SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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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 May 1, 2002 was 47,043,999 and 46,431,368,
respectively.
MICROSTRATEGY INCORPORATED
FORM 10-Q
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2002 (unaudited) and December 31, 2001.................... 1
Consolidated Statements of Operations For the Three Months Ended March 31, 2002 (unaudited) and
2001 (unaudited)...................................................................................... 3
Consolidated Statements of Cash Flows For the Three Months Ended March 31, 2002 (unaudited) and
2001 (unaudited)...................................................................................... 4
Notes to Consolidated Financial Statements (unaudited)................................................ 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................. 21
Item 3. Quantitative and Qualitative Disclosures About Market Risk............................................ 44
PART II. OTHER INFORMATION
Item 1. Legal Proceedings..................................................................................... 46
Item 6. Exhibits and Reports on Form 8-K...................................................................... 47
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MICROSTRATEGY INCORPORATED
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
March 31, December 31,
2002 2001
--------- ------------
(unaudited)
Assets
Current assets:
Cash and cash equivalents $ 32,627 $ 38,409
Restricted cash 194 439
Short-term investments 590 904
Accounts receivable, net 22,652 22,281
Prepaid expenses and other current assets 4,736 5,902
--------- ---------
Total current assets 60,799 67,935
--------- ---------
Property and equipment, net 24,303 26,506
Goodwill and intangible assets, net 4,437 5,402
Deposits and other assets 5,913 3,789
--------- ---------
Total assets $ 95,452 $ 103,632
========= =========
Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
Accounts payable and accrued expenses $ 17,210 $ 18,935
Accrued compensation and employee benefits 8,373 13,654
Accrued interest and preferred dividends 8,012 7,351
Accrued restructuring costs 6,455 7,422
Deferred revenue and advance payments 22,796 20,987
Contingency from terminated contract 17,167 17,074
Working capital line of credit -- 1,212
Net liabilities of discontinued operations 3,309 4,479
--------- ---------
Total current liabilities 83,322 91,114
--------- ---------
Deferred revenue and advance payments 4,198 5,431
Accrued litigation settlement 65,120 68,637
Other long-term liabilities 2,929 3,536
Accrued restructuring costs 4,861 4,271
--------- ---------
Total liabilities 160,430 172,989
--------- ---------
Commitments and contingencies
Series A redeemable convertible preferred stock, par value $0.001 per
share, 18 shares authorized, 1 and 1 shares issued and
outstanding, respectively 6,449 6,385
Series B redeemable convertible preferred stock, par value $0.001
per share, 3 shares authorized, 3 and 3 shares issued and
outstanding, respectively 32,422 32,343
Series C redeemable convertible preferred stock, par value $0.001
per share, 3 shares authorized, 3 and 3 shares issued and
outstanding, respectively 26,130 25,937
The accompanying notes are an integral part of these Consolidated Financial
Statements.
1
MICROSTRATEGY INCORPORATED
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
(Continued)
March 31, December 31,
2002 2001
--------- ------------
(unaudited)
Series D convertible preferred stock, par value $0.001 per share, 2 shares
authorized, 1 and 1 shares issued and outstanding,
respectively 4,215 3,985
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, 46,429 and 43,689 shares issued and outstanding,
respectively 46 44
Class B common stock, par value $0.001 per share, 165,000 shares
authorized, 46,531 and 48,233 shares issued and outstanding,
respectively 47 48
Additional paid-in capital 240,379 239,580
Deferred compensation (69) (99)
Accumulated other comprehensive income 2,545 2,547
Accumulated deficit (377,142) (380,127)
--------- ---------
Total stockholders' equity (deficit) (134,194) (138,007)
--------- ---------
Total liabilities, convertible preferred stock and stockholders'
equity (deficit) $ 95,452 $ 103,632
========= =========
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)
(unaudited)
Three Months Ended
March 31,
--------------------
2002 2001
-------- --------
Revenues:
Product licenses $ 14,498 $ 18,636
Product support and other services 21,161 30,776
-------- --------
Total revenues 35,659 49,412
-------- --------
Cost of revenues:
Product licenses 521 1,049
Product support and other services 6,640 15,345
-------- --------
Total cost of revenues 7,161 16,394
-------- --------
Gross profit 28,498 33,018
-------- --------
Operating expenses:
Sales and marketing 12,470 26,630
Research and development 5,351 10,463
General and administrative 6,762 11,728
Restructuring and impairment charges 1,232 --
Amortization of goodwill and intangible assets 965 4,249
-------- --------
Total operating expenses 26,780 53,070
-------- --------
Income (loss) from operations 1,718 (20,052)
Financing and other income (expense):
Interest income 230 809
Interest expense (1,619) (284)
Loss on investments (289) (1,097)
Reduction in estimated cost of litigation settlement 3,460 9,665
Other expense, net (116) (90)
-------- --------
Total financing and other income 1,666 9,003
-------- --------
Income (loss) from continuing operations before income taxes 3,384 (11,049)
Provision for income taxes 399 289
-------- --------
Net income (loss) from continuing operations 2,985 (11,338)
-------- --------
Discontinued operations:
Loss from discontinued operations -- (9,233)
-------- --------
Net income (loss) 2,985 (20,571)
-------- --------
Dividends on and accretion of series A, B, C, and D convertible
preferred stock (2,557) (2,158)
-------- --------
Net income (loss) attributable to common stockholders $ 428 $(22,729)
======== ========
Basic earnings (loss) per share:
Continuing operations $ 0.00 $ (0.17)
Discontinued operations $ -- $ (0.11)
-------- --------
Net income (loss) attributable to common stockholders $ 0.00 $ (0.28)
======== ========
Weighted average shares outstanding used in computing basic
earnings (loss) per share 93,377 81,269
======== ========
Diluted earnings (loss) per share:
Continuing operations $ (0.08) $ (0.17)
Discontinued operations $ -- $ (0.11)
-------- --------
Net income (loss) attributable to common stockholders $ (0.08) $ (0.28)
======== ========
Weighted average shares outstanding used in computing diluted
earnings (loss) per share 118,824 81,269
======== ========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
3
MICROSTRATEGY INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Three Months Ended
March 31,
------------------
2002 2001
------- --------
Operating activities:
Net income (loss) from continuing operations $ 2,985 $(11,338)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 3,493 7,368
Bad debt provision (461) 2,511
Net realized loss on sale and write-down of short-term investments 289 1,097
Non-cash portion of restructuring and impairment charges (36) --
Decrease in estimated cost of litigation settlement (3,460) (9,665)
Non-cash charges and fees on Credit Facility 172 53
Other, net 447 151
Changes in operating assets and liabilities:
Accounts receivable 90 9,830
Prepaid expenses and other current assets 1,261 1,049
Deposits and other assets (2,669) (583)
Accounts payable and accrued expenses, compensation and employee benefits,
interest and preferred dividends (5,157) (12,875)
Accrued restructuring costs (341) --
Deferred revenue and advance payments, net of reclass on contingency from
terminated contract 704 (6,612)
Other long-term liabilities (607) --
------- --------
Net cash used in operating activities (3,290) (19,014)
------- --------
Investing activities:
Purchases of property and equipment (582) (1,842)
Purchases of short-term investments -- (1,599)
Proceeds from sales of short-term investments -- 2,166
Decrease in restricted cash 245 25,484
------- --------
Net cash (used in) provided by investing activities (337) 24,209
------- --------
Financing activities:
Proceeds from sale of class A common stock and exercise of stock options 565 3,471
Proceeds from term loan in connection with the Credit Facility -- 10,000
Net cash payments under the Modified Credit Facility (1,316) --
------- --------
Net cash (used in) provided by financing activities (751) 13,471
Effect of foreign exchange rate changes on cash and cash equivalents (234) (588)
------- --------
Net (decrease) increase in cash and cash equivalents from continuing operations (4,612) 18,078
Net cash (advanced to) received from discontinued operations (1,170) 3,459
------- --------
Net (decrease) increase in cash and cash equivalents (5,782) 21,537
Cash and cash equivalents, beginning of period 38,409 33,203
------- --------
Cash and cash equivalents, end of period $32,627 $ 54,740
======= ========
Supplemental disclosure of noncash investing and financing activities:
Stock received in exchange for products and services $ 93 $ 762
======= ========
Issuance of class A common stock warrants $ -- $ 414
======= ========
Payment of redeemable convertible preferred stock dividends through the
issuance of class A common stock $ 2,811 $ 599
======= ========
The accompanying notes are an intergral 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 ("MicroStrategy" or
the "Company") as of March 31, 2002, the related consolidated statements of
operations for the three months ended March 31, 2002 and 2001 and the
consolidated statements of cash flows for the three months ended March 31, 2002
and 2001 are unaudited. In the opinion of management, all adjustments
(consisting of normal recurring items) necessary for a fair presentation of such
financial statements have been included. Interim results are not necessarily
indicative of results for a full year.
The consolidated financial statements and notes are presented as required by
Form 10-Q and do not contain certain information included in the Company's
annual financial statements and notes. These financial statements should be read
in conjunction with the Company's audited financial statements and the notes
thereto filed with the Securities and Exchange Commission ("SEC") in the
Company's Annual Report on Form 10-K for the year ended December 31, 2001.
The Company has incurred substantial losses for each of the three years in the
period ended December 31, 2001. For the three months ended March 31, 2002, the
Company incurred negative cash flows from operations of $3.3 million. As of
March 31, 2002, the Company had an accumulated deficit of $377.1 million and a
working capital deficit of $2.0 million, excluding contingency from terminated
contract and net liabilities of discontinued operations of $17.2 million and
$3.3 million, respectively. The Company has taken several actions to realign its
cost structure to better match its expected revenues, including reducing its
workforce, consolidating its office space, reducing and limiting discretionary
operating expenses, reducing capital expenditures, and discontinuing the
operations of Strategy.com. Additionally, the Company is exploring alternative
financing arrangements, which include credit facilities, the sale of equity in
MicroStrategy, or other financing sources for the Company. Alternative debt or
equity financing may not be available on acceptable terms. If financing is not
available on acceptable terms and/or if the Company does not achieve revenues
and generate cash flow at anticipated levels, it will need to take further
actions to reduce costs in order to minimize 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 7) will
be sufficient to meet the Company's working capital requirements and anticipated
capital expenditures through the end of 2002.
Certain prior year amounts in the consolidated financial statements have been
reclassified to conform to the current year presentation.
(2) Recent Accounting Standards
In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations,"
which addresses the financial accounting and reporting for business combinations
and supersedes Accounting Principles Board Opinion No. 16, "Business
Combinations," and SFAS No. 38, "Accounting for Preacquisition Contingencies of
Purchased Enterprises," and is applicable to business combinations initiated
after June 30, 2001. SFAS No. 141 requires business combinations initiated after
June 30, 2001 to be accounted for using the purchase method of accounting and
broadens the criteria for recording intangible assets separate from goodwill.
Recorded goodwill and intangibles will be evaluated against the new criteria and
may result in certain intangibles being reclassified to goodwill, or
alternatively, amounts initially recorded as goodwill may be separately
identified and recognized apart from goodwill. The adoption of this statement as
of January 1, 2002 had no material impact on the Company's consolidated
financials statements.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which is effective for the Company beginning in 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 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. The adoption of this standard as of
January 1, 2002 did not have a material impact on the Company's amortization of
goodwill and intangible assets.
5
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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 adoption of this statement as of
January 1, 2002 did not have a material impact on the Company's consolidated
financial statements.
In November 2001, the FASB staff reached a consensus on Emerging Issues Task
Force ("EITF") Issue No. 01-09, "Accounting for Consideration Given by a Vendor
to a Customer or a Reseller of the Vendor's Products." EITF No. 01-09 concludes
that consideration from a vendor to a customer or a reseller is a reduction of
the selling price of the vendor's products or services and, therefore, should be
characterized as a reduction of revenue when recognized in the vendor's income
statement. EITF No. 01-09 is effective for fiscal years beginning after December
15, 2001 and all prior period amounts are required to be reclassified to conform
to the current period presentation. The adoption of this standard as of January
1, 2002 did not have any impact on the Company's consolidated financial
statements.
In November 2001, the FASB staff issued EITF Topic D-103, "Income Statement
Characterization of Reimbursements Received for 'Out-of-Pocket' Expenses
Incurred," which has subsequently been recharacterized as EITF Issue No. 01-14.
