UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1999
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 51-0323571
(State of incorporation) (I.R.S. Employer Identification Number)
8000 Towers Crescent Drive, Vienna, VA 22182
(Address of Principal Executive Offices) (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 August 1, 1999 was 9,112,060 and 29,105,465,
respectively.
MICROSTRATEGY INCORPORATED
FORM 10-Q
TABLE OF CONTENTS
Page
----
PART I--FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets, June 30, 1999 (unaudited) and December 31, 1998............................ 1
Consolidated Statements of Operations and Comprehensive Income, Three Months ended June 30,
1999 and 1998 (unaudited)............................................................................. 2
Consolidated Statements of Operations and Comprehensive Income, Six Months ended June 30,
1999 and 1998 (unaudited)............................................................................. 3
Consolidated Statements of Cash Flows, Six Months ended June 30, 1999 and 1998 (unaudited).............. 4
Notes to Consolidated Financial Statements (unaudited).................................................. 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............ 7
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................................... 20
PART II--OTHER INFORMATION.................................................................................. 21
MICROSTRATEGY INCORPORATED
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
ITEM 1. FINANCIAL STATEMENTS
June 30, December 31,
1999 1998
---- ----
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents ............................................................. $ 34,793 $ 27,491
Short-term investments ................................................................ 19,389 --
Accounts receivable, net .............................................................. 46,437 33,054
Prepaid expenses and other current assets ............................................. 4,755 2,914
--------- ---------
Total current assets ........................................................... 105,374 63,459
Property and equipment, net ........................................................... 21,472 13,773
Long-term accounts receivable ......................................................... 1,800 2,700
Deposits and other assets ............................................................. 2,473 2,757
--------- ---------
Total assets ................................................................... $ 131,119 $ 82,689
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses ................................................. $ 13,169 $ 11,904
Accrued compensation and employee benefits ............................................ 8,002 7,356
Deferred revenue ...................................................................... 12,230 10,732
Dividend notes payable ................................................................ -- 5,000
--------- ---------
Total current liabilities ...................................................... 33,401 34,992
Deferred revenue ......................................................................... 3,034 746
Other long-term liabilities .............................................................. 671 671
--------- ---------
Total liabilities .............................................................. 37,106 36,409
--------- ---------
Commitments and contingencies
Stockholders' equity:
Preferred Stock, par value $0.001 per share, 5,000,000 shares authorized,
no shares issued or outstanding ....................................................... -- --
Common Stock, par value $0.001 per share, 50,000,000 shares authorized,
no shares issued or outstanding ....................................................... -- --
Class A Common Stock, par value $0.001 per share, 100,000,000 shares
authorized, 8,455,525 shares issued and outstanding at June 30, 1999;
5,052,110 shares issued and outstanding at December 31, 1998 .......................... 8 5
Class B Common Stock, par value $0.001 per share, 100,000,000 shares
authorized, 29,714,404 shares issued and outstanding at June 30, 1999;
30,633,114 shares issued and outstanding at December 31, 1998 ......................... 30 31
Additional paid-in capital ............................................................... 85,453 42,219
Accumulated other comprehensive income ................................................... 171 894
Accumulated earnings ..................................................................... 10,299 5,229
Deferred compensation .................................................................... (1,948) (2,098)
--------- ---------
Total stockholders' equity ............................................................... 94,013 46,280
--------- ---------
Total liabilities and stockholders' equity ............................................... $ 131,119 $ 82,689
========= =========
The accompanying notes are an integral part of these
Consolidated Financial Statements.
1
MICROSTRATEGY INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED JUNE 30, 1999 AND 1998
(In thousands, except share and per share data)
Three Months Ended
June 30,
----------------------------------
1999 1998
------------ ------------
(Unaudited)
Revenues:
Product licenses .................................................................... $ 31,057 $ 16,245
Product support ..................................................................... 14,581 7,545
------------ ------------
Total revenues ............................................................... 45,638 23,790
------------ ------------
Cost of revenues:
Product licenses .................................................................... 563 552
Product support ..................................................................... 7,906 4,113
------------ ------------
Total cost of revenues ....................................................... 8,469 4,665
------------ ------------
Gross margin ........................................................................... 37,169 19,125
Operating expenses: ------------ ------------
Sales and marketing ................................................................. 21,145 12,005
Research and development ............................................................ 6,088 2,776
General and administrative .......................................................... 5,363 2,600
------------ ------------
Total operating expenses ..................................................... 32,596 17,381
------------ ------------
Income from operations .............................................................. 4,573 1,744
Interest income ..................................................................... 671 84
Interest expense .................................................................... (51) (264)
Other expense, net .................................................................. (14) (45)
------------ ------------
Income before income taxes .......................................................... 5,179 1,519
Provision for income taxes .......................................................... 1,968 577
------------ ------------
Net income ............................................................................. $ 3,211 $ 942
============ ============
Other comprehensive (loss) income:
Foreign currency translation adjustment ............................................. (273) 59
Unrealized loss on investments, net of tax .......................................... (74) --
------------ ------------
Comprehensive income ................................................................... $ 2,864 $ 1,001
============ ============
Basic net income per share ............................................................. $ 0.08 $ 0.03
============ ============
Weighted average shares outstanding used in computing basic net income per
share ............................................................................... 38,026,186 31,836,613
============ ============
Diluted net income per share ........................................................... $ 0.08 $ 0.03
============ ============
Weighted average shares outstanding used in computing diluted net income per
share ............................................................................... 41,953,981 36,644,863
============ ============
Pro forma information (unaudited):
Income before income taxes, as reported ................................................ -- $ 1,519
Pro forma income taxes ................................................................. -- (577)
------------
Pro forma net income ................................................................... -- $ 942
============
Pro forma basic net income per share ................................................... -- $ 0.03
============
Pro forma diluted net income per share ................................................. -- $ 0.03
============
The accompanying notes are an integral part of these
Consolidated Financial Statements.
2
MICROSTRATEGY INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998
(In thousands, except share and per share data)
Six Months Ended
June 30
----------------------------------
1999 1998
------------ ------------
(Unaudited)
Revenues:
Product licenses .................................................................... $ 54,181 $ 30,527
Product support ..................................................................... 27,241 13,158
------------ ------------
Total revenues ............................................................... 81,422 43,685
------------ ------------
Cost of revenues:
Product licenses .................................................................... 1,083 1,090
Product support ..................................................................... 14,515 7,276
------------ ------------
Total cost of revenues ....................................................... 15,598 8,366
------------ ------------
Gross margin ........................................................................... 65,824 35,319
------------ ------------
Operating expenses:
Sales and marketing ................................................................. 37,919 22,833
Research and development ............................................................ 11,148 4,868
General and administrative .......................................................... 9,643 5,163
------------ ------------
Total operating expenses ..................................................... 58,710 32,864
------------ ------------
Income from operations .............................................................. 7,114 2,455
Interest income ..................................................................... 1,175 131
Interest expense .................................................................... (143) (501)
Other income (expense), net ......................................................... 32 (24)
------------ ------------
Income before income taxes .......................................................... 8,178 2,061
Provision for income taxes .......................................................... 3,108 577
------------ ------------
Net income ............................................................................. $ 5,070 $ 1,484
============ ============
Other comprehensive (loss) income:
Foreign currency translation adjustment
(608) 63
Unrealized loss on investments, net of tax .......................................... (74) --
------------ ------------
Comprehensive income ................................................................... $ 4,388 $ 1,547
============ ============
Basic net income per share ............................................................. $ 0.14 $ 0.05
============ ============
Weighted average shares outstanding used in computing basic net income per
Share ............................................................................... 37,463,246 30,885,791
============ ============
Diluted net income per share ........................................................... $ 0.12 $ 0.04
============ ============
Weighted average shares outstanding used in computing diluted net income per
Share ............................................................................... 41,733,561 35,426,161
============ ============
Pro forma information (unaudited):
Income before income taxes, as reported ................................................ -- $ 2,061
Pro forma income taxes ................................................................. -- (783)
------------
Pro forma net income ................................................................... -- $ 1,278
============
Pro forma basic net income per share ................................................... -- $ 0.04
============
Pro forma diluted net income per share ................................................. -- $ 0.04
============
The accompanying notes are an integral part of these
Consolidated Financial Statements.
