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 September 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
(State of incorporation)
51-0323571
(I.R.S. Employer Identification Number)
8000 Towers Crescent Drive
Vienna, VA
(Address of Principal Executive Offices)
22182
(Zip Code)
Registrant's telephone number, including area code: (703) 848-8600
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [ X ] No [ ]
The number of shares of the registrant's Class A Common Stock and Class B
Common Stock outstanding on November 1, 1999 was 9,889,657 and 28,670,465,
respectively.
MICROSTRATEGY INCORPORATED
FORM 10-Q
TABLE OF CONTENTS
Page
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets, September 30, 1999 (unaudited)
and December 31, 1998....................................... 1
Consolidated Statements of Operations and Comprehensive
Income, For the Three Months ended September 30, 1999 and
1998 (unaudited)............................................ 2
Consolidated Statements of Operations and Comprehensive
Income, For the Nine Months ended September 30, 1999 and
1998 (unaudited)............................................ 3
Consolidated Statements of Cash Flows, For the Nine Months
ended September 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..................... 8
Item 3. Quantitative and Qualitative Disclosures About Market
Risk.................................................... 22
Part II. OTHER INFORMATION...................................... 23
Item 1. Financial Statements
MICROSTRATEGY INCORPORATED
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
September December 31
1999 1998
---------- -----------
(unaudited)
Assets
Current Assets:
Cash and cash equivalents..................... $ 22,380 $ 27,491
Short-term investments........................ 21,404 ---
Accounts receivable, net...................... 54,587 33,054
Prepaid expenses and other current assets..... 5,004 2,914
-------- --------
Total current assets....................... 103,375 63,459
Property and equipment, net.................... 34,601 13,773
Long-term accounts receivable.................. --- 2,700
Deposits and other assets...................... 2,296 2,757
-------- --------
Total assets............................... $140,272 $ 82,689
======== ========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable and accrued expenses......... $ 15,890 $ 11,904
Accrued compensation and employee benefits.... 7,593 7,356
Deferred revenue.............................. 8,012 10,732
Dividend notes payable........................ --- 5,000
-------- --------
Total current liabilities.................. 31,495 34,992
Deferred revenue............................... 3,284 746
Other long-term liabilities.................... 671 671
-------- --------
Total liabilities.......................... 35,450 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, 9,387,915 shares
issued and outstanding at September 30, 1999;
5,052,110 shares issued and outstanding at
December 31, 1998............................. 9 5
Class B Common Stock, par value $0.001 per share,
100,000,000 shares authorized, 29,055,465 shares
issued and outstanding at September 30, 1999;
30,633,114 shares issued and outstanding at
December 31, 1998............................. 29 31
Additional paid-in capital..................... 91,736 42,219
Accumulated other comprehensive income......... 710 894
Deferred compensation.......................... (1,755) (2,098)
Accumulated earnings........................... 14,093 5,229
-------- --------
Total stockholders' equity................. 104,822 46,280
-------- --------
Total liabilities and stockholders' equity. $140,272 $ 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 September 30, 1999 and 1998
(in thousands, except share and per share data)
Three Months Ended
September 30,
1999 1998
---- ----
(unaudited)
Revenues:
Product licenses.............................. $ 38,219 $ 16,949
Product support............................... 16,336 10,065
---------- ----------
Total revenues.............................. 54,555 27,014
---------- ----------
Cost of revenues:
Product licenses.............................. 844 586
Product support............................... 9,056 4,658
---------- ---------
Total cost of revenues...................... 9,900 5,244
---------- ----------
Gross margin.................................... 44,655 21,770
---------- ----------
Operating expenses:
Sales and marketing........................... 24,376 12,926
Research and development...................... 8,433 3,218
General and administrative.................... 6,315 2,941
---------- ----------
Total operating expenses.................... 39,124 19,085
---------- ----------
Income from operations.......................... 5,531 2,685
Interest income................................. 594 551
Interest expense................................ --- (120)
Other expense, net.............................. (6) (7)
---------- ----------
Income before income taxes...................... 6,119 3,109
Provision for income taxes...................... 2,325 1,181
---------- ----------
Net income...................................... $ 3,794 $ 1,928
========== ==========
Other comprehensive income:
Foreign currency translation adjustment....... 534 332
Unrealized gain on investments, net of tax.... 3 ---
---------- ----------
Comprehensive income............................ $ 4,331 $ 2,260
========== ==========
Basic net income per share..................... $ 0.10 $ 0.05
========== ==========
Weighted average shares outstanding used in
computing basic net income per share.......... 38,361,338 35,543,737
========== ==========
Diluted net income per share.................... $ 0.09 $ 0.05
========== ==========
Weighted average shares outstanding used in
computing diluted net income per share........ 42,737,259 40,881,728
========== ==========
The accompanying notes are an integral part of these Consolidated
Financial Statements.