EITF No. 01-14 requires that reimbursements received for out-of-pocket expenses,
such as airfare, mileage, hotel stays, and out-of-town meals, be characterized
as revenues in the consolidated statement of operations. EITF No. 01-14 is
effective for all fiscal years beginning after December 15, 2001, and requires
reclassification of all prior period amounts to conform to the current period
presentation. During the first quarter of 2002, the Company classified $207,000
of such reimbursed out-of-pocket expenses as product support and other services
revenues. The consolidated statement of operations for the first quarter of 2001
has been reclassified to include $463,000 of such reimbursed out-of-pocket
expenses as product support and other services revenues with a corresponding
increase to the cost of product support and other services. The adoption of this
standard as of January 1, 2002 had no impact on the Company's net income (loss)
for either period.
(3) Discontinued Operations
During the second quarter of 2001, the Company substantially curtailed
operations of its subsidiary, Strategy.com, and reduced the Strategy.com
workforce to approximately 40 employees. During the third quarter of 2001, the
Company further reduced the Strategy.com workforce to approximately 6 employees
and continued to review its options with respect to the remaining assets of
Strategy.com. On December 31, 2001, the Company discontinued the operations of
Strategy.com and shut down its services. Accordingly, the Company recorded a
loss from abandonment of its discontinued operations of $2.1 million during the
fourth quarter of 2001. The loss from abandonment included remaining lease
payments associated with abandoned computer equipment, personal property taxes
due under equipment leases, certain other costs, and estimated results from
operations from the measurement date of December 31, 2001 through the expected
disposal date in the first half of 2002. The historical consolidated financial
statements of the Company reflect Strategy.com as a discontinued operation for
all periods presented. Strategy.com revenues were $0 and $2.4 million for the
three months ended March 31, 2002 and 2001, respectively. The net loss from
Strategy.com was $0 and $9.2 million for the three months ended March 31, 2002
and 2001, respectively. The net liabilities of Strategy.com included within net
liabilities of discontinued operations in the accompanying consolidated balance
sheets consist of the following, as of, (in thousands):
6
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
March 31, December 31,
2002 2001
--------- ------------
Current assets (liabilities):
Cash and cash equivalents $ -- $ --
Accounts receivable, net 11 25
Prepaid expenses and other current assets 22 272
Accounts payable and accrued expenses (3,129) (4,307)
Accrued compensation and employee benefits -- (100)
Accrued restructuring costs (213) (300)
Deferred revenue and advance payments -- (3)
Other liabilities -- (66)
------- -------
Net liabilities of discontinued operations $(3,309) $(4,479)
======= =======
(4) Investments
The following summarizes by major security type the fair market value and cost
of the Company's investments as of, (in thousands):
March 31, December 31,
2002 2001
------------ ------------
Fair Fair
Value Cost Value Cost
----- ---- ----- ----
Marketable equity securities $590 $629 $904 $826
Non-publicly traded equity securities -- -- -- --
---- ---- ---- ----
$590 $629 $904 $826
==== ==== ==== ====
Classified as:
Short-term investments $590 $904
Long-term investments -- --
---- ----
$590 $904
==== ====
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. Due to a subsequent decrease in
the market value of the publicly-traded company's common 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, 2001 and recognized a loss
of $1.4 million during 2001. Due to a further decrease in the market value of
the publicly-traded company's common stock during the first quarter of 2002 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, 2002 and
recognized a loss of $209,000 during the three months ended March 31, 2002.
During 2000, the Company received 805,800 shares of Exchange Applications, Inc.
("Exchange Applications") common stock, originally valued at $13.1 million, in
consideration for the sale of MicroStrategy software, technical support and
consulting services. During the first quarter of 2001, the Company sold 161,300
of these shares for a gain of $24,000.
In March 2001, the Company received an additional 320,733 shares of Exchange
Applications' stock, originally valued at $762,000, in consideration for the
sale of MicroStrategy software, technical support and consulting services. Due
to a subsequent decrease in the market value of Exchange Applications' 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
7
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
March 31, 2001 and recognized a loss of $281,000 during the three months ended
March 31, 2001.
In January 2002, the Company received an additional 320,733 shares of Exchange
Applications' stock, originally valued at $93,000, in consideration for the sale
of MicroStrategy software, technical support and consulting services. Due to a
subsequent decrease in the market value of Exchange Applications' 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, 2002 and
recognized a loss of $80,000 during the three months ended March 31, 2002.
(5) Accounts Receivable
Accounts receivable, net of allowances, consist of the following, as of (in
thousands):
March 31, December 31,
2002 2001
--------- ------------
Billed and billable $36,699 $ 41,997
Less: billed and unpaid deferred revenue (8,756) (12,607)
------- --------
27,943 29,390
Less: allowance for doubtful accounts (5,291) (7,109)
------- --------
$22,652 $ 22,281
======= ========
The Company offsets its accounts receivable and deferred revenue for any billed
and unpaid items included in deferred revenue and advance payments.
(6) Contingency from Terminated Contract
In the third quarter of 2001, the Company notified Exchange Applications, Inc.
that it was in material default in the performance of its obligations under the
software development and OEM agreement (the "OEM Agreement") that the companies
had entered into as of December 28, 1999. The Company advised Exchange
Applications that it must use commercially reasonable efforts to cure the
defaults by paying the Company approximately $23.3 million plus interest.
Exchange Applications responded by denying the default of its obligations and
alleging that the Company had breached its contractual obligations. Exchange
Applications also informed the Company that it may seek a reimbursement of all
amounts paid to MicroStrategy, including a refund of $10.0 million and the
return of 2,592,741 shares of common stock of Exchange Applications, 320,733
shares of which were received by the Company in January 2002. Management
believes that the Company has not committed any breach of obligations alleged by
Exchange Applications. Accordingly, the Company responded to Exchange
Applications by denying the claim and, in the fourth quarter of 2001, sent a
notice of termination to terminate the OEM Agreement as a result of Exchange
Applications' material default. As of March 31, 2002, Exchange Applications had
not agreed to the termination. Because the Company is no longer performing
services under the OEM Agreement, the remaining current and long-term deferred
revenue associated with the contract of $9.4 million and $7.8 million,
respectively, or $17.2 million in aggregate, has been classified as contingency
from terminated contract in the accompanying consolidated balance sheet as of
March 31, 2002. The ultimate resolution of this contract dispute will determine
the final disposition of the recorded amounts. The final resolution of this
matter is currently uncertain; however, the Company does not believe it will
incur any additional liabilities related to this contract dispute.
(7) Borrowings
In March 1999, the Company entered into a line of credit agreement with a
commercial bank which provided for a $25.0 million unsecured revolving line of
credit for general working capital purposes. In May 2000, the Company entered
into a modification of the line of credit agreement, which, among other things,
increased the aggregate credit available to include an additional letter of
credit, removed any financial covenants and cured any financial covenant
defaults. The line of credit accrued interest at LIBOR plus 1.75%, included a
0.2% unused line of credit fee, and required monthly payments of interest. The
line of credit was secured by $25.9 million of cash and cash equivalents.
8
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
The cash was restricted through February 2001, at which time the agreement was
terminated upon the closing of a new credit facility agreement described below.
On February 9, 2001, the Company entered into a loan and security agreement (the
"New Credit Facility") with Foothill Capital, a subsidiary of Wells Fargo Bank,
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, and replaced the
previous line of credit agreement. 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
through March 2002, and the 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.
Borrowings under the Modified Credit Facility bear interest at a variable rate.
The Company's borrowing rate in effect at March 31, 2002 was 6.25%. The Modified
Credit Facility also includes an annual 1.50% letter of credit fee. Monthly
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. During the three months ended March 31, 2002, the
Company made payments under the Modified Credit Facility of $2.3 million
which were offset by cash advances of $1.0 million. At March 31, 2002, the
Company had no principal amounts outstanding under the Modified Credit Facility.
Taking into account outstanding letters of credit of $5.6 million, the Company
had $24.4 million available for future drawdowns, subject to borrowing base
limitations. As a result of the borrowing base limitations, $4.5 million of
additional borrowing capacity under the Modified Credit Facility was available
at March 31, 2002. If the borrowing base is less than the outstanding letters of
credit, the Company is required to deposit an amount of cash equal to the
deficiency into a restricted account.
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 March 31, 2002, the
Company was in compliance with all covenants. The Modified Credit Facility
included a covenant to raise $10.0 million of additional financing by March 31,
2002 through equity financing, subordinated debt, or net proceeds from the sale
of non-core assets, as defined in the agreement, which was modified in February
2002 to extend the date by which this additional financing is required to June
30, 2002. On April 26, 2002, the Modified Credit Facility was further amended to
eliminate this covenant requiring additional financing. Additionally, in
conjunction with the amendment, the financial covenant requiring achievement of
certain minimum earnings amounts was revised to increase the levels of those
minimum earnings amounts in future periods.
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, and expiring five years after the
date of issuance. The fair value of the warrants of $414,000 was accounted for
as debt issuance costs and will be amortized as 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 during the three
months ended March 31, 2002. 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
9
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
recorded as interest expense. During 2002, 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. As a result of a decline in the
fair value of the warrants as of March 31, 2002, the Company recorded reductions
in the carrying value of its warrant liability and a decrease in interest
expense in the amount of $20,000 during the three months ended March 31, 2002.
(8) Deferred Revenue and Advance Payments
Deferred revenue and advance payments from customers consist of the following,
as of (in thousands):
March 31, December 31,
2002 2001
--------- ------------
Current:
Deferred product revenue $ 624 $ 2,587
Deferred product support and other services revenue 30,602 30,480
------- --------
31,226 33,067
Less: billed and unpaid deferred revenue (8,430) (12,080)
------- --------
$22,796 $ 20,987
======= ========
Non-current:
Deferred product revenue $ 498 $ 709
Deferred product support and other services revenue 4,026 5,249
------- --------
4,524 5,958
Less: billed and unpaid deferred revenue (326) (527)
------- --------
$ 4,198 $ 5,431
======= ========
The Company offsets its accounts receivable and deferred revenue for any billed
and unpaid items included in deferred revenue and advance payments.
(9) 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 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. On March 12, 2002, the United States District Court entered the final
distribution order allowing distribution of the settlement consideration. The
Company expects that the consideration will be issued to the class members in
the second or third quarter of 2002 after the remaining closing conditions have
been met. At a hearing on August 7, 2001, the Chancery Court approved the
derivative settlement.
10
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Under the class action settlement agreements, class members will receive: 1)
five-year unsecured subordinated promissory notes issued by the Company having
an aggregate principal amount of $80.5 million and bearing interest at 7.5% per
year; 2) 2,777,778 shares of the Company's class A common stock; and 3) warrants
issued by the Company to purchase 1,900,000 shares of the Company's class A
common stock at an exercise price of $40 per share, with the warrants expiring
five years from the date they are issued. The 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.
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. Upon
maturity, the outstanding principal balance of the promissory notes will become
due.
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, were required
to tender to the Company for no consideration an aggregate of 1,683,504 shares
of class A common stock for cancellation. On November 7, 2001, Mr. Saylor, Mr.
Bansal, and Mr. Lynch contributed 1,683,504 shares of class A common stock to
the Company. Since Mr. Saylor and Mr. Bansal are principal shareholders of the
Company, their actions were deemed to be actions undertaken on behalf of the
Company for accounting purposes. Accordingly, the Company recognized a capital
contribution during the fourth quarter of 2001 for the shares received from Mr.
Saylor and Mr. Bansal for approximately $4.3 million, which represents the fair
value of the stock on the date of the contribution, and a corresponding increase
in treasury stock for that same amount. Upon receipt, the Company immediately
canceled the contributed shares. Accordingly, upon completion of the
distribution of the securities under the settlement agreements, the Company will
have effected a net issuance of 1,094,274 shares of class A common stock as part
of the class action settlement.