3
MICROSTRATEGY INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 1998
(In thousands)
Six Months Ended
June 30,
-----------------------------
1999 1998
-----------------------------
(Unaudited)
Operating activities:
Net income .................................................................................. $ 5,070 $ 1,484
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization ............................................................... 2,771 1,258
Provision for doubtful accounts, net of write-offs and recoveries ........................... 773 --
Amortization of deferred compensation ....................................................... 150 49
Changes in operating assets and liabilities, net of effect of foreign exchange
rate changes:
Accounts receivable ......................................................................... (14,786) (6,454)
Prepaid expenses and other current assets ................................................... (1,954) (50)
Accounts payable and accrued expenses, compensation and benefits ............................ 2,457 639
Deferred revenue ............................................................................ 4,072 966
Deposits and other assets ................................................................... (85) (3)
Long-term accounts receivables .............................................................. 900 --
-------- --------
Net cash used in operating activities ..................................................... (632) (2,111)
-------- --------
Investing activities:
Acquisition of property and equipment ....................................................... (10,469) (2,492)
Purchase of short-term investments .......................................................... (22,491) --
Sales/maturities of short-term investments .................................................. 3,000 --
-------- --------
Net cash used in investing activities ..................................................... (29,960) (2,492)
-------- --------
Financing activities:
Proceeds from sale of Class A Common Stock and exercise of stock options, net of
offering costs ............................................................................ 43,236 48,950
Repayments on short-term line of credit, net ................................................ -- (4,508)
Payments of dividend notes payable .......................................................... (5,000) --
Proceeds from issuance of notes payable ..................................................... -- 862
Principal payments on notes payable ......................................................... -- (4,211)
-------- --------
Net cash provided by financing activities ................................................. 38,236 41,093
-------- --------
Effect of foreign exchange rate changes on cash and cash equivalents ...................... (342) (20)
-------- --------
Net increase in cash and cash equivalents ...................................................... 7,302 36,470
Cash and cash equivalents, beginning of year ................................................... 27,491 3,506
-------- --------
Cash and cash equivalents, end of period ....................................................... $ 34,793 $ 39,976
======== ========
Supplemental disclosure of noncash investing and financing activities:
Retirement of treasury stock ........................................................... $ -- $ 193
======== ========
Unrealized loss on investments ......................................................... $ 119 $ --
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the year for interest ................................................. $ 87 $ 536
======== ========
Cash paid during the year for income taxes ............................................. $ 500 $ --
======== ========
The accompanying notes are an integral part of these
Consolidated Financial Statements.
4
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(1) Basis of Presentation
The consolidated balance sheet of MicroStrategy Incorporated (the
"Company") as of June 30, 1999, the related consolidated statements of
operations for the three and six month periods ended June 30, 1999 and 1998, and
the consolidated statements of cash flows for the six months ended June 30, 1999
and 1998 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 for the year ended December 31, 1998 filed with the Securities and
Exchange Commission (the "Commission") in the Company's Annual Report on Form
10-K for the year ended December 31, 1998.
(2) Public Offering
On February 10, 1999, the Company sold to the public 1,585,000 shares of
Class A Common Stock for approximately $40,100,000, net of expenses. In
addition, certain holders of Class B Common Stock converted 415,000 shares of
Class B Common Stock to Class A Common Stock in connection with their sale of
such shares in the public offering.
(3) Cash, Cash Equivalents and Short-Term Investments
Cash equivalents include high quality money market instruments, commercial
paper, U.S. agency notes and corporate notes. The Company considers all highly
liquid investments with an original maturity of three months or less when
purchased to be cash equivalents.
Short-term investments are comprised of readily marketable debt securities
with original maturities of more than three months when purchased. Where the
original maturity is more than one year, the securities are classified as
short-term investments if the Company's intention is to convert them to cash
within one year. All short-term investments are available-for-sale and are
stated at fair value with unrealized gains and losses included as a component of
stockholders' equity.
(4) Use of Estimates
The preparation of the consolidated financial statements, in conformity
with generally accepted accounting principles, requires management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and accompanying notes. Actual results could differ from
those estimates.
(5) Income Taxes
Prior to the Company's initial public offering in June 1998 (the "Initial
Public Offering"), the Company had elected to be treated for federal and state
income tax purposes as a Subchapter S corporation. Under Subchapter S, the
taxable income or loss is reported by the stockholders and, accordingly, no
federal or state income taxes had been provided in the financial statements
prior to consummation of the Initial Public Offering.
The consolidated statement of operations includes pro forma information to
reflect income taxes as if the Company had been a Subchapter C corporation for
the three and six month periods ended June 30, 1998.
5
(6) Net Income Per Share
Reconciliations of the basic net income per share and diluted net income
per share computations for the three and six month periods ended June 30, 1999
and 1998 are as follows:
For the Three Months For the Six Months
Ended June 30, Ended June 30,
1999 1998 1999 1998
------------ ----------- ----------- ----------
(in thousands, except share and per share data)
Net income ................................................. $ 3,211 $ 942 $ 5,070 $ 1,484
=========== =========== =========== ===========
Basic net income per share:
Weighted average common shares outstanding ............ 38,026,186 31,836,613 37,463,246 30,885,791
Basic net income per share ................................. $ 0.08 $ 0.03 $ 0.14 $ 0.05
=========== =========== =========== ===========
Diluted net income per share:
Weighted average common shares outstanding ............ 38,026,186 31,836,613 37,463,246 30,885,791
Dilutive impact of common shares issuable
upon exercise of stock options and warrants ......... 3,927,795 4,808,250 4,270,315 4,540,370
----------- ----------- ----------- -----------
Weighted average common shares assuming
dilution ............................................ 41,953,981 36,644,863 41,733,561 35,426,161
=========== =========== =========== ===========
Diluted net income per share ............................... $ 0.08 $ 0.03 $ 0.12 $ 0.04
=========== =========== =========== ===========
Common stock equivalents are included in the computation of diluted net
income per share using the treasury stock method. During the three and six month
periods ended June 30, 1999 stock options granted by the Company to purchase
1,130,150 and 760,400 shares of Class A Common Stock, respectively, were not
included in the computation because the effect was anti-dilutive. During the
three and six month periods ended June 30, 1998 there were no stock options
granted by the Company with exercise prices greater than the average fair market
value of the shares of Class A Common Stock.