2
MICROSTRATEGY INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME
For the Nine Months Ended September 30, 1999 and 1998
(in thousands, except share and per share data)
Nine Months Ended
September 30,
1999 1998
---- ----
(unaudited)
Revenues:
Product licenses.............................. $ 92,400 $ 47,476
Product support............................... 43,577 23,223
---------- ----------
Total revenues.............................. 135,977 70,699
---------- ----------
Cost of revenues:
Product licenses.............................. 1,927 1,676
Product support............................... 23,571 11,934
---------- ----------
Total cost of revenues...................... 25,498 13,610
---------- ----------
Gross margin.................................... 110,479 57,089
---------- ----------
Operating expenses:
Sales and marketing........................... 62,295 35,759
Research and development...................... 19,581 8,086
General and administrative.................... 15,958 8,104
---------- ----------
Total operating expenses.................... 97,834 51,949
---------- ----------
Income from operations.......................... 12,645 5,140
Interest income................................. 1,771 682
Interest expense................................ (145) (621)
Other expense, net.............................. 26 (31)
---------- ----------
Income before income taxes...................... 14,297 5,170
Provision for income taxes...................... 5,433 1,758
---------- ----------
Net income...................................... $ 8,864 $ 3,412
========== ==========
Other comprehensive (loss) income:
Foreign currency translation adjustment....... (70) 395
Unrealized loss on investments, net of tax.... (71) ---
---------- ----------
Comprehensive income............................ $ 8,723 $ 3,807
========== ==========
Basic net income per share...................... $ 0.24 $ 0.10
========== ==========
Weighted average shares outstanding used in
computing basic net income per share.......... 37,710,230 32,771,485
========== ==========
Diluted net income per share.................... $ 0.21 $ 0.09
========== ==========
Weighted average shares outstanding used in
computing diluted net income per share........ 42,002,352 37,936,672
========== ==========
Pro forma information (unaudited):
Income before income taxes, as reported...... --- 5,170
Pro forma provision for income taxes......... --- 1,965
----------
Pro forma net income............................ --- 3,205
==========
Pro forma basic net income per share............ --- 0.10
==========
Pro forma diluted net income per share.......... --- 0.08
==========
The accompanying notes are an integral part of these Consolidated
Financial Statements.
