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, 2000
OR
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Transition Period From __________ to __________
Commission File Number 000-24435
MICROSTRATEGY INCORPORATED
(Exact name of registrant as specified in its charter)
Delaware
(State of incorporation)
51-0323571
(I.R.S. Employer Identification Number)
8000 Towers Crescent Drive
Vienna, VA
(Address of Principal Executive Offices)
22182
(Zip Code)
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, 2000 was 24,358,362 and 55,179,115,
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, 2000 (unaudited) and December 31, 1999........ 1
Consolidated Statements of Operations For the Three Months Ended March 31, 2000
and 1999 (unaudited)..................................................................... 2
Consolidated Statements of Cash Flows For the Three Months Ended March 31, 2000
and 1999 (unaudited)..................................................................... 3
Notes to Consolidated Financial Statements (unaudited).................................... 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................................... 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk................................ 28
Part II. OTHER INFORMATION.........................................................................
Item 1. Legal Proceedings......................................................................... 29
Item 6. Exhibits and Reports on Form 8-K.......................................................... 29
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
MICROSTRATEGY INCORPORATED
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
March 31, December 31,
2000 1999
------------------- -------------------
(unaudited) (Restated)
See Note 2
Assets
Current assets:
Cash and cash equivalents...................................................... $ 17,534 $ 25,941
Short-term investments......................................................... 37,226 42,418
Accounts receivable, net....................................................... 35,348 37,586
Prepaid expenses and other current assets...................................... 12,301 15,461
-------- --------
Total current assets.......................................................... 102,409 121,406
Property and equipment, net..................................................... 39,824 30,594
Goodwill and other intangible assets, net of accumulated amortization of
$4,408 and $503, respectively.................................................. 43,293 47,154
Deposits and other assets....................................................... 7,696 4,214
-------- --------
Total assets.................................................................. $193,222 $203,368
======== ========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses.......................................... $ 23,655 $ 15,357
Accrued compensation and employee benefits..................................... 16,321 14,912
Deferred revenue and advance payments.......................................... 36,127 38,028
-------- --------
Total current liabilities..................................................... 76,103 68,297
Deferred revenue and advance payments........................................... 34,514 33,255
-------- --------
Total liabilities............................................................. 110,617 101,552
-------- --------
Commitments and contingencies
Stockholders' equity:
Preferred stock, par value $0.001 per share, 5,000 shares authorized;
no shares issued or outstanding............................................... -- --
Class A common stock, par value $0.001 per share, 100,000 shares
authorized; 24,170 and 22,384 shares issued and outstanding, respectively..... 24 22
Class B common stock, par value $0.001 per share, 100,000 shares
authorized; 55,279 and 55,867 shares issued and outstanding, respectively..... 55 56
Additional paid-in capital..................................................... 143,321 138,943
Accumulated other comprehensive income......................................... 10,835 1,643
Deferred compensation.......................................................... (827) (895)
Accumulated deficit............................................................ (70,803) (37,953)
-------- --------
Total stockholders' equity.................................................... 82,605 101,816
-------- --------
Total liabilities and stockholders' equity.................................... $193,222 $203,368
======== ========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
1
MICROSTRATEGY INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months Ended March 31, 2000 and 1999
(in thousands, except per share data)
Three Months Ended
March 31,
-------------------------------------
2000 1999
------------- -----------
(Restated)
See Note 2
(unaudited) (unaudited)
Revenues:
Product licenses............................................................ $ 26,011 $16,418
Product support and other services.......................................... 24,604 12,904
-------- -------
Total revenues............................................................ 50,615 29,322
Cost of revenues:
Product licenses............................................................ 605 520
Product support and other services.......................................... 15,761 6,609
-------- -------
Total cost of revenues.................................................... 16,366 7,129
-------- -------
Gross profit................................................................. 34,249 22,193
-------- -------
Operating expenses:
Sales and marketing......................................................... 41,512 16,754
Research and development.................................................... 16,200 5,061
General and administrative.................................................. 12,118 4,233
Amortization of goodwill and other intangible assets........................ 3,906 20
-------- -------
Total operating expenses.................................................. 73,736 26,068
-------- -------
Loss from operations......................................................... (39,487) (3,875)
Interest income.............................................................. 460 504
Interest expense............................................................. (3) (92)
Other income, net............................................................ 6,430 46
-------- -------
Loss before income taxes..................................................... (32,600) (3,417)
Provision for income taxes................................................... 250 387
-------- -------
Net loss..................................................................... $(32,850) $(3,804)
======== =======
Basic and diluted net loss per share......................................... $ (0.42) $ (0.05)
======== =======
Weighted average shares used in computing basic and diluted net loss per
share....................................................................... 78,926 72,779
======== =======
The accompanying notes are an integral part of these Consolidated Financial
Statements.
2
MICROSTRATEGY INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 2000 and 1999
(in thousands)
Three Months Ended
March 31,
---------------------------------
2000 1999
------------ ------------
(Restated)
See Note 2
(unaudited) (unaudited)
Operating activities:
Net loss................................................................. $(32,850) $ (3,804)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization............................................ 6,131 1,390
Provision for doubtful accounts.......................................... 507 60
Amortization of deferred compensation.................................... 67 67
Realized gain on sales of short-term investments......................... (6,431) --
Changes in operating assets and liabilities:
Accounts receivable................................................... 1,370 4,658
Prepaid expenses and other current assets............................. 3,107 (805)
Deposits and other assets............................................. (3,681) (271)
Accounts payable and accrued expenses, compensation and benefits...... 9,928 (1,503)
Deferred revenue and advance payments................................. (1,898) (953)
-------- --------
Net cash used in operating activities............................... (23,750) (1,161)
-------- --------
Investing activities:
Purchases of property and equipment...................................... (9,937) (4,751)
Purchases of short-term investments...................................... (1,496) (16,487)
Maturities of short-term investments..................................... 5,500 --
Sales of short-term investments.......................................... 17,204 --
-------- --------
Net cash provided by (used in) investing activities................. 11,271 (21,238)
-------- --------
Financing activities:
Proceeds from sale of Class A common stock and exercise of
stock options, net of offering costs.................................... 4,379 42,782
Payments of dividend notes payable....................................... -- (2,500)
-------- --------
Net cash provided by financing activities........................... 4,379 40,282
-------- --------
Effect of foreign exchange rate changes on cash and cash
equivalents........................................................ (307) (251)
-------- --------
Net (decrease) increase in cash and cash equivalents...................... (8,407) 17,632
Cash and cash equivalents, beginning of period............................ 25,941 27,491
-------- --------
Cash and cash equivalents, end of period.................................. $ 17,534 $ 45,123
======== ========
Supplemental disclosure of noncash investing and financing activities:
Change in unrealized gain on short-term investments, net of tax.......... $ 9,571 $ --
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the period for interest................................. $ -- $ 54
======== ========
Cash paid during the period for income taxes............................. $ 47 $ 460
======== ========
The accompanying notes are an integral part of these Consolidated Financial
Statements.
3
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(1) Basis of Presentation
The consolidated balance sheet of MicroStrategy Incorporated as of March
31, 2000, the related consolidated statements of operations for the three month
periods ended March 31, 2000 and 1999, and the consolidated statements of cash
flows for the three month periods ended March 31, 2000 and 1999 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, 1999.
(2) Restatement of Financial Statements
Subsequent to the filing of a registration statement on Form S-3 with the
SEC which included the Company's audited financial statements for the years
ended December 31, 1999, 1998 and 1997, the Company became aware that the timing
and amount of reported earned revenues from license transactions in 1999, 1998
and 1997 required revision.
As discussed in the Company's Annual Report on Form 10-K for the year
ended December 31, 1999 in Note 3 of the Notes to Consolidated Financial
Statements, these revisions primarily addressed the recognition of revenue for
certain software arrangements which should be accounted for under the
subscription method or the percentage of completion method, which spread the
recognition of revenue over the entire contract period. The effect of these
revisions is to defer the time in which revenue is recognized for large, complex
contracts that combine both products and services. These revisions also resulted
in a substantial increase in the amount of deferred revenue reflected on the
Company's balance sheet as of December 31, 1999. Additionally, these revisions
include the effects of changes in the reporting periods when revenue from
certain contracts are recognized. In the course of reviewing its revenue
recognition on various transactions, the Company became aware that, in certain
instances, the Company had recorded revenue on certain contracts in one
reporting period where customer signature and delivery had been completed, but
where the contract may not have been fully executed by the Company in that
reporting period. The Company subsequently reviewed license agreements executed
near the end of the quarter ended March 31, 1999 and determined that revisions
to its reported revenues for the quarter ended March 31, 1999 were necessary,
primarily to ensure that all agreements for which the Company was recognizing
revenue in a reporting period were executed by both parties no later than the
end of the reporting period in which the revenue is recognized. The effect of
all revisions for the three months ended March 31, 1999 was to reduce total
revenues by $6.5 million.
Additionally, the Company also made certain revisions to its balance sheet
as of December 31, 1999. These revisions are discussed in the Company's Annual
Report on Form 10-K for the year ended December 31, 1999 in Note 3 of the Notes
to Consolidated Financial Statements.
Accordingly, such financial statements for the periods presented in this
Form 10-Q have been restated as follows (in thousands):
4
Three Months Ended
March 31, 1999
----------------------------------
As Reported Restated
--------------- -----------------
Statements of Operations Data
Revenues:
Product licenses............................................. $23,124 $16,418
Product support and other services........................... 12,660 12,904
Income (loss) from operations................................. 2,541 (3,875)
Provision for income taxes.................................... 1,140 387
Net income (loss)............................................. 1,859 (3,804)
Net income (loss) per share:
Basic........................................................ 0.03 (0.05)
Diluted...................................................... 0.02 (0.05)
(3) Recent Accounting Pronouncements
In March 2000, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation (FIN) No. 44, "Accounting for Certain Transactions Involving
Stock Compensation - An Interpretation of APB Opinion No. 25." FIN 44 clarifies
the application of APB Opinion No. 25 and, among other issues, clarifies the
following: the definition of an employee for purposes of applying APB Opinion
No. 25; the criteria for determining whether a plan qualifies as a non-
compensatory plan; the accounting consequence of various modifications to the
terms of previously fixed stock options or awards; and the accounting for an
exchange of stock compensation awards in a business combination. FIN 44 is
effective July 1, 2000, but certain conclusions in FIN 44 cover specific events
that occurred after either December 15, 1998 or January 12, 2000. The Company
does not expect the application of FIN 44 to have a material impact on its
financial position or results of operations.