(7) Segment Information
The following table presents a summary of operations by geographic region,
including eliminations of all significant intercompany transactions:
For the Three Months For the Six Months
Ended June 30, Ended June 30,
------------------------------------ -------------------------------------
1999 1998 1999 1998
---------------- ---------------- ------------------- ---------------
(in thousands, except share and per share data)
Revenue:
Domestic ................................... $ 36,612 $ 18,403 $ 64,732 $ 34,135
Europe ..................................... 9,026 5,387 16,690 9,550
-------- -------- -------- --------
Total Revenue .......................... $ 45,638 $ 23,790 $ 81,422 $ 43,685
======== ======== ======== ========
Operating income (loss):
Domestic ................................... $ 2,061 $ 1,700 $ 2,676 $ 3,154
Europe ..................................... 2,512 44 4,438 (699)
-------- -------- -------- --------
Total operating income ................. $ 4,573 $ 1,744 $ 7,114 $ 2,455
======== ======== ======== ========
Identifiable assets:
Domestic ................................... $111,896 $ 63,590 $111,896 $ 63,590
Europe ..................................... 19,223 11,669 19,223 11,669
-------- -------- -------- --------
Total assets ........................... $131,119 $ 75,259 $131,119 $ 75,259
======== ======== ======== ========
Transfers of $2,030,000 and $1,446,000 for the three months ended June 30,
1999 and 1998, respectively, and of $3,788,000 and $2,494,000 for the six months
ended June 30, 1999 and 1998, respectively, from foreign to domestic operations
have been excluded from the above table and eliminated in the consolidated
financial statements.
6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
We develop and sell enterprise decision support systems (DSS) software
products. We first released a full complement of DSS products in 1995. Since
this time, we have continued to focus significant resources on the development
of additional functionality and features to our DSS software products.
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 in each of the last
twelve quarters, we experienced fluctuating operating margins during the six
months ended June 30, 1999 and during 1998, 1997 and 1996 primarily as a result
of increases in staff levels. We expect to continue to increase staffing levels
and incur additional associated costs in future periods. If we are unable to
achieve corresponding substantial revenue growth, we could suffer operating
losses in one or more quarters and may be unable to forecast such losses prior
to the end of any given quarter. In addition, we have experienced net losses and
losses from operations for the year ended December 31, 1996, and were only
marginally profitable for the years ended December 31, 1997 and December 31,
1995. While we have experienced significant percentage growth in revenues in
recent periods, prior percentage revenue growth rates should not be considered
as necessarily indicative of future growth rates or operating results.
Additionally, there are a number of factors that could materially affect
expected revenue and operating results for 1999 and subsequent periods. See
"Risk Factors."
Our revenues are derived from two principal sources: (i) product licenses
and (ii) fees for maintenance, technical support, education and consulting
services (collectively, "product support"). We recognized revenue in accordance
with Statement of Position 97-2 (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." Product
license revenues are generally recognized upon the execution of a contract and
shipment of the related software product, provided that no significant
obligations remain outstanding on the part of the Company 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 plans are recorded as deferred revenue when billed to the
customer and recognized ratably over the term of the maintenance and support
agreement, which is typically one year. Fees for our education and consulting
services are recognized at the time the services are performed.
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. Moreover, we currently operate with
virtually no order backlog because our software products typically are shipped
shortly after orders are received. Product license revenues in any quarter are
substantially dependent on orders booked and shipped in that quarter. As a
result of these and other factors, our quarterly 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. See "Risk Factors--Quarterly Operating Results
May Fluctuate Significantly."
We license our software through our direct sales force and increasingly
through, or in conjunction with, Value Added Resellers (VARs), System
Integrators (SIs), and Original Equipment Manufacturers (OEMs). Channel partners
accounted for, directly or indirectly, approximately 32.8%, 35.0%, 27.5%, and
9.0% of our revenues for the six months ended June 30, 1999 and for the years
ended December 31, 1998, 1997 and 1996, 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.
7
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:
For the Three Months For the Six Months
Ended June 30, Ended June 30,
------------------------ --------------------------
1999 1998 1999 1998
--------- --------- -------- --------
Consolidated Statements of Operations Data:
Revenues:
Product licenses .................................. 68.1% 68.3% 66.5% 69.9%
Product support ................................... 31.9 31.7 33.5 30.1
------- ------- ------- -------
Total revenues ................................ 100.0 100.0 100.0 100.0
------- ------- ------- -------
Cost of revenues:
Product licenses .................................. 1.2 2.3 1.3 2.5
Product support ................................... 17.3 17.3 17.8 16.7
------- ------- ------- -------
Total cost of revenues ........................ 18.5 19.6 19.1 19.2
------- ------- ------- -------
Gross margin ......................................... 81.5 80.4 80.9 80.8
------- ------- ------- -------
Operating expenses:
Sales and marketing ............................... 46.3 50.5 46.6 52.3
Research and development .......................... 13.3 11.7 13.7 11.1
General and administrative ........................ 11.8 10.9 11.8 11.8
------- ------- ------- -------
Total operating expenses ...................... 71.4 73.1 72.1 75.2
------- ------- ------- -------
Income from operations ............................... 10.1 7.3 8.8 5.6
Interest income (expense), net ....................... 1.3 (0.7) 1.2 (0.8)
Other expense, net ................................... -- (0.2) -- (0.1)
Provision for income taxes ........................... 4.3 2.4 3.8 1.3
------- ------- ------- -------
Net income ........................................... 7.1% 4.0% 6.2% 3.4%
======= ======= ======= =======
Comparison of Three Months Ended June 30, 1999 and 1998
Revenues
Total revenues increased to $45.6 million for the three months ended June
30, 1999 from $23.8 million for the three months ended June 30, 1998,
representing an increase of 91.8%. Total revenues consist of revenues derived
from sales of software product licenses and product support. There can be no
assurance that total revenues will continue to increase at the rates experienced
in prior periods.
Product License Revenues. Product license revenues increased to $31.1
million for the three months ended June 30, 1999 from $16.2 million for the
three months ended June 30, 1998, representing an increase of 91.2%. The
significant increase in product license revenues was due to growing market
acceptance of our software products and continued expansion of our sales and
marketing organization. Product license revenues constituted 68.1% and 68.3% of
total revenues for the three months ended June 30, 1999 and 1998, respectively.
Product Support Revenues. Product support revenues increased to $14.6
million for the three months ended June 30, 1999 from $7.5 million for the three
months ended June 30, 1998, representing an increase of 93.3%. Product support
revenues constituted 31.9% and 31.7% of total revenues for the three months
ended June 30, 1999 and 1998, respectively. The increase in product support
revenues was primarily due to the increase in product licenses sold, in
conjunction with several large consulting projects during the quarter. We expect
product support revenues as a percentage of total revenues to fluctuate on a
period to period basis, but generally not to vary significantly from the
percentage of total revenues achieved in prior quarters.
