Strategy Inc annual report, FY2014

Business context and reporting period

MicroStrategy Incorporated’s Form 10-K covers the fiscal year ended December 31, 2014. The company sells enterprise analytics, mobile and cloud software, related product support and services; its main revenue sources are product support and software licenses. Usher, its mobile identity and security offering, had not generated significant revenue. The filing contains unaudited quarterly results, including Q4, but reports annual financial statements.

Financial performance and liquidity

Revenue grew 0.7% year over year. Product license revenue fell 14.8% to $126.0 million, while subscription revenue rose 82.3% to $22.3 million and product support revenue increased 6.6% to $295.7 million. Other services revenue declined 1.7% to $135.9 million. The company reported $5.8 million of other income in 2014, primarily from foreign-currency gains.

Cash and short-term investments totaled $345.5 million at year-end. Management said existing liquidity and expected cash generation should cover working capital, capital expenditures, restructuring and contractual obligations for at least the next 12 months. Operating cash flow declined 52.3%. Investing activities used $82.1 million, mainly reflecting purchases and redemptions of short-term investments. The filing does not report material conventional borrowings; disclosed capital leases and other financing arrangements totaled $1.7 million. Operating lease commitments were $117.1 million.

Material changes versus the prior comparable period

• Product license revenue declined by $21.9 million. Management attributed the decrease in part to execution challenges in sales, marketing and technology, particularly during restructuring; domestic license revenue fell 21.0%.
• Growth in product support and subscriptions partly offset weaker licenses. Subscription revenue increased by $10.1 million, reflecting more customers and greater use by existing customers.
• Operating expenses increased to $439.5 million from $417.9 million, including $14.7 million of restructuring charges and $11.8 million of share-based compensation. GAAP income from continuing operations before tax and after tax both fell substantially.
• 2013 net income included a $57.4 million after-tax gain from the Angel.com sale; 2014 had no discontinued-operations income. The 2013 net income and EPS comparison therefore overstate the decline in underlying continuing operations.
• Q4 2014 revenue was $148.9 million and continuing-operations net income was $22.7 million. The quarter included a $7.4 million benefit from a reduction in accrued bonus expense following a change in estimate.

Outlook, risks, contingencies and unusual items

• The company does not provide guidance for anticipated financial performance. It expected the 2014 restructuring to generate approximately $67.2 million of annualized pretax savings, revised down from its prior estimate of $73.4 million. It reduced headcount by 777; the plan’s total expected costs were approximately $15.0 million.
• Management cautioned that quarterly results can fluctuate, sales cycles may be long, and revenue shortfalls may be difficult to offset quickly because some expenses are relatively fixed. A shift from perpetual licenses to subscriptions could also change revenue and cash-flow timing.
• Key business risks include intense competition, dependence on analytics products and related services, limited Usher revenue, foreign-exchange exposure, customer and project delays, cybersecurity and privacy risks, and the effects of restructuring on execution and employee retention.
• Management and the auditor identified a material weakness in internal control over financial reporting tied to a third-party cloud system used to track consulting billable time and travel and entertainment expenses. The auditor issued an adverse opinion on internal control effectiveness; the financial-statement audit opinion was unqualified. Management reported no financial-statement adjustment was required and planned alternative controls, additional testing and efforts to obtain an adequate service-organization report or transition systems.
• DataTern patent litigation was remanded for further proceedings after an appellate court vacated summary judgment; MicroStrategy filed new summary-judgment motions in February 2015. A separate Vasudevan patent case was awaiting appeal decision. Outcomes and potential losses were not determinable, and no related liabilities were accrued.
• The effective tax rate on continuing operations was 54.4%, affected in part by an increased deferred-tax valuation allowance. The company had $201.7 million of undistributed foreign earnings and noted that repatriation could create additional U.S. tax. It was evaluating the effect of the new revenue-recognition standard.
• Class B shares carried ten votes per share. CEO Michael Saylor held approximately 67.9% of total voting power as of February 20, 2015, limiting other shareholders’ influence and ability to affect a change of control.

Important facts for investors to verify

• Whether license sales recover and subscription growth can offset declining license revenue, while tracking recurring product-support renewals.
• Whether restructuring savings approach $67.2 million and do not impair sales execution, product development or customer service.
• Remediation of the material weakness and whether subsequent-period controls and third-party reporting are adequate.
• Cash-flow trends, investment balances, lease obligations and the effect of holding cash and investments outside the United States.
• Developments in patent litigation, tax examinations and deferred-tax-asset realizability.
• The effect of share-based compensation: $46.6 million of estimated unrecognized expense remained at year-end, and additional options were granted in February 2015 subject to shareholder approval.