(4) Short-term Investments
In December 1999, the Company received 824,742 shares (adjusted for a two-
for-one stock split) of Exchange Applications stock, valued at $21.5 million, in
consideration for the sale of MicroStrategy software, technical support and
consulting services. In March 2000, the Company sold 412,372 of these shares at
an average price of $41.72 per share, which resulted in a realized gain of $6.4
million.
During May 2000, the Company sold its economic interest in the remaining
412,370 shares of Exchange Applications stock to a financial institution for
approximately $5.9 million, from which the Company expects to recognize a
realized loss of approximately $4.9 million. Overall, the Company has sold all
of its economic interest in the shares it received in December 1999 for an
expected total net gain of approximately $1.5 million.
(5) Accounts Receivable
Accounts receivable, net of allowances, consist of the following, as of (in
thousands):
March 31, December 31,
2000 1999
--------- ------------
Billed and billable................................... $ 75,292 $ 66,181
Less deferred revenue................................. (36,108) (25,266)
-------- --------
39,184 40,915
Less allowance for doubtful accounts.................. (3,836) (3,329)
-------- --------
$ 35,348 $ 37,586
======== ========
(6) Bank Borrowings
In March 1999, the Company entered into a line of credit agreement with a
commercial bank which provides for a $25.0 million unsecured revolving line of
credit for general working capital purposes. As of March 31, 2000, no amounts
were outstanding under the line of credit; however, borrowing capacity was
reduced by $3.8 million of letters of credit.
5
The line of credit agreement required the Company to comply with certain
financial covenants. The Company was not in compliance with all of the
covenants contained in the line of credit agreement as of March 31, 2000.
However, the Company has previously received a waiver through April 30, 2000.
On May 15, 2000, the Company entered into a modification of the line of credit
agreement which, among other things, increased the line of credit TO $28.6
million, removed any financial covenants and cured any financial covenant
defaults. The modification is effective as of March 30, 2000. The modified
line of credit is guaranteed by both the Company's Chief Executive Officer
("CEO") and an entity controlled by him, and the guaranty by the entity is
secured by certain of its assets. The modified line of credit bears interest at
LIBOR plus 1.75%, includes a 0.2% unused line of credit fee, requires monthly
payments of interest, and expires on May 31, 2001. Draw downs under the
modified line of credit are subject to the Company providing certain items such
as an opinion of counsel relating to the pledged collateral. The Company
currently has $7.4 million of letters of credit under the line of credit. The
CEO's guarantee of this line is effective during the entire term of the loan.
The CEO does not receive any compensation from providing that guarantee and
collateral.
(7) Deferred Revenue and Advance Payments
Deferred revenue and advance payments from customers consist of the
following, as of (in thousands):
March 31, December 31,
2000 1999
-------- -----------
Current:
Deferred product revenue.................................. $ 35,808 $ 38,164
Deferred product support and other services revenue....... 35,582 24,267
-------- --------
71,390 62,431
Less amount in accounts receivable........................ (35,263) (24,403)
-------- --------
$ 36,127 $ 38,028
======== ========
Non-current:
Deferred product revenue.................................. $ 10,108 $ 9,461
Deferred product support and other services revenue....... 25,251 24,657
-------- --------
35,359 34,118
Less amount in accounts receivable........................ (845) (863)
-------- --------
$ 34,514 $ 33,255
======== ========
(8) Commitments and Contingencies
As of March 31, 2000, the Company had $6.0 million in commitments for
computer software and equipment, $10.0 million in marketing agreements, and $3.6
million in commitments for future operating expenses.
(9) Litigation
The Company is a defendant in numerous purported class action suits in
which the Company and several of its officers are alleged to have violated
Section 10(b) of the Securities Exchange Act of 1934, as amended (the "1934
Act"), Rule 10(b) (5) promulgated thereunder and Section 20(a) of the 1934 Act.
The complaints do not specify the amount of the damages sought. Accordingly, the
Company is unable to determine or estimate the outcome at this time. It is
possible that the Company may be required to pay substantial damages or
settlement costs which could have a material adverse effect on the Company's
financial condition or results of operations. The Company has not yet filed any
responsive pleadings, but intends to defend the matter vigorously.
In March 2000, the Company was notified that the SEC had issued a formal
order of private investigation in connection with matters relating to the
Company's restatement of its financial results. The SEC has requested that the
Company provide the SEC with certain documents concerning the Company's revision
of its financial results and financial reporting documents. The SEC indicated
that its inquiry should not be construed as an indication by the SEC or its
staff that any violation of law has occurred, nor as an adverse reflection upon
any person, entity or security. The Company is cooperating with the SEC in
connection with this investigation and its outcome cannot yet be determined.
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.
6
(10) Comprehensive Loss
Comprehensive loss includes foreign currency translation adjustments and
unrealized gains and losses on short-term investments, net of related tax
effects, that have been excluded from net loss and reflected in stockholders'
equity as accumulated other comprehensive income.
Comprehensive loss for the three months ended March 31, 2000 and 1999 is
calculated as follows (in thousands):
Three Months Ended March 31,
------------------------------------
2000 1999
--------------- ----------------
Net loss................................................ $(32,850) $(3,804)
Foreign currency translation losses..................... (379) (331)
Unrealized gain on short-term investments,
net of applicable taxes............................... 9,571 --
-------- -------
Total comprehensive loss................................ $(23,658) $(4,135)
======== =======
(11) Basic and Diluted Net Loss Per Share
Basic net loss per share is determined by dividing the net loss applicable
to common stockholders by the weighted average number of common shares
outstanding during the period. Diluted net loss per share is determined by
dividing the net loss applicable to common stockholders by the weighted average
number of common shares and potential common shares outstanding during the
period. Potential common shares are included in the diluted net loss per share
calculation when dilutive. Potential common shares consisting of common stock
issuable upon exercise of outstanding common stock options and warrants are
computed using the treasury stock method. The Company's net loss per share
calculation for basic and diluted is based on the weighted average common shares
outstanding. There are no reconciling items in the numerator and denominator of
the Company's net loss per share calculation. Employee stock options of
12,688,504 and 11,484,104 and warrants of 100,000 and 100,000 for the three
months ended March 31, 2000 and 1999, respectively, have been excluded from the
net loss per share calculation because their effect would be anti-dilutive.
(12) Segment Information
The Company applies provisions of SFAS No. 131, "Disclosure about Segments
of an Enterprise and Related Information." SFAS No. 131 requires certain
disclosures about operating segments, products and services, geographic areas,
and major customers. The method for determining what information to report is
based on the way that management organizes the operating segments within the
Company for making operational decisions and assessments of financial
performance. The Company's chief operating decision maker is considered to be
the Company's CEO. The CEO reviews financial information presented on a
consolidated basis accompanied by disaggregated information about revenues by
operating segments for purposes of making operating decisions and assessing
financial performance.
The Company has two operating segments, MicroStrategy Platform and
Strategy.com. MicroStrategy Platform provides scalable, sophisticated and
maintainable solutions that enable businesses to develop and deploy intelligent
e-business systems. Revenues are derived from sales of product licenses and
product support and other services, including technical support, education and
consulting and hosting services. Strategy.com delivers personalized information
to consumers through its personal intelligence network via the web, wireless
applications, protocol-enabled devices, e-mail, mobile phone, fax, pager and
regular telephone. Strategy.com syndicates its channels through network
affiliates and offers them to consumers directly through its website. Revenues
are derived from network affiliate fees, OEM and subscription fees, advertising
fees and transaction fees. The Company began operating its business as two
segments in the latter part of 1999. Revenues were recognized for Strategy.com
beginning in 2000. Prior years' segment information has been restated to reflect
the operations of Strategy.com.
The accounting policies of both segments are the same as those described in
the summary of significant accounting policies in the Company's Annual Report on
Form 10-K for the year ended December 31, 1999.
7
Certain corporate support costs are allocated to Strategy.com based on factors
such as headcount, gross asset value and the specific level of activity directly
related to such costs.
The following summary discloses certain financial information regarding the
Company's operating segments (in thousands):
MicroStrategy
Platform Strategy.com Consolidated
------------- ----------------- -----------------
Three Months Ended March 31, 2000
Total license and service revenues......... $ 50,502 $ 113 $ 50,615
Gross profit............................... 34,343 (94) 34,249
Depreciation and amortization.............. 5,360 771 6,131
Operating expenses......................... 62,352 11,384 73,736
Loss from operations....................... (28,009) (11,478) (39,487)
Total assets............................... 182,608 10,614 193,222
Three Months Ended March 31, 1999
Total license and service revenues......... $ 29,322 $ -- $ 29,322
Gross profit............................... 22,193 -- 22,193
Depreciation and amortization.............. 1,370 20 1,390
Operating expenses......................... 25,625 443 26,068
Loss from operations....................... (3,432) (443) (3,875)
Total assets............................... 109,318 453 109,771
The following summary discloses total revenues and long-lived assets,
excluding long-term deferred tax assets, relating to the Company's geographic
regions (in thousands):
Domestic International Consolidated
------------------- ------------------- -------------------
Three Months Ended March 31, 2000
Total license and service revenues......... $39,185 $11,430 $50,615
Long-lived assets.......................... 85,615 3,423 89,038
Three Months Ended March 31, 1999
Total license and service revenues......... $21,710 $ 7,612 $29,322
Long-lived assets.......................... 17,883 2,109 19,992
Transfers of $2.4 million and $1.7 million for the three months ended March
31, 2000 and 1999, respectively, from international to domestic operations have
been excluded from the above table and eliminated in the consolidated financial
statements.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
We are a leading worldwide provider of intelligent e-business software and
related services that enable the transaction of one-to-one electronic business
through web, wireless and communication channels. Our product line enables both
proactive and interactive delivery of information from large-scale databases.
