<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
__________________
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED: MARCH 31, 1999 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)
(703) 848-8600
(Registrant's telephone number)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No __
-
The number of shares of the registrant's Class A Common Stock and Class B Common
Stock outstanding on May 1, 1999 was 8,115,894 and 29,875,904, respectively.
<PAGE>
MICROSTRATEGY INCORPORATED
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
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<S> <C>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets, March 31, 1999 (unaudited) and December 31, 1998........... 2
Consolidated Statements of Operations and Comprehensive Income, Three Months ended
March 31, 1999 and 1998 (unaudited).................................................... 3
Consolidated Statements of Cash Flows, Three Months ended March 31, 1999 and 1998 4
(unaudited)............................................................................
Notes to Consolidated Financial Statements (unaudited).................................. 5
Item 2. Management's Discussion and Analysis of Financial Condition and Results of 7
Operations...............................................................................
Item 3. Quantitative and Qualitative Disclosures About Market Risk....................... 19
PART II - OTHER INFORMATION............................................................... 20
</TABLE>
<PAGE>
ITEM 1. FINANCIAL STATEMENTS
MICROSTRATEGY INCORPORATED
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1999 1998
------------- --------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................................................. $ 45,123 $27,491
Short-term investments.................................................................... 16,487 ---
Accounts receivable, net.................................................................. 37,221 33,054
Prepaid expenses and other current assets................................................. 2,940 2,198
Deferred tax assets, net.................................................................. 716 716
-------- -------
Total current assets..................................................................... 102,487 63,459
Property and equipment, net................................................................ 17,151 13,773
Long-term accounts receivable.............................................................. 1,800 2,700
Deposits and other assets.................................................................. 2,841 2,757
-------- -------
Total assets............................................................................. $124,279 $82,689
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses..................................................... $ 12,751 $11,904
Accrued compensation and employee benefits................................................ 5,401 7,356
Deferred revenue.......................................................................... 11,114 10,732
Dividend notes payable.................................................................... 2,500 5,000
-------- -------
Total current liabilities................................................................ 31,766 34,992
Deferred revenue........................................................................... 1,171 746
Deferred tax liabilities, net.............................................................. 671 671
-------- -------
Total liabilities........................................................................ 33,608 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,
7,874,713 shares issued and outstanding at March 31, 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,
30,023,373 shares issued and outstanding at March 31, 1999; 30,633,114 shares issued
and outstanding at December 31, 1998..................................................... 30 31
Additional paid-in capital................................................................ 84,998 42,219
Accumulated other comprehensive income.................................................... 563 894
Accumulated earnings...................................................................... 7,088 5,229
Deferred compensation..................................................................... (2,016) (2,098)
-------- -------
Total stockholders' equity............................................................... 90,671 46,280
-------- -------
Total liabilities and stockholders' equity............................................... $124,279 $82,689
======== =======
</TABLE>
The accompanying notes are an integral part of these Consolidated Financial
Statements.
2
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MICROSTRATEGY INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------------
1999 1998
------------ ------------
<S> <C> <C>
Revenues:
Product licenses..................................................................... $ 23,124 $ 14,282
Product support...................................................................... 12,660 5,613
----------- -----------
Total revenues...................................................................... 35,784 19,895
----------- -----------
Cost of revenues:
Product licenses..................................................................... 520 538
Product support...................................................................... 6,609 3,163
----------- -----------
Total cost of revenues.............................................................. 7,129 3,701
----------- -----------
Gross margin.......................................................................... 28,655 16,194
----------- -----------
Operating expenses:
Sales and marketing.................................................................. 16,774 10,828
Research and development............................................................. 5,060 2,092
General and administrative........................................................... 4,280 2,563
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Total operating expenses............................................................. 26,114 15,483
----------- -----------
Income from operations................................................................ 2,541 711
Interest income....................................................................... 504 47
Interest expense...................................................................... (92) (237)
Other income, net..................................................................... 46 21
----------- -----------
Income before income taxes............................................................ 2,999 542
Provision for income taxes............................................................ 1,140 ---
----------- -----------
Net income............................................................................ $ 1,859 $ 542
=========== ===========
Other comprehensive (loss) income:
Foreign currency translation adjustment.............................................. (331) 4
----------- -----------
Comprehensive income.................................................................. $ 1,528 $ 546
=========== ===========
Basic net income per share............................................................ $ 0.05 $ 0.02
=========== ===========
Weighted average shares outstanding used in computing basic net income per share...... 36,389,742 30,895,514
=========== ===========
Diluted net income per share.......................................................... $ 0.05 $ 0.02
=========== ===========
Weighted average shares outstanding used in computing diluted net income per share.... 40,969,116 35,312,065
=========== ===========
Pro forma information (unaudited):
Net income, as reported............................................................... --- $ 542
Pro forma income taxes................................................................ --- (206)
-----------
Pro forma net income.................................................................. --- $ 336
===========
Pro forma basic net income per share.................................................. --- $ 0.01
===========
Pro forma diluted net income per share................................................ --- $ 0.01
===========
</TABLE>
The accompanying notes are an integral part of these Consolidated Financial
Statements.