3
MICROSTRATEGY INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 1999 and 1998
(in thousands)
September 30,
1999 1998
---- ----
(unaudited)
Operating activities:
Net income...................................... $ 8,864 $ 3,412
Adjustments to reconcile net income to net
cash used in operating activities:
Depreciation and amortization................. 4,907 2,045
Provision for doubtful accounts, net of
write-offs and recoveries................... 1,039 150
Amortization of deferred compensation......... 342 163
Changes in operating assets and liabilities, net
of effect of foreign exchange rate changes:
Accounts receivable........................... (22,656) (13,228)
Prepaid expenses and other current assets..... (2,171) (938)
Accounts payable and accrued expenses,
compensation and benefits................... 4,641 1,213
Deferred revenue.............................. (58) 1,145
Deposits and other assets..................... (67) (48)
Long-term accounts receivables................ 2,700 ---
--------- --------
Net cash used in operating activities....... (2,459) (6,086)
Investing activities:
Acquisition of property and equipment......... (25,578) (6,144)
Purchase of short-term investments............ (31,492) ---
Sale of short-term investments................ 10,000 ---
--------- --------
Net cash used in investing activities....... (47,070) (6,144)
Financing activities:
Proceeds from sale of Class A Common Stock
and exercise of stock options, net of
offering costs.............................. 45,624 48,797
Stock option income tax benefit............... 3,883 ---
Repayments on short-term line of credit, net.. --- (4,508)
Payments of dividend notes payable............ (5,000) (2,500)
Proceeds from issuance of notes payable....... --- 862
Principal payments on notes payable........... --- (4,211)
-------- --------
Net cash provided by financing activities... 44,507 38,440
Effect of foreign exchange rate changes on
cash and cash equivalents................... (89) 152
-------- --------
Net (decrease) increase in cash and cash
equivalents................................... (5,111) 26,362
Cash and cash equivalents, beginning of period.. 27,491 3,506
-------- --------
Cash and cash equivalents, end of period........ $ 22,380 $ 29,868
======== ========
Supplemental disclosure of noncash investing and
financing activities:
Unrealized loss on investments................ $ 114 $ ---
======== ========
Supplemental disclosure of cash flow information:
Cash paid during the year for interest........ $ 87 $ 576
======== ========
Cash paid during the year for income taxes.... $ 2,113 $ 1,330
======== ========
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 as of
September 30, 1999, the related consolidated statements of operations for the
three and nine month periods ended September 30, 1999 and 1998, and the
consolidated statements of cash flows for the nine month periods ended September
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 filed with the Securities and Exchange 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 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.
5
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
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 nine month period ended September 30, 1998.
(6) Commitments
In September 1999, the Company entered into a commitment to purchase
$10,000,000 of computer equipment and software over the twelve month period
ending September 2000.
(7) Net Income Per Share
Reconciliations of the basic net income per share and diluted net income
per share computations for the three and nine month periods ended September 30,
1999 and 1998 are as follows:
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
1999 1998 1999 1998
---------- ---------- ---------- ----------
(in thousands, except share and per share data)
Net income.................... $ 3,794 $ 1,928 $ 8,864 $ 3,412
========== ========= ========= ==========
Basic net income per share:
Weighted average common
shares outstanding........ 38,361,338 35,543,737 37,710,230 32,771,485
========== ========== ========== ==========
Basic net income per share.... $ 0.10 $ 0.05 $ 0.24 $ 0.10
========== ========== ========== ==========
Diluted net income per share:
Weighted average common
shares outstanding........ 38,361,338 35,543,737 37,710,230 32,771,485
========== ========== ========== ==========
Dilutive impact of common
shares issuable upon exercise
of stock options and
warrants................... 4,375,921 5,337,991 4,292,122 5,165,187
========== ========== ========== ==========
Weighted average common
shares assuming dilution.. 42,737,259 40,881,728 42,002,352 37,936,672
========== =========== ========== ==========
Diluted net income per share.. $ 0.09 $ 0.05 $ 0.21 $ 0.09
========== =========== ========== ==========
Common stock equivalents are included in the computation of diluted net
income per share using the treasury stock method. During the three and nine
month periods ended September 30, 1999 stock options granted by the Company to
purchase 323,000 and 798,000 shares of Class A Common Stock, respectively, were
not included in the computation because the effect was anti-dilutive. During the
three and nine month periods ended September 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.
