingly, we recorded a net gain attributable to common
stockholders on the refinancing of the series A preferred stock of $29.4
million. This net gain represents the excess of the fair value of the
consideration transferred to the holders of the series A preferred stock over
the carrying value of those preferred securities, equal to $11.0 million, plus
the amount of the previously recognized beneficial conversion feature equivalent
to the pro-rata portion of the shares redeemed of $18.4 million. The net gain of
$29.4 million was recognized as an increase to net income attributable to common
stockholders in the accompanying consolidated statement of operations for the
nine months ended September 30, 2001.
Gain on Early Redemption of Mandatorily Redeemable Convertible Preferred Stock
of Consolidated Subsidiary. On August 29, 2001, we entered into an exchange
agreement (the "Exchange Agreement") whereby MicroStrategy acquired all
16,536,049 shares of Strategy.com's series A preferred stock in exchange for
3,500,000 shares of MicroStrategy's class A common stock. Based on the closing
price of our class A common stock of $2.49 per share on the date of the closing
and the carrying value of Strategy.com's series A preferred stock of $53.6
million on that same date, the early redemption resulted in a consolidated gain
of $44.9 million. This gain represents the excess of the carrying value of
Strategy.com's preferred stock over the fair value of our class A common stock
exchanged in the transaction. The gain of $44.9 million was recognized as an
increase to net income attributable to common stockholders in the accompanying
consolidated statement of operations.
Preferred Stock Beneficial Conversion Feature. During the second quarter of
2000, we recorded a $19.4 million charge to additional paid-in capital
attributable to the beneficial conversion feature of the series A redeemable
convertible preferred stock based on the difference between the fair market
value of the class A common stock on the closing date of the private placement
and the conversion rate.
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 require 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 $58.4 million as of
September 30, 2001 compared to $81.6 million as of December 31
32
, 2000. As a result of a few large contracts involving multiple elements that
were entered into in the latter part of 1999 and the earlier part of 2000,
deferred revenue increased during that period. As revenues on these contracts
are recognized, the deferred revenue balance will continue to decrease each
period. Also contributing to the overall decrease in deferred revenue is the
execution of more lower dollar contracts during the current year that do not
contain elements which require revenue deferral. We expect to recognize
approximately $42.0 million of this deferred revenue over the next 12 months;
however, the timing and ultimate recognition of our deferred revenue depends on
our performance of various service obligations.
Strategy.com is currently negotiating to terminate its remaining customer
contracts. As of September 30, 2001, Strategy.com had $7.8 million of deferred
revenue remaining associated with these contracts. A significant portion of this
deferred revenue may not ultimately be recognized as revenue in the event that
the contracts are terminated early. Additionally, 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 revenue for any succeeding period.
Liquidity and Capital Resources
On September 30, 2001 and December 31, 2000, we had $43.1 million and $94.7
million of cash, cash equivalents, and short-term investments, respectively, of
which $603,000 and $25.9 million was restricted cash as of September 30, 2001
and December 31, 2000, respectively.
Net cash used in operating activities was $43.1 million and $82.2 million for
the nine months ended September 30, 2001 and 2000, respectively. The decrease in
net cash used in operating activities from 2000 to 2001 was primarily
attributable to a decrease in our operating losses, excluding the restructuring
and impairment charges recorded during 2001, and improvement in accounts
receivable collections offset by an increase in cash used for payment of
accounts payable and accrued expenses. During the latter part of 2000 and during
the second and third quarters of 2001, we have taken several actions to curtail
our operating expenses including a reduction in headcount, consolidation of
facilities, reduction in the use of consultants and reductions in marketing
programs and advertising expenses. These actions were taken in furtherance of
our goal of profitability in the core business on an operating basis by the end
of 2001, excluding amortization, preferred dividends and other non-operating
expenses.