3
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MICROSTRATEGY INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
----------------------
1999 1998
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<S> <C> <C>
Operating activities:
Net income............................................................................ $ 1,859 $ 542
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization......................................................... 1,390 650
Provision for doubtful accounts, net of write-offs and recoveries..................... 60 ---
Amortization of deferred compensation................................................. 82 ---
Changes in operating assets and liabilities, net of effect of foreign exchange rate
changes:
Accounts receivable................................................................... (4,632) 113
Prepaid expenses and other current assets............................................. (805) (37)
Accounts payable and accrued expenses, compensation and benefits...................... (719) (3,162)
Deferred revenue...................................................................... 975 1,168
Deposits and other assets............................................................. (271) (155)
Long-term accounts receivables........................................................ 900 ---
-------- -------
Net cash used in operating activities................................................ (1,161) (881)
-------- -------
Investing activities:
Acquisition of property and equipment................................................. (4,751) (1,365)
Purchase of short-term investments.................................................... (16,487) ---
-------- -------
Net cash used in investing activities................................................ (21,238) (1,365)
-------- -------
Financing activities:
Proceeds from sale of Class A Common Stock and exercise of stock options, net of
offering costs....................................................................... 42,782 ---
Borrowings on short-term line of credit, net.......................................... --- 868
Repayments of dividend notes payable.................................................. (2,500) ---
Proceeds from issuance of notes payable............................................... --- 432
Principal payments on notes payable................................................... --- (240)
-------- -------
Net cash provided by financing activities............................................ 40,282 1,060
-------- -------
Effect of foreign exchange rate changes on cash and cash equivalents................. (251) (16)
-------- -------
Net increase (decrease) in cash and cash equivalents................................... 17,632 (1,202)
Cash and cash equivalents, beginning of year........................................... 27,491 3,506
-------- -------
Cash and cash equivalents, end of period............................................... $ 45,123 $ 2,304
======== =======
Supplemental disclosure of noncash financing activities:
Issuance of common stock in exchange for minority interest of Company's
foreign subsidiaries................................................................. $ --- $ 1,068
======= =======
Supplemental disclosure of cash flow information:
Cash paid during the year for interest................................................ $ 54 $ 205
======== =======
Cash paid during the year for income taxes............................................ $ 460 $ ---
======== =======
</TABLE>
The accompanying notes are an integral part of these Consolidated Financial
Statements.
4
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MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) BASIS OF PRESENTATION
The consolidated balance sheet of MicroStrategy Incorporated (the "Company") as
of March 31, 1999, the related consolidated statements of operations for the
three months ended March 31, 1999 and 1998, and the consolidated statements of
cash flows for the three months ended March 31, 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 and short-term investments include high quality money markets,
commercial paper, U.S. Treasury and agency 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. All short-term
investments are classified as available-for-sale and are carried at amortized
cost, which approximates estimated fair value based on quoted market prices.
(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 months ended March 31, 1998.
5
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MICROSTRATEGY INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
(6) NET INCOME PER SHARE
Reconciliations of the basic net income per share and diluted net income per
share computations for the three months ended March 31, 1999 and 1998 are as
follows:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
(in thousands, except share and per share data) ENDED MARCH 31,
------------------------------
1999 1998
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<S> <C> <C>
Net income....................................................... $ 1,859 $ 542
=========== ===========
Basic net income per share:
Weighted average common shares outstanding..................... 36,389,742 30,895,514
=========== ===========
Basic net income per share....................................... $ 0.05 $ 0.02
=========== ===========
Diluted net income per share:
Weighted average common shares outstanding..................... 36,389,742 30,895,514
=========== ===========
Diluted impact of common shares issuable on exercise of
stock options and warrants.................................... 4,579,374 4,416,551
=========== ===========
Weighted average common shares assuming dilution............... 40,969,116 35,312,065
=========== ===========
Diluted net income per share..................................... $ 0.05 $ 0.02
=========== ===========
</TABLE>
Common stock equivalents are included in the computation of diluted net income
per share using the treasury stock method. During the three months ended March
31, 1999 stock options granted by the Company to purchase 329,450 shares of
Class A Common Stock were not included in the computation because the effect was
anti-dilutive. During the three months ended March 31, 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:
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
(in thousands) ENDED MARCH 31,
---------------------------
1999 1998
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<S> <C> <C>
Revenue:
Domestic.............................. $ 28,120 $ 15,732
Europe................................ 7,664 4,163
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Total revenue..................... $ 35,784 $ 19,895
========= ========
Operating income (loss):
Domestic.............................. $ 615 $ 1,454
Europe................................ 1,926 (743)
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Total operating income............ $ 2,541 $ 711
========= ========
Identifiable assets:
Domestic.............................. $ 104,822 $ 24,824
Europe................................ 19,457 5,767
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Total assets...................... $ 124,279 $ 30,591
========= ========
</TABLE>
Transfers of $1,758,000 and $1,048,000 for the three months ended March 31, 1999
and 1998, respectively, from foreign to domestic operations have been excluded
from the above table and eliminated in the consolidated financial statements.
