Strategy Inc quarterly report, Q3 FY2023

Business context and reporting period

MicroStrategy Incorporated (the issuer named in this filing; now known as Strategy Inc.) filed this unaudited Form 10-Q for the quarter ended September 30, 2023. It operates an enterprise analytics software business and pursues a separate strategy of acquiring and holding bitcoin. Unless otherwise stated, dollar amounts below are in millions.

Financial performance and position

Metric	Q3 2023	Q3 2022	Nine months 2023	Nine months 2022
Revenue	$129.5	$125.4	$371.8	$366.7
Gross profit / margin	$102.8 / 79.4%	$100.0 / 79.7%	$290.1 / 78.0%	$290.4 / 79.2%
Operating income (loss)	$(25.2)	$6.1	$(72.3)	$(1,082.0)
Net income (loss)	$(143.4)	$(27.1)	$340.0	$(1,220.1)
Diluted earnings (loss) per share	$(10.09)	$(2.39)	$23.87	$(107.99)

• Q3 revenue rose 3.3%. Subscription services revenue increased 27.8% to $21.0 million; product-license revenue rose 7.9% to $24.0 million. Other services fell 14.9% to $17.6 million.
• For the first nine months, revenue grew 1.4%; subscription services rose 37.9% to $59.7 million, while product licenses declined 3.3% and other services declined 12.5%. Product support was broadly flat.
• Q3 operating results included $33.6 million of bitcoin impairment losses, versus $0.7 million a year earlier. The nine-month 2023 result included $76.6 million of impairment losses, versus $1.089 billion in 2022.
• Nine-month net income was substantially affected by a $403.9 million income-tax benefit and a $44.7 million gain on extinguishing debt. Q3 instead recorded a $109.6 million tax provision despite a pretax loss.

Cash flow, liquidity and debt

• For the nine months, operating cash flow was $11.5 million, investing cash outflow was $690.6 million (principally bitcoin purchases), and financing cash inflow was $676.0 million. Cash, cash equivalents and restricted cash ended at $46.9 million.
• At September 30, cash and cash equivalents were $45.0 million; current assets were $199.6 million and current liabilities $267.7 million. The company cautions that bitcoin is less liquid than cash and may not be readily saleable at reported market prices.
• Debt carrying value was $2.18 billion; stated principal obligations totaled approximately $2.21 billion. This included $650 million of 2025 convertible notes, $1.05 billion of 2027 convertible notes, $500 million of 2028 secured notes, and about $10.5 million of other secured debt.
• The $205 million secured term loan was repaid in March 2023 for approximately $161 million, including accrued interest; the repayment generated the $44.7 million accounting gain. The 2028 secured notes have springing-maturity conditions tied to liquidity and the convertible notes; management said it expected to meet the requirements to avoid acceleration and reported covenant compliance at quarter-end.
• The company sold shares through at-the-market offerings for $819.7 million net proceeds during the first nine months and used proceeds in part to acquire bitcoin and repay debt. As of September 30, approximately $602.1 million of offering capacity remained.

Material changes versus comparable periods

• Software revenue mix continued shifting toward subscriptions: subscription services increased, while product-support revenue was nearly flat and consulting revenue declined.
• Bitcoin holdings increased to approximately 158,245 from 132,500 at December 31, 2022. The balance-sheet carrying value rose to $2.451 billion from $1.840 billion, reflecting the accounting cost-less-impairment method, not quarter-end market value. At the quarter-end bitcoin price cited by the company, the holdings’ mathematical market value was approximately $4.277 billion.
• Deferred revenue and advance payments fell to $186.8 million from $230.2 million at year-end. Remaining performance obligations were $282.3 million, with $217.7 million expected to be recognized within 12 months.
• Stockholders’ equity improved to $840.4 million from a $383.1 million deficit at year-end, reflecting nine-month net income and equity issuance.
• Cash flow from operations declined to $11.5 million from $21.4 million for the comparable 2022 period. Financing inflows increased, primarily due to ATM share sales.

Outlook, management commentary and key risks

• Management expects subscription revenue to continue growing as it promotes its cloud offering; it cautioned that product-license and product-support revenue may decline as customers migrate to cloud subscriptions. No numerical earnings or revenue guidance is provided, and the company states it does not give guidance on anticipated financial performance.
• Management said existing and anticipated cash and cash equivalents should cover working capital, expected capital expenditures and contractual obligations for at least 12 months. It also said software-business cash generation alone is not expected to cover longer-term obligations; potential funding sources include refinancing, equity issuance, bitcoin-backed borrowing or bitcoin sales.
• Bitcoin price volatility and the company’s impairment accounting can materially affect reported earnings: impairment losses are recognized when required, while increases in bitcoin value generally are not recognized until sale. The filing discusses proposed fair-value accounting changes that could increase earnings volatility in future periods.
• Key exposures include bitcoin price, liquidity, custody and counterparty risks; debt service, refinancing and springing-maturity risk; possible equity dilution from additional ATM sales; and foreign-currency, software competition, cloud-transition and cybersecurity risks.
• Brazilian procurement-related investigations and proceedings remain unresolved. The company accrued a minimum loss of $1.2 million but could not estimate a range beyond that amount; any final loss could be significantly greater. The District of Columbia’s case naming the company and Executive Chairman Michael Saylor remained unresolved. A separate patent case was set for trial in January 2024; its outcome was not determinable.
• Subsequent to quarter-end and before filing, the company purchased approximately 155 additional bitcoins for $5.3 million, which serve as collateral for the 2028 secured notes.
• Management concluded disclosure controls and procedures were effective at the reasonable-assurance level and reported no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

1. How much of nine-month net income reflects the $403.9 million tax benefit and $44.7 million debt-extinguishment gain, rather than recurring software operations?
2. How would bitcoin price declines, accounting changes, or reduced bitcoin liquidity affect carrying value, earnings, collateral and debt-service capacity?
3. What are the specific liquidity tests and consequences governing the 2028 notes’ springing maturity, and can the company satisfy those tests as the convertible notes approach maturity?
4. How much additional ATM equity issuance may occur, and what would the resulting dilution be?
5. What are the eventual outcomes and potential financial exposure from the Brazil, District of Columbia and patent matters?