Based on the terms of the settlement agreements, the Company determined that a
liability related to these actions was probable and that the value was
reasonably estimable. Accordingly, during 2000, the Company established an
estimate for the cost of the litigation settlement of $89.7 million, net of
insurance recoveries of $13.0 million. Subsequently, during each successive
financial reporting period, the Company has updated the estimated value assigned
to each individual component of the settlement based upon valuation assumptions
stemming from the settlement. As a result of the changes in the estimated value
of each element of the securities litigation settlement, the Company recorded an
aggregate reduction in the provision for the litigation settlement of $3.5
million and $9.7 million during the three months ended March 31, 2002 and 2001,
respectively. The reduction in estimated cost of litigation settlement was
comprised of the following, during the periods ending (in thousands):
11
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
March 31, March 31,
2002 2001
--------- ---------
Promissory notes to be issued $ -- $ --
Class A common stock to be issued (2,222) --
Warrants to be issued (1,238) (9,915)
Pending loss on additional settlement -- 250
Legal fees -- --
Administration costs -- --
------- -------
Reduction in estimated cost of litigation settlement $(3,460) $(9,665)
======= =======
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 2000 assuming a market
borrowing rate of 12%. Based on an estimated market borrowing rate of 12%, an
expected discount of $11.3 million was initially computed on the unsecured
subordinated promissory notes during 2000. Due to changes in market conditions
since the settlement, the fair value of the promissory notes was revalued
utilizing an estimated market borrowing rate of 20% during the second quarter of
2001. 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 market conditions and assumptions remained similar, no change in the
estimated fair value of the promissory notes was recorded during the first
quarter of 2002. Upon issuance of these promissory notes, the discount will be
amortized to interest expense over the term of the promissory notes.
Prior to approval of the class action settlement by 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 from $3.85 per share as of
December 31, 2001 to $3.05 per share as of March 31, 2002, the value of the
common stock to be issued under the settlement agreement was reduced by $2.2
million to $8.5 million during the first quarter of 2002.
The fair value of the warrants to be issued in connection with the litigation
settlement was computed utilizing the Black-Scholes pricing model with the
following assumptions used for the calculation during the first quarter of 2002
and 2001, respectively: volatility factors of 120% and 119%, risk free interest
rate of 4.9% and 5.5%, expected life of 5 years, and no dividend yield. As a
result of changes in the estimated fair value of the warrants during the first
quarter of 2002 and 2001, the Company recorded reductions in the provision for
the litigation settlement of $1.2 million and $9.9 million, respectively, during
the three months ended March 31, 2002 and 2001.
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 and until they are exercised or expire.
12
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
The details of the accrued litigation settlement consist of the following, as of
(in thousands):
March 31, 2002 December 31, 2001
--------------------------------------- ---------------------------------------
Accounts Accrued Accounts Accrued
Payable and Litigation Total Payable and Litigation Total
Accrued Expenses Settlement Accrual Accrued Expenses Settlement Accrual
---------------- ---------- ------- ---------------- ---------- -------
Promissory notes to be issued $ -- $52,500 $52,500 $ -- $52,500 $52,500
Class A common stock to be issued -- 8,473 8,473 -- 10,695 10,695
Warrants to be issued -- 4,014 4,014 -- 5,252 5,252
Pending loss on additional settlement -- 133 133 -- 190 190
Legal fees 69 -- 69 331 -- 331
Administration costs 409 -- 409 409 -- 409
---- ------- ------- ---- ------- -------
Total accrual $478 $65,120 $65,598 $740 $68,637 $69,377
==== ======= ======= ==== ======= =======
(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 alleged that these employees, who previously worked for the Company,
breached their fiduciary and contractual obligations to the Company by, among
other things, misappropriating trade secrets and confidential information and
soliciting the Company's employees and customers. The Company's complaint sought
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. A trial date has not yet
been set in the Northern District of California action. 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. On March 13,
2002, the Company voluntarily dismissed without prejudice its lawsuit pending in
the Virginia Circuit Court for Fairfax County against the two field employees of
BO. On April 2, 2002, the Company amended its complaint against BO to add claims
for violations of the federal Computer Fraud and Abuse Act, misappropriation of
trade secrets, and tortious interference with contractual relations. On May 13,
2002, the Company submitted an agreed order to further amend its complaint
against BO to add claims for violations of the Virginia Conspiracy Act. The
Company is seeking monetary damages and injunctive relief. Trial is scheduled to
commence on October 8, 2002.
(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.
13
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(10) Redeemable Convertible Preferred Stock
On June 19, 2000, the Board of Directors of the Company authorized the issuance
of 17,500 shares of series A redeemable convertible preferred stock with a par
value of $0.001 per share. Upon adoption of this resolution, 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 all but 650 shares of its series
A redeemable convertible preferred stock with a combination of cash, class A
common stock and newly issued preferred stock. The 650 shares of the series A
redeemable convertible stock that remain outstanding have a stated value of $6.5
million. The Company redeemed or exchanged the remaining 11,850 shares of its
series A redeemable convertible preferred stock as follows:
... $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;
... $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;
... $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;
... $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
the Company elects to mandatorily convert these shares into class A common
stock; and
... $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. In November 2001, holders of
the series D preferred stock exercised their right to convert series D preferred
stock and converted 175 shares of series D preferred stock into shares of class
A common stock at the fixed conversion price of $5 per share. As a result of the
conversion, the Company issued 350,000 shares of class A common stock. The
difference between the carrying value of the 175 shares of series D preferred
stock at the time of conversion and the par value of the class A common stock
was recorded as an increase in additional paid-in capital.
14
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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. This cash redemption
payment was substantially equal to the carrying value of the series E preferred
stock on the date of redemption.
The series B and series C preferred stock is redeemable upon certain triggering
events such as suspension from trading or failure of the Company's class A
common stock to be listed on the Nasdaq National Market or the Nasdaq SmallCap
Market for a period of five consecutive trading days or for more than an
aggregate of ten trading days in any 365-day period and other events as defined
in the respective Certificate of Designations, Preferences and Rights of the
series B and series C preferred stock. In the event of redemption upon a
triggering event, the series B and series C preferred stock is redeemable 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. The series D preferred stock is
also redeemable upon certain triggering events as defined in the Certificate of
Designations, Preferences and Rights of the series D preferred stock. In the
event of redemption upon a triggering event, the series D preferred stock is
redeemable at the stated value of such shares of preferred stock or the product
of the number of shares of class A common stock into which the series D
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. As of March 31, 2002, none of these triggering events have
occurred. In addition, upon a change of control of the Company, each holder of
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.
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. 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 accordance with the terms of the agreements relating to the issuance of
redeemable convertible preferred stock, the Company may be required to pay
substantial penalties to a holder of preferred stock under specified
circumstances, including nonpayment of dividends on series A, series B, and
series C preferred stock, failure to deliver shares of class A common stock upon
the conversion of preferred shares, nonpayment of the redemption price at
maturity of any remaining series A, series B, and series C preferred stock, and
the unavailability of the registration statement relating to the shares of class
A common stock issuable upon conversion of and in lieu of cash dividends on the
preferred stock to cover the resale of such shares for more than brief
intervals. Such penalties are generally paid in the form of interest payments,
subject to any restrictions imposed by applicable law.
In connection with the refinancing of the Company's series A redeemable
convertible preferred stock in June 2001, the Company determined that 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 of $118.5 million
over the carrying value of those preferred securities of $107.5 million, or
$11.0 million, plus the pro-rata portion of the previously recognized beneficial
conversion feature on the series A preferred shares redeemed of $18.4 million.
15
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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 months ended March 31, 2002, accretion to the carrying
value of the beneficial conversion feature was $231,000.
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 650
remaining shares of series A preferred stock was adjusted downward from $33.39
per share 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 days
immediately preceding July 5, 2001. As a result of this adjustment to the
conversion price, the series A preferred stock is convertible, as of March 31,
2002, 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 elected to
mandatorily convert the 650 remaining shares of series A preferred stock at its
June 19, 2002 maturity into class A common stock based on a conversion price
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. The series A preferred stock is redeemable upon
certain triggering events such as suspension from trading or failure of the
Company's class A common stock to be listed on the Nasdaq National Market for a
period of five consecutive trading days or for more than an aggregate of ten
trading days in any 365-day period and other events as defined in the
Certificate of Designations, Preferences and Rights of the series A 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 March 31, 2002, none of these triggering events
have occurred. In addition, upon a change of control of the Company, each holder
of series A 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.
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 months ended March 31, 2002,
accretion to the carrying value of the preferred stock was $335,000. 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 months ended March 31, 2002 and 2001, the Company accrued total
dividends of $2.0 million and $2.2 million, respectively, on all of its series
of preferred stock. During the three months ended March 31, 2002, the Company
paid aggregate preferred stock dividends valued at $2.8 million through the
issuance of 756,726 shares of class A common stock in lieu of cash. During the
three months ended March 31, 2001, the Company paid aggregate preferred stock
dividends valued at $599,000 through the issuance of 63,146 shares of class A
common stock in lieu of cash. As of March 31, 2002 and December 31, 2001, the
Company accrued preferred stock dividends of $2.0 million and $2.8 million,
respectively, which are included in accrued interest and preferred dividends in
the accompanying consolidated balance sheets.
(11) Redeemable Convertible Preferred Stock of Discontinued Operations
In October 2000, the Board of Directors of Strategy.com authorized the issuance
of 47,884,011 shares of series A redeemable convertible preferred stock with a
par value of $0.001. Dividends are accreted at a rate of $0.2552 per annum. The
preferred stock is automatically convertible into class A common stock of
Strategy.com, at the then
16
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
effective conversion rate, at the time of an initial public offering resulting
in at least $30.0 million of net proceeds to Strategy.com. The preferred shares
are mandatorily redeemable for $3.19 per share plus any dividends accrued or
declared but unpaid thereon at mandatory redemption dates of October 17, 2005,
2006 and 2007, with the maximum redemption portions at each date being 33%, 50%
and 100%, respectively. Each holder of outstanding shares of series A redeemable
convertible preferred stock of Strategy.com is entitled to the number of votes
equal to the number of whole shares of Strategy.com common stock into which the
shares of series A redeemable convertible preferred stock held by such holder
are convertible as of the record date for determining stockholders entitled to
vote on such matters. Additionally, the preferred stock has a liquidation
preference of $3.19 per share plus any dividends accrued or declared but unpaid
thereon.
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") pursuant to which 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 attributable to common stockholders. This gain represented 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.
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 ended March 31, 2001, the Company accreted offering costs and dividends
of $1.1 million on the preferred stock of Strategy.com. The accretion of
offering costs and dividends on Strategy.com's preferred stock until the date of
redemption was previously classified as minority interest and is now reflected
within loss from discontinued operations in the accompanying consolidated
statements of operations.
(12) Comprehensive Income (Loss)
Comprehensive income (loss) includes foreign currency translation adjustments
and unrealized gains and losses on short-term investments, net of related tax
effects, that have been excluded from net loss and reflected in stockholders'
equity (deficit) as accumulated other comprehensive income.
Comprehensive income (loss) for the three months ended March 31, 2002 and 2001
is calculated as follows (in thousands):
Three Months Ended
March 31,
------------------
2002 2001
------ --------
Net income (loss) $2,985 $(20,571)
Foreign currency translation adjustment 115 (287)
Unrealized loss on short-term investments, net of applicable taxes (117) (443)
------ --------
Comprehensive income (loss) $2,983 $(21,301)
====== ========
(13) 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
17
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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. 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 to
be a participating convertible security and is therefore included in the
computation of basic earnings (loss) per share to the extent they are dilutive.
Three months ended Three months ended
March 31, 2002 March 31, 2001
--------------------------------------- ---------------------------------------
Income Shares Per Share Income Shares Per Share
(Numerator) (Denominator) Amount (Numerator) (Denominator) Amount
----------- ------------- --------- ----------- ------------- ---------
Net income (loss) from continuing
operations $ 2,985 $(11,338)
Loss from discontinued operations -- (9,233)
-------- --------
Net income (loss) 2,985 (20,571)
Dividends on and accretion of series
A, B, C, and D convertible
preferred stock (2,557) (2,158)
-------- --------
Net income (loss) attributable
to common stockholders 428 (22,729)
Effect of common stock:
Weighted average shares of
class A common stock 46,846 30,293
Weighted average shares of
class B common stock 46,531 50,976
-------- ------- -------- ------
Basic earnings (loss) per share 428 93,377 $ 0.00 (22,729) 81,269 $(0.28)
====== ======
Effect of dilutive securities:
Series C preferred stock (4,957) 10,500
Series B preferred stock (4,585) 12,500
Series A preferred stock (894) 2,447
-------- ------- -------- ------
Diluted loss per share $(10,008) 118,824 $(0.08) $(22,729) 81,269 $(0.28)
======== ======= ====== ======== ====== ======
The numerator in the diluted loss per share calculation for the three months
ended March 31, 2002 has been adjusted to add a $10.4 million assumed loss on
conversion on the series C, B, and A preferred stock that would have resulted
assuming settlement at the end of the period as required by the share settlement
method.