Net cash provided by investing activities was $24.1 million and net cash used in
investing activities was $31.8 million for the nine months ended September 30,
2001 and 2000, respectively. As discussed further below, net cash provided by
investing activities consisted primarily of the $25.3 million in restricted cash
that was released in connection with the termination of our prior credit
facility. Additionally, we received $2.2 million in cash relating to the sale of
a 5% interest we held in a voice portal technology 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 change in net cash
provided by investing activities from 2000 to 2001 is primarily attributable to
a $37.9 million reduction in capital expenditures. During the 2000 period, we
received $39.8 million in proceeds from the sale of short-term investments which
was offset by a $26.2 million requirement to fund a restricted cash account.
Net cash used in financing activities was $5.9 million and net cash provided by
financing activities was $127.5 million for the nine months ended September 30,
2001 and 2000, respectively. On June 19, 2000, we issued 12,500 shares of our
series A redeemable convertible preferred stock in a private placement to
institutional investors for $119.6 million, net of offering costs of $5.4
million. On June 14, 2001, we refinanced our series A redeemable convertible
preferred stock. As a result of the refinancing, 650 shares of the series A
redeemable convertible stock with a $6.5 million stated value remain
outstanding. We redeemed or exchanged the remaining 11,850 shares of our series
A redeemable convertible preferred stock, in connection with the refinancing, as
follows:
o $12.5 million stated value of the series A redeemable convertible preferred
stock, or 1,250 shares, were redeemed for $12.5 million in cash;
o $38.75 million stated value of the series A redeemable convertible
preferred stock and accrued dividends of $1.7 million on all series A
redeemable convertible preferred stock redeemed or exchanged were exchanged
for 5,568,466 shares of class A common stock and $16.3 million stated value
of series D redeemable convertible preferred stock, or 1,626.1 shares, with
a fixed conversion price of $5.00 per share;
33
o $33.125 million stated value of the series A redeemable convertible
preferred stock were exchanged for an equivalent stated value of series B
redeemable convertible preferred stock, or 3,312.5 shares, with a fixed
conversion price of $12.50 per share, subject to adjustment at maturity if
we elect to mandatorily convert these shares into class A common stock;
o $27.825 million stated value of the series A redeemable convertible
preferred stock were exchanged for an equivalent stated value of series C
redeemable convertible preferred stock, or 2,782.5 shares, with a fixed
conversion price of $17.50 per share, subject to adjustment at maturity if
we elect to mandatorily convert these shares into class A common stock; and
o $6.3 million stated value of the series A redeemable convertible preferred
stock were exchanged for an equivalent stated value of series E redeemable
convertible preferred stock, or 630 shares.
The series B preferred stock and the series C preferred stock mature three years
after the date of issuance and accrue cumulative dividends at a rate of 12.5%
per annum, payable in cash or shares of class A common stock at our option,
subject to satisfaction of certain conditions. Prior to maturity, holders have
the right to convert their series B preferred stock and series C preferred stock
into shares of our class A common stock. At our option, the series B and series
C preferred stock may be redeemed at maturity at stated value plus accrued
dividends or mandatorily converted into class A common stock at a conversion
price of 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 matures three years
after the date of issuance, does not carry any dividend rate, and has 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 had the right to redeem the series E preferred stock prior to December 11,
2001 for 105% of the stated value plus accrued and unpaid dividends if redeemed
on or before October 27, 2001, 110% of the stated value plus accrued and unpaid
dividends if redeemed from October 28, 2001 through December 11, 2001, and at
120% of the stated value plus accrued dividends if redeemed thereafter. In
addition, the holders of the series E preferred stock had the right to require
us to redeem the series E preferred stock at specified prices upon specified
financing transactions or other events. Upon the closing of the Exchange
Agreement pursuant to which we acquired the outstanding Strategy.com series A
preferred stock, the holders exercised this right and on September 10, 2001 we
paid $6.8 million in cash to redeem all 630 shares of the series E preferred
stock for 105% of the stated value of $6.3 million plus accrued and unpaid
dividends of $155,000. The cash redemption payment was substantially equal to
the carrying value of the series E preferred stock on the date of redemption.