6
MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(unaudited)
(8) 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 Nine Months
Ended September 30, Ended September 30,
1999 1998 1999 1998
---------- ---------- ---------- ----------
(in thousands, except share and per share data)
Revenue:
Domestic.................... $ 45,257 $ 20,504 $ 109,989 $ 54,639
Europe...................... 9,298 6,510 25,988 16,060
-------- -------- --------- --------
Total revenue.............. $ 54,555 $ 27,014 $ 135,977 $ 70,699
======== ======== ========= ========
Operating income:
Domestic.................... $ 4,553 $ 1,502 $ 7,230 $ 4,656
Europe...................... 978 1,183 5,415 484
-------- -------- --------- --------
Total operating income..... $ 5,531 $ 2,685 $ 12,645 $ 5,140
======== ======== ========= ========
Identifiable assets:
Domestic.................... $118,255 $ 61,998 $118,255 $ 61,998
Europe...................... 22,017 14,565 22,017 14,565
-------- -------- -------- --------
Total assets............... $140,272 $ 76,563 $140,272 $ 76,563
======== ======== ======== ========
Transfers of $2,044,000 and $1,654,000 for the three month periods ended
September 30, 1999 and 1998, respectively, and of $5,832,000 and $4,148,000 for
the nine month periods ended September 30, 1999 and 1998, respectively, from
foreign to domestic operations have been excluded from the above table and
eliminated in the consolidated financial statements. Additionally, 33.8% and
13.5% of consolidated net sales for the three and nine month periods ended
September 30, 1999 involved the sale of product licenses to one customer.
(9) Acquisition
In September 1999, the Company entered into a binding memorandum of
understanding to purchase certain assets such as software assets and computer
equipment from NCR Corporation. In consideration for the assets, the Company has
agreed to issue NCR approximately 303,000 shares of Class A Common Stock, valued
at approximately $19.2 million, based on the average market price of the
Company's stock three days before and after the transaction date and on the date
the transaction was announced. The Company has agreed that NCR will have the
right to demand the filing of a registration statement to register the resale of
the shares by NCR. The transaction is expected to close in November 1999.
7
MICROSTRATEGY INCORPORATED
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Overview
We are a leading worldwide provider of intelligent e-business software and
related services. Our product line enables both proactive and interactive
delivery of information from large-scale databases, providing Global 2000
enterprises a platform for developing solutions that deliver insight and
intelligence to their enterprise, supply-chain and customers.
Our platform enables users to query and analyze the most detailed,
transaction-level databases, turning data into business intelligence. In
addition to supporting internal enterprise users, our platform delivers critical
business information beyond corporate boundaries to customers, partners and
supply chain constituencies through a broad range of pull and push technology
such as the Internet, e-mail, telephones, pagers and other wireless
communications devices. Our platform is used in the development of e-business
solutions that are personalized and proactive, and that reach millions of users.
We also offer a comprehensive set of consulting, education and support services
for our customers and partners.
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 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.
Results of Operations
The following table sets forth for the periods indicated the percentage of
total revenues represented by certain items reflected in our consolidated
statements of operations:
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
1999 1998 1999 1998
---------- ---------- ---------- ----------
Consolidated Statements of
Operations Data:
Revenues:
Product licenses............ 70.1% 62.7% 68.0% 67.2%
Product support............. 29.9 37.3 32.0 32.8
----- ----- ----- -----
Total revenues............. 100.0 100.0 100.0 100.0
----- ----- ----- -----
Cost of revenues:
Product licenses............ 1.5 2.2 1.4 2.4
Product support............. 16.6 17.2 17.3 16.9
----- ----- ----- -----
Total cost of revenues..... 18.1 19.4 18.7 19.3
----- ----- ----- -----
Gross margin.................. 81.9 80.6 81.3 80.7
----- ----- ----- -----
Operating expenses:
Sales and marketing......... 44.7 47.8 45.8 50.6
Research and development.... 15.5 11.9 14.4 11.4
General and administrative.. 11.6 10.9 11.7 11.5
----- ----- ----- -----
Total operating expenses... 71.8 70.6 71.9 73.5
----- ----- ----- -----
Income from operations........ 10.1 10.0 9.4 7.2
Interest income (expense), net 1.1 1.6 1.2 0.1
Other expense, net............ --- --- --- ---
Provision for income taxes.... (4.3) (4.4) (4.0) (2.5)
----- ----- ----- -----
Net income.................... 6.9% 7.2% 6.6% 4.8%
===== ===== ===== =====
8
Comparison of Three Months Ended September 30, 1999 and 1998
Revenues
Total revenues increased to $54.6 million for the three months ended
September 30, 1999 from $27.0 million for the three months ended September 30,
1998, representing an increase of 102.0%. 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 $38.2
million for the three months ended September 30, 1999 from $16.9 million for the
three months ended September 30, 1998, representing an increase of 125.5%. 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 70.1% and 62.7% of
total revenues for the three months ended September 30, 1999 and 1998,
respectively.