The diluted loss per share calculation for the three months ended March 31, 2002
excludes series D preferred stock, which was convertible into 2,902,200 shares
of class A common stock, because its effect would have been anti-dilutive.
Employee stock options of 2,675,034 and 3,398,999 for the three months ended
March 31, 2002 and 2001, respectively, have also been excluded from the diluted
loss per share calculation because their effect would have been anti-dilutive.
Additionally, series A preferred stock, which was convertible into 3,744,152
shares of class A common stock, was excluded from the diluted loss per share
calculation for the three months ended March 31, 2001 because its effect would
have been anti-dilutive.
18
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(14) Segment Information
On December 31, 2001, the Company discontinued the operations of Strategy.com
and shut down its services. Accordingly, the historical consolidated financial
statements of the Company reflect Strategy.com as a discontinued operation for
all periods presented (Note 3). Prior to this, the Company had two operating
segments and had begun operating its business as such in the latter part of
1999. As a result of the shutting down of Strategy.com operations, the Company
operates in one significant business segment - business intelligence.
The following summary discloses total revenues and long-lived assets, excluding
long-term net assets of discontinued operations, relating to the Company's
geographic regions (in thousands):
Domestic International Consolidated
-------- ------------- ------------
Three Months Ended March 31, 2002
Total license and service revenues $23,367 $12,292 $35,659
Long-lived assets 32,315 2,338 34,653
Three Months Ended March 31, 2001
Total license and service revenues $32,633 $16,779 $49,412
Long-lived assets 67,249 3,700 70,949
Transfers relating to intercompany software license royalties from international
to domestic operations of $2.4 million and $4.6 million for the three months
ended March 31, 2002 and 2001, respectively, have been excluded from the above
tables and eliminated in the consolidated financial statements.
For the three months ended March 31, 2002 and 2001, no individual customer
accounted for 10% or more of consolidated total revenue.
(15) Restructuring and Impairment Charges
During the second quarter of 2001, the Company adopted a restructuring plan
designed to focus its commercial activities. The restructuring plan included 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 450
domestic and international employees and 147 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.
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. At December 31, 2001, all headcount reductions
were completed.
As a result of these restructuring plans, the Company recorded restructuring and
impairment charges during 2001 for severance costs and other benefits for
terminated employees, the write-down of impaired assets, 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 recoverable or
that the useful lives of these assets are no longer appropriate. Each impairment
test is based on a
19
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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 plans adopted during 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. Additionally, in connection
with a periodic assessment of the carrying value of long-lived assets, the
Company concluded that the products derived from its Teracube intangible asset,
which had been acquired in connection with the purchase of intellectual property
and other tangible and intangible assets relating to NCR Corporation's Teracube
project, would not generate sufficient cash flow to support its carrying value.
Accordingly, the Company recorded an impairment charge to write-down that
intangible asset to its fair value.
In connection with the impairment charges recorded during 2001, certain 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 $912,000. During 2001, the Company sold approximately $400,000 of these
assets held for sale. During the three months ended March 31, 2002, the Company
sold an additional $39,000 of these assets held for sale and recognized a loss
of $137,000 related to the disposal of certain of these assets held for sale.
The following table sets forth a summary of the accrued restructuring costs as
of March 31, 2002 (in thousands):
Accrued Adjustments and Accrued
Restructuring Charges for 2002 2002 Restructuring
Costs at First Non-cash Cash Costs at
December 31, 2001 Quarter 2002 Charges Payments March 31, 2002
----------------- --------------- --------- -------- --------------
Severance and other employee
termination benefits $ 72 $ -- $ -- $ (33) $ 39
Write-down of impaired assets -- -- -- -- --
Estimated sublease losses and
other facility closing costs 10,967 1,232 (36) (1,418) 10,745
Terminations of computer and
equipment leases 485 -- -- (122) 363
Accrual for professional fees 169 -- -- -- 169
------- ------ ---- ------- -------
Total restructuring and
impairment charges $11,693 $1,232 $(36) $(1,573) $11,316
======= ====== ==== ======= =======
Based upon a decline in estimated sublease rates and an increase in the expected
length of time to sublease vacant space, the Company adjusted its restructuring
reserve by recording additional sublease losses of $1.2 million during the three
months ended March 31, 2002. As of March 31, 2002, unpaid amounts of $6.5
million and $4.9 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 second quarter
of 2002. 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 204,000 square feet of vacant
office space, of which 101,000 square feet has been subleased as of March 31,
2002. The remaining vacant office space is currently being marketed for
sublease. The accrual for estimated computer, equipment and real estate losses
of $11.1 million at March 31, 2002 represents $19.7 million in gross lease
obligations and $2.3 million of estimated commissions, concessions, and other
costs, offset by $10.9 million in estimated gross sublease income recoveries
during the remaining lease terms. The Company estimated its sublease losses
based upon current information available relating to sublease commission costs,
sub-tenant concession costs, sublease rental income, and the length of time
expected to sublease excess space. Final amounts could differ from current
estimates once all vacant office space has been entirely sublet. The Company is
also considering terminating certain leases early. Except for its estimated
sublease losses and other facility closing costs and computer and equipment
leases, the Company expects that the 2001 restructuring plans will be
substantially completed by June 2002.
20
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q contains forward-looking statements within
the meaning of Section 21E of the Securities Exchange Act of 1934, as amended.
For this purpose, any statements contained herein that are not statements of
historical fact, including without limitation, certain statements regarding
industry prospects and our results of operations or financial position, may be
deemed to be forward-looking statements. Without limiting the foregoing, the
words "believes," "anticipates," "plans," "expects," and similar expressions are
intended to identify forward-looking statements. The important factors discussed
below under the caption "Risk Factors," among others, could cause actual results
to differ materially from those indicated by forward-looking statements made
herein and presented elsewhere by management from time to time. Such
forward-looking statements represent management's current expectations and are
inherently uncertain. Investors are warned that actual results may differ from
management's expectations.
Overview
We are a leading worldwide provider of business intelligence software 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 workgroups, the enterprise and
extranet communities via e-mail, web, wireless and voice communication channels.
Businesses can use our software platform 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 about 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 7i software to
build stronger relationships by linking customers and suppliers via the
Internet. We also offer a comprehensive set of consulting, education and
technical support services for our customers and partners.
Towards the end of 2000 and throughout 2001 and 2002, we have been affected by
the global economic slowdown which has resulted in a decrease in corporate
spending on information technology. These macro-economic factors have had an
adverse impact on our results of operations.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations
are based upon our condensed consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and assumptions that affect the reported amounts of assets,
liabilities and equity and disclosure of contingent assets and liabilities as of
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting periods. Areas where significant judgments are
made include, but are not limited to, restructuring and impairment charges,
refinancing of preferred stock, discontinued operations, contingency from
terminated contract, litigation, and other contingencies. Actual results could
differ materially from these estimates. For a more detailed explanation of the
judgments made in these areas, refer to our Annual Report on Form 10-K for the
year ended December 31, 2001.
21
Results of Operations
The following table sets forth for the periods indicated the percentage of total
revenues represented by certain items reflected in our consolidated statements
of operations:
Three Months Ended March 31,
----------------------------
2002 2001
----- -----
Statements of Operations Data
Revenues:
Product licenses 40.7% 37.7%
Product support and other services 59.3 62.3
----- -----
Total revenues 100.0 100.0
----- -----
Cost of revenues:
Product licenses 1.5 2.1
Product support and other services 18.6 31.1
----- -----
Total cost of revenues 20.1 33.2
----- -----
Gross profit 79.9 66.8
----- -----
Operating expenses:
Sales and marketing 35.0 53.9
Research and development 15.0 21.2
General and administrative 19.0 23.7
Restructuring and impairment charges 3.4 --
Amortization of goodwill and intangible assets 2.7 8.6
----- -----
Total operating expenses 75.1 107.4
----- -----
Income (loss) from operations 4.8 (40.6)
Financing and other income (expense):
Interest income 0.6 1.6
Interest expense (4.5) (0.6)
Loss on investments (0.8) (2.2)
Reduction in estimated cost of litigation settlement 9.7 19.6
Other expense, net (0.3) (0.2)
----- -----
Total financing and other income 4.7 18.2
----- -----
Income (loss) from continuing operations before income taxes 9.5 (22.4)
Provision for income taxes 1.1 0.5
----- -----
Net income (loss) from continuing operations 8.4 (22.9)
----- -----
Discontinued operations:
Loss from discontinued operations -- (18.7)
----- -----
Net income (loss) 8.4 (41.6)
----- -----
Dividends on and accretion of series A, B, C, and D convertible
preferred stock (7.2) (4.4)
----- -----
Net income (loss) attributable to common stockholders 1.2% (46.0)%
===== =====
Comparison of the Three Months Ended March 31, 2002 and 2001
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 from $49.4 million to $35.7
million for the three months ended March 31, 2001 and 2002, respectively,
representing a decrease of 27.8%.
Based on the revenue recognition criteria established in SOP 97-2 and SOP 81-1,
revenue from certain large, multiple element arrangements have been recorded as
deferred revenue and advance payments, with both product license revenues and
product support and other services revenues recognized using the percentage of
completion
22
method based on cost inputs as the work progresses. Contracts accounted for
under the percentage of completion method represented approximately 1.1% and
10.1% of total revenues during the three months ended March 31, 2002 and 2001,
respectively.
In the third quarter of 2001, we notified Exchange Applications, Inc. that it
was in material default in the performance of its obligations under the software
development and OEM agreement (the "OEM Agreement") that had been entered into
as of December 28, 1999. Exchange Applications responded by denying the default
of its obligations and alleging that we had breached our contractual
obligations. Exchange Applications also informed us that it may seek a
reimbursement of all amounts paid to us. Management believes that MicroStrategy
has not committed any breach of obligations alleged by Exchange Applications.
Accordingly, we responded to Exchange Applications by denying the claim and, in
the fourth quarter of 2001, sent a notice of termination to terminate the OEM
Agreement as a result of Exchange Applications' alleged material default. As of
March 31, 2002, Exchange Applications had not agreed to the termination. Because
we are no longer performing services under the OEM Agreement, the remaining
current and long-term deferred revenue associated with the contract of $9.4
million and $7.8 million, respectively, or $17.2 million in aggregate, has been
classified as contingency from terminated contract in the accompanying
consolidated balance sheet as of March 31, 2002. The ultimate resolution of this
contract dispute will determine the final disposition of the recorded amounts.
The final resolution of this matter is currently uncertain; however, we do not
believe we will incur any additional liability related to this contract dispute.
During the three months ended March 31, 2001, we recognized $231,000 of product
licenses revenues and $2.6 million of product support and other services
revenues relating to this contract. We did not recognize any revenues relating
to this contract during the three months ended March 31, 2002.
Product Licenses Revenues. Product licenses revenues decreased from $18.6
million to $14.5 million for the three months ended March 31, 2001 and 2002,
respectively, representing a decrease of 22.2%. The overall decrease in product
licenses revenues was primarily due to the continued economic slowdown in the
first quarter of 2002, which led to decreased corporate spending in information
technology. We expect product licenses 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 from $30.8 million to $21.2 million for the three months
ended March 31, 2001 and 2002, respectively, representing a decrease of 31.2%.
The overall decrease in product support and other services revenues was
primarily attributable to a decrease in demand for consulting and education
services while revenues from maintenance services remained relatively constant.
Also contributing to the decline in product support and other services revenues
was the implementation of restructuring plans under which we reduced our
consulting, education and technical support staffing levels. As a result of
possible fluctuations in product licenses revenues discussed above, product
support and other services revenues as a percentage of total revenues may
fluctuate on a period-to-period basis and 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 from $16.8 million to $12.3 million for the
three months ended March 31, 2001 and 2002, respectively, representing a
decrease of 26.7%. International product licenses revenues decreased from $8.2
million to $5.2 million for the three months ended March 31, 2001 and 2002,
respectively, representing a decrease of 36.6%. International product support
and other services revenues decreased from $8.6 million to $7.1 million for the
three months ended March 31, 2001 and 2002, respectively, representing a
decrease of 17.4%. The decrease in international revenues is primarily
attributable to the continued global economic slowdown, particularly in Latin
America, which led to decreased corporate spending on information technology.