Our objective is to provide the largest 2000 enterprises in the world, leading
Internet businesses and high-volume data providers with a software platform to
develop solutions that deliver insight and intelligence to their enterprises,
customers and supply-chain partners.
Our software platform enables users to query and analyze the most detailed,
transaction-level databases, turning data into business intelligence. In
addition to supporting internal enterprise users, the platform delivers critical
business information beyond corporate boundaries to customers, partners and
supply chain constituencies through a broad range of communication channels such
as the Internet, e-mail, telephones and wireless communications devices. Our
platform is ideal for developing e-business solutions that are personalized and
proactive and that reach millions of users. We also offer a comprehensive set of
consulting, education and technical support services for our customers and
partners.
In July 1999, we launched a new business unit called Strategy.com.
Strategy.com is our personal intelligence network, a new form of media that
brings speed to transactions by actively delivering highly personalized,
relevant and timely information to individuals through a wide variety of
delivery methods, including e-mail, telephone and wireless devices. The
Strategy.com network leverages the MicroStrategy software platform and is
organized around a suite of information channels. The network currently operates
Finance, News and Weather Channels and plans to launch additional information
channels in the future. Strategy.com syndicates its channels through other
companies that serve as network affiliates and network associates, which we
refer to collectively as affiliates. Affiliates offer the Strategy.com channels
and services on a co-branded basis directly to their customers and in turn share
with Strategy.com a percentage of revenues they generate. Strategy.com also
provides application maintenance, development, customer billing, hosting and
support services for these channels, enabling affiliates to focus on their core
businesses. Strategy.com has established approximately 150 network affiliate
agreements with leading Internet companies, communications carriers, media
companies and financial institutions and now has approximately 350,000
subscribers for its Strategy.com network.
Since 1995, we have significantly increased our sales and marketing, service
and support, research and development and general and administrative staff.
Although our revenues have significantly increased over the last three years, we
experienced fluctuating operating margins during 1997, 1998 and 1999 primarily
as a result of increases in staff levels. We expect to continue to increase
staff levels and incur additional associated costs in future periods. In
addition, we intend to aggressively pursue financing to allow us to invest
significant resources to market, operate and develop Strategy.com. We expect
that such ongoing investment in Strategy.com would result in significantly
increased operating losses.
Our revenues historically have been derived from two principal sources, fees
for product licenses and fees for maintenance, technical support, education and
consulting services, which we refer to collectively as product support and other
services. We recognize revenue in accordance with Statement of Position ("SOP")
97-2, "Software Revenue Recognition," as amended by SOP 98-4, "Deferral of the
Effective Date of a Provision of SOP 97-2" and SOP 98-9, "Modification of SOP
97-2, Software Revenue Recognition," and SOP 81-1, "Accounting for Performance
of Construction-Type and Certain Production-Type Contracts," as applicable.
Product license revenues are generally recognized upon the execution of a
contract and shipment of the related software product if no significant
obligations remain outstanding on our part and the resulting receivable is
deemed collectible by management.
Technical support revenues are derived from customer support agreements
generally entered into in connection with initial product license sales and
subsequent renewals. Fees for our technical support services are displayed as
deferred revenue when paid by the customer and recognized ratably over the term
of the
9
maintenance and support agreement, which is typically one year. We also record
as deferred revenue the fair value of implicit maintenance arrangements when
resellers or other customers that sell our software to end users offer these end
users the right to receive the then current version of our software at the time
of resale. Certain of these agreements extend over several years. Fees for our
education and consulting services are typically recognized at the time the
services are performed.
Revenues recognized from multiple-element software arrangements are allocated
to each element of the arrangement based on the relative fair values of the
elements, such as software products, upgrades, enhancements, technical support,
installation or education. The determination of fair value of each element is
based on objective evidence based on historical sales of the individual element
by us to other customers. If such evidence of fair value for each element of the
arrangement does not exist, all revenue from the arrangement is deferred until
such time that evidence of fair value does exist or until all elements of the
arrangement are delivered.
Customers at times require consulting and implementation services which
include evaluating their business needs, identifying resources necessary to meet
their needs and installing the solution to fulfill their needs. When the
software license arrangement requires the Company to provide significant
consulting services to produce, customize or modify software or when the
customer considers these services essential to the functionality of the software
product, both the product license revenue and product support and other services
revenue are recognized in accordance with the provisions of SOP 81-1. The
Company recognizes revenue from these arrangements using the percentage of
completion method and, therefore, both product license and product support and
other services revenue are recognized as work progresses. If the software
license arrangement obligates the Company to the delivery of unspecified future
products, then revenue is recognized on the subscription basis, ratably over the
term of the contract.
Beginning initially in the fourth quarter of 1998 we began to sell our
products and services to customers for large scale e-commerce applications and
have continued to enter into similar transactions through the current quarter.
In contrast to earlier periods in which our typical customer transaction
involved a stand-alone software license and maintenance, these transactions
typically involve multiple software products and services for use by very large
numbers of end users across web, wireless and voice communications channels, and
often incorporate elements from our Strategy.com network. These multiple element
transactions also often include significant implementation and other consulting
work and may also include our providing the customer with hosting services, in
which we manage the operation of hosting the customer's specific e-commerce
application. Customers often use our products and services in a variety of ways,
including internal use, integration with their own products for resale to end
users and creation of e-commerce applications. These arrangements typically lead
to our recording revenue from multiple sources, including product license fees,
product support fees and royalties based on advertising, e-commerce transactions
or the resale of solutions that incorporate our software platform.
These large, multiple element transactions typically involve more complex
licensing and product support arrangements than the software licensing and
product support arrangements that comprised the bulk of our revenues in earlier
periods. Based on the revenue recognition criteria established in SOP 97-2 and
SOP 81-1, revenue from many of these large, multiple element contracts is not
recognizable upon full execution and delivery of the software product as in the
past, but instead is initially recorded as deferred revenue upon receipt of
cash, with product revenue recognized using the percentage of completion method
based on cost inputs or ratably over the entire term of the contract. As a
result of the size and complexity of these transactions, our results for any
quarter may depend significantly on the types of customer transactions that we
enter into during the quarter and on the mix of product licenses, support
agreements, implementation work and other specific terms of each transaction,
each of which may have a significant effect on the manner in which we recognize
revenue from the transaction.
The sales cycle for our products may span nine months or more. Historically,
we have recognized a substantial portion of our revenues in the last month of a
quarter, with these revenues frequently concentrated in the last two weeks of a
quarter. Even minor delays in booking orders may have a significant adverse
impact on revenues for a particular quarter. To the extent that delays are
incurred in connection with orders of significant size, the impact will be
correspondingly greater. Product license revenues in any quarter can be
dependent on orders booked and shipped in that quarter. As a result of these and
other factors, our quarterly
10
results have varied significantly in the past and are likely to fluctuate
significantly in the future. Accordingly, we believe that quarter-to-quarter
comparisons of our results of operations are not necessarily indicative of the
results to be expected for any future period.
We license our software through our direct sales force and increasingly
through, or in conjunction with, value-added resellers, system integrators and
original equipment manufacturers. Channel partners accounted for, directly or
indirectly, approximately 40.4%, 39.2%, 33.6% and 27.0% of our revenues for the
three months ended March 31, 2000 and the years ended December 31, 1999, 1998
and 1997, respectively. 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. However, there can be no assurance that our
efforts to continue to expand indirect sales will be successful. We also intend
to continue to expand our international operations and have committed, and
continue to commit, significant management time and financial resources to
developing direct and indirect international sales and support channels.
Our operations and prospects have been and will be significantly affected by
the developments relating to our revision to our 1999, 1998 and 1997 financial
statements described in Note 2 of the Notes to Consolidated Financial
Statements. As previously reported in our Annual Report on Form 10-K for the
year ended December 31, 1999, numerous separate complaints purporting to be
class actions were filed in federal courts in various jurisdictions alleging
that we and certain of our officers and directors violated various securities
laws and in March 2000, we were notified that the SEC had issued a formal order
of private investigation in connection with the matters relating to our
restatement of our financial results. These legal proceedings are more fully
described in Note 9 of the Notes to Consolidated Financial Statements and in
"Other Information-Legal Proceedings" of Part II of this Quarterly Report on
Form 10-Q. The revision to our financial statements and these legal proceedings
could have a material adverse effect on our business, financial condition and
results of operations. See "Risk Factors" discussed below.
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,
------------------------------------
2000 1999
------- ------
(Restated)(1)
Statements of Operations Data
Revenues:
Product licenses............................................. 51.4% 56.0%
Product support and other services........................... 48.6 44.0
------ ------
Total revenues.............................................. 100.0 100.0
Cost of revenues:
Product licenses............................................. 1.2 1.8
Product support and other services........................... 31.1 22.5
------ ------
Total cost of revenues...................................... 32.3 24.3
------ ------
Gross profit.................................................. 67.7 75.7
Operating expenses:
Sales and marketing.......................................... 82.0 57.1
Research and development..................................... 32.0 17.3
General and administrative................................... 24.0 14.4
Amortization of goodwill and other intangible assets......... 7.7 0.1
------ ------
Total operating expenses.................................... 145.7 88.9
Loss from operations.......................................... (78.0) (13.2)
Interest income............................................... 0.9 1.7
Interest expense.............................................. (--) (0.3)
Other income, net............................................. 12.7 0.1
Provision for income taxes.................................... 0.5 1.3
------ ------
Net loss...................................................... (64.9)% (13.0)%
====== ======
______________________
(1) See Note 2 of the Notes to Consolidated Financial Statements regarding
restatement of 1999, 1998 and 1997 financial statements.
