Strategy Inc quarterly report, Q2 FY2019

Business context and reporting period

The filing is MicroStrategy Incorporated’s unaudited Form 10-Q for the quarter and six months ended June 30, 2019. The registrant is identified in the filing as MicroStrategy Incorporated; it is not identified there as Strategy Inc. The company sells enterprise analytics and mobility software, subscriptions, product support, and related services.

Financial performance and liquidity

Amounts below are in millions of dollars except per-share data. Comparisons are with the corresponding 2018 period.

Q2 other income included a $29.8 million gain from the May sale of the Voice.com domain name for $30.0 million. Excluding the after-tax gain, the company’s supplemental non-GAAP net result was a loss of $1.4 million for Q2 and $9.3 million for H1; corresponding diluted EPS was $(0.14) and $(0.90). These measures are non-GAAP and should be considered alongside GAAP results.

At June 30, cash and cash equivalents were $261.5 million and short-term investments were $313.3 million, together $574.8 million, versus $576.1 million at year-end 2018. Current assets were $727.3 million and current liabilities $250.6 million. No borrowing debt is presented on the balance sheet; operating lease liabilities were $117.4 million, and $28.9 million of Transition Tax remained unpaid. Management said available cash, investments, and expected cash generation should cover working capital, capital expenditures, and contractual obligations for at least 12 months.

H1 investing cash flow was positive $148.9 million, primarily reflecting short-term investment maturities and purchases; financing cash flow was negative $46.4 million, including $48.2 million of share repurchases. The company repurchased no shares in Q2. Deferred revenue and advance payments totaled $181.0 million, with $176.8 million expected to be recognized within 12 months.

Material changes versus the prior period

• Q2 revenue fell 2.4%; H1 revenue fell 4.3%. H1 other services revenue declined 17.5%, mainly as consulting activity and billable hours decreased. Product support revenue declined 2.5% in H1; product license revenue rose 5.0%.
• Operating losses widened despite lower sales and marketing expense, as research and development costs increased 15.1% in H1 and product support delivery costs rose 53.9%. Management said R&D investment reflects its product-development strategy and expected spending to continue at the current pace.
• GAAP net income increased, but results included the one-time domain sale gain. The company’s non-GAAP results excluding that gain were losses in both Q2 and H1 2019.
• Operating cash flow more than doubled year over year in H1, helped by changes in operating assets and liabilities, including deferred revenue. The company adopted lease accounting in January 2019, recognizing right-of-use assets and lease liabilities; prior periods were not restated and are not directly comparable.

Outlook, risks, and unusual items

• The filing provides no numerical revenue or earnings guidance. The company states it does not give financial-performance guidance and cautions that quarterly results may fluctuate due to deal timing, customer decisions, foreign exchange, and relatively fixed costs.
• Management cited intense analytics competition, declining consulting and subscription revenue, foreign-exchange exposure, and reliance on its installed customer base and a single product platform. International revenue was 42.8% of Q2 revenue; management reported H1 revenue was reduced 3.5% by unfavorable currency movements.
• Management concluded disclosure controls and procedures were not effective at the reasonable-assurance level because of previously reported material weaknesses in internal control. Remediation was underway, with completion expected before year-end 2019.
• The company said its Brazilian subsidiary failed or likely failed to comply with local procurement regulations in certain government business. A loss was considered probable, but the amount or range was not reasonably estimable; the filing said the matter could materially affect earnings when a liability is accrued, though management did not expect a material effect on financial position.
• Two executive officers departed in July 2019; approximately $4.2 million of previously unrecognized stock compensation related to their options had been expected to be recognized over time and was expected to be forfeited.
• Other notable obligations include $168.4 million of operating lease commitments, $24.0 million of purchase obligations, and $28.9 million of remaining Transition Tax payments. The filing reports no material off-balance-sheet arrangements.

Important facts for investors to verify

• Confirm the identity and reporting entity: this 2019 filing names MicroStrategy Incorporated, not Strategy Inc.
• Assess ongoing operating performance separately from the $29.8 million Voice.com gain; review recurring revenue trends, operating losses, and non-GAAP exclusions.
• Track remediation and testing of the disclosed material weaknesses, and monitor any accounting or reporting consequences.
• Follow developments in the Brazilian procurement matter, including whether a loss accrual is made and its potential size.
• Review lease and tax payment schedules, foreign-currency sensitivity, and the sustainability of cash generation and repurchases.