Additionally during the latter part of 2001, we closed our Switzerland and
Austria offices. As a percentage of total revenues, international revenues were
34.5% and 34.0% for the three months ended March 31, 2002 and 2001,
respectively. We anticipate that international revenues will continue to account
for a significant amount of total revenues, and management expects to continue
to commit significant time and financial resources to the maintenance and
ongoing development of direct and indirect international sales and support
channels. In the latter part of 2001 and throughout the first quarter of 2002,
there has been extensive economic turmoil in Argentina, which has resulted in a
significant devaluation of the Argentine peso. Revenues from our operations in
Argentina accounted for 0.6% of
23
total revenues during the three months ended March 31, 2002. Management believes
that our economic exposure in that region is not significant.
Costs and Expenses
Cost of Product Licenses Revenues. Cost of product licenses 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 licenses revenues decreased from $1.0 million to $521,000 for the three
months ended March 31, 2001 and 2002, respectively, and as a percentage of
product licenses revenues, decreased from 5.6% to 3.6%, for these periods,
respectively. The decrease in cost of product licenses revenues as a percentage
of product licenses revenues was primarily due to decreased software royalty
arrangements with third-party software vendors resulting from a decrease 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 licenses revenues as a
percentage of total product licenses revenues may increase. Additionally, we
expect the quarterly cost of product licenses revenues to increase by
approximately $235,000 throughout the remainder of 2002 as a result of the
incremental amortization of capitalized software development costs associated
with the release of MicroStrategy 7i and Narrowcast Server 7.2 in April 2002.
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 $15.3 million to $6.6 million for the three months ended
March 31, 2001 and 2002, respectively, and as a percentage of product support
and other services revenues, decreased from 49.9% to 31.4%, for these periods,
respectively. The decrease in total cost of product support and other services
revenues as a percentage of product support and other services revenues
("services cost") was primarily due to a decrease in our consulting, technical
support and education staffing levels by approximately 52% in the first quarter
of 2002 over the first quarter of 2001 in connection with the implementation of
our restructuring plans in the second and third quarters of 2001. Additionally,
the significant decrease in services cost was also attributable to a decrease in
the use of third parties to perform consulting services, 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, and improved utilization
of consulting personnel due to the reduction in consulting personnel as part of
the 2001 restructuring plans.
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 $26.6 million to $12.5 million for the three months ended March
31, 2001 and 2002, respectively, and as a percentage of total revenues,
decreased from 53.9% to 35.0%, for these periods, respectively. The decrease in
sales and marketing expenses was primarily due to decreased staffing levels in
the sales force as a result of our 2001 restructuring plans, decreased
commissions expense as a result of lower product license revenues and decreased
promotional activities and advertising. Staffing levels for sales and marketing
personnel decreased by approximately 63% in the first quarter of 2002 over the
first quarter of 2001. As part of the restructuring plans adopted in the second
and third quarters 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.
Research and Development Expenses. Research and development expenses consist
primarily of salaries and benefits of software engineering personnel,
depreciation of equipment and other costs. Research and development expenses
decreased from $10.5 million to $5.4 million for the three months ended March
31, 2001 and 2002, respectively, and as a percentage of total revenues,
decreased from 21.2% to 15.0%, for these periods, respectively. During 2001 and
2002, 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 2001 restructuring
plans, research and development expenses declined due to a reduction in staffing
levels and a decrease in the use of third-party consultants. Staffing levels of
our research and development personnel decreased by approximately 35% in the
first quarter of 2002 over the first quarter of 2001. Also contributing to the
decline in research and development expenses was the capitalization of software
development costs during the first quarter of 2002 associated with the
development of certain products, as discussed further below.
24
In April 2002, we released the new version of our business intelligence
platform, MicroStrategy 7i, and Narrowcast Server 7.2 and will no longer
capitalize development costs associated with these products after that date. We
are also currently working on the development of Unix-based business
intelligence products which are expected to be available for general release
during late 2002 and early 2003. We did not capitalize software development
costs associated with our Unix-based products and do not expect to capitalize
any costs during the second quarter of 2002. As of March 31, 2002, our research
and development engineering resources were allocated to the following major
projects: 58% to our MicroStrategy 7i product, 7% to our Narrowcast Server 7.2
product, 13% to our Unix products, and 22% to on-going support of existing
products and other research and development efforts. The allocation of our
research and development resources is expected to change as project development
efforts require, as current projects are completed, and as new projects
commence.
During the three months ended March 31, 2002, in accordance with SFAS No. 86,
"Accounting for the Costs of Computer Equipment to be Sold, Leased, or Otherwise
Marketed," we capitalized an additional $2.0 million and $320,000 of software
development costs associated with the development of MicroStrategy 7i and
Narrowcast Server 7.2 software, respectively. Software development costs are
capitalized from the time that technological feasibility is reached until the
general release of the respective software products. We consider technological
feasibility to be achieved when a product design and working model of the
software product has been completed. These capitalized software costs are
amortized over their respective useful lives of approximately three years.
Amortization expense related to software development costs was $179,000 and
$165,000 for the three months ended March 31, 2002 and March 31, 2001,
respectively. We expect the quarterly cost of product licenses revenues to
increase by approximately $235,000 throughout the remainder of 2002 as a result
of the incremental amortization of capitalized software development costs
associated with the release of MicroStrategy 7i and Narrowcast Server 7.2.
General and Administrative Expenses. General and administrative expenses include
domestic and international personnel and other costs of our finance, human
resources, information systems, administrative and executive departments as well
as third-party consulting, legal and other professional fees. General and
administrative expenses decreased from $11.7 million to $6.8 million for the
three months ended March 31, 2001 and 2002, respectively, and as a percentage of
total revenues decreased from 23.7% to 19.0%, for these periods, respectively.
The decrease in general and administrative expenses was primarily due to a
reduction in staff levels and office occupancy costs 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. Staffing levels for our general and administrative personnel
decreased by approximately 45% in the first quarter of 2002 over the first
quarter of 2001. 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
During the second quarter of 2001, we adopted a restructuring plan designed to
focus our commercial activities. The restructuring plan included 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 our workforce by 450 domestic and
international employees and 147 Strategy.com employees throughout all functional
areas, or approximately 33% of our then 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 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.
At December 31, 2001, all headcount reductions were completed.
As a result of the 2001 restructuring plans, we recorded restructuring and
impairment charges of $39.5 million during 2001 for severance costs and other
benefits for terminated employees, the write-down of impaired assets, costs
associated with exiting facilities, and fees incurred for professional services
directly related to the restructuring. Amounts related to estimated sublease
losses associated with exiting facilities and terminations of computer and
25
equipment leases will be paid over the respective lease terms through February
2009. As a result of the restructuring, we have approximately 204,000 square
feet of vacant office space, of which approximately 101,000 square feet has been
subleased as of March 31, 2002. The remaining vacant office space is currently
being marketed for sublease. As of March 31, 2002, we had $11.1 million accrued
for our estimated computer, equipment and real estate lease losses, representing
$19.7 million in gross lease obligations and $2.3 million of estimated
commissions, concessions, and other costs, offset by $10.9 million in estimated
gross sublease income recoveries during the remaining lease terms. If we are
unable to obtain this level of estimated sublease income, we will incur
additional restructuring costs and our cash position would be adversely
affected. We are also considering terminating certain leases early. We estimated
sublease losses based upon current information available relating to sublease
commission costs, sub-tenant concession costs, sublease rental income, and the
length of time expected to sublease our idle space. Final actual amounts could
differ from current estimates once all vacant space has been entirely sublet.
On a quarterly basis, we assess the adequacy of our restructuring reserve based
upon changes in current market conditions. Due to a decline in estimated
sublease rates and an increase in the expected length of time to sublease vacant
space, we adjusted the restructuring reserve by recording additional sublease
losses of $1.2 million during the three months ended March 31, 2002. The
following table sets forth a summary of the accrued restructuring costs as of
March 31, 2002 (in thousands):
Accrued Adjustments and Accrued
Restructuring Charges for 2002 2002 Restructuring
Costs at First Non-cash Cash Costs at
December 31, 2001 Quarter 2002 Charges Payments March 31, 2002
----------------- --------------- -------- -------- --------------
Severance and other employee
termination benefits $ 72 $ -- $ -- $ (33) $ 39
Write-down of impaired assets -- -- -- -- --
Estimated sublease losses and
other facility closing costs 10,967 1,232 (36) (1,418) 10,745
Terminations of computer and
equipment leases 485 -- -- (122) 363
Accrual for professional fees 169 -- -- -- 169
------- ------- ---- ------- -------
Total restructuring and
impairment charges $11,693 $1,232 $(36) $(1,573) $11,316
======= ======= ==== ======= =======
As a result of the various restructuring initiatives adopted during 2001,
management expects that operating expenses for 2002 will be reduced by
approximately $36 million to $45 million as compared to actual operating
expenses for 2001. Except for our estimated sublease losses and other facility
closing costs and computer and equipment leases, we expect that the 2001
restructuring plans will be substantially completed by June 2002.
Amortization of Goodwill and Intangible Assets. We have recorded $4.2 million
and $965,000 in amortization expense for the three months ended March 31, 2001
and 2002, respectively. The decrease in amortization expense is attributable to
the impairment charge of $12.2 million recorded in 2001 to write-down the
carrying value of our Teracube intangible asset, which had been acquired in
connection with the purchase of intellectual property and other tangible and
intangible assets relating to NCR Corporation's Teracube project, to its fair
value. Additionally, see "Recent Accounting Pronouncements" below regarding the
issuance of SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill
and Other Intangible Assets."
Loss on Investments. Loss on investments was $1.1 million and $289,000 during
the three months ended March 31, 2001 and 2002, respectively. This decline was
primarily attributable to the decline in our short-term investment holdings as
of March 31, 2002 of $590,000, as compared to our short-term investment holdings
of $4.2 million as of March 31, 2001.
Reduction in Estimated Cost of Litigation Settlement. MicroStrategy 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
26
respect to our 1999, 1998 and 1997 financial results. The action was
consolidated in the United States District Court for the Eastern District of
Virginia. In June 2000, purported holders of our common stock filed a
shareholder derivative lawsuit in the Delaware Court of Chancery seeking
recovery for various alleged breaches of fiduciary duties by certain of our
directors and officers relating to the restatement of financial results for
1999, 1998 and 1997.
In October 2000, we entered into agreements to settle these lawsuits. On January
19, 2001, the United States District Court authorized notice of the proposed
class action settlement 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. On March 12,
2002, the United States District Court entered the final distribution order
allowing distribution of the settlement consideration. The Company expects that
the consideration will be issued to the class members in the second quarter or
third quarter of 2002 after the remaining closing conditions have been met. 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 having an aggregate principal
amount of $80.5 million and bearing interest at 7.5% per year; 2) 2,777,778
shares of 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. As part of the derivative
settlement agreement described above and in satisfaction of a condition of the
class action settlement, certain officers tendered 1,683,504 shares of class A
common stock to the Company for no consideration during the fourth quarter of
2001, and we have cancelled these shares. Accordingly, upon the completion of
the distribution, we will have effected a net issuance of 1,094,274 shares of
class A common stock as part of the class action settlement.
We will have the right, at any time, to prepay the promissory notes, or to
mandatorily convert the promissory notes into shares of 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 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. Upon maturity, the outstanding
principal balance of the promissory notes will become due. 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.
Based on the terms of the settlement agreements, we determined that a liability
related to these actions was probable and that the value was reasonably
estimable. Accordingly, during 2000, we established an estimate for the cost of
the litigation settlement of $89.7 million, net of insurance recoveries of $13.0
million. Subsequently, during each successive financial reporting period, we
have updated the estimated value assigned to each individual component of the
settlement based upon valuation assumptions stemming from the settlement. 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 estimated cost of the litigation settlement of $3.5 million and $9.7 million
during the three months ended March 2002 and 2001, respectively. The reduction
in estimated cost of litigation settlement was comprised of the following, as of
(in thousands):
March 31, March 31,
2002 2001
--------- ---------
Promissory notes to be issued $ -- $ --
Class A common stock to be issued (2,222) --
Warrants to be issued (1,238) (9,915)
Pending loss on additional settlement -- 250
Legal fees -- --
Administration costs -- --
------- -------
Reduction in estimated cost of litigation settlement $(3,460) $(9,665)
======= =======
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 our class A common stock when
27
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 and until they are
exercised or expire.