International Revenues. International revenues were $9.0 million and $5.4
million for the three months ended June 30, 1999 and 1998, respectively,
representing approximately 19.8% and 22.6% of total revenues, respectively. We
opened sales offices in Australia, Canada and Italy in 1998 and in Austria,
France, the Netherlands, Germany, United Kingdom and Spain prior to 1998.
8
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 and shipping paid to third parties. Cost of product license revenues
was $0.6 million for both the three months ended June 30, 1999 and 1998,
representing 1.8% and 3.4% of total product license revenues, respectively. The
decrease in total cost of product license revenues as a percentage of total
product license revenues was due to economies of scale realized by producing
larger volumes of product materials and decreased shipping costs due to an
increase in the percentage of customers reproducing licenses 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 Revenues. Cost of product support revenues consists
of the costs of providing technical support, education and consulting services
to customers and partners. Cost of product support revenues was $7.9 million and
$4.1 million during the three months ended June 30, 1999 and 1998, representing
54.2% and 54.5% of total product support revenues, respectively. The increase in
cost of product support revenues was primarily due to the increase in product
licenses sold and, thus, an increase in the number of personnel providing
consulting, education, and technical support to customers. We expect to continue
to increase the number of customer education and implementation consultants in
the future, as well as technical support personnel. To the extent that our
product support revenues do not increase at anticipated rates, the hiring of
additional consultants and technical support personnel could increase the cost
of product support revenues as a percentage of product support revenues.
Sales and Marketing Expenses. Sales and marketing expenses include
personnel costs, commissions, office facilities, travel, promotional events such
as trade shows, seminars and technical conferences, advertising and public
relations programs. Sales and marketing expenses were $21.1 million and $12.0
million for the three months ended June 30, 1999 and 1998, representing 46.3%
and 50.5% of total revenues, respectively. The increase in sales and marketing
expenses was primarily the result of increased staffing levels in the sales
force, increased commissions earned and increased promotional activities, trade
show participation and general marketing efforts. We believe that it is
critically important to gain market share among high-end customers. We have
invested and will continue to invest heavily in sales and marketing in order to
create better market awareness of the value-added potential of DSS products and
to seek to acquire market share.
Research and Development Expenses. Research and development expenses
consist primarily of salaries and benefits of software engineering personnel,
depreciation of equipment and expendable equipment purchases. Research and
development expenses were $6.1 million and $2.8 million for the three months
ended June 30, 1999 and 1998, representing 13.3% and 11.7% of total revenues,
respectively. The increase in research and development expenses was primarily
due to additional hiring of research and development personnel and continued
development of new products and product releases. We expect that research and
development expenses will continue to increase as we continue to invest in
developing new products, applications and product enhancements. During 1998 and
for the six months ended June 30, 1999, the costs incurred between the
establishment of technological feasibility and general availability of our
products were not material and, therefore, have been expensed.
General and Administrative Expenses. General and administrative expenses
include the 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 were $5.4 million and
$2.6 million for the three months ended June 30, 1999 and 1998, representing
11.8% and 10.9% of total revenues, respectively. The increase in general and
administrative expenses was primarily the result of increased staff levels and
related costs associated with the growth of our business during these periods.
Although we expect that general and administrative expenses will continue to
increase in the foreseeable future, such expenses are not expected to
significantly vary as a percentage of total revenues in the future.
Provision for Income Taxes. Prior to consummation of the Initial Public
Offering, we had elected to be treated as a Subchapter S corporation for federal
and state income tax purposes. Under Subchapter S, our income was allocated and
taxable to our individual stockholders rather than to us. Accordingly, no
federal or state income taxes have been provided for in the financial statements
for any periods prior to consummation of the Initial Public Offering.
Our S corporation status terminated shortly prior to consummation of the
Initial Public Offering at which time we became subject to federal and state
corporate income taxation as a Subchapter C corporation. As a result, we now
account for income taxes as a Subchapter C corporation and have adopted SFAS No.
109, "Accounting for Income Taxes." We recorded income tax expense of $2.0
million for the three months ended June 30, 1999. The adoption of SFAS No. 109
did
9
not have a material impact on our operating results.
Comparison of Six Months Ended June 30, 1999 and 1998
Revenues
Total revenues increased to $81.4 million for the six months ended June 30,
1999 from $43.7 million for the six months ended June 30, 1998, representing an
increase of 86.4%.
Product License Revenues. Product license revenues increased to $54.2
million for the six months ended June 30, 1999 from $30.5 million for the six
months ended June 30, 1998, representing an increase of 77.5%. The significant
increase in product license revenues was due to growing market acceptance of our
software products and continued expansion of our sales and marketing
organization. Product license revenues constituted 66.5% and 69.9% of total
revenues for the six months ended June 30, 1999 and 1998, respectively.
Product Support Revenues. Product support revenues increased to $27.2
million for the six months ended June 30, 1999 from $13.2 million for the six
months ended June 30, 1998, representing an increase of 107.0%. Product support
revenues constituted 33.5% and 30.1% of total revenues for the six months ended
June 30, 1999 and 1998, respectively. The increase in product support revenues
was primarily due to the increase in product licenses sold, in conjunction with
several large consulting projects during 1999.
International Revenues. International revenues were $16.7 million and $9.6
million for the six months ended June 30, 1999 and June 30, 1998, representing
approximately 20.5% and 21.9% of total revenues, respectively.
Costs and Expenses
Cost of Product License Revenues. Cost of product license revenues was $1.1
million for both the six months ended June 30, 1999 and 1998, representing 2.0%
and 3.6% of total product license revenues, respectively. The decrease in total
cost of product license revenues as a percentage of total product license
revenues was due to economies of scale realized by producing larger volumes of
product materials and decreased shipping costs due to an increase in the
percentage of customers reproducing licenses at their sites.
Cost of Product Support Revenues. Cost of product support revenues was
$14.5 million and $7.3 million for the six months ended June 30, 1999 and 1998,
representing 53.3% and 55.3% of total product support revenues, respectively.
The increase in cost of product support revenues in 1999 was primarily due to
the increase in product licenses sold and, thus, an increase in the number of
personnel providing consulting, education, and technical support to customers.
Sales and Marketing Expenses. Sales and marketing expenses were $37.9
million and $22.8 million for the six months ended June 30, 1999 and 1998,
representing 46.6% and 52.3% of total revenues, respectively. The increase in
sales and marketing expenses was primarily the result of increased staffing
levels in the sales force, increased commissions earned and increased
promotional activities, trade show participation and general marketing efforts.
Research and Development Expenses. Research and development expenses were
$11.1 million and $4.9 million for the six months ended June 30, 1999 and 1998,
representing 13.7% and 11.1% of total revenues, respectively. The increase in
research and development expenses was primarily due to additional hiring of
research and development personnel and continued development of new products and
product enhancements.
General and Administrative Expenses. General and administrative expenses
were $9.6 million and $5.2 million for the six months ended June 30, 1999 and
1998, representing 11.8% of total revenues. The increase in general and
administrative expenses was primarily the result of increased staff levels and
related costs associated with the growth of our business during these periods.