Each series of the preferred stock is also redeemable upon certain triggering
events as defined in the respective Certificate of Designations, Preferences and
Rights of each series. In the event of redemption upon a triggering event, the
preferred stock is redeemable, with respect to each series of preferred stock,
at the greater of 125% of the stated value of such shares of preferred stock
plus accrued and unpaid dividends or the product of the number of shares of
class A common stock into which each series of preferred stock is convertible
multiplied by the closing sale price of our class A common stock on the day
immediately before the triggering event occurs, except for the series D
preferred stock which is redeemable at the greater of its stated value or such
product. As of September 30, 2001, none of these triggering events have
occurred. In addition, upon a change of control of the Company, each holder of
series A, series B, and series C prefered stock shall have the right, at the
holder's option, to require us to redeem all or a portion of the preferred stock
at 125% of the stated value of such shares of preferred stock plus accrued and
unpaid dividends. Holders of series D preferred stock shall have the right, at
the holder's option, to require us to redeem all or a portion of the preferred
stock at the stated value of such shares of preferred stock plus accrued and
unpaid dividends upon a change of control.
The remaining 650 shares of series A preferred stock with a $6.5 million stated
value accrue dividends at a rate of 7% per annum, payable in cash or shares of
class A common stock at our election. Following a conversion price reset
adjustment on July 5, 2001, the conversion price of the series A preferred stock
was adjusted downward to $3.08 per share based on the average of the dollar-
volume weighted average price of the class A common stock during the ten trading
day immediately preceding July 5, 2001. Prior to this adjustment, the conversion
price was $33.39 per share. As a result of this adjustment to the conversion
price, the series A preferred stock is convertible, as of September 30, 2001, at
the option of the holders, into 2,108,247 shares of class A common stock, not
including shares of class A common stock that may be issuable as dividends on
the series A preferred stock. We have the right to redeem 120 shares of the
series A preferred stock with a $1.2 million stated value on or prior to
December 11, 2001. In addition, at our option, the series A preferred stock may
be redeemed at its June 19, 2002 maturity at stated value plus accrued dividends
or mandatorily converted into class A common stock equal to 95% of the average
of
34
the dollar volume-weighted average price of the class A common stock during the
30 consecutive trading days immediately preceding the maturity date.
Additionally, at our option, we may extend the maturity of the series A
preferred stock for up to an additional two years. If we elect to extend the
maturity of the series A preferred stock, the conversion price may be adjusted
based on the average of the dollar-volume weighted average price the class A
common stock on each trading day during the ten days immediately following each
anniversary of the original maturity, if such adjustment would result in a lower
conversion price. The preferred stock is also redeemable upon certain triggering
events as defined in the Certificate of Designations, Preferences and Rights of
the series A Redeemable Convertible Preferred Stock. In the event of redemption
upon a triggering event, the series A preferred stock is redeemable at the
greater of 125% of the conversion amount or an agreed upon formula. As of
September 30, 2001, none of these triggering events have occurred.
In January 2001, Strategy.com issued an additional 3,134,796 million shares of
redeemable convertible preferred stock for $10.0 million, in a second and final
closing of sales of the series A redeemable convertible preferred stock of
Strategy.com. On August 29, 2001, we entered into an exchange agreement (the
"Exchange Agreement") whereby MicroStrategy acquired all 16,536,049 shares of
Strategy.com's series A preferred stock in exchange for 3,500,000 shares of
MicroStrategy's class A common stock.
On February 9, 2001, we entered into a loan and security agreement (the "New
Credit Facility") which provided for aggregate borrowing capacity of up to $30.0
million to be used for general working capital purposes. The New Credit Facility
consisted 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 New Credit
Facility replaced a 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. During the first and
second quarters of 2001, we repaid $1.1 million of the term loan under the New
Credit Facility through the use of the revolving line of credit.