11
Comparison of the Three Months Ended March 31, 2000 and 1999
Revenues
Total revenues consist of revenues derived from sales of product licenses and
product support and other services, including technical support, education and
consulting services. Total revenues increased from $29.3 million to $50.6
million for the three months ended March 31, 1999 and 2000, respectively,
resulting in an increase of 72.6%. As discussed in Note 2 of the Notes to
Consolidated Financial Statements, revenues were restated to reduce reported
revenues for the quarter ended March 31, 1999 by $6.5 million, primarily to
ensure that all agreements for which we recognized revenue in the quarter ended
March 31, 1999 were fully executed by the end of the period. Additionally, as a
result of restatement revisions, $5.1 million of the revenues recognized in the
quarter ended March 31, 2000 were attributable to contracts that we had not
fully executed by December 31, 1999. These revenues are primarily product
license revenues. There can be no assurance that total revenues will continue
to increase at the rates experienced in prior periods. Additionally, based on
the revenue recognition criteria established in SOP 97-2 and SOP 81-1, revenue
from many of the large, multiple element arrangements is recorded as deferred
revenue upon receipt of cash, with both product license revenues and product
support and other services revenues recognized using the percentage of
completion method based on cost inputs or ratably over the entire term of the
contract or over the hosting period, as applicable.
In 1999, we launched the Strategy.com Finance, News and Weather Channels and
plan to launch additional information channels in the future. We have not
recognized revenues related to Strategy.com until 2000 in which, during the
three months ended March 31, 2000, we recognized $113,000 in subscription
revenues which are included in product support and other services revenues. We
expect to begin earning more significant network affiliate, OEM and
subscription, advertising, hosting, transaction and other fees from our
Strategy.com service by the end of 2000.
Product License Revenues. Product license revenues increased from $16.4
million to $26.0 million for the three months ended March 31, 1999 and 2000,
respectively, resulting in an increase of 58.4%. The increase in product
license revenues was due to continued demand for our core products, new product
offerings supporting intelligent e-business solutions and increasing market
demand for intelligent e-business solutions. As discussed above, the effect of
our restatement of reported revenues was to reduce reported product license
revenues for the quarter ended March 31, 1999 and increase product license
revenues for the quarter ended March 31, 2000 to ensure that all agreements were
fully executed by the end of the respective periods in which such revenues are
recognized. We are attracting new customers and our existing customer base is
purchasing additional licenses and new products to support their e-business
solutions. As we continue to pursue our new business model of larger-scale,
multiple element transactions, we expect product license revenues as a
percentage of total revenues to fluctuate on a period-to-period basis, and may
vary significantly from the percentage of total revenues achieved in prior
years. There can be no assurance that we will be able to maintain or continue to
increase market acceptance for our family of products.
Product Support and Other Services Revenues. Product support and other
services revenues increased from $12.9 million to $24.6 million for the three
months ended March 31, 1999 and 2000, respectively, resulting in an increase of
90.7%. The increase in product support and other services revenues was primarily
due to the increase in product licenses sold as well as an increase in large
scale e-commerce applications which require significant implementation and other
consulting work. As a result of the above mentioned trends, we expect product
support and other services 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.
International Revenues. International revenues increased from $7.6 million
to $11.4 million for the three months ended March 31, 1999 and 2000,
respectively, resulting in an increase of 50.2%. The increase in these revenues
is due to the expansion of our international operations, new product offerings
and growing international market acceptance of our software products. We opened
sales offices in Brazil in 1999, in Canada and Italy in 1998 and in Austria,
France, the Netherlands, Germany, United Kingdom and Spain prior to 1998. 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. We
may not be able to maintain or continue to increase international market
acceptance for our family of products.
12
Costs and Expenses
Cost of Product License Revenues. Cost of product license revenues consists
primarily of the costs of product manuals, media, amortization of capitalized
software expenses and royalties paid to third party software vendors. Cost of
product license revenues increased from $0.5 million to $0.6 million for the
three months ended March 31, 1999 and 2000, respectively. As a percentage of
product license revenues, however, cost of product license revenues decreased
from 3.2% to 2.3% for the three months ended March 31, 1999 and 2000,
respectively. The decrease in cost of product license revenues as a percentage
of product license revenues was due to economies of scale realized by producing
larger volumes of product materials and decreased materials costs due to an
increase in the percentage of customers reproducing product documentation at
their sites. We anticipate that the cost of product license revenues will
continue to increase as product license revenues increase, but decrease as a
percentage of product license revenues. However, in the event that we enter into
any royalty arrangements with strategic partners in the future, cost of product
license revenues as a percentage of total product license revenues may increase.
Cost of Product Support and Other Services Revenues. Cost of product support
and other services revenues consists of the costs of providing technical
support, education and consulting services to customers and partners. Cost of
product support and other services revenues increased from $6.6 million to $15.8
million for the three months ended March 31, 1999 and 2000, respectively. As a
percentage of product support and other services revenues, cost of product
support and other services revenues increased from 51.2% to 64.1% for the three
months ended March 31, 1999 and 2000, respectively. The increase in cost of
product support and other services revenues was primarily due to the increase in
the number of personnel providing consulting, education and technical support to
customers as a result of the increase in product licenses sold, new large scale
e-commerce applications and complex Strategy.com deployments. The total cost of
product support and other services revenues increased as a percentage of product
support and other services revenues due to the increased use of third parties to
perform consulting services and an increase in consulting services which are at
lower margins.
We expect to continue to increase the number of customer education and
implementation consultants and technical support personnel in the future. To the
extent that our product support and other services revenues do not increase at
anticipated rates, the hiring of additional consultants and technical support
personnel could increase the cost of product support and other services revenues
as a percentage of product support and other services revenues. Also, to the
extent that we cannot hire adequate numbers of support personnel to meet demand,
we may need to rely more heavily on third parties to perform consulting
services, further increasing cost of product support and other services revenues
as a percentage of product support and other services revenues. In addition,
the cost of providing hosting services and operating the Strategy.com network
may become more significant as we build up our customer base, further increasing
cost of product support and other services revenues as a percentage of product
support and other services revenues.
Sales and Marketing Expenses. Sales and marketing expenses include personnel
costs, commissions, office facilities, travel, advertising, public relations
programs and promotional events, such as trade shows, seminars and technical
conferences. Sales and marketing expenses increased from $16.8 million to $41.5
million for the three months ended March 31, 1999 and 2000, respectively. As a
percentage of total revenues, sales and marketing expenses increased from 57.1%
to 82.0% for the three months ended March 31, 1999 and 2000, respectively. The
increase in sales and marketing expenses was primarily the result of increased
staffing levels in the sales force, increased commissions earned, increased
promotional activities and advertising, increased marketing efforts for
Strategy.com and other general marketing efforts. During the three month period
ended March 31, 2000, we invested heavily in advertising, including a national
television and print advertising campaign and other marketing efforts in order
to create better market awareness of the value-added potential of our product
suite and Strategy.com and to seek to acquire market share. Provided we raise
additional external financing, we will continue to substantially increase our
investment in sales and marketing over the next twelve months. See "Comparison
of the Three Months Ended March 31, 2000 and 1999-Liquidity and Capital
Resources" discussed below.
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
increased from $5.0 million to $16.2 million for the three months ended March
31, 1999
13
and 2000, respectively. As a percentage of total revenues, research and
development expenses increased from 17.3% to 32.0% for the three months ended
March 31, 1999 and 2000, respectively. The increase in research and development
expenses was primarily due to hiring additional research and development
personnel to continue development of Strategy.com channels, new products,
product releases and e-commerce technology. We intend to substantially increase
our investment over the next twelve months to develop other channels as part of
our suite of information channels of our Strategy.com network subject to our
securing additional external financing. In addition, we expect that research and
development expenses will continue to increase as we continue to invest in
developing new products, applications and product enhancements for our existing
platform business and the Strategy.com network.
General and Administrative Expenses. General and administrative expenses
include personnel and other costs of our finance, human resources, information
systems, administrative and executive departments as well as outside
professional fees. General and administrative expenses increased from $4.2
million to $12.1 million for the three months ended March 31, 1999 and 2000,
respectively. As a percentage of total revenues, general and administrative
expenses increased from 14.4% to 24.0% for the three months ended March 31, 1999
and 2000, respectively. The increase in general and administrative expenses was
primarily the result of increased staff levels, costs associated with the growth
of our business and an increase in outside professional fees. We expect that
general and administrative expenses will continue to increase in the foreseeable
future.
Amortization of Goodwill and Other Intangible Assets. In December 1999, in
connection with the purchase of intellectual property and other tangible and
intangible assets relating to NCR's Teracube project, we allocated $46.8 million
to tangible and intangible assets. The preliminary allocation to the intangible
assets, which include assembled work force, agreements not to compete and other
intangible assets, was $46.6 million. As a result, we have incurred and will
continue to incur substantially increased amortization expense in periods
subsequent to December 1999. We believe the weighted average estimated useful
life of such assets, based upon the final allocation, will be less than five
years and anticipate the final allocation will be complete during the first half
of 2000.
In January 1998, we recorded $1.1 million for acquired intangible assets
representing the excess of the fair market value of the shares issued in
exchange for the non-controlling interests' shares in the foreign subsidiaries.
The intangible assets consist primarily of distribution channels, trade name and
customer lists and are being amortized on a straight-line basis over weighted
average useful lives of approximately 14 years.
As a result, we have recorded $3.9 million and $20,000 in amortization expense
for the three months ended March 31, 2000 and 1999, respectively, relating to
intangible assets.