Provision for Income Taxes. Prior to consummation of the Initial Public
Offering, we had elected to be treated as a Subchapter S corporation for federal
and state income tax purposes. Under Subchapter S, our income was allocated and
taxable to our individual stockholders rather than to us. Accordingly, no
federal or state income taxes have been provided for in the financial
statements, prior to consummation of the Initial Public Offering.
10
Our S corporation status terminated shortly prior to consummation of the
Initial Public Offering at which time we became subject to federal and state
corporate income taxation as a Subchapter C corporation. As a result, we now
account for income taxes as a Subchapter C Corporation and have adopted SFAS No.
109, "Accounting for Income Taxes." We recorded income tax expense of $0.6
million for the six months ended June 30, 1998. Had we been taxed as a C
corporation for the entire six months ended June 30, 1998, we would have
recorded income tax expense of $0.8 million. The adoption of SFAS No. 109 did
not have a material impact on our operating results. As of June 30, 1998, our
deferred tax assets of approximately $1.5 million consist primarily of net
operating loss carryforwards related to foreign operations. We recorded a
valuation allowance amounting to the entire deferred tax asset balance due to
the lack of consistent earnings in its foreign operations and the uncertainty as
to whether the deferred tax asset is realizable.
Liquidity and Capital Resources
From inception until the 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. We raised $48.7 million, net of
expenses, from our Initial Public Offering. On February 10, 1999, we raised an
additional $40.1 million, net of expenses, from the sale of 1,585,000 shares of
Class A Common Stock. As a result, on June 30, 1999 and December 31, 1998, we
had $34.8 million and $27.5 million of cash and cash equivalents, respectively.
Additionally, we had $19.4 million in short-term investments on June 30, 1999.
Cash used in operations was $0.6 million and $2.1 million for the six
months ended June 30, 1999 and 1998, respectively. The decrease in cash used in
operations during the six months ended June 30, 1999 compared to the same period
in 1998 was primarily attributable to a reduction of accounts receivable due to
increased collections efforts.
Cash used in investing activities was $30.0 and $2.5 million for the six
months ended June 30, 1999 and 1998, respectively. The increase in cash used in
investing activities during the six months ended June 30, 1999 compared to the
same period in 1998 reflected purchases of short-term investments and capital
expenditures related to the acquisition of computer and office equipment
required to support expansion of our operations. We expect to continue to
aggressively invest in capital expenditures to support the growth of the
Company. In particular, we expect significant capital investments in our new
business unit, Strategy.com, which is a personal intelligence network that
delivers personalized information via Internet, telephone and wireless devices.
Our financing activities provided cash of $38.2 million and $41.1 million
for the six months ended June 30, 1999 and 1998, respectively. The principal
source of cash from financing activities during the six months ended June 30,
1999 was from the additional sale of 1,585,000 share of Class A Common Stock in
which we raised $40.1 million, net of expenses. Prior to the sale of Class A
Common Stock and the Initial Public Offering, our principal source of cash from
financing activities was net borrowings from commercial lending institutions.
During December 1996, we entered into a loan agreement with a commercial bank
(the "Business Loan"). The Business Loan, as amended in September 1998, provided
for a $5.0 million revolving line of credit for general working capital
purposes. In July 1998, we repaid all net borrowings under the Business Loan. On
March 26, 1999, we signed an agreement to replace the Business Loan with a $25.0
million revolving line of credit ("Revolving Line"). Borrowings under the
Revolving Line will bear interest at a variable rate equal to LIBOR plus 1.0% to
1.75%, depending upon the ratio of funded debt to earnings. As of June 30, 1999,
no amounts were outstanding under the Revolving Line.
We declared a $10 million dividend to our shareholders prior to the Initial
Public Offering. The dividend was paid in the form of notes (the "Dividend
Notes") prior to the termination of our S corporation election, which occurred
immediately prior to the consummation of the Initial Public Offering. As of June
30, 1999, the entire $10.0 million of the Dividend Notes had been repaid.
We believe that the proceeds generated by the sale of Class A Common Stock
offered by us in our Initial Public Offering, our February 1999 public offering,
the available borrowings under the Revolving Line and the cash generated
internally by operations will satisfy our working capital requirements for the
foreseeable future.
Risk Factors
This quarterly report on Form 10-Q contains forward-looking statements
within the meaning of Section 21E of the Securities Exchange Act of 1934, as
amended, and Section 27A of the Securities Act of 1933, as amended. For this
purpose, any statements contained herein that are not statements of historical
fact may be deemed to be forward-looking statements. Without limiting the
foregoing, the words "believes," "anticipates," "plans," "expects," and similar
expressions
11
are intended to identify forward-looking statements. There are a number of
factors that could cause actual results to differ materially from those
indicated by such forward-looking statements. Among these factors are the
following:
Limited Operating History; Uncertainty of Future Operating Results
We began shipping DSS Agent, the first product in our current product
family, in 1994, and we introduced many of our other products in 1995. Our
limited operating history makes predicting future operating results difficult,
if not impossible. In addition, we had net losses and losses from operations in
1996 and 1994 and were only marginally profitable in 1997 and 1995. Although our
revenues have grown in recent periods, we cannot be certain that we will sustain
or increase our revenues or improve our operating results in the future.
Quarterly Operating Results May Fluctuate Significantly
For a number of reasons, including those described below, our operating
results, revenues and expenses may vary significantly from quarter to quarter.
Fluctuations in Quarterly Operating Results. Our quarterly operating
-------------------------------------------
results may fluctuate as a result of:
. the size and timing of significant orders;
. the timing of new product announcements;
. changes in our pricing policies or those of our competitors;
. market acceptance of decision support 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; and
. changes in foreign currency exchange rates.
Fluctuations in Revenues. In the past, we have typically recognized much of
------------------------
the revenue for any quarter in the last two to four weeks of that quarter. As a
result, even minor delays in booking orders near the end of a quarter can
adversely affect that quarter's revenues, particularly when large orders are
involved.
Because we ship most of our software products shortly after they are
ordered, we have almost no order backlog. Accordingly, product license revenues
for any quarter depend largely on orders booked and shipped in that quarter.
Product license revenues also fluctuate because the market for our products is
evolving rapidly and because sales cycles, which may last many months, vary
widely from customer to customer. Sales cycles are affected by many factors over
which we have little or no control, including:
. customers' budgetary constraints;
. the timing of budget cycles;
. concerns about the introduction of new products by us or our
competitors; and
12
. potential downturns in the economy, which may reduce demand for
management information systems.
Product support revenues depend largely on maintenance revenues from
existing customers and will vary with those customers' maintenance needs.
Seasonal factors may also affect our revenues. For example, the pace of new
sales tends to slow in the summer.
Limited Ability to Adjust Expenses. Because we plan to expand our business,
----------------------------------
we expect our operating costs and expenses to increase substantially. Operating
costs and expenses we expect to increase include those associated 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. We may not be able to reduce the
operating costs and expenses associated with our expansion (or even the rate at
which those operating costs and expenses grow) in the short term even if
expected revenue trends match our actual revenues. As a result, variations in
the timing and amounts of revenue could materially adversely affect our
quarterly operating results.
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 likely 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 price of our Class A Common Stock may fall.