On June 14, 2001, we entered into an Amended and Restated Loan and Security
Agreement (the "Modified Credit Facility"), which replaced the New Credit
Facility. The Modified Credit Facility provides for aggregate borrowing capacity
of up to $30 million, including a $5 million maintenance receivables backed sub-
facility, subject to specified borrowing base limitations based on eligible
maintenance receivables. The maximum amount available under the maintenance
receivables backed sub-facility decreases by $278,000 per month until March
2002, at which time the then remaining balance of $2.5 million may remain
outstanding until maturity. Upon the closing of the Modified Credit Facility, we
also repaid $8.9 million of the term loan under the New Credit Facility and drew
$5.0 million upon the Modified Credit Facility. During the third quarter of
2001, we repaid $5.2 million of the balance on the Modified Credit Facility. At
September 30, 2001, we had $1.1 million outstanding under the Modified Credit
Facility. After consideration of outstanding letters of credit of $5.8 million,
we have $23.1 million available for future drawdowns, subject to borrowing base
limitations. As a result of the borrowing base limitations, $3.8 million of
additional borrowing capacity under the Modified Credit Facility was available
at September 30, 2001. Based upon recent trends in the levels of our accounts
receivable and borrowing base limitations, we expect that our available
borrowing capacity will continue to be substantially lower than the maximum $30
million aggregate borrowing capacity under the Modified Credit Facility.
Borrowings under the Modified Credit Facility bear interest at a variable rate.
The borrowing rate in effect at September 30, 2001 was 7.50%. The Modified
Credit Facility also includes an annual 1.50% unused letter of credit fee.
Monthly principal payments are due to the extent that the balance outstanding
exceeds the borrowing base limitations or the maintenance receivables backed
sub-facility exceeds the maximum month-end amount available. The Modified Credit
Facility matures in February 2004 and is collateralized by substantially all of
our domestic assets. Under the terms of the Modified Credit Facility, we are
required to maintain compliance with various covenants, including certain
financial covenants, the most restrictive of which are achieving certain minimum
earnings amounts, maintaining certain cash balances domestically, and limiting
the amount of additional indebtedness that the Company may incur. At September
30, 2001 we were in compliance with all covenants.
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
35
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 that began accruing on 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 September 30, 2001. Amounts outstanding under the lease schedules
underlying the master lease bear interest at a rate equal to interest on three-
year U.S. treasury notes plus 1.5% to 2.0% and vary in terms from two to three
years. 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, although we expect only limited, near-term,
computer equipment needs that can be met through cash on hand and other
financial resources as a result of the restructuring.
As previously discussed, during the second quarter of 2001, we substantially
curtailed operations of Strategy.com and reduced its workforce to approximately
40 employees. During the third quarter 2001, we further reduced the Strategy.com
workforce to approximately 6 employees and are currently negotiating to
terminate Strategy.com's remaining customer contracts. Although the curtailment
of the business includes a substantial reduction in product, software
development and marketing expenditures, we expect to continue to incur losses
from Strategy.com operations in the foreseeable future.
As discussed above, 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, 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 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 Modified Credit Facility will be
sufficient to meet our working capital requirements and anticipated capital
expenditures for the next twelve months.
Recent Accounting Pronouncements
We adopted SFAS No. 133 as of January 1, 2001. Through September 30, 2001, the
adoption of SFAS No. 133 did not have a material effect on our financial
position or results of operations.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which is effective for the fiscal year 2002. This statement addresses
financial accounting and reporting for intangible assets acquired individually
or with a group of other assets at acquisition. This statement also addresses
financial accounting and reporting for goodwill and other intangible assets
subsequent to their acquisition. Under SFAS No. 142, goodwill will not be
amortized. Instead, the statement requires that a company perform an initial
impairment assessment upon adoption and then again on at least an annual basis
or upon the occurrence of triggering events, if earlier, to identify potential
goodwill impairment and measure the amount of goodwill impairment loss to be
recognized, if any. An impairment loss is recognized when the carrying amount of
reporting unit goodwill exceeds the implied fair value of that goodwill. After a
goodwill impairment loss is recognized, the adjusted carrying amount of the
goodwill shall be its new accounting basis. We are currently assessing the
impact that the adoption of this statement will have on our consolidated
financial statements.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which is effective for fiscal year 2002. SFAS
No. 144 supersedes previous guidance for financial accounting and reporting for
the impairment or disposal of long-lived assets and for segments of a business
to be disposed of. SFAS No. 144 retains the fundamental provisions of existing
generally accepted accounting principles with respect to recognition and
measurement of long-lived asset impairment contained in SFAS No. 121, "
Accounting for the Impairment of Long Lived Assets and for Long-Lived Assets to
be Disposed Of." However, SFAS No. 144 provides new guidance intended to address
certain significant implementation issues associated with SFAS No. 121,
including expanded guidance with respect to appropriate cash flows to be used,
whether recognition of any long-lived asset impairment is required, and if
required, how to measure the amount of impairment. SFAS No. 144 also requires
that any net assets to be disposed of by sale be reported at the lower of
carrying value or fair
36
market value less costs to sell, and expands the reporting of discontinued
operations to include any component of an entity with operations and cash flows
that can be clearly distinguished from the rest of the company. We are currently
assessing the impact that the adoption of this statement will have on our
consolidated financial statements.