Provision for Income Taxes. We recorded $0.3 million and $0.4 million of tax
expense for the three months ended March 31, 2000 and 1999. The provision for
both quarters relates to taxes payable in certain foreign jurisdictions where we
were profitable in 1999 and expect to be profitable in 2000.
Deferred Revenue
Deferred revenue represents product support and other services fees that are
collected in advance, 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 or product license and product support and
other services fees relating to arrangements which require implementation
related services that are significant to the functionality of features of the
software product, including arrangements with subsequent hosting services.
Deferred revenue was $70.6 million as of March 31, 2000 compared to $71.3
million as of December 31, 1999. We expect to recognize approximately $36.1
million of this deferred revenue over the next 12 months; however, the timing
and ultimate recognition of our deferred revenue depends on our performance of
various service obligations. Because of the possibility of customer changes in
development schedules, delays in implementation and development efforts and the
need to satisfactorily perform product support and other services, deferred
revenue as of any particular date may not be representative of actual revenue
for any succeeding period.
14
Liquidity and Capital Resources
From inception until our initial public offering, we primarily financed our
operations and met our capital expenditure requirements through cash flows from
operations and short- and long-term borrowings. On June 16, 1998, we raised
$48.2 million, net of offering costs, from our initial public offering, and we
raised an additional $40.1 million, net of offering costs, on February 10, 1999
from a public offering of 3,170,000 shares of Class A common stock. On March 31,
2000 and December 31, 1999, we had $54.8 million and $68.4 million of cash, cash
equivalents, and short-term investments, respectively.
Cash used in operations was $23.8 million and $1.2 million for the three
months ended March 31, 2000 and 1999, respectively. The increase in cash used in
operations from 1999 to 2000 was primarily attributable an increase in net loss
due to increased sales and marketing and other operating expenses. We intend to
aggressively pursue financing to allow us to invest significant resources to
market, develop and operate our core business and Strategy.com. Because of this
anticipated ongoing investment, we expect to use significant cash in operations.
Cash provided by investing activities was $11.3 million for the three months
ended March 31, 2000 and cash used in investing activities was $21.2 million for
the same period in 1999. In December 1999, we received 824,742 shares (adjusted
for a two-for-one stock split) of Exchange Applications, valued at $21.5
million, in consideration for the sale of MicroStrategy software, technical
support and application development. In March 2000, we sold 412,372 of these
shares at an average price of approximately $41.72 per share, which resulted in
a realized gain of $6.4 million. The increase in cash provided by investing
activities from 1999 to 2000 reflected the sale of these shares offset by
purchases of additional short-term investments and capital expenditures related
to the acquisition of computer and office equipment required to support
expansion of our operations and building of infrastructure to support
Strategy.com. During May 2000, we sold our economic interest in the remaining
412,370 shares of Exchange Applications stock to a financial institution for
approximately $5.9 million, from which we expect to recognize a realized loss of
approximately $4.9 million. Overall, we have sold our economic interest in the
shares we received in December 1999 for an expected total net gain of
approximately $1.5 million. As of March 31, 2000 we had $6.0 million in
commitments for computer software and equipment, $10.0 million in marketing
arrangements and $3.6 million for future operating expenses.
Our financing activities provided cash of $4.4 million and $40.3 million for
the three months ended March 31, 2000 and 1999, respectively. The principal
source of cash from financing activities during 1999 was from the sale of
3,170,000 shares of Class A common stock in which we raised $40.1 million, net
of offering costs. Prior to our initial public offering, we declared a $10.0
million dividend to our stockholders. The dividend was paid in the form of
notes, prior to the termination of our S corporation election, which occurred
immediately prior to the consummation of our initial public offering. As of
March 31, 2000, the entire $10.0 million of the dividend notes had been repaid.
In March 1999, we entered into a line of credit agreement with a commercial
bank which provides for a $25.0 million unsecured revolving line of credit for
general working capital purposes. As of March 31, 2000, no amounts were
outstanding under the line of credit; however, borrowing capacity was reduced by
$3.8 million of outstanding letters of credit.
The line of credit agreement required us to comply with certain financial
covenants. We were not in compliance with all of the covenants contained in the
line of credit agreement as of March 31, 2000. However, we have previously
received a waiver through April 30, 2000. On May 15, 2000, we entered into a
modification of the line of credit agreement which, among other things,
increased the line of credit to $28.6 million, removed any financial covenants
and cured any financial covenant defaults. The modification is effective as of
March 30, 2000. The modified line of credit is guaranteed by both the Company's
Chief Executive Officer and an entity controlled by him, and the guaranty by the
entity is secured by certain of its assets. The modified line of credit bears
interest at LIBOR plus 1.75%, includes a 0.2% unused line of credit fee,
requires monthly payments of interest, and expires on May 31, 2001. Draw downs
under the modified line of credit are subject to us providing certain items such
as an opinion of counsel relating to the pledged collateral. We currently have
$7.4 million of letters of credit outstanding under the line of credit. The
Chief Executive Officer's guarantee of this line is effective during the entire
term of the loan. The Chief Executive Officer does not receive any compensation
from providing that guarantee and collateral.
Additionally, in November 1999, we signed a three-year master lease agreement
to lease up to $40.0 million of computer equipment, of which we leased
approximately $17.8 million as of April 30, 2000. The
15
lease bears interest at a rate equal to interest on three-year U.S. treasury
notes plus 1.5% to 2.0%. Future draw downs and interest rates under the lease
agreement are subject to our credit worthiness. Currently we are not able to
draw down additional amounts under the lease agreement, although we are seeking
modification of this lease in order to enable future draw downs.
We will require additional external financing through credit facilities, sale
of additional equity in MicroStrategy or Strategy.com or other financing
facilities to support our planned investment of significant resources to
continue to grow the MicroStrategy software platform business, to build the
Strategy.com personal intelligence network, and to increase both MicroStrategy
and Strategy.com brand awareness. There are no assurances that such financing
facilities would be available on acceptable terms. We believe that our existing
cash, cash generated internally by operations and the amended line of credit
entered into in May 2000 will meet our working capital requirements for at least
the next 12 months; provided that we would be required to modify our plans to
expand our business rapidly and would instead be required to conduct operations
with only minimal growth in Strategy.com and MicroStrategy, minimal capital
expenditures and minimal brand awareness expenditures.
Recent Accounting Pronouncements
In March 2000, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation (FIN) No. 44, "Accounting for Certain Transactions Involving
Stock Compensation - An Interpretation of APB Opinion No. 25." FIN 44 clarifies
the application of APB Opinion No. 25 and, among other issues, clarifies the
following: the definition of an employee for purposes of applying APB Opinion
No. 25; the criteria for determining whether a plan qualifies as a non-
compensatory plan; the accounting consequence of various modifications to the
terms of previously fixed stock options or awards; and the accounting for an
exchange of stock compensation awards in a business combination. FIN 44 is
effective July 1, 2000, but certain conclusions in FIN 44 cover specific events
that occurred after either December 15, 1998 or January 12, 2000. We do not
expect the application of FIN 44 to have a material impact on our financial
position or results of operations.
Risk Factors
The following important factors, among others, could cause actual results to
differ materially from those contained in forward-looking statements made in
this quarterly report on Form 10-Q or presented elsewhere by management from
time to time. The risks and uncertainties described below are not the only ones
facing our company. Additional risks and uncertainties not presently known to us
or that we currently deem immaterial may also impair our business operations.
If any of the events described in the following risks actually occur, our
business, financial condition or results of operations could be materially
adversely affected. In such case, the trading price of our Class A common stock
could decline and you may lose all or part of your investment.
We will need additional financing which could be difficult to obtain
We intend to grow our business rapidly, including investing substantial
amounts in our Strategy.com business and expect to incur operating losses for
the foreseeable future. Therefore, our ability to execute a business plan in
which our operations experience more than minimal growth will require
significant external financing in the future. Obtaining additional financing
will be subject to a number of factors, including:
. market conditions;
. our operating performance; and
. investor sentiment.
16
These factors may make the timing, amount, terms and conditions of additional
financing unattractive to us. If we are unable to raise capital to fund our
growth, our business, operating results and financial condition would 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 expanding our direct sales force and adding to our indirect
distribution channels;
. the pace and success of our international expansion;
. delays or deferrals of customer implementation;
. changes in foreign currency exchange rates; and
. seasonal factors such as a lower pace of new sales in the summer.
Limited Ability to Adjust Expenses. Because we plan to expand our business,
we expect our operating expenses to increase substantially. In particular,
during 2000 we expect to increase significantly the costs associated with
marketing, developing and operating our Strategy.com network and with expanding
our technical support, research and development and sales and marketing
organizations. We also expect to devote substantial resources to expanding our
indirect sales channels and international operations. We base our operating
expense budgets on expected revenue trends. In the short term we may not be able
to reduce the actual operating expenses associated with our expansion.
Based on the above factors, we believe that quarter-to-quarter comparisons of
our operating results are not a good indication of our future performance. It is
possible that in one or more future quarters, our operating results may be below
the expectations of public market analysts and investors. In that event, the
trading price of our Class A common stock may fall.
We have recently introduced Strategy.com and it is uncertain whether it will
achieve widespread acceptance
17
We have implemented the Finance, News and Weather Channels of our Strategy.com
networks. We plan to introduce additional channels as part of our suite of
information channels, but they are still in development. While we expect to
implement these additional channels on a commercial basis by the end of 2000, we
may encounter delays or difficulties in this commercial introduction. We expect
that a portion of our future revenue will depend on fees from subscribers for
the use of the Strategy.com network service, from products and services offered
through this network, and from royalties from affiliates who bundle our
Strategy.com network with their own product and service offerings. We have not,
to date, generated any material revenue from our Strategy.com network and may
not be able to do so in the future. If this service, or the products and
services offered through it, fail to achieve widespread customer acceptance, our
business, operating results and financial condition may be materially adversely
affected. In addition, revenue from Strategy.com would be adversely affected if
our affiliates do not perceive that the integration of our Strategy.com network
with their product and service offerings will increase demand for their products
and services or will otherwise be able to generate a sufficient return on their
investment in the use of our network.