Sales May Be Delayed or Lost Due to Long Sales and Implementation Cycles for Our
Products
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 first contact for
customers to place orders while they seek internal approval for, among other
things, the necessary capital expenditures. During this long sales cycle,
certain 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. It
is also possible that our customers will divert technology expenditures in 1999
to fund Year 2000 compliance plans. See "Year 2000 Issues; Potential Impact on
Customers."
Even after an order is placed, the time it takes to deploy our products
(the implementation cycle) varies widely from one customer to the next. The
implementation cycle can sometimes last several months, depending on the
customer's data warehousing and other requirements, 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.
These and other events affecting the sales and implementation cycles for
our products could materially adversely affect our business, operating results
or financial condition.
Increased Competition May Lead to Lower Prices, Reduced Gross Margins and Loss
of Market Share
The markets for decision support and Internet-based information services
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 information analysis and
broadcasting products.
Our most direct competitors in the markets for decision support and
Internet- based information services provide:
. decision support software;
. push products;
. browsers with webcasting functionality;
. electronic and Internet commerce systems;
. vertical Internet information systems;
13
. wireless communications products;
. online services; and
. event-driven technology.
Each of these products or services is discussed more fully below.
Decision Support Software. In the decision support market, we compete with
vendors of relational online analytical processing software, such as Information
Advantage, Inc. and Platinum Technology Incorporated; vendors of desktop online
analytical processing, or OLAP, software, such as Business Objects S.A. and
Cognos Incorporated; and vendors of multidimensional OLAP software, such as
Oracle Corporation, Hyperion Solutions Corporation (which has entered into a
strategic relationship with International Business Machines Corporation),
Seagate Software, Inc. and SAS Institute Incorporated.
We expect continued growth and competition in this market. In addition, new
competitors may emerge. Microsoft Corporation, for example, has indicated that
it will introduce certain products in 1999 that may compete with ours.
Push Products. Our competitors in the push product market, including
PointCast Incorporated, Marimba, Inc. and BackWeb Technologies Inc., offer
technologies that deliver information over the Internet to recipients via Web
browsers and proprietary interfaces. Push product vendors mostly deliver
text-based information, such as news and sports, but often include some
number-based information, such as stock price updates. Marimba is expanding its
services to include the delivery of information and analysis from relational
data sources, which could provide us with increased competition in this market.
Browsers with Webcasting Functionality. Web browsers with channels or the
ability to webcast, such as Microsoft Internet Explorer or Netscape Navigator,
provide an infrastructure for automatically updating information on a
recipient's computer. This infrastructure is a competitive alternative to our
DSS Broadcaster product line (although we use the same infrastructure to enhance
our DSS Web product line).
Electronic and Internet Commerce Systems. Products and turn-key solutions
for electronic commerce, Internet commerce and electronic business, such as
those provided by IBM, Open Market Inc., USWeb/CKS Corp., Viant Corporation and
Sun Microsystems, Inc., can be used to provide Internet-based information
services. To the extent they can be used to deliver information and analysis
from relational database management systems, these products will compete with
ours.
Vertical Internet Information Systems. Microsoft Expedia, Microsoft
Investor, StockBoss, Microsoft CarPoint, Mercury Mail, TechWeb, ESavers (US
Airways, Inc.), C.O.O.L. (Continental Airlines, Inc.), 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 delivering stock prices, and cannot
easily be used for others, such as delivering airfares. However, they pose a
competitive risk because, as a group, they offer applications similar to some
that have been developed using our products.
Wireless Communications Products. Wireless communications and messaging
providers, such as AT&T Corp., Nextel Communications, Sprint Corporation, MCI
WorldCom, Inc., Iridium LLC, PageNet, Inc. and SkyTel Corp., offer a variety of
alpha-enabled mobile phones and pagers. It is possible that these companies will
someday offer custom-developed information services to their customers that will
compete with applications using our products and services.
Online Service Providers. Online service providers include America Online,
Inc., Microsoft's Microsoft Network, Prodigy, Inc., @Home Corporation and WebTV
Networks, Inc. (acquired by Microsoft). These companies provide text-based
information over the Internet and on proprietary online services. They could
develop applications that compete with the functionality of our products.
Event-Driven Technology. Providers of event notification systems include
TIBCO Finance Technology Inc., which sells a product that monitors stock tickers
and notifies subscribers when preset thresholds are crossed; Clarify Inc., which
handles loan applications with a financial system developed by SAP AG; BEA
Systems, Inc., which provides middleware; and Vitria Technology Inc., which
provides event-based workflow software. The technology resulting from these
systems
14
has overlapped with our technology in the past and may do so in the future.
If a single competing vendor gains a large share of the relational database
management system market, we may find it more difficult to differentiate our
products. This may materially adversely affect our business, operating results
and financial condition.
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 data warehouse industry. As a result, they may be able to respond more
quickly to new or emerging technologies and changes in customer requirements, or
to 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 materially adversely affect 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 future indirect channel partners may establish
cooperative relationships with our current or future competitors. Such
relationships may limit our ability to sell our products through certain
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 have a material adverse
effect on our margins and on our ability to obtain maintenance revenues for new
and existing product licenses on favorable terms.
Continued Growth Will Increase Demands on Resources
We have been expanding rapidly and we expect to continue expanding our
operations. The total number of our employees grew from 59 on January 1, 1995 to
1,208 on June 30, 1999, and we expect our 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. 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
greatly expand our support organization to further develop indirect distribution
channels in different and broader markets and to accommodate growth in our
installed customer base. Failure to effectively manage our expansion could have
a material adverse effect on our business, operating results and financial
condition.
Need to Recruit Additional Skilled Personnel; Dependence on Key Personnel
Our future success depends on our continuing ability to attract, train,
assimilate and retain highly qualified personnel. Competition for these
personnel is intense. We may not be able to retain our current key employees or
attract, train, assimilate or retain other highly qualified 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 President and
Chief Executive Officer, and Sanju K. Bansal, our Executive Vice President and
Chief Operating Officer. Losing the services of one or more of these individuals
or other key personnel could materially adversely affect our business, operating
results and financial condition.
Dependence on New Versions, New Products and Rapid Technological Change
The market for our products is characterized by rapid technological change,
frequent new product introductions and enhancements, uncertain product life
cycles, changing customer demands and evolving industry standards. The
introduction of products embodying new technologies and the emergence of new
industry standards can quickly make existing products obsolete and unmarketable.
The emergence of new standards in related fields may also adversely affect
existing products. This could happen, for example, if new Web protocols emerged
that were incompatible with deployment of our DSS applications over the Web.
Although our DSS solutions allow the core database component to reside on nearly
all enterprise server hardware and operating system combinations (Mainframe,
AS/400, Unix, Windows NT and Windows), our application server component runs at
present only on the Windows NT operating system. Therefore, our ability to
increase sales may depend on the continued acceptance of the Windows NT
operating system. We cannot market our current DSS 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
15
a timely or cost effective basis, if at all.
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 timely develop new products that achieve market acceptance, maintain
technological competitiveness and meet an expanding range of customer
requirements. DSS applications, however, 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.