Risk Factors
You should carefully consider the risks described below before making an
investment decision. The risks and uncertainties described below are not the
only ones facing 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 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 of $59.9 million
in the nine months ended September 30, 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 September 30, 2001, our accumulated deficit was $359.1
million. We expect our gross revenue to decline from the fiscal year ended
December 31, 2000 to the fiscal year ending December 31, 2001. In connection
with our April and September 2001 corporate restructurings and the additional
Strategy.com restructurings in April and May 2001, we recorded restructuring and
impairment charges of $2.9 million and $46.0 million during the three and nine
months ended September 30, 2001, respectively.
We expect that we will not achieve sufficient revenue to become profitable in
consolidation 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:
o the size, timing and execution of significant orders and shipments;
o 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;
o the timing of new product announcements;
o changes in our pricing policies or those of our competitors;
o market acceptance of business intelligence software generally and of new
and enhanced versions of our products in particular;
o the length of our sales cycles;
37
o changes in our operating expenses;
o personnel changes;
o our success in adding to our indirect distribution channels;
o 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;
o changes in foreign currency exchange rates; and
o seasonal factors, such as our traditionally lower pace of new sales in
the summer.
Limited Ability to Adjust Expenses. We base our operating expense budgets
on expected revenue trends. Many of our expenses, such as office and equipment
leases, 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 product 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 recognition of deferred revenue is subject to future performance obligations
and may not be representative of revenues for succeeding periods
Our deferred revenue was approximately $58.4 million as of September 30, 2001.
The timing and ultimate recognition of our deferred revenue depend on our
performance of various service obligations. Because of the possibility of
customer changes in development schedules, delays in implementation and
development efforts and the need to satisfactorily perform product support
services, deferred revenue at any particular date may not be representative of
revenue for any succeeding period. Additionally, Strategy.com is currently
negotiating to terminate its remaining customer contracts. As of September 30,
2001, Strategy.com had $7.8 million of deferred revenue remaining associated
with these contracts. A significant portion of this deferred revenue may not
ultimately be recognized as revenue in the event that the contracts are
terminated early.
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
38
MicroStrategy or by obtaining other financing facilities to support our
operations, as we expect to incur operating losses through the third quarter of
2001 and possibly longer. Obtaining additional financing will be subject to a
number of factors, including:
o market conditions;
o our operating performance; and
o 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 needed 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 settlements have received court approval, 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.
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 consideration 1,683,502 shares of class A
common stock for cancellation, resulting in a net issuance of 1,094,276 shares
of class A common stock. In addition, the settlement agreements require the
issuance of warrants to purchase 1,900,000 shares of class A 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 dollar volume-weighted average trading
price of the class A common stock over a ten 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
the notes were based on the dollar volume-weighted average trading price of the
class A common stock during the 10 trading days ending November 1, 2001, we
would be obligated to issue 40,545,161 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.