We are also involved in patent infringement lawsuits with Business Objects, S.A.
As the actions relating to Business Objects are in a preliminary stage, we are
currently unable to estimate the potential range of gain or loss, if any, and as
such the outcome of this uncertainty is not presently determinable. Accordingly,
no provision for these matters has been made in the accompanying consolidated
financial statements. Additional information regarding these matters is included
below under "Risk Factors."
We are also involved in 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 and
results of operations or cash flows.
Other Expense, net. Other expense, net includes gains and losses on foreign
currency transactions and, for the three months ended March 31, 2002, includes
gains and losses on certain legal and contract settlements and losses from
disposals of property and equipment and certain other assets held for sale.
Provision for Income Taxes. During the three months ended March 31, 2002 and
2001, we recorded income tax expense of $399,000 and $289,000, respectively,
primarily related to foreign jurisdictions where we are profitable, withholding
taxes associated with international sales, and withholding taxes on repatriated
cash in certain countries. 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.
Loss from Discontinued Operations. On December 31, 2001, we discontinued the
operations of our Strategy.com subsidiary and shut down its services. Our
historical consolidated financial statements reflect Strategy.com as a
discontinued operation for all periods presented. Loss from discontinued
operations was $0 and $9.2 million for the three months ended March 31, 2002 and
2001, respectively. The remaining net liabilities of discontinued operations as
of March 31, 2002 are based on estimates and actual results could differ under
different assumptions or conditions.
Dividends on and Accretion of Series A, B, C, and D Convertible Preferred Stock.
During the three months ended March 31, 2002 and March 31, 2001, we recorded
aggregate preferred stock dividends and accretion of $2.6 million and $2.2
million, respectively. During the three months ended March 31, 2002, we paid
aggregate preferred stock dividends valued at $2.8 million through the issuance
of 756,726 shares of class A common stock in lieu of cash. As of March 31, 2002,
we had accrued preferred stock dividends of $2.0 million, which are included in
accrued interest and preferred dividends in the accompanying consolidated
balance sheet. During the three months ended March 31, 2001, we paid aggregate
preferred stock dividends valued at $599,000 through the issuance of 63,146
shares of class A common stock in lieu of cash.
Deferred Revenue and Advance Payments
Deferred revenue and advance payments represent product support and other
services fees that are collected in advance and recognized over the contract
service period and product license and product support and other services fees
relating to multiple element software arrangements for which the fair value of
each element cannot be established. Aggregate deferred revenue and advance
payments were $27.0 million as of March 31, 2002 compared to $26.4 million as of
December 31, 2001. The increase in deferred revenue and advanced payments was
attributable to an increase in maintenance contracts during the current quarter
which was offset by the reduction of deferred revenue and advance payment
balances due to the recognition of revenues on existing license and maintenance
contracts. We expect to recognize approximately $22.8 million of this deferred
revenue and advance payments over the next 12 months; however, the timing and
ultimate recognition of our deferred revenue and advance payments
28
depends on our performance of various service obligations and the amount of
deferred revenue and advance payments at any date should not be considered
indicative of actual revenues for any succeeding period.
Liquidity and Capital Resources
Our principal source of liquidity is our cash, cash equivalents, short-term
investments, and on-going collection of our accounts receivable. On March 31,
2002 and December 31, 2001, we had $33.4 million and $39.8 million of cash, cash
equivalents, and short-term investments, respectively, of which $194,000 and
$439,000 was restricted cash as of March 31, 2002 and December 31, 2001,
respectively.
The following are our contractual obligations associated with our restructuring
plans, interest obligations and lease commitments (in thousands):
Twelve months ending March 31,
2003 2004 2005 2006 2007 Thereafter Total
------- ------- ------- ------- ------- ---------- --------
Restructuring-related
obligations:
Leases (1) $ 6,247 $ 2,020 $ 860 $ 843 $ 535 $ 603 $ 11,108
Other 208 -- -- -- -- -- 208
------- ------- ------- ------- ------- ------- --------
Restructuring-related
obligations, net 6,455 2,020 860 843 535 603 11,316
------- ------- ------- ------- ------- ------- --------
Other Obligations:
Interest on litigation
settlement
promissory notes (2) 12,074 6,038 6,038 6,038 6,038 1,509 37,735
Operating leases 12,727 9,202 8,137 7,363 6,237 18,009 61,675
------- ------- ------- ------- ------- ------- --------
Other obligations 24,801 15,240 14,175 13,401 12,275 19,518 99,410
------- ------- ------- ------- ------- ------- --------
Total contractual cash
obligations $31,256 $17,260 $15,035 $14,244 $12,810 $20,121 $110,726
======= ======= ======= ======= ======= ======= ========
(1) Restructuring-related lease obligations include estimated concessions,
commission payments, and other costs associated with marketing our
idle space for sublease of $2.3 million and are reflected net of
estimated sublease income of $10.9 million. Total gross
restructuring-related lease obligations are $19.7 million. We may
incur additional charges and expend more cash than currently expected
if we are unable to sublet our idle space on the estimated terms.
(2) The interest obligation on the promissory notes to be issued in
connection with the securities class action litigation settlement may
be reduced if we exercise our right to convert the promissory notes
into shares of class A common stock prior to their maturity five years
after their issuance date. Additionally, the interest obligation
reflected in this table assumes an issuance date for the promissory
notes of July 1, 2002. Interest charges began accruing on the
settlement hearing date of April 2, 2001. As such, the interest
obligation in 2002 includes interest accrued in 2001 that is expected
to be paid in 2002 following issuance of the promissory notes.
In addition to the contractual cash obligations identified above, we have other
contractual obligations which may be settled in cash or common stock. These
additional contractual obligations, which are discussed more fully below,
include the promissory notes to be issued in connection with the litigation
settlement and our preferred stock.
We also have a credit facility which includes a $30 million line of credit,
subject to specified borrowing base limitations and outstanding letters of
credit. This credit facility is discussed more fully below.
Operating Activities
29
Net cash used in operating activities was $3.3 million and $19.0 million for the
three months ended March 31, 2002 and 2001, respectively. The decrease in net
cash used in operating activities was primarily attributable to an improvement
in operating results from continuing operations and a decrease in cash used for
payment of accounts payable and accrued expenses. These cash flow improvements
are a result of the restructuring actions discussed above.
Investing Activities
Net cash used in investing activities was $337,000 for the three months ended
March 31, 2002 as compared to net cash provided by investing activities of $24.2
million for the three months ended March 31, 2001. The change was primarily
attributable to the $25.5 million in restricted cash that was released during
the first quarter of 2001 in connection with the termination of our prior credit
facility, as discussed further below. Additionally, we received $2.2 million in
cash during the first quarter of 2001 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.
Financing Activities
Net cash used in financing activities was $751,000 and net cash provided by
financing activities was $13.5 million for the three months ended March 31, 2002
and 2001, respectively. This change was primarily due to proceeds of $10.0
million from a term loan during the first quarter of 2001, as discussed further
below, and a decline in proceeds from the exercise of stock options.
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
all but 650 shares of our series A redeemable convertible preferred stock with a
combination of cash, class A common stock and newly issued preferred stock. The
650 shares of the series A redeemable convertible stock that remain outstanding
have a stated value of $6.5 million. We redeemed or exchanged the remaining
11,850 shares of our series A redeemable convertible preferred stock as follows:
... $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;
... $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;
... $33.125 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;
... $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
... $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
30
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 our class A common stock. In November 2001, holders of the series
D preferred stock exercised their right to convert series D preferred stock and
converted 175 shares of series D preferred stock into shares of class A common
stock at the fixed conversion price of $5 per share. As a result of the
conversion, we issued 350,000 shares of class A common stock. The difference
between the carrying value of the 175 shares of series D preferred stock at the
time of conversion and the par value of the class A common stock was recorded as
an increase in additional paid-in capital.
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. This cash redemption payment was
substantially equivalent to the carrying value of the series E preferred stock
on the date of redemption.
The series B and series C preferred stock is redeemable upon certain triggering
events such as suspension from trading or failure of our class A common stock to
be listed on the Nasdaq National Market or the Nasdaq SmallCap Market for a
period of five consecutive trading days or for more than an aggregate of ten
trading days in any 365-day period and other events as defined in the respective
Certificate of Designations, Preferences and Rights of the series B and series C
preferred stock. In the event of redemption upon a triggering event, the series
B and series C preferred stock is redeemable 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. The series D preferred stock is also redeemable upon certain triggering
events as defined in the Certificate of Designations, Preferences and Rights of
the series D preferred stock. In the event of redemption upon a triggering
event, the series D preferred stock is redeemable at the stated value of such
shares of preferred stock or the product of the number of shares of class A
common stock into which the series D 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. As of March 31, 2002, none of these
triggering events have occurred. In addition, upon a change of control of the
Company, each holder of series B and series C 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 125% of the stated value of such shares of preferred stock
plus accrued and unpaid dividends.
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 650 remaining shares of
series A preferred stock was adjusted downward from $33.39 per share 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 days immediately preceding July
5, 2001. As a result of this adjustment to the conversion price, the series A
preferred stock is convertible, as of March 31, 2002, 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 elected to mandatorily convert the 650 remaining shares of series
A preferred stock at its June 19, 2002 maturity into class A common stock based
on a conversion price 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. The series A preferred stock is
redeemable upon certain triggering events such as suspension from trading or
failure of our class A common stock to be listed on the Nasdaq National Market
for a period of five consecutive trading days or for more than an aggregate of
ten trading days in any 365-day period and other events as defined in the
Certificate of Designations, Preferences and Rights of the series A 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 March 31, 2002, none of these triggering events
had occurred. In addition, upon a change of control of the Company, each holder
of series A preferred stock shall have the right, at the holder's option, to
require us to redeem all or a
31
portion of the preferred stock at 125% of the stated value of such shares of
preferred stock plus accrued and unpaid dividends. If the dollar-volume weighted
average price of our class A common stock for the 30 trading days prior to the
June 19, 2002 maturity date were $1.90, the closing sale price of our class A
common stock as of May 1, 2002, we would be required to issue a total of
3,601,108 shares of our class A common stock upon conversion of the series A
preferred stock at maturity plus a number of shares reflecting accrued but
unpaid dividends.
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, we entered into an exchange
agreement pursuant to which 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.
In March 1999, we entered into a line of credit agreement with a commercial bank
which provided for a $25.0 million unsecured revolving line of credit for
general working capital purposes. In May 2000, we entered into a modification of
the line of credit agreement, which, among other things, increased the aggregate
credit available to include an additional letter of credit, removed any
financial covenants and cured any financial covenant defaults. The line of
credit accrued interest at LIBOR plus 1.75%, included a 0.2% unused line of
credit fee, and required monthly payments of interest. The line of credit was
secured by $25.9 million of cash and cash equivalents. The cash was restricted
through February 2001, at which time the agreement was terminated upon the
closing of a new credit facility agreement described below.
On February 9, 2001, we entered into a loan and security agreement (the "New
Credit Facility") with Foothill Capital, a subsidiary of Wells Fargo Bank, 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, and replaced the previous line
of credit agreement. 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 decreased by $278,000 per month through March
2002, and the 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
under the Modified Credit Facility. At March 31, 2002, we had no principal
amounts outstanding under the Modified Credit Facility. Taking into account
outstanding letters of credit of $5.6 million, we have $24.4 million available
for future drawdowns, subject to borrowing base limitations discussed above.
After taking into consideration these borrowing base limitations, $4.5 million
of additional borrowing capacity under the Modified Credit Facility was
available at March 31, 2002. If the borrowing base is less than the outstanding
letters of credit, the Company is required to deposit an amount of cash equal to
the deficiency into a restricted account. 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 March 31, 2002 was 6.25%. The Modified Credit
Facility also includes an annual 1.50% letter of credit fee. Monthly 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 March 31, 2002, the
Company was in compliance with all covenants. The Modified Credit Facility
32
included a covenant to raise $10.0 million of additional financing by March 31,
2002 through equity financing, subordinated debt, or net proceeds from the sale
of non-core assets, as defined in the agreement, which was modified in February
2002 to extend the date by which this additional financing is required to June
30, 2002. On April 26, 2002, the Modified Credit Facility was further amended to
eliminate this covenant requiring additional financing. Additionally, in
conjunction with the amendment, the financial covenant requiring achievement of
certain minimum earnings amounts was revised to increase those levels of the
minimum earnings amounts in future periods.