6
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Our primary business following our incorporation in 1989 was to provide software
consulting services for customers to help them build custom decision support
systems. Our activities during 1994 and 1995 increasingly focused on the
development and sale of software products, culminating in the release of 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. As a result, we have transitioned our
primary business from that of a provider of services to a provider of software
products.
Since 1995, we have significantly increased our sales and marketing, service and
support, research and development and general and administrative staff. We have
nearly doubled our headcount each year since 1995. At January 1, 1995 we had 59
employees and at March 31, 1999 we had 1,068 employees. Although our revenues
have significantly increased in each of the last twelve quarters, we experienced
fluctuating operating margins during the three months ended March 31, 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 years ended December 31, 1996 and December 31, 1994, 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, and 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," which
was amended on March 31, 1998 by SOP 98-4, "Deferral of the Effective Date of a
Provision of SOP 97-2." Subsequently, the American Institute of Certified
Public Accountants (AICPA) issued SOP 98-9, "Modification of SOP 97-2, Software
Revenue Recognition," which amended SOP 98-4, and became effective after
December 31, 1998. The adoption of these new statements did not have a material
effect on the timing of our revenue recognition or cause changes to our revenue
recognition policies. 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 37.0%, 35.0%, 27.5%, and 9.0% of our
revenues for the three months ended March 31, 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
7
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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.
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:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED MARCH 31,
--------------------
1999 1998
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<S> <C> <C>
Consolidated Statements of Operations Data:
Revenues:
Product licenses............................ 64.6% 71.8%
Product support............................. 35.4 28.2
----- -----
Total revenues............................. 100.0 100.0
----- -----
Cost of revenues:
Product licenses............................ 1.4 2.7
Product support............................. 18.5 15.9
----- -----
Total cost of revenues..................... 19.9 18.6
----- -----
Gross margin................................. 80.1 81.4
----- -----
Operating expenses:
Sales and marketing......................... 46.9 54.4
Research and development.................... 14.1 10.5
General and administrative.................. 12.0 12.9
----- -----
Total operating expenses................... 73.0 77.8
----- -----
Income from operations....................... 7.1 3.6
Interest income (expense), net............... 1.2 (1.0)
Other income, net............................ 0.1 0.1
Provision for income taxes................... 3.2 ---
----- -----
Net income................................... 5.2% 2.7%
===== =====
</TABLE>
COMPARISON OF THREE MONTHS ENDED MARCH 31, 1999 AND 1998
REVENUES
Total revenues increased to $35.8 million for the three months ended March 31,
1999 from $19.9 million for the three months ended March 31, 1998, representing
an increase of 79.9%. 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 $23.1 million
for the three months ended March 31, 1999 from $14.3 million for the three
months ended March 31, 1998, representing an increase of 61.9%. Product license
revenues constituted 64.6% and 71.8% of total revenues for the three months
ended March 31, 1998 and 1998, respectively. 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 Support Revenues. Product support revenues increased to $12.7 million
for the three months ended March 31, 1999 from $5.6 million for the three months
ended March 31, 1998, representing an increase of 125.5%. Product support
revenues constituted 35.4% and 28.2% of total revenues for the three months
ended March 31, 1999 and 1998, respectively. The increase in product support
revenues was primarily due to the increase in the number of DSS licenses sold,
in conjunction with several large consulting deployments 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 1998 and 1997.