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
On June 14, 2001, holders of our series A preferred stock exchanged 11,850
shares of series A preferred stock for cash and shares of our class A common
stock, series B preferred stock, series C preferred stock, series D preferred
stock and series E preferred stock. On September 10, 2001, we redeemed all 630
outstanding shares of series E preferred stock. The series B preferred stock,
series C preferred stock and series D preferred stock 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. The outstanding shares of
series B preferred stock, series C preferred stock and series D preferred stock
39
would currently convert into 7,492,200 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 preferred stock and series C
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 preferred stock and series C
preferred stock at maturity, the conversion price for such shares will be reset
to a price equal to 95% of the dollar volume-weighted average price of our class
A common stock for the 30 trading days prior to the maturity date. If the market
price at maturity of our class A common stock is less than the applicable
conversion price, the number of shares of class A common stock that we could be
required to issue upon conversion of the series B preferred stock and series C
preferred stock would increase. For instance, if the market price of our class A
common stock on the maturity date of our series B preferred stock and series C
preferred stock were $2.47, the closing sale price of our class A common stock
as of November 1, 2001, the holders of the series B preferred stock and series C
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 24,676,113 shares of our class A common stock
upon conversion of such shares at maturity plus a number of shares reflecting
accrued but unpaid dividends.
After the exchange of shares of our series A preferred stock for shares of our
class A common stock, series B preferred stock, series C preferred stock, series
D preferred stock and series E preferred stock as described above, 650 shares of
our series A preferred stock remain outstanding. We have the right to redeem 120
of such shares through December 11, 2001. As of November 1, 2001, shares of
series A preferred stock are convertible into 2,108,247 shares of class A common
stock based on the current conversion price equal to $3.08313 per share. At our
option, the series A preferred stock may be redeemed at maturity at stated value
plus accrued dividends or mandatorily converted into class A common stock equal
to 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. Additionally, at our option, we may extend the maturity of the
series A preferred stock for up to an additional two years. If we elect to
extend the maturity of the series A preferred stock, the conversion price may be
adjusted based on the average of the dollar-volume weighted average price the
class A common stock on each trading day during the ten days immediately
following each anniversary of the original maturity, if such adjustment would
result in a lower conversion price. The conversion price of the series A
preferred stock 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.
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 series A preferred stock, series B preferred stock and series
C 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 holder may convert
its preferred stock if upon such conversion the holder 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 holder may still sell a substantial number of shares
in the market. By periodically selling shares into the market, an individual
holder 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 our
redeemable convertible preferred stock, we are required to pay substantial
penalties to a holder of preferred stock under specified circumstances,
40
including, among others:
o nonpayment of dividends on the series A preferred stock, series B
preferred stock and series C preferred stock in a timely manner;
o failure to deliver shares of our class A common stock upon
conversion of the preferred shares after a proper request;
o nonpayment of the redemption price at maturity of any remaining
series A preferred stock, series B preferred stock, and series C
preferred stock; or
o 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.
These 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 preferred 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 in November 1999, of which we have leased approximately $17.8
million as of September 30, 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.
MicroStrategy's most direct competitors provide:
o business intelligence software;
o online analytical processing, or OLAP, tools;
o query and reporting tools;
o web-based static reporting tools;
o information delivery and proactive reporting;
o analytical customer relationship management products;
o web traffic analysis applications; and
o marketing automation.
Each of these markets are discussed more fully below.
41
Business Intelligence Software. Makers of business intelligence
software provide business intelligence capabilities designed for integration,
customization and application development. Leading industry analysts classify
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, 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
customize the result set for that particular person. Some limited drilling
capabilities are 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 applications, 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 our offerings. Typically these tools serve to produce compiled
reports on a scheduled basis to sets of users based on job type. Our 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 software
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.
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 devote. 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 effect on our
business, operating results and financial condition.
Current and future competitors may also make strategic acquisitions or establish
cooperative relationships among
42
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 the
second and third quarters of 2001, we implemented corporate restructuring plans
which included a reduction in our worldwide workforce of approximately one-
third. These reductions in force could adversely impact our employee morale and
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:
o our ability to continue to support a number of popular operating
systems and databases;
o our ability to maintain and improve our current product line; and
o 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 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.
43
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.
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
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 November 1, 2001, holders of our class B common stock owned or
controlled 49,421,262 shares of class B common stock, or 92.0% of the total
voting power. Michael J. Saylor, our Chairman and Chief Executive Officer,
controlled 2,389,106 shares of class A common stock and 38,581,556 shares of
class B common stock, or 72.2% of total voting power, as of November 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 whom are current employees or former employees of our company or related
parties, to transfer shares of class B common stock, subject to the approval of
stockholders possessing a majority of the outstanding class B common stock. Mr.