We intend to make significant expenditures in developing our Strategy.com
network, which would result in us incurring operating losses
We plan to substantially increase the amounts we will expend on our
Strategy.com network compared to the expenses we have incurred to date, subject
to our securing additional financing. We would then substantially increase our
investment in Strategy.com over the next twelve months to market, develop and
operate Strategy.com and would expect operating losses to increase in 2000. We
also intend to continue making significant investments in Strategy.com after
2000 subject to our securing additional financing and therefore believe we will
continue to be unprofitable for the foreseeable future.
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. 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. 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 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 employees, investors, customers, vendors and lenders may react adversely to
the revision of our 1999, 1998 and 1997 revenues and operating results
Our future success depends in large part on the support of our key employees,
investors, customers, vendors and lenders, who may react adversely to the
revision of our 1999, 1998 and 1997 revenues and operating results. The revision
of our 1999, 1998 and 1997 revenues and operating results has resulted in
substantial amounts of negative publicity about us. We may not be able to retain
key employees and customers if they lose confidence in us, and our vendors and
lenders may reexamine their willingness to do business with us. In addition,
investors may lose confidence, which may cause the trading price of our Class A
common stock to decrease. If we lose the services of our key employees or are
unable to retain and attract our existing and new customers, vendors and
lenders, our business, operating results and financial condition could be
materially and adversely affected.
Our recognition of deferred revenue is subject to future performance obligations
and may not be representative of actual revenues for succeeding periods
18
Our deferred revenue was $70.6 million as of March 31, 2000. The timing and
ultimate recognition of our deferred revenue depends on our performance of
various service obligations. Because of the possibility of customer changes in
development schedules, delays in implementation and development efforts and the
need to satisfactorily perform product support services, deferred revenue at any
particular date may not be representative of actual revenue for any succeeding
period.
We face litigation that could have a material adverse effect on our business,
financial condition and results of operations
We and some of our directors and executive officers are named as defendants in
a number of private securities litigation matters. Although we intend to defend
these actions vigorously, no assurance can be given as to the outcomes. 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. In addition, the SEC has issued a formal order of private
investigation in connection with matters relating to our restatement of our
financial results. The SEC has requested that we provide them with certain
documents concerning the revision of our financial results and financial
reporting documents. We are cooperating with the SEC in connection with this
investigation. Regardless of the outcome of any of these actions, it is likely
that we will incur substantial defense costs and that such actions will cause a
diversion of management time and attention.
We expect that our ability to borrow money under our master equipment lease
agreement will require waivers or amendments to that agreement
We signed a three-year master lease agreement to lease up to $40.0 million of
computer equipment, of which we have leased approximately $17.8 million as of
April 30, 2000. Future draw downs and interest rates under the lease agreement
are subject to our credit worthiness. Currently, we are not able to draw down
additional amounts under the lease agreement; however, we are working with the
lessor to enable future draw downs.
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 e-business, e-commerce, customer relationship management,
portals, business intelligence and Internet-based and wireless-based information
networks 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 our products and our
Strategy.com network.
Our most direct competitors provide:
. e-business infrastructure software;
. customer relationship management products;
. e-commerce transaction systems;
. business intelligence products;
. web portals and information networks;
. vertical Internet portals and information networks; and
. wireless communications and wireless access protocol enabled products.
19
Each of these market segments are discussed more fully below.
E-business Infrastructure Software. In the e-business infrastructure market,
BroadVision, E.piphany, Vignette, Net Perceptions, Broadbase, Art Technology
Group, Engage Technologies, Doubleclick and Personify all provide products that
compete directly or indirectly with our software platform. Many of these
companies provide alternatives to our technology for adding intelligence and
personalization to e-commerce applications. For example, customer information,
such as past purchases, clickstream data and stated preferences, can be used to
create a personalized e-commerce experience that targets customers with offers
and interactions to which they are more likely to respond.
Customer Relationship Management Products. Companies that deliver customer
relationship management products alone or in conjunction with e-commerce
applications, such as BroadVision, E.piphany, Vignette, and Siebel, compete with
our intelligent e-business products.
E-Commerce Transaction Systems. Products that support e-commerce
transactions, such as those provided by Microsoft, IBM, America Online's
Netscape division, BroadVision, Open Market, InterWorld, and Oracle could
provide competition for us. These products have the potential to extend their
capabilities to use customer information as the basis for generating targeted,
personalized product offers, which would compete with our e-business products.
Business Intelligence Products. In the business intelligence market, we
compete with providers of software used to enable businesses to analyze and
optimize their operations. In the enterprise category, which is generally
focused on large deployments, Information Advantage, which was recently acquired
by Sterling Software, competes with us. In the desktop analysis and reporting
category, we face competition from companies such as Business Objects, Cognos,
and Brio Technology. A third category includes products from companies such as
Oracle, Microsoft, and IBM that are generally bundled with or designed to work
with their own relational databases.
Web Portals and Information Networks. Web portals and information networks,
such as Microsoft Network, Yahoo, Lycos, Excite, America Online and
InfoSpace.com, offer an array of information that is similar to information
provided by Strategy.com. Strategy.com seeks to differentiate itself by:
. providing a greater level of personalization;
. allowing users to receive the precise information they want across the
broadest range of information delivery devices including through email,
wireless phone, pager, wireless access protocol enabled products, fax,
personal digital assistants and the telephone; and
. partnering with financial institutions, device manufacturers, Internet
companies, communication carriers, media companies and wireless companies,
to embed Strategy.com information services as an ingredient in their own
offerings.
One or more of these companies, however, could expand their offerings and
reduce our differentiation in these three areas.
Vertical Internet Portals and Information Networks. Expedia, Weather.com,
CNBC.com, ABC.com, ESPN.com, Microsoft Investor, StockBoss, Microsoft CarPoint,
InfoBeat, Internet Travel Network and others have developed custom applications
and products to commercialize, analyze and deliver specific information over the
Internet. These systems are usually tailored to one application, such as
providing news, sports or weather, but in the aggregate, they offer applications
similar to those provided by Strategy.com. Any one of these companies could
expand their offerings to more closely compete with Strategy.com.
Wireless Communications and Wireless Access Protocol Enabled Products.
Wireless communications providers, such as AT&T, Sprint, MCI WorldCom, Nextel
Communications, British Telecom, Deutsche Telekom, PageNet, Nokia, Ericsson,
Aether Systems, 3COM and Palm offer a variety of mobile phones and wireless
devices over which Strategy.com delivers information. These companies may
develop in-house
20
information services or partner with other companies to deliver information that
is competitive to that offered by Strategy.com.
Many of our competitors have longer operating histories, significantly greater
financial, technical, marketing or other resources, and greater name recognition
than we do. In addition, many of our competitors have strong relationships with
current and potential customers and extensive knowledge of the e-business
industry. As a result, they may be able to respond more quickly to new or
emerging technologies and changes in customer requirements or devote greater
resources to the development, promotion and sale of their products than we can.
Increased competition may lead to price cuts, reduced gross margins and loss of
market share. We cannot be sure that we will be able to compete successfully
against current and future competitors or that the competitive pressures we face
will not have a material adverse affect on our business, operating results and
financial condition.
Current and future competitors may also make strategic acquisitions or
establish cooperative relationships among themselves or with others. By doing
so, they may increase their ability to meet the needs of our potential
customers. Our current or prospective indirect channel partners may establish
cooperative relationships with our current or future competitors. These
relationships may limit our ability to sell our products through specific
distribution channels. Accordingly, it is possible that 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.
Our business is expanding, and our failure to manage this expansion effectively,
as well as the strain on our resources, could have a material adverse effect on
our business, operating results and financial condition
We have been expanding rapidly and we expect to continue expanding our
operations subject to the availability of additional financing. Our total number
of employees has grown from 907 on December 31, 1998 to 2,055 on March 31, 2000
and we expect the number of employees to continue to increase. We have placed
significant demands on our administrative, operational, financial and personnel
resources and expect to continue doing so. In particular, we expect the current
and planned growth of our international operations to lead to increased
financial and administrative demands. For example, expanded facilities will
complicate operations, managing relationships with new foreign partners will
mean additional administrative burdens, and managing foreign currency risks will
require expanded treasury functions. We may also need to expand our support
organization to develop our indirect distribution channels in new and expanded
markets and to accommodate growth in our installed customer base. Failure to
manage our expansion effectively could have a material adverse effect on our
business, operating results and financial condition.
In addition, the development of our Strategy.com network could divert the time
and attention of our senior management from our other business. Michael J.
Saylor, our chairman, president and chief executive officer, currently is
responsible for the strategic planning and direction of both our MicroStrategy
Platform and Strategy.com businesses. If Mr. Saylor does not effectively manage
his time and attention between our businesses, it could materially adversely
affect our business, operating results and financial condition.
If we are unable to recruit or retain skilled personnel, or if we lose the
services of any of our key management personnel, our business, operating results
and financial condition would be materially adversely affected
Our future success depends on our continuing ability to attract, train,
assimilate and retain highly skilled personnel. Competition for these employees
is intense. We may not be able to retain our current key employees or attract,
train, assimilate or retain other highly skilled personnel in the future. Our
future success also depends in large part on the continued service of key
management personnel, particularly Michael J. Saylor, our chairman, president
and chief executive officer, and Sanju K. Bansal, our 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.
21
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.
The emergence of new industry standards may adversely affect our ability to
market our existing products
The emergence of new industry standards in related fields may adversely affect
the demand for our existing products. This could happen, for example, if new web
standards and technologies emerged that were incompatible with customer
deployments of our MicroStrategy applications. 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 operating system. Therefore, our ability to increase sales currently
depends on the continued acceptance of the Windows operating system. We cannot
market our current business intelligence applications to potential customers who
use Unix operating systems as their application server. We would have to invest
substantial resources to develop a Unix product and we cannot be sure that we
could introduce such a product on a timely or cost effective basis, if at all.