Product Support Revenues. Product support revenues increased to $16.3
million for the three months ended September 30, 1999 from $10.1 million for the
three months ended September 30, 1998, representing an increase of 62.3%.
Product support revenues constituted 29.9% and 37.3% of total revenues for the
three months ended September 30, 1999 and 1998, respectively. The increase in
product support revenues was primarily due to the increase in product licenses
sold. 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 $9.3 million and $6.5
million for the three months ended September 30, 1999 and 1998, respectively,
representing approximately 17.0% and 24.1% 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.
Costs and Expenses
Cost of Product License Revenues. Cost of product license revenues consists
primarily of the costs of product manuals, media, amortization of capitalized
software expenses and royalties paid to third party software vendors. Cost of
product license revenues was $0.8 million and $0.6 million for the three months
ended September 30, 1999 and 1998, representing 2.2% and 3.5% 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
materials costs due to an increase in the percentage of customers reproducing
product documentation at their sites. We anticipate that the cost of product
license revenues will continue to increase as product license revenues increase,
but decrease as a percentage of product license revenues. However, in the event
that we enter into any royalty arrangements with strategic partners in the
future, cost of product license revenues as a percentage of total product
license revenues may increase.
Cost of Product Support 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 $9.1 million and
$4.7 million during the three months ended September 30, 1999 and 1998,
representing 55.4% and 46.3% 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 $24.4 million and $12.9
million for the three
9
months ended September 30, 1999 and 1998, representing 44.7% and 47.8% 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 MicroStrategy 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 $8.4 million and $3.2 million for the three months
ended September 30, 1999 and 1998, representing 15.5% and 11.9% 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 nine months ended September 30, 1999, no costs were capitalized
as the establishment of technological feasibility and general release of such
software had substantially coincided.
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 $6.3 million and
$2.9 million for the three months ended September 30, 1999 and 1998,
representing 11.6% 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. The Company's effective tax rate of 38.0% for
the three months ended September 30, 1999 is consistent with the effective tax
rate in the comparable prior year period. The Company's increase in the
effective federal rate from 34% to 35%, due to the increase in taxable income,
is offset by an increase in federal tax credits and exempt earnings of the
foreign sales corporation.
Comparison of Nine Months Ended September 30, 1999 and 1998
Revenues
Total revenues increased to $136.0 million for the nine months ended
September 30, 1999 from $70.7 million for the nine months ended September 30,
1998, representing an increase of 92.3%.
Product License Revenues. Product license revenues increased to $92.4
million for the nine months ended September 30, 1999 from $47.5 million for the
nine months ended September 30, 1998, representing an increase of 94.6%. 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 68.0% and 67.2% of
total revenues for the nine months ended September 30, 1999 and 1998,
respectively.
Product Support Revenues. Product support revenues increased to $43.6
million for the nine months ended September 30, 1999 from $23.2 million for the
nine months ended September 30, 1998, representing an increase of 87.6%. Product
support revenues constituted 32.0% and 32.8% of total revenues for the nine
months ended September 30, 1999 and 1998, respectively. The increase in product
support revenues was primarily due to the increase in product licenses sold.