Saylor or a group of stockholders possessing a majority of the outstanding class
B common 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.
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 nine months ended September 30, 2001 and
the years ended December 31, 2000, 1999 and 1998, channel partners accounted
for, directly or indirectly, approximately 32.3%, 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.
44
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 to enter
into costly royalty or licensing agreements. If successful, a claim of
infringement against us and our inability to license the infringed or similar
technology could have a material adverse effect on our business, operating
results and financial condition.
On October 2, 2001, we filed a lawsuit in the Virginia Circuit Court for Fairfax
County against two field employees of Business Objects, S.A. ("BO"). Our lawsuit
alleges that these employees, who previously worked for us, have breached their
fiduciary and contractual obligations to us by, among other things,
misappropriating our trade secrets and confidential information and soliciting
our employees and customers. Our complaint seeks injunctive relief and damages
of at least $3 million. On October 17, 2001, BO filed suit against us in the
United States District Court for the Northern District of California, claiming
that our software infringes a patent issued to BO relating to relational
database access. The suit seeks injunctive relief and unspecified monetary
damages. We intend to vigorously defend the case. On October 31, 2001, we filed
suit against BO in the United States District Court for the Eastern District of
Virginia, claiming that BO's software infringes two patents held by us relating
to asynchronous control of report generation using a web browser and a system
and method of adapting automatic output of OLAP reports to disparate user output
devices. We are seeking monetary damages and injunctive relief.
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 31.9%, 24.9%, 24.0% and 26.1% of our total
revenues for the nine months ended September 30, 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:
o changes in foreign currency exchange rates;
o unexpected changes in regulatory requirements;
o tariffs and other trade barriers;
o costs of localizing products for foreign countries;
o lack of acceptance of localized products in foreign countries;
o longer accounts receivable payment cycles;
45
o difficulties in managing international operations;
o tax issues, including restrictions on repatriating earnings;
o weaker intellectual property protection in other countries; and
o the burden of complying with a wide variety of foreign laws.
These factors may have a material adverse effect on our future international
sales and, consequently, on our business, operating results and financial
condition.
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.
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:
o quarter-to-quarter variations in our operating results;
o developments or disputes concerning proprietary rights;
o technological innovations or new products;
o governmental regulatory action;
o general conditions in the software industry;
o increased price competition;
o changes in revenue or earnings estimates by analysts;
o 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
o 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
46
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
The following discussion about our market risk disclosures involves
forward-looking statements. Actual results could differ materially from those
projected in the forward-looking statements. We are exposed to the impact of
interest rate changes and foreign currency fluctuations.
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily to
our cash equivalents and short-term investments. We invest our excess cash in
short-term, fixed income financial instruments. These fixed rate investments are
subject to interest rate risk and may fall in value if market interest rates
increase. If market interest rates were to increase immediately and uniformly by
10% from the levels at September 30, 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
We face exposure to adverse movements in foreign currency exchange rates. Our
international revenues and expenses are denominated in foreign currencies,
principally the British pound sterling, the German deutsche mark, the Spanish
peseta, and the Italian lira. 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
September 30, 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,
operating results, financial condition and cash flows will not be materially
adversely affected by exchange rate fluctuations.
47
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 1,900,000 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. Prior to the issuance of these securities, some of our officers will
tender to us for no consideration 1,683,502 shares of class A common stock for
cancellation, as part of the settlement of the Delaware Derivative Litigation
described below, resulting in a net issuance of 1,094,276 shares of class A
common stock. 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 object the proposed settlement and pursue their claims
separately. On April 2, 2001, the district court approved the settlement, and
the period from which an appeal could have been taken has expired. The
settlement is subject to various closing conditions.
Delaware Derivative Litigation
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 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 have added two new independent directors 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,
prior to the distribution of the securities to be issued as part of the class
action settlement, 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 and current Vice President of Business Affairs, will tender to
the Company for cancellation an aggregate of 1,683,502 shares of class A common
stock held by them. At a hearing on August 7, 2001, the Chancery Court approved
the settlement.