The legal environment regarding collection and use of personal information is
uncertain and new laws or government regulations could have a material adverse
effect on our business, operating results and financial condition
Although some existing laws govern the collection and use of personal
information obtained through the Internet or other public data networks, it is
unclear whether they apply to us and our products. Most of these laws were
adopted before the widespread use and commercialization of the Internet and
other public data networks. As a result, the laws do not address the unique
issues presented by these media.
Due to increasing use of the Internet and the dramatically increased access to
personal information made possible by technologies like ours, the U.S. federal
and various state and foreign governments have recently proposed limitations on
the collection and use of personal information of users of the Internet and
other public data networks.
Although we attempt to obtain permission from users prior to collecting or
processing their personal data, new laws or regulations governing personal
privacy may change the ways in which we and our customers and affiliates may
gather this personal information. There may be significant costs and delays
involved with adapting our products to any change in regulations.
22
Our business, and in particular our Strategy.com network, depends upon our
receiving detailed personal information about subscribers in order to provide
them with the services they select. Privacy concerns may cause some potential
subscribers to forego subscribing to our service. If new laws or regulations
prohibit us from using information in the ways that we currently do, or if users
opt out of making their personal preferences and information available to us and
our affiliates, the utility of our products will decrease, which could have a
material adverse effect on our business, operating results and financial
condition. If personal information is misused by us, our customers or our
network affiliates, our legal liability may be increased and our growth may be
limited.
The Federal Trade Commission has recently launched investigations of the data
collection practices of various Internet companies. In addition, numerous
individuals and privacy groups have filed lawsuits or administrative complaints
against other companies asserting that they were harmed by the misuse of their
personal information. If comparable legal proceedings were commenced against us,
regardless of the merits of the claim, we could be required to spend significant
amounts on legal defense and our senior management's time and attention could be
diverted from our business. In addition, demand for our products could be
reduced if companies are not permitted to use clickstream data derived from
their web sites. This could materially and adversely affect our business,
operating results and financial condition.
In addition, in Europe, the European Union Directive on Data Protection, a
comprehensive administrative and regulatory program, currently limits the
ability of companies to collect, store and exchange personal data with other
entities. Because the U.S. may not currently provide a level of data protection
sufficient to meet the guidelines under the European Union Directive, U.S.
companies could be prohibited from obtaining personal data from or exchanging
such data with companies in Europe.
Our business may suffer if either the Internet infrastructure or the wireless
communication infrastructure is unable to effectively support the growth in
demand placed upon it
Our Strategy.com network and our other products depend increasingly upon the
Internet infrastructure and wireless communications infrastructures to collect
information and deliver information to customers. We cannot assure you that
either of these infrastructures will continue to effectively support the
capacity, speed and security demands placed upon them as they continue to
experience increased numbers of users, frequency of use and increased
requirements for data transmission by users. Even if the necessary
infrastructure or technologies are developed, we may incur considerable costs to
adapt our solutions accordingly. Furthermore, the Internet has experienced a
variety of outages and other delays due to damage to portions of its
infrastructure or attacks by hackers. These outages and delays could impact the
web sites using our products or hosting our Strategy.com network and could
materially affect our business, operating results and financial condition.
If the market for business intelligence software fails to grow as we expect, or
if businesses fail to adopt our products, our business, operating results and
financial condition would be materially adversely affected
Nearly all of our revenues to date have come from sales of business
intelligence software and related technical support, consulting and education
services. We expect these sales to account for a large portion of our revenues
for the foreseeable future. Although demand for business intelligence software
has grown in recent years, the market for business intelligence software
applications is still emerging. Resistance from consumer and privacy groups to
increased commercial collection and use of data on spending patterns and other
personal behavior may impair the further growth of this market, as may other
developments. We cannot be sure that this market will continue to grow or, even
if it does grow, that businesses will adopt our solutions. We have spent, and
intend to keep spending, considerable resources to educate potential customers
about business intelligence software in general and our solutions in particular.
However, we cannot be sure that these expenditures will help our products
achieve any additional market acceptance. If the market fails to grow or grows
more slowly than we currently expect, our business, operating results and
financial condition would be materially adversely affected.
Because of the rights of our two classes of common stock, and because we are
controlled by our existing stockholders, these stockholders could transfer
control of MicroStrategy to a third party without anyone else's approval or
prevent a third party from acquiring MicroStrategy
23
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, 2000, holders of our Class B common stock owned or
controlled 55,179,115 shares of Class B common stock, or 95.8% of the total
voting power. Michael J. Saylor, our chairman, president and chief executive
officer, controlled 43,549,324 shares of Class B common stock, or 75.6% of the
total voting power, as of May 1, 2000. 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 employees of our company or related parties, to transfer
shares of Class B common stock, subject to the approval of a majority of the
holders of outstanding Class B common stock. Mr. Saylor or a group of
stockholders possessing a majority of the outstanding Class B common stock
could, without seeking anyone else's approval, transfer voting control of
MicroStrategy to a third party. Such a transfer of control could have a material
adverse effect on our business, operating results and financial condition. Mr.
Saylor will also be able to prevent a change of control of MicroStrategy,
regardless of whether holders of Class A common stock might otherwise receive a
premium for their shares over the then-current market price.
We rely on our strategic channel partners and if we are unable to develop or
maintain successful relationships with them, our business, operating results and
financial condition will suffer
In addition to our direct sales force, we rely on strategic channel partners,
such as original equipment manufacturers, system integrators and value-added
resellers, to license and support our products in the United States and
internationally. In particular, for the three months ended March 31, 2000 and
the years ended December 31, 1999, 1998 and 1997, channel partners accounted
for, directly or indirectly, approximately 40.4%, 39.2%, 33.6% and 27.0% of our
total 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, there
can be no assurance that our efforts to continue to expand indirect sales in
this manner will be successful. We cannot be sure that we will 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 rely on our network affiliates to market our Strategy.com network to their
customers and if we are unable to enter into arrangements with a sufficient
number of affiliates, or if our affiliates are unable to interest their
customers in our services, our business will suffer
We rely on our network affiliates to market our Strategy.com network to their
customers. We cannot be sure that we will attract affiliates who will market our
services effectively. Our ability to achieve revenue growth in the future will
depend in part on our success in recruiting and maintaining successful
relationships with affiliates. If we are unable to recruit affiliates or
maintain our relationships with them, our business, operating results and
financial condition will suffer.
Third party providers of information and services for our Strategy.com network
may fail to provide us such information and services or may also provide such
information and services to our competitors
We rely on third parties to provide information and services for our
Strategy.com network. For example, we rely on Ameritrade to provide users of our
Strategy.com network with stock quote information and expect to rely upon a
third party to execute trades in securities when this capability is added to our
network. If one or more of these providers were to stop working with us, we
would have to rely on other parties to provide the information and services we
need. We cannot predict whether other parties would be willing to do so on
24
reasonable terms. Furthermore, we do not have long-term agreements with our
providers of information and services and we cannot restrict them from providing
similar information and services to our competitors. As a result, our
competitors may be able to duplicate some of the information and services that
we provide and may, therefore, find it easier to enter the market for personal
intelligence and compete with us.
We rely upon our network affiliates to deliver services we offer through our
Strategy.com network and if they have difficulty in doing so, we could be
exposed to liability and our reputation could suffer
We depend upon our affiliates to deliver services to subscribers of our
Strategy.com network. If our affiliates fail to deliver reliable services, we
could face liability claims from our subscribers and our reputation could be
damaged. In addition, we will be dependent on the performance of the systems
deployed and maintained by these parties, whom we will not control. We expect to
include contractual provisions limiting our liability to the subscriber for
failures and delays, but we cannot be sure that these limits will be enforceable
or will be sufficient to shield us from liability. We will seek to obtain
liability insurance to cover problems of this sort, but we cannot guarantee that
insurance will be available or that the amounts of our coverage will be
sufficient to cover all potential claims.
Our network affiliates will rely on us to maintain the infrastructure of the
Strategy.com network and any problems with that infrastructure could expose us
to liability from our affiliates and their customers
Our network affiliates depend on us to maintain the software and hardware
infrastructure of our Strategy.com network. If this infrastructure fails or our
affiliates or their customers otherwise experience difficulties or delays in
accessing the network, we could face liability claims from them. We expect to
include contractual provisions limiting our liability to our affiliates for
system failures and delays, but we cannot be sure that these limits will be
enforceable or will be sufficient to shield us from liability. We will seek to
obtain liability insurance to cover problems of this sort, but we cannot
guarantee that insurance will be available or that the amounts of our coverage
will be sufficient to cover all potential claims.
We are vulnerable to system failures which could cause interruptions or
disruptions in our service
The hardware infrastructure on which the Strategy.com system operates is
located at the Exodus Communications data center in Northern Virginia. We cannot
assure you that we will be able to manage this relationship successfully to
mitigate any risks associated with having our hardware infrastructure maintained
by Exodus. Unexpected events such as natural disasters, power losses and
vandalism could damage our systems. Telecommunications failures, computer
viruses, electronic break-ins or other similar disruptive problems could
adversely affect the operation of our systems. Our insurance policies may not
adequately compensate us for any losses that may occur due to any damages or
interruptions in our systems. Accordingly, we could be required to make capital
expenditures in the event of damage. We do not currently have a formal disaster
recovery plan. Periodically, we experience unscheduled system downtime that
results in our web site being inaccessible to subscribers. Although we have not
suffered material losses during these downtimes to date, if these problems
persist in the future, users, network affiliates and advertisers could lose
confidence in our services.