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. 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. We expect to issue the
promissory notes during the second or third quarter of 2002. Interest on the
notes is payable semi-annually with the first interest payment payable on the
six month anniversary of the issuance. Also as part of the settlement, we will
issue warrants to purchase 1,900,000 shares of class A common stock at an
exercise price of $40 per share, with the warrants expiring five years from the
date they are issued.
In 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. 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. As a result
of the expiration of certain lease schedules during the first quarter of 2002,
amounts leased under the master lease agreement are $13.9 million as of March
31, 2002. Currently, we are unable to draw down additional amounts under the
lease agreement; however, we expect only limited, near-term, computer equipment
purchase needs that we expect will be met through cash on hand and other
financial resources.
As discussed above, we have taken various actions to realign our cost structure
to better match our expected revenues including reducing our workforce,
consolidating our office space, reducing and limiting discretionary operating
expenses, reducing capital expenditures, and discontinuing the operations of
Strategy.com. Additionally, we are exploring alternative financing arrangements,
which include credit facilities, the sale of equity in MicroStrategy, or other
financing sources. Alternative debt or equity financing may not be available on
acceptable terms. If financing is not available on acceptable terms and/or if we
do not achieve revenues and generate cash flow at anticipated levels, we will
need to take further actions to reduce costs in order to minimize 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
will be sufficient to meet our working capital requirements and anticipated
capital expenditures through the end of 2002. Our liquidity and capital
resources and ability to generate revenues are subject to various business and
economic risks discussed below under "Risk Factors."
Recent Accounting Standards
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
141, "Business Combinations," which addresses the financial accounting and
reporting for business combinations and supersedes Accounting Principles Board
Opinion No. 16, "Business Combinations," and SFAS No. 38, "Accounting for
Preacquisition Contingencies of Purchased Enterprises," and is applicable to
business combinations initiated after June 30, 2001. SFAS No. 141 requires
business combinations initiated after June 30, 2001 to be accounted for using
the purchase method of accounting and broadens the criteria for recording
intangible assets separate from goodwill. Recorded goodwill and intangibles will
be evaluated against the new criteria and may result in certain intangibles
being reclassified to goodwill, or alternatively, amounts initially recorded as
goodwill may be separately identified and recognized apart from goodwill. The
adoption of this statement as of January 1, 2002 had no material impact on our
consolidated financial statements.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which is effective beginning in 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 entities perform an initial
impairment assessment upon
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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. The
adoption of this standard as of January 1, 2002 did not have a material impact
on the amortization of goodwill and intangible assets.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," which is effective 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 adoption of this statement as of January 1, 2002 did not have a
material impact on our consolidated financial statements.
In November 2001, the FASB staff reached a consensus on Emerging Issues Task
Force ("EITF") Issue No. 01-09, "Accounting for Consideration Given by a Vendor
to a Customer or a Reseller of the Vendor's Products." EITF No. 01-09 concludes
that consideration from a vendor to a customer or a reseller is a reduction of
the selling price of the vendor's products or services and, therefore, should be
characterized as a reduction of revenue when recognized in the vendor's income
statement. EITF No. 01-09 is effective for fiscal years beginning after December
15, 2001 and all prior period amounts are required to be reclassified to conform
to the current period presentation. The adoption of standard as of January 1,
2002 did not have any impact on our consolidated financial statements.
In November 2001, the FASB staff issued EITF Topic D-103, "Income Statement
Characterization of Reimbursements Received for 'Out-of-Pocket' Expenses
Incurred," which has subsequently been recharacterized as EITF Issue No. 01-14.
EITF No. 01-14 requires that reimbursements received for out-of-pocket expenses,
such as airfare, mileage, hotel stays, and out-of-town meals, be characterized
as revenues in the consolidated statement of operations. EITF No. 01-14 is
effective for all fiscal years beginning after December 15, 2001, and requires
reclassification of all prior period amounts to conform to the current period
presentation. During the first quarter of 2002, we classified $207,000 of such
reimbursed out-of-pocket expenses as product support and other services
revenues. The consolidated statement of operations for the first quarter of 2001
has been reclassified to include $463,000 of such reimbursed out-of-pocket
expenses as product support and other services revenues with a corresponding
increase in the cost of product support and other services. The adoption of this
standard as of January 1, 2002 had no impact on our net income (loss) for either
period.
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
We have incurred significant operating losses in each of the last five years. We
incurred net losses of $80.9 million, $261.3 million, and $33.7 million for the
years ended December 31, 2001, 2000 and 1999, respectively. As of March 31,
2002, our accumulated deficit was $377.1 million. We expect our gross revenue to
decline from the year ended December 31, 2001 to the year ending December 31,
2002. In connection with our April and September 2001
34
corporate restructurings, we recorded restructuring and impairment charges of
$39.5 million for the year ended December 31, 2001 and $1.2 million for the
three months ended March 31, 2002.
We did not generate net income for the year ended December 31, 2001 and do not
expect to do so for the six month period ending June 30, 2002. Even if we are
able to generate net income, we may not be able sustain or increase
profitability on a quarterly or annual basis in the future. If revenue declines
more significantly than we anticipate, or if operating expenses exceed our
expectations or cannot be adjusted accordingly, our business, results of
operations and financial condition will be materially and adversely affected.
Our quarterly operating results, revenues and expenses may fluctuate
significantly, which could have an adverse effect on the market price of our
stock
For a number of reasons, including those described below, our operating results,
revenues and expenses may vary significantly from quarter to quarter. These
fluctuations could have an adverse effect on the market price of our class A
common stock.
Fluctuations in Quarterly Operating Results. Our quarterly operating results may
fluctuate as a result of:
. the size, timing and execution of significant orders and shipments;
. the mix of products and services of customer orders, which can affect
whether we recognize revenue upon the signing and delivery of our
software products or whether revenue must be recognized as work
progresses or over the entire contract period;
. the timing of new product announcements;
. changes in our pricing policies or those of our competitors;
. market acceptance of business intelligence software generally and of
new and enhanced versions of our products in particular;
. the length of our sales cycles;
. changes in our operating expenses;
. personnel changes;
. our success in adding to our indirect distribution channels;
. utilization of our consulting personnel, which can be affected by
delays or deferrals of customer implementation of our software
products and consulting, education and support services;
. changes in foreign currency exchange rates; and
. seasonal factors, such as our traditionally lower pace of new sales in
the summer.
Limited Ability to Adjust Expenses. We base our operating expense budgets on
expected revenue trends. Many of our expenses, 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
35
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 and advance payments is subject to future
performance obligations and may not be representative of revenues for succeeding
periods
Our deferred revenue and advance payments were approximately $27.0 million as of
March 31, 2002. The timing and ultimate recognition of our deferred revenue and
advance payments depend on our performance of various service obligations.
Because of the possibility of customer changes in development schedules, delays
in implementation and development efforts and the need to satisfactorily perform
product support services, deferred revenue and advance payments at any
particular date may not be representative of actual revenue for any succeeding
period.
We may need additional financing which could be difficult to obtain
We may require additional external financing through credit facilities, sale of
additional debt or equity securities in MicroStrategy or by obtaining other
financing facilities to support our operations. Obtaining additional financing
will be subject to a number of factors, including:
... market conditions;
... our operating performance; and
... investor sentiment.
These factors may make the timing, amount, terms and conditions of additional
financing unattractive to us. If we are unable to raise capital needed to fund
our operations, our business, operating results and financial condition may be
materially and adversely affected.
We face securities 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.
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The issuance of class A common stock as part of the proposed settlement of the
securities class action and derivative litigation and the 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. As part of the settlement agreements, certain
officers tendered 1,683,504 shares of class A common stock to the Company for no
consideration, and we have cancelled these shares. Accordingly, upon completion
of the distribution, we will have effected a net issuance of 1,094,274 shares of
class A common stock. In addition, the settlement agreements require the
issuance of 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 May 1, 2002, we would be obligated to issue 47,949,166 shares of class A
common stock if we elected to convert the notes. In addition, if we elect to
convert the notes at prices that would result in the issuance of shares with a
market value in excess of the value of the notes reflected on our balance sheet,
we would incur a non-cash charge to earnings at the time of conversion equal to
the amount of such excess, and this charge could be substantial. The issuance of
a substantial number of shares of class A common stock as part of the litigation
settlement and future conversions of the notes 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
Our 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 would currently convert into 7,142,200 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 dollar-volume weighted average price of our class A common stock for the 30
trading days prior to the maturity date of our series B preferred stock and
series C preferred stock were $1.90, the closing sale price of our class A
common stock as of May 1, 2002, and 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 33,767,313 shares of our class A common
stock upon conversion of such shares at maturity plus a number of shares
reflecting accrued but unpaid dividends.
We currently have 650 shares of our series A preferred stock outstanding. As of
May 1, 2002, 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
$3.08 per share. We have elected to mandatorily convert the series A preferred
stock on the maturity date of June 19, 2002 into class A common stock based on a
conversion price 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. If the dollar-volume weighted average
price of our class A common stock
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for the 30 trading days prior to the June 19, 2002 maturity date were $1.90, the
closing sale price of our class A common stock as of May 1, 2002, we would be
required to issue a total of 3,601,108 shares of our class A common stock upon
conversion of the series A preferred stock at maturity plus a number of shares
reflecting accrued but unpaid dividends.
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.
The conversion and other features of our preferred stock will have the effect of
reducing earnings per share if we were to generate net income in any future
period.
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,
including, among others:
... nonpayment of dividends on the series A preferred stock, series B preferred
stock and series C preferred stock in a timely manner;
... failure to deliver shares of our class A common stock upon conversion of
the preferred shares after a proper request;
... nonpayment of the redemption price at maturity of any remaining series A
preferred stock, series B preferred stock and series C preferred stock; or
... 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.
We have substantial real estate lease commitments for unoccupied space and if we
are unable to sublet this space on acceptable terms our operating results and
financial condition could be adversely affected
We are party to real estate leases relating to approximately 103,000 square feet
that are unoccupied. We have established a restructuring reserve of $10.7
million related to the costs of disposition of this space as of March 31,
38
2002. In establishing this reserve, we have assumed that we will be able to
sublet the available space and receive approximately $10.9 million of sublease
income relating to this space. We may not be able to sublet this space on the
assumed terms. If we are unable to do so, we would incur additional
restructuring costs relating to these leases and would expend more cash than
currently expected, which could have an adverse effect on our operating results
and financial condition.
We face intense competition, which may lead to lower prices for our products,
reduced gross margins, loss of market share and reduced revenue
The markets for business intelligence software, analytical applications, and
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:
... business intelligence software;
... OLAP tools;
... query and reporting tools;
... web-based static reporting tools; and
... information delivery and proactive reporting.
Each of these markets is discussed more fully below.
Business Intelligence Software. Makers of business intelligence software provide
business intelligence capabilities designed for integration, customization and
application development. Leading analyst firms classify companies such as
Microsoft, Oracle, Hyperion Solutions, SAP AG, Computer Associates and SAS to be
leading providers of business intelligence software.
OLAP Tools. Companies that build software to perform online analytical
processing (OLAP) provide offerings competitive with the core MicroStrategy 7i
platform. Whether web-based or client-server, these tools give end users the
ability to 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 Solutions, Brio Software, IBM, Crystal Decisions and
Microsoft.
Query and Reporting Tools. Query and reporting tools allow large numbers of end
users to gain access to pre-defined reports for simple analysis. Often the end
users are able to specify some sort of run-time criteria that customizes the
result set for that particular person. Some limited drilling is also provided.
Companies which produce query and reporting tools include Business Objects,
Cognos, Oracle, Crystal Decisions, nQuire, Information Builders and Brio
Software.
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's platform, but can be attractive for small,
departmental applications. Vendors in this category include Actuate, Business
Objects, Crystal Decisions, Microsoft and SAS.
Information Delivery and Proactive Reporting. Companies that focus on the
proactive delivery of information, via e-mail, website, or other medium can
compete with MicroStrategy's offerings. Typically, these tools serve to push out
compiled reports on a scheduled basis to sets of users based on job type.
MicroStrategy software has integrated this technology into the MicroStrategy 7i
platform. Vendors of such technology include Actuate and Business Objects.