48
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 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On August 29, 2001, the Company issued an aggregate of 3,500,000 shares of its
class A common stock to seven persons in exchange for the remaining 16,536,049
outstanding shares of Series A Preferred Stock, $.001 par value per share, of
the Company's subsidiary Strategy.com Incorporated. The issuance of the class A
common stock in this transaction was made in reliance on the exemption from
registration under the Securities Act of 1933, as amended, provided by Section
4(2) thereunder. No underwriters were involved in the foregoing issuance of
securities.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Reference is made to the information set forth under Item 5 (Other Information)
of Part II of the Company's Quarterly Report on Form 10-Q for the quarterly
period ended June 30, 2001 (File No. 000-24435), which is incorporated herein by
reference.
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 Series A Convertible Preferred
Stock. (Filled 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).
3.4 Certificate of Designations, Preferences and Rights of the Series B Convertible Preferred
Stock. (Filed as Exhibit 4.1 to the Company's Current Report on Form 8-K (File No.
000-24435) filed on June 18, 2001, and incorporated by reference herein).
3.5 Certificate of Designations, Preferences and Rights of the Series C Convertible Preferred
Stock (Filed as Exhibit 4.2 to the Company's Current Report on Form 8-K (File No.
000-24435) filed on June 18, 2001, and incorporated by reference herein).
49
3.6 Certificate of Designations, Preferences and Rights of the Series D Convertible Preferred
Stock (Filed as Exhibit 4.3 to the Company's Current Report on Form 8-K (File No.
000-24435) filed on June 18, 2001, and incorporated by reference herein).
3.7 Certificate of Designations, Preferences and Rights of the Series E Convertible Preferred
Stock (Filed as Exhibit 4.4 to the Company's Current Report on Form 8-K (File No.
000-24435) filed on June 18, 2001, and incorporated by reference herein).
3.8 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).
10.1 Amendment No. 2 to the Company's 1997 Director Option Plan.
10.2 Registration Rights Agreement, dated as of August 29, 2001, by and among the Company and
certain individuals and entities set forth therein (Filed as Exhibit 10.1 to the Company's
Current Report on Form 8-K (File No. 000-24435) filed on September 5, 2001, and
incorporated by reference herein).
10.3 Consent and Amendment Number One to Amended and Restated Loan and Security Agreement, dated
as of August 29, 2001, by and among Foothill Capital Corporation, the Company and
MicroStrategy Services Corporation.
10.4 Amended and Restated General Continuing Guaranty, dated as of August 29, 2001, by the
Company, Aventine, Incorporated, MicroStrategy Capital Corporation, MicroStrategy
Management Corporation and Strategy.com Incorporated, in favor of Foothill Capital
Corporation.
B. Reports on Form 8-K
On July 6, 2001, the Company filed a Current Report on Form 8-K dated July 2,
2001 to report that (a) the conversion price of the outstanding shares of series
A preferred stock was adjusted in accordance with the terms of the Company's
Certificate of Designations, Preferences and Rights of the Series A Convertible
Preferred Stock and (b) the Company had issued a press release announcing that
NCR Corporation had dismissed its patent infringement lawsuit against the
Company filed on June 20, 2001 in the United States District Court for the
District of Delaware.
On August 7, 2001, the Company filed a Current Report on Form 8-K dated July 31,
2001 to report that it had issued a press release announcing its financial
results for the quarter ended June 30, 2001, and providing additional outlook
and financial guidance information.
On September 5, 2001, the Company filed a Current Report on Form 8-K dated
August 29, 2001 to report that (a) it had acquired the remaining 16,536,049
outstanding shares of Series A Preferred Stock of Strategy.com Incorporated in
exchange for the issuance of 3,500,000 shares of the Company's class A common
stock; (b) the Company had entered into a registration rights agreement in
connection with the exchange transaction; and (c) the exchange transaction
resulted in the holders of the Company's series E preferred stock having the
right to require the Company's redemption of such stock, and such right had been
exercised with respect to the 360 shares of Series E Preferred Stock then
outstanding.
All other items included in a Quarterly Report of Form 10-Q are omitted because
they are not applicable or the answers are "none".
50
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: November 13, 2001
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