Business context and reporting period
MicroStrategy Incorporated (the registrant named in this 2015 filing; not identified here as “Strategy Inc”) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2015. It operated one segment, providing analytics, mobile and security software, cloud subscriptions, support and related services. MicroStrategy 10 Secure Enterprise became generally available in June 2015. Management said Usher had not yet generated significant revenue.
Financial performance and liquidity
Amounts below are in millions of dollars except per-share data. Comparisons are with the corresponding 2014 period.
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $129.5 | $151.2 | $386.3 | $431.0 |
| Gross profit / margin | $104.9 / 80.9% | $116.2 / 76.9% | $308.7 / 79.9% | $327.4 / 76.0% |
| Operating income (loss) / margin | $30.7 / 23.7% | $(7.0) / (4.6)% | $88.1 / 22.8% | $(28.1) / (6.5)% |
| Net income (loss) | $23.9 | $(0.8) | $66.8 | $(17.7) |
| Diluted EPS | $2.06 | $(0.07) | $5.80 | $(1.56) |
| Operating cash flow | Not presented quarterly | $123.4 | $16.3 |
For the nine months, cash flow from investing was $(40.9) million and financing provided $5.0 million; cash and cash equivalents increased $83.3 million to $230.2 million. Cash plus short-term investments totaled $456.9 million at September 30. Current assets were $536.9 million against current liabilities of $181.2 million. Total liabilities were $219.4 million, with no material borrowings reported; lease and other financing obligations totaled $0.2 million, alongside $94.6 million of future operating lease payments. Operating cash flow less purchases of property and equipment and capitalized software development was approximately $110.5 million; the filing does not label this measure free cash flow.
Material changes versus prior comparable periods
- Revenue declined 14.3% in Q3 and 10.4% year to date. Product license revenue fell 19.0% and 14.9%, respectively; other services revenue fell 33.5% and 24.8%. Subscription revenue grew 9.2% and 24.3% but remained a relatively small share of total revenue.
- Product support revenue decreased 4.8% in Q3 and 4.4% year to date. Management attributed much of the international decline to unfavorable currency translation; consulting revenue also fell, primarily with fewer billable hours.
- Operating results turned profitable as expenses contracted substantially following the 2014 restructuring and other cost reductions. Operating expenses fell 39.9% in Q3 and 38.0% year to date. The prior-year periods included $11.6 million in restructuring costs; 2015 costs were minimal.
- Foreign exchange reduced revenue by 6.4% for the nine months compared with 2014, according to management. At period end, cash and short-term investments were $456.9 million, up from $345.5 million at December 31, 2014.
Outlook, risks, contingencies and unusual items
- Management did not provide earnings or revenue guidance and said it does not give guidance on anticipated future financial performance. It expected cost savings to continue reducing 2015 operating expenses compared with 2014, and stated existing liquidity and expected cash generation were sufficient for at least the next 12 months.
- The company expected to recognize approximately $167.1 million of deferred revenue and advance payments over the next 12 months, subject to performance obligations. It also disclosed $138.4 million of future customer minimum purchase commitments through 2020, not included in deferred revenue.
- Key risks include declining license and services revenue, intense competition, reliance on analytics products, foreign exchange exposure, dependence on successful product releases, and possible shifts from perpetual licenses to subscriptions that could affect revenue timing. Management cautioned that fixed costs and long, variable sales cycles can make results fluctuate materially.
- A DataTern patent case was remanded for further proceedings; the court denied MicroStrategy’s summary judgment motions on September 4, 2015. The company said the outcome and possible loss could not be reasonably estimated and recorded no liability. It also reported other ordinary-course litigation not expected by management to have a material adverse effect.
- Management concluded disclosure controls were not effective at the reasonable-assurance level because of a material weakness involving a third-party service organization that had not provided an adequate SOC 1 Type 2 report. Management said substantive testing supported fair presentation of the financial statements; no material change in internal control over financial reporting occurred during the quarter.
- Other notable items: $12.5 million of share-based compensation expense year to date and $54.5 million of unrecognized expense expected over a weighted-average three years; $2.7 million of unrecognized tax benefits; no share repurchases during the period. The company was evaluating new revenue-recognition guidance effective in 2018 and cloud-computing accounting guidance effective in 2016.
Important facts for investors to verify
- Whether the sharp reduction in operating expenses and headcount can be sustained without impairing product development, sales capacity, customer support or growth.
- Whether the license-revenue and consulting declines stabilize, and how subscription growth and deferred revenue translate into recognized revenue and cash collections.
- The continuing impact of currency movements, including the company’s international revenue exposure and the absence of foreign-currency forward contracts at quarter end.
- Developments in the DataTern patent litigation and any resulting loss exposure, including indemnification requests from customers and channel partners.
- Remediation of the third-party-service-organization control weakness and any updates to disclosure-control effectiveness.
- The effects of tax-jurisdiction earnings mix, deferred tax asset realizability, potential repatriation taxes and pending tax examinations.