International Revenues. International revenues were $26.0 million and $16.1
million for the nine months ended September 30, 1999 and 1998, representing
approximately 19.1% and 22.7% of total revenues, respectively.
10
Costs and Expenses
Cost of Product License Revenues. Cost of product license revenues was $1.9
million and $1.7 million for the nine months ended September 30, 1999 and 1998,
representing 2.1% and 3.5% 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 materials 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
$23.6 million and $11.9 million for the nine months ended September 30, 1999 and
1998, representing 54.1% and 51.4% 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 $62.3
million and $35.8 million for the nine months ended September 30, 1999 and 1998,
representing 45.8% and 50.6% 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
$19.6 million and $8.1 million for the nine months ended September 30, 1999 and
1998, representing 14.4% and 11.4% 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 $16.0 million and $8.1 million for the nine months ended September 30, 1999
and 1998, representing 11.7% and 11.5% 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.
Provision for Income Taxes. The Company's effective tax rate was 38.0% for
the nine months ended September 30, 1999. For the nine months ended September
30, 1998 we recorded income tax expense of $1.8 million. Prior to 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 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 June 1998, when we converted to a C corporation. Had the
Company been a tax paying entity all year, we would have recorded income tax
expense of $2.0 million, a 38.0% effective tax rate.
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 September 30, 1999 and December 31, 1998,
we had $43.8 million and $27.5 million of cash, cash equivalents, and short-term
investments, respectively.
Cash used in operations was $2.5 million and $6.1 million for the nine
months ended September 30, 1999 and 1998, respectively. The decrease in cash
used in operations during the nine months ended September 30, 1999 compared to
the same period in 1998 was primarily attributable to an increase in net income.
Cash used in investing activities was $47.1 and $6.1 million for the nine
months ended September 30, 1999 and 1998, respectively. The increase in cash
used in investing activities during the nine months ended September 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 and building of
infrastructure to support Strategy.com, which is a personal intelligence network
that
11
delivers personalized information via Internet, telephone and wireless
devices. We expect to continue to aggressively invest in capital expenditures to
support the growth of the Company.
Our financing activities provided cash of $44.5 million and $38.4 million
for the nine months ended September 30, 1999 and 1998, respectively. The
principal source of cash from financing activities during the nine months ended
September 30, 1999 was from the additional sale of 1,585,000 shares 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. In July 1998, we repaid all net borrowings under the
business loan. On March 26, 1999, we signed a $25.0 million revolving line of
credit. Borrowings under the revolving line of credit 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 September 30, 1999, no amounts were outstanding
under the revolving line of credit.
We declared a $10 million dividend to our shareholders prior to the initial
public offering. The dividend was paid in the form of notes prior to the
termination of our S corporation election, which occurred immediately prior to
the consummation of the initial public offering. As of September 30, 1999, the
entire $10.0 million of the dividend notes had been repaid.
In September 1999, the Company entered into a binding memorandum of
understanding to purchase certain assets such as software assets and computer
equipment from NCR Corporation. In consideration for the assets, the Company has
agreed to issue NCR approximately 303,000 shares of Class A Common Stock, valued
at approximately $19.2 million, based on the average market price of the
Company's stock three days before and after the transaction date and on the date
the transaction was announced. The Company has agreed that NCR will have the
right to demand the filing of a registration statement to register the resale of
the shares by NCR. The transaction is expected to close in November 1999.
Also in September 1999, the Company entered into a commitment to purchase
$10,000,000 of computer equipment and software over the twelve month period
ending September 2000.
In November 1999, the Company signed a three year master lease agreement to
lease computer equipment. The lease bears interest at a rate equal to interest
on U.S. treasury notes with equivalent terms as in the lease plus 1.5%. We
anticipate that we will lease up to $20,000,000 in computer equipment over the
term of the agreement.