8
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International Revenues. We recognized $7.7 million and $4.2 million of
international revenues for the three months ended March 31, 1999 and 1998,
respectively, representing approximately 21.4% and 20.9% of total revenues,
respectively. We opened sales offices in Australia, Canada and Italy in 1998; in
Austria, France and the Netherlands in 1997; in Germany in 1996; in the United
Kingdom in 1995; and in Spain in 1994.
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 $0.5 million for the three months ended March 31, 1999 and 1998,
representing 2.2% and 3.8% of total product license revenues, respectively. The
total cost of product license revenues as a percentage of license revenues
decreased during the three months ended March 31, 1999 and 1998, due to
economies of scale realized by producing larger volumes of product materials and
an increasing number of customers reproducing licenses at their sites. We
anticipate that the cost of product license revenues will increase in dollar
amount as license fee revenues increase, but decrease as a percentage of product
license revenues. However, in the event that we enter into any royalty
arrangements 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 $6.6 million and
$3.2 million during the three months ended March 31, 1999 and 1998, representing
52.2% and 56.4% of total product support revenues, respectively. The increase in
cost of product support revenues was primarily due to the increase in the number
of personnel providing consulting, education, and technical support to customers
and to the training and related costs associated with increasing personnel
levels. Despite the increases in personnel and other costs during the three
months ended March 31, 1999, the total cost of product support revenues
decreased as a percentage of product support revenues during the three months
ended March 31, 1999 from the three months ended March 31, 1998, primarily due
to increases in technical support revenues which typically do not require
proportionate increases in the costs required to perform associated technical
support services. 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 $16.8 million and $10.8 million for
the three months ended March 31, 1999 and 1998, representing 46.9% and 54.4% of
total revenues, respectively. The increase in sales and marketing expenses was
primarily due to increased staffing, as we established new domestic and
international sales offices and expanded our existing direct sales force, and to
a lesser extent, increased commissions to sales representatives, as a result of
increased sales of software licenses and increased promotional activities
relating to the announcement of certain product enhancements or releases. 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 $5.1 million and $2.1 million for the three months
ended March 31, 1999 and 1998, representing 14.1% and 10.5% of total revenues,
respectively. The increase in research and development expenses was primarily
due to additional hiring of research and development personnel. 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 three months ended March 31, 1999, in accordance with Statement
of Financial Accounting Standards (SFAS) No. 86, "Accounting for the Costs of
Computer Software to Be Sold, Leased, or Otherwise Marketed," the costs incurred
between the establishment of technological feasibility and general availability
of our products were not material and therefore have been expensed rather than
capitalized.
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 $4.3 million and
$2.6 million for the three months ended March 31, 1999 and 1998, representing
12.0% and 12.9% 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
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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 $1.1 million
for the three months ended March 31, 1999. The adoption of SFAS No. 109 did not
have a material impact on our operating results.
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 $48.1 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 March 31, 1999 and December 31, 1998, we
had $45.1 million and $27.5 million of cash and cash equivalents, respectively.
Cash flows used in operations were $1.2 million and $0.9 million for the three
months ended March 31, 1999 and 1998, respectively. The increase in cash used in
operations during the three months ended March 31, 1999 was primarily due to an
increase in accounts receivable.
Cash flows used in investing activities were $21.2 and $1.4 million for the
three months ended March 31, 1999 and 1998, respectively. The principal use of
cash in investing activities was for the purchase of investments and capital
expenditures related to the acquisition of computer equipment required to
support expansion of our operations.
Our financing activities provided cash of $40.3 million and $1.1 million for the
three months ended March 31, 1999 and 1998, respectively. The principal source
of cash from financing activities during the three months ended March 31, 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 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, provides for
a $5.0 million revolving line of credit for general working capital purposes.
Borrowings under the Business Loan may not exceed 80% of eligible accounts
receivable for the revolving working capital line of credit. The borrowings bear
interest at the lender's prime rate or LIBOR plus 1.50% for the revolving line
of credit. Borrowings under the Business Loan are collateralized by
substantially all of the Company's assets. 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 to 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 March 31,
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. The
Dividend Notes (i) have a term of one year; (ii) bear interest at 5.46%; and
(iii) are payable in four equal quarterly installments. The Dividend Notes may
be prepaid without penalty at any time at our option. We intend to repay the
Dividend Notes from cash flows generated from operations, current available cash
and cash equivalents, and, to the extent that other sources are insufficient for
this purpose, from the proceeds of the Initial Public Offering. As of March 31,
1999, $7.5 million of the Dividend Notes had been repaid. The remaining $2.5
million was repaid as of April 16, 1999.
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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
Management's Discussion and Analysis of Financial Condition and Results of
Operations contains a number of forward-looking statements. These statements are
based on current expectations and actual results could differ significantly.