System capacity constraints may diminish our ability to generate revenues from
Strategy.com
A substantial increase in the use of the products and services offered by
Strategy.com could strain the capacity of our systems, which could lead to
slower response time or system failures. System failures or slowdowns could
adversely affect the speed and responsiveness of our Strategy.com network. These
would diminish the experience for our subscribers and affect our reputation. The
ability of our systems to manage a significantly increased volume of
transactions in a production environment is unknown. As a result, we face risks
related to our ability to scale up to our expected transaction levels while
maintaining satisfactory performance. If our transaction volume increases
significantly, we may need to purchase additional servers and networking
equipment to maintain adequate data transmission speeds. The availability of
these products and related services may be limited or their cost may be
significant.
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
25
We regard our software products as proprietary and we rely on a combination of
federal and international copyright, state and federal trademark and service
mark and state and common law 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. We have no patents, and no registered trademarks other
than MicroStrategy(R), DSS Agent(R) and QuickStrike(R). 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 affect on our business, operating
results and financial condition.
Expanding our international operations will be difficult 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 22.6%, 24.0%, 26.1% and 27.1% of our total
revenues for the three months ended March 31, 2000 and the years ended December
31, 1999, 1998 and 1997, respectively. We plan to continue expanding our
international operations and to enter new international markets. This will
require significant management attention and financial resources and could
adversely affect our business, operating results and financial condition. In
order to expand international sales successfully, we must set up additional
foreign operations, hire additional personnel and recruit additional
international resellers and distributors. We cannot be sure that we will be able
to do so in a timely manner, and our failure to do so may limit our
international sales growth.
There are certain risks inherent in our international business activities
including:
. changes in foreign currency exchange rates;
. unexpected changes in regulatory requirements;
. tariffs and other trade barriers;
. costs of localizing products for foreign countries;
. lack of acceptance of localized products in foreign countries;
. longer accounts receivable payment cycles;
. difficulties in managing international operations;
. tax issues, including restrictions on repatriating earnings;
. weaker intellectual property protection in other countries; and
. the burden of complying with a wide variety of foreign laws.
26
These factors may have a material adverse effect on our future international
sales and, consequently, our business, operating results and financial
condition.
The nature of our products makes them particularly vulnerable to undetected
errors, or bugs, which could cause problems with how the products perform and
which could in turn reduce demand for our products, reduce our revenue and lead
to product liability claims against us
Software products as complex as ours may contain errors or defects, especially
when first or subsequent versions are released. Although we test our products
extensively, we have in the past discovered software errors in new products
after their introduction. We cannot be certain that, despite testing by us and
by our current and potential customers, errors will not be found in new products
or releases after commercial shipments begin. This could result in lost revenue
or delays in market acceptance, which could have a material adverse effect upon
our business, operating results and financial condition.
Our license agreements with customers typically contain provisions designed to
limit our exposure to product liability claims. It is possible, however, that
these provisions may not be effective under the laws of certain domestic or
international jurisdictions. Although there have been no product liability
claims against us to date, our license and support of products may involve the
risk of these claims. A successful product liability claim against us could have
a material adverse effect on our business, operating results and financial
condition.
27
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 do not use derivative
financial instruments. We invest our excess cash in short-term, fixed income
financial instruments. These fixed rate investments are subject to interest rate
risk and may fall in value if market interest rates increase. If market interest
rates were to increase immediately and uniformly by 10% from the levels at March
31, 2000, the fair market value of the portfolio would decline by an immaterial
amount. We have the ability to hold our fixed income investments until maturity
and, therefore, we do not expect our operating results or cash flows to be
materially affected by a sudden change in market interest rates on our
investment portfolio.
Foreign Currency Risk
We face exposure to adverse movements in foreign currency exchange rates. Our
international revenues and expenses are denominated in foreign currencies,
principally the British pound sterling and the German deutsche mark. The
functional currency of each of our foreign subsidiaries is the local currency.
Our international business is subject to risks typical of an international
business, including, but not limited to differing tax structures, other
regulations and restrictions, and foreign exchange rate volatility. Based on our
overall currency rate exposure at March 31, 2000, a 10% change in foreign
exchange rates would have had an immaterial effect on our financial position,
results of operations and cash flows. To date, we have not hedged the risks
associated with foreign exchange exposure. Although we may do so in the future,
we cannot be sure that any hedging techniques we may implement will be
successful or that our business, operating results, financial condition and cash
flows will not be materially adversely affected by exchange rate fluctuations.
To date, our foreign currency gains and losses have been immaterial.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Actions Arising under Federal Securities Laws. In March 2000, numerous
separate complaints purporting to be class actions 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 Exchange Act of 1934, as
amended, Rule 10b-5 promulgated by the Securities and Exchange Commission
("SEC") thereunder, and section 20(a) of the Securities Exchange Act of 1934, as
amended.
The complaints contain varying allegations, including that we made materially
false and misleading statements with respect to our 1999 and 1998 financial
results in our filings with the SEC, analysts' reports, press releases and media
reports. The complaints do not specify the amount of damages sought.
We have not filed any answers, motions to dismiss or other responsive
pleadings in this litigation. We intend to defend this matter vigorously.
SEC Investigation. In March 2000, we were notified that the SEC had issued a
formal order of private investigation in connection with matters relating to our
restatement of our financial results. The SEC has requested that we provide
them with certain documents concerning the revision of our financial results and
financial reporting documents. The SEC indicated that its inquiry should not be
construed as an indication by the SEC or its staff that any violation of law has
occurred, nor as an adverse reflection upon any person, entity or security. We
are cooperating with the SEC in connection with this investigation and its
outcome cannot yet be determined.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibits
3.1 Amended and Restated Certificate of Incorporation of the Company
(Filed as Exhibit 3.1 to the Company's Registration Statement on
Form S-1 (Registration No. 333-49899) and incorporated by reference
herein.)
3.2 Restated Bylaws of the Company (Filed as Exhibit 3.2 to the
Company's Registration Statement on Form S-1 (Registration No. 333-
49899) and incorporated by reference herein.)
4.1 Form of Certificate of Class A Common Stock of the Company (Filed as
Exhibit 4.1 to the Company's Registration Statement on Form S-1
(Registration No. 333-49899) and incorporated by reference herein.)
10.1 1997 Director Option Plan (as amended) of the Company (Filed as
Exhibit 10.3 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 1999 (File No. 000-24435) and
incorporated by reference herein.)
10.2 Deed of Lease, dated January 7, 2000, between Tysons Corner Property
LLC and the Company (Filed as Exhibit 10.18 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1999
(File No. 000-24435) and incorporated by reference herein.)
10.3 First Modification Agreement, dated May 15, 2000, among Bank of
America, N.A., MicroStrategy Incorporated, Michael J. Saylor and
Alcantara LLC
10.4 Pledge and Security Agreement, dated May 15, 2000, by Alcantara LLC
in favor of Bank of America, N.A.
10.5 Guaranty of Payment, dated May 15, 2000, made by Alcantara LLC to
Bank of America, N.A.
10.6 Guaranty of Payment, dated May 15, 2000, made by Michael J. Saylor
to Bank of America, N.A.
27.1 Financial Data Schedule
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29
B. Reports on Form 8-K
On January 7, 2000, the Company filed a Current Report on Form 8-K, dated
December 23, 1999, announcing that the Company had completed its acquisition of
the intellectual property and other intangible assets relating to NCR's TeraCube
business.
On March 23, 2000, the Company filed a Current Report on Form 8-K, dated
March 20, 2000, to report that it had (a) issued a press release announcing that
it is revising its 1999 and 1998 revenues and operating results, (b) issued a
clarification on March 21, 2000 of its March 20, 2000 public statements,
indicating that the principal reason for its decision to revise its 1999 and
1998 reported revenues and operating results was the need to do so under
existing accounting principles articulated in Statement of Position 97-2, (c)
announced on March 21, 2000 that a number of lawsuits purporting to be class
actions had been filed naming the Company and certain of its officers and
directors as defendants alleging violations of various securities laws in
connection with the Company's previously announced revision of its 1999 and 1998
revenues and operating results and (d) filed on March 21, 2000, an Application
for Withdrawal of Registration Statement relating to the Company's Registration
Statement on Form S-3 (File No. 333-31042) with the SEC.
All other items are omitted because they are not applicable or the answers
are none.
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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
President and Chief Executive Officer
By: /s/ Mark S. Lynch
------------------------------
Mark S. Lynch
Chief Financial Officer
Date: May 15, 2000
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INDEX TO EXHIBITS
3.1 Amended and Restated Certificate of Incorporation of the Company (Filed as
Exhibit 3.1 to the Company's Registration Statement on Form S-1
(Registration No. 333-49899) and incorporated by reference herein.)
3.2 Restated Bylaws of the Company (Filed as Exhibit 3.2 to the Company's
Registration Statement on Form S-1 (Registration No. 333-49899) and
incorporated by reference herein.)
4.1 Form of Certificate of Class A Common Stock of the Company (Filed as
Exhibit 4.1 to the Company's Registration Statement on Form S-1
(Registration No. 333-49899) and incorporated by reference herein.)
10.1 1997 Director Option Plan (as amended) of the Company (Filed as Exhibit
10.3 to the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 1999 (File No. 000-24435) and incorporated by reference
herein.)
10.2 Deed of Lease, dated January 7, 2000, between Tysons Corner Property LLC
and the Company (Filed as Exhibit 10.18 to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1999 (File No. 000-24435)
and incorporated by reference herein.)
10.3 First Modification Agreement, dated May 15, 2000, among Bank of America,
N.A., MicroStrategy Incorporated, Michael J. Saylor and Alcantara LLC
10.4 Pledge and Security Agreement, dated May 15, 2000, by Alcantara LLC in
favor of Bank of America, N.A.
10.5 Guaranty of Payment, dated May 15, 2000, made by Alcantara LLC to Bank of
America, N.A.
10.6 Guaranty of Payment, dated May 15, 2000, made by Michael J. Saylor to Bank
of America, N.A.
27.1 Financial Data Schedule