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 of credit, computer equipment
leasing facility and the cash generated internally by operations will satisfy
our working capital requirements for at least the next twelve months.
Risk Factors
Limited Operating History; Uncertainty of Future Operating Results
We began shipping MicroStrategy 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 1994 and 1996 and were only marginally profitable in 1995 and
1997. 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:
12
- 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 business intelligence software generally and
of new and enhanced versions of our products in particular;
- the length of our sales cycles;
- changes in our operating expenses;
- personnel changes;
- our success in expanding our direct sales force and adding to our
indirect distribution channels;
- the pace and success of our international expansion;
- delays or deferrals of customer implementation; 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
- potential downturns in the economy, which may reduce demand for
management information systems.
Product support revenues depend largely on technical support revenues from
existing customers and will vary with those customers' technical support needs.
Seasonal factors may also affect our revenues. For example, the pace of new
sales tends to slow in the summer and sales in the fourth quarter of 1999 and
first quarter of 2000 may be impacted by year 2000 issues. See "Year 2000
Issues; Potential Impact on Customers".
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. As a result,
variations in the timing and amounts of revenue could materially adversely
affect our quarterly operating results.
13
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 the
last quarter of 1999 to fund Year 2000 compliance plans or will restrict their
purchases of new software in order to dedicate information technology staff to
the implementation of year 2000 remedial measures. 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 e-business, e-commerce, customer relationship management
(CRM), portals, business intelligence and Internet-based and wireless-based
information networks are intensely competitive and subject to rapidly changing
technology. In addition, many of our competitors in these markets are offering
(or may soon offer) products and services that may compete with our products and
our Strategy.com Personal Intelligence Network.
Our most direct competitors provide:
- E-business products (business to business and business to consumer);
- CRM (customer relationship management) products;
- E-commerce transaction systems (business to business and business to
consumer);
- Business intelligence products;
- Internet and wireless information networks and portals;
- Vertical Internet portals and information networks; and
- Wireless communications and wireless access protocol (WAP) enabled
products.
Each of these market segments are discussed more fully below.
E-Business Products. In the e-business market, BroadVision, E.piphany,
Vignette, Net.Perceptions, Broadbase, Art Technology Group (ATG), Engage, and
Personify all provide products that compete directly or indirectly with our
Intelligent E-Business product line.
14
Many of these companies provide alternatives to our technology for adding
intelligence and personalization to e-commerce applications. One example is the
use of customer information (e.g., past purchases, click stream, explicit
preferences, or actions in a peer group,) as the basis for driving a
personalized e-commerce experience that targets customers with offers and
interactions to which they are likely to respond.
CRM (customer relationship management) products. Companies that deliver CRM
alone or in conjunction with e-commerce applications, such as BroadVision,
E.piphany, Vignette, and Siebel, compete with our Intelligent E-Business
products.
E-Commerce Transaction Systems. Products that support e-commerce
transactions, such as those provided by Microsoft, IBM, Netscape (recently
acquired by America Online), BroadVision, Open Market, InterWorld, and Oracle
could provide competition to MicroStrategy. These products have the potential to
extend their capabilities to use customer information as the basis for
generating targeted, personalized product offers, which would compete with our
products.
Business intelligence products. In the business intelligence market, we
compete with providers of software used to enable businesses to analyze and
optimize their operations. In the enterprise category, which is generally
focused on large deployments (typically tens to hundreds of thousands of users
and/or terabyte-sized databases), Information Advantage (recently acquired by
Sterling Software) competes with us. In the desktop analysis and reporting
category, we face competition from companies such as Business Objects, Cognos,
and Brio Technology. The third category includes products from companies such as
Oracle, Microsoft, and IBM that are generally bundled with or designed to work
with their own relational databases.