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Many of our competitors have longer operating histories, significantly greater
financial, technical, marketing or other resources, and greater name recognition
than we do. In addition, many of our competitors have strong relationships with
current and potential customers and extensive knowledge of the business
intelligence industry. As a result, they may be able to respond more quickly to
new or emerging technologies and changes in customer requirements or devote
greater resources to the development, promotion and sale of their products than
we can. Increased competition may lead to price cuts, reduced gross margins and
loss of market share. We cannot be sure that we will be able to compete
successfully against current and future competitors or that the competitive
pressures we face will not have a material adverse effect on our business,
operating results and financial condition.
Current and future competitors may also make strategic acquisitions or establish
cooperative relationships among themselves or with others. By doing so, they may
increase their ability to meet the needs of our potential customers. Our current
or prospective indirect channel partners may establish cooperative relationships
with our current or future competitors. These relationships may limit our
ability to sell our products through specific distribution channels.
Accordingly, new competitors or alliances among current and future competitors
may emerge and rapidly gain significant market share. These developments could
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:
... our ability to continue to support a number of popular operating systems
and databases;
... our ability to maintain and improve our current product line; and
... our ability to rapidly develop new products that achieve market acceptance,
maintain technological competitiveness and meet an expanding range of
customer requirements.
Business intelligence applications are inherently complex, and it can take a
long time to develop and test major new products and product enhancements. In
addition, customers may delay their purchasing decisions because they anticipate
that new or enhanced versions of our products will soon become available. We
cannot be sure that we will succeed in developing and marketing, on a timely and
cost-effective basis, product enhancements or new products that respond to
technological change, introductions of new competitive products or customer
requirements, nor can we be sure that our new products and product enhancements
will achieve market acceptance.
40
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 and
Windows 2000 operating systems. Therefore, our ability to increase sales
currently depends on the continued acceptance of the Windows NT and Windows 2000
operating systems.
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 holders of class B common stock, 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 May 1, 2002, holders of our class B common stock owned or
controlled 46,431,368 shares of class B common stock, or 90.8% of the total
voting power. Michael J. Saylor, our Chairman and Chief Executive Officer,
controlled 441,420 shares of class A common stock and 37,090,235 shares of class
B common stock, or 72.6% of total voting power, as of May 1, 2002. 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 value-added resellers, system integrators and original equipment
manufacturers to license and support our products in the United States and
internationally. In particular, for the three months ended March 31, 2002 and
the years ended December 31, 2001,
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2000 and 1999, channel partners accounted for, directly or indirectly,
approximately 35.2%, 35.4%, 45.0% and 39.2% 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.
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
alleged that these employees, who previously worked for us, breached their
fiduciary and contractual obligations to us by, among other things,
misappropriating our trade secrets and confidential information and soliciting
our employees and customers. Our complaint sought 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. A trial date has not yet been set in the Northern District of
California action. 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. On March 13, 2002, we
voluntarily dismissed without prejudice our lawsuit pending in the Virginia
Circuit Court for Fairfax County against the two field employees of BO. On April
2, 2002, we amended our complaint against BO to add claims for violations of the
federal Computer Fraud and Abuse Act, misappropriation of trade secrets, and
tortious interference with contractual relations. On May 13, 2002, we submitted
an agreed order to further amend our complaint against BO to add claims for
violations of the Virginia Conspiracy Act. We are seeking monetary damages and
injunctive relief. Trial is scheduled to commence on October 8, 2002.
42
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 34.5%, 34.1%, 25.9% and 24.0% of our total
revenues for the three months ended March 31, 2002 and for the years ended
December 31, 2001, 2000 and 1999, respectively. Our international operations
require significant management attention and financial resources.
There are certain risks inherent in our international business activities
including:
... changes in foreign currency exchange rates;
... unexpected changes in regulatory requirements;
... tariffs and other trade barriers;
... costs of localizing products for foreign countries;
... lack of acceptance of localized products in foreign countries;
... longer accounts receivable payment cycles;
... difficulties in managing international operations;
... tax issues, including restrictions on repatriating earnings;
... weaker intellectual property protection in other countries;
... economic weakness or currency related crises that may arise in different
countries or geographic regions; and
... the burden of complying with a wide variety of foreign laws.
These factors may have a material adverse effect on our future international
sales and, consequently, on our business, operating results and financial
condition.
The nature of our products makes them particularly vulnerable to undetected
errors, or bugs, which could cause problems with how the products perform and
which could in turn reduce demand for our products, reduce our revenue and lead
to product liability claims against us
Software products as complex as ours may contain errors or defects. Although we
test our products extensively, we have in the past discovered software errors in
new products after their introduction. Despite testing by us and by our current
and potential customers, errors may be found in new products or releases after
commercial shipments begin. This could result in lost revenue or delays in
market acceptance, which could have a material adverse effect upon our business,
operating results and financial condition.
Our license agreements with customers typically contain provisions designed to
limit our exposure to product liability claims. It is possible, however, that
these provisions may not be effective under the laws of certain domestic or
international jurisdictions. Although there have been no product liability
claims against us to date, our license and
43
support of products may involve the risk of these claims. A successful product
liability claim against us could have a material adverse effect on our business,
operating results and financial condition.
The price of our stock may be extremely volatile
The market price for our class A common stock has historically been volatile and
could fluctuate significantly for any of the following reasons:
... quarter-to-quarter variations in our operating results;
... developments or disputes concerning proprietary rights;
... technological innovations or new products;
... governmental regulatory action;
... general conditions in the software industry;
... increased price competition;
... changes in revenue or earnings estimates by analysts;
... any change in the actual or expected amount of dilution attributable to
issuances of additional shares of class A common stock upon conversion of
our preferred stock or as a result of the litigation settlement; or
... other events or factors.
Many of the above factors are beyond our control.
The stock market has recently experienced extreme price and volume fluctuations.
These fluctuations have particularly affected the market price of many software
companies, often without regard to their operating performance.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following discussion about our market risk disclosures involves
forward-looking statements. Actual results could differ materially from those
projected in the forward-looking statements. We are exposed to the impact of
interest rate changes and foreign currency fluctuations.
Interest Rate Risk
Our exposure to market risk for changes in interest rates relates primarily to
our cash equivalents and short-term investments. We invest our excess cash in
short-term, fixed income financial instruments. These fixed rate investments are
subject to interest rate risk and may fall in value if market interest rates
increase. If market interest rates were to increase immediately and uniformly by
10% from the levels at March 31, 2002, the fair market value of the portfolio
would decline by an immaterial amount. We have the ability to hold our fixed
income investments until maturity and, therefore, we do not expect our operating
results or cash flows to be materially affected by a sudden change in market
interest rates on our investment portfolio.
Foreign Currency Risk
We face exposure to adverse movements in foreign currency exchange rates. Our
international revenues and expenses are denominated in foreign currencies,
principally the Euro and the British pound sterling. The functional currency of
each of our foreign subsidiaries is the local currency. Our international
business is subject to risks typical of an international business, including,
but not limited to differing tax structures, other regulations and restrictions,
44
and foreign exchange rate volatility. Based on our overall currency rate
exposure at March 31, 2002, a 10% change in foreign exchange rates would have
had an immaterial effect on our financial position, results of operations and
cash flows. As a percentage of total revenues, international revenues grew from
34.0% for the three months ended March 31, 2001 to 34.5% for the three months
ended March 31, 2002, and we anticipate that international revenues will
continue to account for a significant amount of total revenues. To date, we have
not hedged the risks associated with foreign exchange exposure. Although we may
do so in the future, we cannot be sure that any hedging techniques we may
implement will be successful or that our business, results of operations,
financial condition and cash flows will not be materially adversely affected by
exchange rate fluctuations. In the latter part of 2001 and throughout the first
quarter of 2002, there has been extensive economic turmoil in Argentina, which
has resulted in a significant devaluation of the Argentine peso. Revenues from
our operations in Argentina accounted for 0.6% of total revenues during the
three months ended March 31, 2002. We believe that our economic exposure in that
region is not significant.
45
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 Securities and Exchange Commission, 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. On November 7, 2001, as part of the Delaware Derivative Litigation
described below and in satisfaction of a condition to the settlement agreement
relating to the class action, certain of our officers tendered to us for no
consideration an aggregate of 1,683,504 shares of class A common stock held by
them for cancellation. Accordingly, upon the completion of the distribution, we
will have effected a net issuance of 1,094,274 shares of class A common stock as
part of the class action settlement.
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. On March 12, 2002, the
court entered the final distribution order allowing distribution of the
settlement consideration. We expect that the consideration will be issued to the
class members in the second or third quarter of 2002 after the remaining closing
conditions have been met.
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. On November 7,
2001 as a part of the derivative settlement agreement and in satisfaction of a
condition 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,
tendered to the Company for cancellation an aggregate of 1,683,504 shares of
class A common stock held by them. At a hearing on August 7, 2001, the Chancery
Court approved the derivative settlement.
46
Business Objects Litigation
On October 2, 2001, we filed a lawsuit in the Virginia Circuit Court for Fairfax
County against two field employees of Business Objects, S.A. ("BO"). Our lawsuit
alleged that these employees, who previously worked for us, breached their
fiduciary and contractual obligations to us by, among other things,
misappropriating our trade secrets and confidential information and soliciting
our employees and customers. Our complaint sought 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. A trial date has not yet been set in the Northern District of
California action. 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. On March 13, 2002, we
voluntarily dismissed without prejudice our lawsuit pending in the Virginia
Circuit Court for Fairfax County against the two field employees of BO. On April
2, 2002, we amended our complaint against BO to add claims for violations of the
federal Computer Fraud and Abuse Act, misappropriation of trade secrets, and
tortious interference with contractual relations. On May 13, 2002, we submitted
an agreed order to further amend our complaint against BO to add claims for
violations of the Virginia Conspiracy Act. We are seeking monetary damages and
injunctive relief. Trial is scheduled to commence on October 8, 2002.
Other Proceedings
We are also involved in other legal proceedings through the normal course of
business. Management believes that any unfavorable outcome related to these
other proceedings will not have a material effect on our financial position,
results of operations or cash flows.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
Exhibit
Number Description
- ------- -----------
3.1 Amended and Restated Certificate of Incorporation of the registrant,
as amended (filed as Exhibit 3.1 to the registrant'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 registrant (filed as Exhibit 3.2 to the
registrant's Quarterly Report on Form 10-Q for the quarterly period
ended June 30, 2000 (File No. 000-24435) and incorporated by reference
herein).
47
Exhibit
Number Description
- ------- -----------
3.3 Certificate of Designations, Preferences and Rights of the Series A
Convertible Preferred Stock (filed as Exhibit 3.1 to the registrant'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 registrant'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 registrant's
Current Report on Form 8-K (File No. 000-24435) filed on June 18,
2001 and incorporated by reference herein).
3.6 Certificate of Designations, Preferences and Rights of the Series D
Convertible Preferred Stock (filed as Exhibit 4.3 to the registrant's
Current Report on Form 8-K (File No. 000-24435) filed on June 18,
2001 and incorporated by reference herein).
3.7 Restated By-Laws of the registrant (filed as Exhibit 3.2 to the
registrant's Registration Statement on Form S-1 (Registration No.
333-49899) and incorporated by reference herein).
10.1 Amendment Number Two to Amended and Restated Loan and Security
Agreement, dated February 28, 2002, by and among Foothill Capital
Corporation, the registrant and MicroStrategy Services Corporation
(filed as Exhibit 10.16 to the registrant's Annual Report on Form 10-K
for the fiscal year ended December 31, 2001 (File No. 000-24435) and
incorporated by reference herein).
10.2 Amendment Number Three to Amended and Restated Loan and Security
Agreement, dated April 26, 2002, by and among Foothill Capital
Corporation, the registrant and MicroStrategy Services Corporation
(filed as Exhibit 10.1 to the registrant's Current Report on Form 8-K
(File No. 000-24435) filed on May 1, 2002 and incorporated by
reference herein).
B. Reports on Form 8-K
On February 8, 2002, the registrant filed a Current Report on Form 8-K dated
January 31, 2002 to report that it had issued a press release announcing its
financial results for the year ended December 31, 2001, and providing additional
outlook and financial guidance information.
All other items included in a Quarterly Report of Form 10-Q are omitted because
they are not applicable or the answers are none.
48
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
MICROSTRATEGY INCORPORATED
By: /s/ Michael J. Saylor
---------------------
Michael J. Saylor
Chairman of the Board of Directors
and Chief Executive Officer
By: /s/ Eric F. Brown
-----------------
Eric F. Brown
President and Chief Financial
Officer
Date: May 14, 2002
49