Among the factors that could cause actual results to differ 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;
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. 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 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;
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. electronic and Internet commerce systems;
. vertical Internet information systems;
. 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
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Vitria Technology Inc., which provides event-based workflow software. The
technology resulting from these systems 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
1,068 on March 31, 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
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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. 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. It is possible that some or all of this legislation may become law.
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 March 31, 1999, holders of our Class B Common Stock owned or
controlled 30,023,373 shares of Class B Common Stock, or 97.4%
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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 72.8% of our voting power as of March 31, 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 to Class A 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 three months ended March 31, 1999 and for 1998, 1997 and
1996, channel partners accounted directly or indirectly for 37.0%, 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
patent applications pending, 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 21.4%, 23.6%, 26.7%, and 11.1% of our total
revenue for the three months ended March 31, 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.
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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. Our task force is currently
assessing the impact of these events on our company. In addition to tax and
accounting issues, the task force is considering:
. 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.
At this early stage, we cannot yet predict the consequences of euro conversion
for our company.
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
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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 intend to make any required changes
in the second and third quarters of 1999 and to conduct additional testing in
the fourth quarter of 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.
We do not currently have much information on the Year 2000 compliance status of
our customers. As is the case with other similarly situated software companies,
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
18
<PAGE>
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 March 31, 1999 the fair value of the
portfolio would decline by an immaterial amount. We have the ability to hold our
fixed income investments until maturity, and therefore we do not expect our
operating results or cash flows to be materially affected by a sudden change in
market interest rates on our investment portfolio.
FOREIGN CURRENCY RISK
We face exposure to adverse movements in foreign currency exchange rates. Our
international revenues and expenses are denominated in foreign currencies,
principally the British Pound Sterling and the German Deutsche Mark. The
functional currency of each of our foreign subsidiaries is the local currency.
Our international business is subject to risks typical of an international
business, including, but not limited to differing tax structures, other
regulations and restrictions, and foreign exchange rate volatility. Based on
our overall currency rate exposure at March 31, 1999, a 10% change in foreign
exchange rates would have had an immaterial effect on our financial position,
results of operations and cash flows. On January 1, 1999 the Euro was introduced
as a common currency for members of the European Monetary Union. We have not
determined what impact, if any, the Euro will have on our foreign exchange
exposure. 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.
19
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITITES 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 offering were Merrill
Lynch & Co., Hambrecht & Quist, and Friedman, Billings, Ramsey & Co., Inc. The
aggregate gross proceeds raised in the offering from the sale of Class A Common
Stock by the Company and the selling stockholders were $53.3 million and $1.9
million, respectively. The Company's total expenses in connection with the
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 offering were approximately
$48.7 million. From the Effective Date through March 31, 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 $7.5 million of such net proceeds
to repay a portion 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 offering. Approximately $7.2 million of the $7.5 million
dividend payment was paid to certain officers, directors and 10% shareholders of
the Company. As of April 30, 1999 the Company had approximately $13.6 million of
proceeds remaining from the Offering, and pending use of the proceeds, the
Company intends to invest such proceeds primarily in investment-grade, interest-
bearing instruments.
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. 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 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
None
All other items are omitted because they are not applicable or the answers are
none.
20
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities and 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
Vice President and Chief Financial Officer
Date: May __, 1999
21
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit Number Description
- -------------- -----------
<S> <C>
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 Financial Data Schedule (Filed Herewith)
</TABLE>
* Incorporated by reference from the Company's Registration Statement on Form
S-1 (Registration No. 333-49899).
22
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 45,123,000
<SECURITIES> 16,487,000
<RECEIVABLES> 38,718,000
<ALLOWANCES> 1,497,000
<INVENTORY> 0
<CURRENT-ASSETS> 102,487,000
<PP&E> 23,112,000
<DEPRECIATION> 5,961,000
<TOTAL-ASSETS> 124,279,000
<CURRENT-LIABILITIES> 31,766,000
<BONDS> 0
0
0
<COMMON> 38,000
<OTHER-SE> 90,633,000
<TOTAL-LIABILITY-AND-EQUITY> 124,279,000
<SALES> 23,124,000
<TOTAL-REVENUES> 35,784,000
<CGS> 520,000
<TOTAL-COSTS> 7,129,000
<OTHER-EXPENSES> 26,114,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 92,000
<INCOME-PRETAX> 2,999,000
<INCOME-TAX> 1,140,000
<INCOME-CONTINUING> 1,859,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,859,000
<EPS-PRIMARY> 0.05
<EPS-DILUTED> 0.05
</TABLE>