Moreover, only a few of our customers to date have deployed our products in
environments that involve terabytes of data and thousands of active users. As
deployment in these complex environments becomes more widespread, unexpected
delays or other difficulties may arise. As a result, lengthy delays in the
general availability of new releases or significant problems in installing or
implementing new releases could arise that will have a material adverse effect
on our business, operating results and financial condition. 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, evolving industry standards or customer requirements. Nor can we be sure
that we will not have difficulties that could delay or prevent the successful
development, introduction or marketing of these enhancements. Finally, we cannot
be sure that our new products and product enhancements will achieve market
acceptance.
Government Regulation and Other Legal Uncertainties
We are not directly regulated by any governmental agency, although we are
subject to the laws that generally apply to businesses. Certain U.S. and foreign
laws restricting the use of consumers' personal information may also apply to
us. Due to increasing use of the Internet and the dramatically increased access
to personal information made possible by technologies like ours, laws and
regulations may be adopted in the U.S. and abroad to limit access to personal
information over the Internet and other public data networks in ways that
adversely affect our business. The European Union Directive on Data Protection,
a comprehensive administrative and regulatory program controlling many aspects
of personal data collection and distribution, was required to be implemented by
its member nations in October 1998. This Directive limits the ability of
companies to collect, store and exchange personal data with other entities. In
response to consumer pressures, the U.S. Congress and various state legislatures
are considering legislation that would apply to us in areas such as privacy
protection. Because the United States 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. The U.S. Department of Commerce
is currently negotiating with the European Commission to develop a set of "safe
harbor" principles under which U.S. companies could operate freely under the
European Union Directive. However, there can be no assurance that such a "safe
harbor" will be agreed upon, or that, if agreed upon, will permit us or our
customers to make such uses of consumer data as they currently make.
Although existing laws govern such issues as personal privacy over the
Internet or other public data networks, it is unclear whether they apply to us.
Most of these laws were adopted before the widespread use and commercialization
of the Internet and other public data networks. As a result, these laws do not
address the unique issues presented by these media.
Any new law or regulation or any expanded governmental enforcement of
existing regulations may limit our growth or increase our legal exposure, which
could have a material adverse effect on our business, financial condition and
results of operations.
Dependence on Growth of Market for Decision Support Software
All of our revenues have come from sales of decision support software and
related maintenance, consulting and training services. We expect these sales to
account for substantially all of our revenues for the foreseeable future.
Although demand for decision support software has grown in recent years, the
market for decision support software applications is still emerging. Resistance
from consumer and privacy groups to increased commercial collection and use of
data on spending 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 that, even if it does grow, businesses will adopt our
solutions. We have spent, and intend to keep spending, considerable resources to
educate potential customers about decision support software generally 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.
Control by Existing Stockholders; Anti-Takeover Effect of Two Classes of Common
Stock
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 June 30, 1999, holders of our Class B Common Stock owned
or controlled 29,714,404 shares of Class B Common Stock, or 97.2%
16
of our voting power. Michael J. Saylor, our Chairman, President and Chief
Executive Officer, through his sole ownership and control of Alcantara LLC,
controlled 22,424,662 shares of Class B Common Stock and 50,000 shares of Class
A Common Stock, or 73.4% of our voting power as of June 30, 1999. Accordingly,
Mr. Saylor will be 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 certain 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 prospects 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.
Reliance on Channel Partners
In addition to our direct sales force, we rely on 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 six months ended June 30, 1999 and for 1998, 1997 and 1996,
channel partners accounted directly or indirectly for 32.8%, 35.0%, 27.5% and 9%
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. However, there can be no assurance that our
efforts to continue to expand indirect sales 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 recruiting and
maintaining successful relationships with those strategic partners.
Risks Associated with Intellectual Property
We regard our software products as proprietary, and we rely on a
combination of statutory and common law copyright, trademark and trade secret
laws, customer licensing agreements, employee and third-party nondisclosure
agreements and other methods to protect our proprietary rights. However, these
laws and contractual provisions provide only limited protection. We have no
patents no registered trademarks (other than MicroStrategy or QuickStrike) and
no registered copyrights (other than the EISToolkit 2.0 reference manual).
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.
As the number of software products in our target markets increases and the
functionality of these products further overlap, software developers may become
increasingly subject to infringement claims. Someone may even claim that our
technology infringes their proprietary rights. Any such claims, whether with or
without merit, can 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 product infringement against us and our inability to
license the infringed or similar technology could adversely affect our business.
Difficulties Associated with International Operations and Expansion
International sales accounted for 20.5%, 23.6%, 26.7%, and 11.1% of our
total revenue for the six months ended June 30, 1999 and for the years ended
December 31, 1998, 1997, and 1996, 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 or financial condition. In
order to expand international sales successfully in 1999 and beyond, 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. Nor can we be sure that we will be able to maintain
or increase international market demand for our products.
17
There are certain risks inherent in our international business activities.
In addition to the currency fluctuations described below, these include:
. 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; and
. the burden of complying with a wide variety of foreign laws.
These factors may have a material adverse effect on our future
international sales and, consequently, our results of operations.
Currency Fluctuations
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 our local
currency. Our foreign currency translation gains and losses have so far been
immaterial. However, future fluctuations in exchange rates between the U.S.
Dollar and foreign currencies may materially adversely affect our business,
results of operations and financial condition, particularly our operating
margins. We cannot accurately predict the impact of future exchange rate
fluctuations on our results of operations. To date, we have not hedged the risks
associated with these fluctuations. Although we may do so in the future, we
cannot be sure that any hedging techniques we may implement will be successful
or that our business, results of operations, financial condition and cash flows
will not be materially adversely affected by exchange rate fluctuations.
Possible Consequences of Euro Conversion
On January 1, 1999, eleven of the fifteen member countries of the European
Union set fixed conversion rates between their existing sovereign currencies and
the euro and adopted the euro as their legal currency. We have assessed the
impact of these events on our company. In particular, we have considered:
. the technical challenges of adapting our systems to accommodate
euro-denominated transactions;
. the competitive impact of cross-border price transparency, which may
make it more difficult for businesses to charge different prices for
the same products in different countries;
. the impact on currency exchange costs and currency exchange rate risk;
and
. the impact on existing contracts.
Based on our assessment, we do not believe the euro conversion will have a
material impact on our business; however, there can be no assurance that the
adoption of the euro will not have an adverse effect on our business, financial
condition, or results of operations.
Risk of Software Defects; Potential Product Liability for Software Defects
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 certain
of our new products after their introduction. While we have not experienced
material adverse effects from any such errors to date, we
18
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 limitation of liability 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.
Year 2000 Issues; Potential Impact on Customers
Many currently installed computer systems and software products are coded
to accept only two-digit entries in the date code field. These date code fields
will need to accept four-digit entries in order for 20th century dates to be
distinguished from 21st century dates. As a result, before the end of this year,
computer systems and software used by many companies may need to be upgraded to
comply with these "Year 2000" requirements.
We have developed and largely implemented a Year 2000 readiness plan for
the current versions of most of our products. Accordingly, we believe that the
current versions of most of our products are Year 2000 compliant when configured
and used properly, provided that the underlying operating system of the host
machine and any other software used with or in the host machine or our products
are also Year 2000 compliant.