Internet and wireless information networks and portals. Web portals and
information networks such as Microsoft Network (MSN), Yahoo, Excite, and America
Online, offer an array of information (e.g., Finance, Sports, News, Weather)
that is similar to information provided by Strategy.com. Strategy.com seeks to
differentiate itself by 1) providing a greater level of personalization, 2)
allowing users to receive the precise information they want across the broadest
range of information delivery devices (e.g., email, wireless phone, pager, WAP,
fax, personal digital assistants such as the Palm VII, and voice via telephone),
and 3) partnering with financial institutions, device manufacturers, Internet
companies, communication carriers and media companies, dot com's, and wireless
carriers, to embed Strategy.com information services as an ingredient in their
own offerings. One or more of these companies, however, could expand their
offerings and reduce our differentiation in these three areas.
Vertical Internet Portals and Information Networks. Expedia, Weather.com,
CNBC.com, ABC.com, ESPN.com, Microsoft Investor, StockBoss, Microsoft CarPoint,
InfoBeat, Internet Travel Network and others have developed custom applications
and products to commercialize, analyze and deliver specific information over the
Internet. These systems are usually tailored to one application, such as
providing news, sports, or weather, but in the aggregate, they offer
applications similar to those provided by Strategy.com and any one of these
companies could expand their offering to more closely compete with
MicroStrategy.
Wireless Communications and WAP-enabled Products. Wireless communications
providers, such as AT&T, Sprint, MCI WorldCom, Nextel Communications, British
Telecom, Deutsche Telecom, PageNet, Nokia, Ericcson, 3COM, and Palm Pilot offer
a variety of mobile phones and wireless devices over which Strategy.com delivers
information. These companies may develop in-house information services or
partner with other companies to deliver information that is competitive to that
offered by Strategy.com.
Many of our competitors have longer operating histories, significantly
greater financial, technical, marketing or other resources, and greater name
recognition than we do. In addition, many of our competitors have strong
relationships with current and potential customers and extensive knowledge of
the e-business industry. As a result, they may be able to respond more quickly
to new or emerging technologies and changes in customer requirements, or 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.
15
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
1,450 on September 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 MicroStrategy applications over
the Web. Although our business intelligence 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
business intelligence applications to potential customers who use Unix operating
systems as their application server. We would have to invest substantial
resources to develop a Unix product, and we cannot be sure that we could
introduce such a product on a timely or cost effective basis, if at all.
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. Business intelligence 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
16
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
17
votes per share. As of September 30, 1999, holders of our Class B Common Stock
owned or controlled 29,055,465 shares of Class B Common Stock, or 96.9% 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 74.8% of our voting power as of September 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 nine months ended September 30, 1999 and for 1998, 1997 and
1996, channel partners accounted directly or indirectly for 50.0%, 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 or registered trademarks (other than MicroStrategy and 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.
18
Difficulties Associated with International Operations and Expansion
International sales accounted for 19.1%, 23.6%, 26.7%, and 11.1% of our
total revenue for the nine months ended September 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, 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.
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;
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- 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 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, the data to be accessed 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 September 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.
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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.
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 or information
technology personnel (especially those 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. In addition, certain customers may delay the
purchase of software in the fourth quarter of 1999 and the first quarter of 2000
to focus their resources on ensuring that their existing information technology
infrastructure is year 2000 compliant.
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.
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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 September 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 September 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.
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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. 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 million
was for other expenses. The Company's net proceeds from the initial public
offering were approximately $48.7 million. From the effective date through
September 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 September 30, 1999 the
Company had used all proceeds from the initial public offering for general
corporate purposes 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
None
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
27.1 Financial Data Schedule
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B. Reports on Form 8-K
None
All other items are omitted because they are not applicable or the
answers are none.
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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
27.1 Financial Data Schedule
* Incorporated by reference from the Company's Registration Statement
on Form S-1 (Registration No. 333-49899).
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Microstrategy Incorporated
By: /s/ MICHAEL J. SAYLOR
Michael J. Saylor
President and Chief
Executive Officer
By: /s/ MARK S. LYNCH
Mark S. Lynch
Chief Financial Officer
Date: November 15, 1999
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