We began testing our own material internal information technology, or IT,
systems (including both our own software products and third-party software and
hardware technology) and our non-IT systems (such as our security system,
building equipment, and embedded microcontrollers) for Year 2000 compliance
beginning in the first quarter of 1999. We have completed the majority of the
testing of our mission critical systems with only minor issues encountered and
repaired as of June 30, 1999. To the extent that we are not able to test
technology provided by third-party vendors, we are asking them to assure us that
their systems are Year 2000 compliant.
Although we are not currently aware of any material operational issues or
costs associated with preparing our material internal IT and non-IT systems for
the Year 2000, we may experience material unanticipated problems and costs
caused by undetected errors or defects in the technology used in these systems.
While we cannot be sure that all our non-material systems will be Year 2000
compliant by 2000, we believe that failure of such systems will not have a
material adverse affect on our business, financial condition or results of
operations. We are currently developing a contingency plan to provide for the
remote possibility that our material systems will not achieve timely Year 2000
compliance.
We have funded most of our past Year 2000 compliance activities from cash
flows and have not allocated additional funds to making our products or internal
systems Year 2000 compliant. During 1999, we plan to spend approximately
$100,000 on preparing our internal systems for the Year 2000. We do not expect
to receive much outside assistance in completing our internal Year 2000 effort.
Apart from current versions of our products and our internal systems, we
have identified four potential Year 2000 problem areas.
First, we have not yet determined whether certain third-party software
incorporated in one of our products is Year 2000 compliant. Although we are not
currently aware of any material Year 2000 issues with these third-party software
products, undetected errors or defects, if they exist, may cause material
unanticipated problems and costs.
Second, some of our customers may be using a version of our software that
is not Year 2000 compliant. While we have tried to make sure that all our
customers are using Year 2000 compliant versions of our software, we cannot be
certain that they have installed these versions.
Third, not all platforms or versions of the operating systems that our
products currently support are Year 2000 compliant.
Fourth, certain customers have elected to operate systems in a two-digit
year date environment, which is not Year 2000 compliant.
19
We do not currently have much information on the Year 2000 compliance
status of our customers. If our current or future customers do not become Year
2000 compliant, or if they divert technology expenditures (especially technology
expenditures that were reserved for enterprise decision support software) to
address Year 2000 compliance problems, our business, results of operations,
financial condition or cash flows could be materially adversely affected.
Since we are in the business of selling software, our risk of lawsuits
relating to Year 2000 issues with our products is likely to be greater than that
of companies in some other industries. Because computer systems may incorporate
components from different manufacturers, it may be difficult to determine which
component in a computer system may cause a Year 2000 problem.
As a result, we may be subjected to Year 2000-related lawsuits whether or
not our products and services are Year 2000 compliant. We cannot be certain at
this time what the outcomes or impact of any such lawsuits may be.
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 for speculative or trading purposes. 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 June 30, 1999, 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 June 30, 1999, a 10% change in foreign
exchange rates would have had an immaterial effect on our financial position,
results of operations and cash flows. To date, we have not hedged the risks
associated with foreign exchange exposure. Although we may do so in the future,
we cannot be sure that any hedging techniques we may implement will be
successful or that our business, results of operations, financial condition and
cash flows will not be materially adversely affected by exchange rate
fluctuations. To date, our foreign currency gains and losses have been
immaterial.
20
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company sold 4,440,000 shares of its Class A Common Stock on June
16, 1998 pursuant to a Registration Statement on Form S-1 (Registration No.
333-49899), which was declared effective by the Securities Exchange Commission
on June 10, 1998 (the "Effective Date"). Certain stockholders of the Company
sold an aggregate of 160,000 shares of Class A Common Stock pursuant to such
registration statement. The managing underwriters of the Initial Public Offering
were Merrill Lynch & Co., Hambrecht & Quist, and Friedman, Billings, Ramsey &
Co., Inc. The aggregate gross proceeds raised in the Initial Public Offering
from the sale of Class A Common Stock by the Company and the selling
shareholders were $53.3 million and $1.9 million, respectively. The Company's
total expenses in connection with the Initial Public Offering were approximately
$4.6 million, of which $3.7 million was for underwriting discounts and
commissions and approximately $0.9 milion was for other expenses. The Company's
net proceeds from the Initial Public Offering were approximately $48.7 million.
From the Effective Date through June 30, 1999, the Company used $13.6 million of
such net proceeds to repay all net borrowings under the Business Loan. In
addition, the Company used $10.0 million of such net proceeds to repay all of
the borrowings under the Company's $10.0 million Dividend Notes which were
issued to certain shareholders of the Company prior to the consummation of the
Initial Public Offering. Approximately $9.5 million of the $10.0 million
dividend payment was paid to certain officers, directors and 10% shareholders of
the Company. As of August 1, 1999 the Company had used all proceeds from the
Initial Public Offering to support the growth of the Company.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company's Annual Meeting of Stockholders was held on May 21, 1999. The
following proposals were adopted by the vote specified below:
[CAPTION]
Against/ Broker
Proposal For Withheld Abstain Non-Votes
-------- --- -------- ------- ---------
1. Election of Directors:
Michael J. Saylor 285,917,958 24,128
Sanju K. Bansal 285,917,958 24,128
Frank A. Ingari 285,917,958 24,128
Jonathan J. Ledecky 285,917,958 24,128
Ralph S. Terkowitz 285,917,958 24,128
2. Approval of the Company's 1999 Stock
Option Plan 281,055,607 1,218,447 38,694 3,629,338
3. Ratification of PricewaterhouseCoopers LLP
as Independent Auditors 285,929,730 8,222 4,134
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
A. EXHIBITS
3.1* Form of Amended and Restated Certificate of Incorporation of the
Company
3.2* Form of Restated Bylaws of the Company
4.1* Form of Certificate of Class A Common Stock of the Company
10.1 Credit Agreement between NationsBank, N.A. and the Company dated
March 26, 1999
10.2 Modification to Credit Agreement between NationsBank, N.A. and the
Company dated July 12, 1999
10.3 1999 Stock Option Plan of the Company
27.1 Financial Data Schedule
- -----------------
* Incorporated by reference from the Company's Registration Statement on Form
S-1 (Registration No. 333-49899).
B. REPORTS ON FORM 8-K
On June 2, 1999, the Company filed a Current Report on Form 8-K, dated
May 27, 1999, announcing that the Company had entered into an agreement
with Ameritrade Holding Corporation.
21
All other items are omitted because they are not applicable or the answers are
none.
22
INDEX TO EXHIBITS
Exhibit
Number Description
- ------- -----------
3.1* Form of Amended and Restated Certificate of Incorporation of the
Company
3.2* Form of Restated Bylaws of the Company
4.1* Form of Certificate of Class A Common Stock of the Company
10.1 Credit Agreement between NationsBank, N.A. and the Company dated
March 26, 1999
10.2 Modification to Credit Agreement between NationsBank, N.A. and
the Company dated July 12, 1999
10.3 1999 Stock Option Plan of the Company
27.1 Financial Data Schedule
- -----------------
* Incorporated by reference from the Company's Registration Statement on Form
S-1 (Registration No. 333-49899).
23
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: August __, 1999
24