Microstrategy Inc

NASDAQ:MSTR

Earnings Call Transcript 2018-Q2

[Operator]

Good day, ladies and gentlemen, and welcome to the MicroStrategy Second Quarter 2018 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to introduce your host for today's conference, Michael Saylor, Chairman, President and CEO. Sir, you may begin.

[Michael Saylor, executive]

Hello. This is Michael Saylor. I'm Chairman, President and CEO of MicroStrategy. I'd like to welcome all of you to today's conference call regarding our 2018 second quarter financial results. I'm here with our Chief Operating Officer and Chief Financial Officer, Phong Le.

First, I'd like to pass the floor to Phong, who's going to read the safe harbor statement and make some statements on our results for the second quarter.

[Phong Le, executive]

Thank you, Michael, and good evening, everyone. Various remarks that we may make about our future expectations, plans and prospects may constitute forward-looking statements for purposes of the safe harbor provision under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in our most recent quarterly report on Form 10-Q filed with the SEC.

These statements reflect our views only as of today and should not be relied upon as representing our views as of any subsequent date. We anticipate that subsequent events and developments may cause the company's views to change. While the company may elect to update these forward-looking statements at some point in the future, the company specifically, disclaims any obligation to do so.

Also, during the course of today's call, we'll refer to certain non-GAAP financial measures. There's a reconciliation schedule showing GAAP versus non-GAAP results currently available in our press release issued after the close of the market today, which is located on our website at www.microstrategy.com.

One year after sharing our plan to invest in MicroStrategy to drive growth, we're starting to see initial signs of improvement. For the first time in 7 quarters, we saw product license revenue increase by 9% or $1.6 million year-over-year. Total revenue also increased by 1% or $1.4 million year-over-year. Total revenue excluding services increased by 4% to $3.7 million year-over-year.

We continue to see success in the area of customer service. This is a result of improvement and investments in our product support team where we grew headcount 5% per year and as a result of our proactive customer outreach and company-wide emphasis on the customer. The result has been increased to 4% or $2.9 million year-over-year in product support revenue.

In technology, we recently announced our plan to deliver version 11.0 in September followed by a major platform release, version 11.1 in December. Version 11.0 introduces the next generation of our platform: the MicroStrategy Intelligence Enterprise platform. Versions 11.0 and 11.1 will be the most significant releases of MicroStrategy's software in over 3 years. These efforts were made possible by our investments in technology where we've added 125 people, or 24% to our headcount year-over-year.

In marketing, our significant investments improved market brand awareness, generated high-quality digital marketing and field marketing leads and added more net new prospects to our marketing pipeline. We also worked hard to improve our marketing collateral, social media presence and introduced persona-based and solution-based marketing. Our increased marketing efforts resulted in increased sales and marketing expenses of $9.4 million or 22% year-over-year. We're also excited about the arrival of our new CMO, Marge Breya, who recently served on our MicroStrategy Board of Directors and brings more than 30 years of enterprise software and marketing experience.

In the area of people, we continue to invest heavily in growing our organization, adding 196 people in the last year and 74 people in the last quarter. In addition to recruiting, we're investing heavily in employee retention, development and HR analytics activities.

Now to our detailed financials. Total revenue for Q2 2018 was $120.6 million, a $1.4 million or 1% increase year-over-year. Foreign currency effects from Q2 2018 favorably impacted our total revenue by $1.9 million or 2%. Product license revenue was $19.3 million in Q2 2018, a $1.6 million or 9% increase year-over-year. Foreign currency effects in Q2 2018 favorably impacted our product license revenues by $0.2 million or 1%. Q2 2017 product license revenue reflected a decrease of $1.4 million due to the adoption of ASC 606. As part of our Q1 2018 earnings, we announced that we chose a full retrospective adoption of ASC 606, adjusting our prior-period financial statements. Further details on these and other adjustments are provided in our 10-Q filed with the SEC.

Our subscription services revenue, primarily driven by our cloud customers, was $7.6 million in Q2 2018, a 9% decrease year-over-year. Our support revenue was $73.7 million in Q2 2018, a 4% increase year-over-year with foreign currency changes favorably impacting such revenue by $1.2 million or 2%. Our other services revenue was $20.1 million in Q2 2018, a 10% decrease year-over-year with foreign currency changes favorably impacting such revenue by $0.4 million or 2%. This decrease is primarily due to lower bookings, billable hours and utilization in our consulting business. However, our bill rates continue to increase as we focus on higher-end services.

Turning to cost. Q2 2018 cost of revenues was $25.0 million, a 3% increase year-over-year and 1% decrease quarter-over-quarter. Q2 operating expenses were $97.4 million, a 21% increase year-over-year and flat quarter-over-quarter. We implemented compensation increases across our employee base in Q2 2018.

Sales and marketing expenses increased $9.4 million or 22% year-over-year and decreased $0.4 million or 1% quarter-over-quarter. Our sales and marketing headcount increased 45 people or 7% year-over-year. These investments were primarily in the field and inside sales, such as field marketing, partner managers and business development. We learned a lot about our more -- most effective marketing channels and campaigns, and we'll focus on improving ROI while continuing our marketing expenses in the second half of 2018.

Research and development expenses increased $5.5 million or 28% year-over-year and $1.5 million or 6% quarter-over-quarter. Our research and development headcount increased 125 people, 20% -- 24% year-over-year and 47 people or 8% quarter-over-quarter. We expect to continue the strong pace of research and development headcount growth throughout 2018 across our key development centers in Tysons Corner, Virginia; Hangzhou, China; and Warsaw, Poland.

General and administrative expenses increased $1.7 million or 9% year-over-year and decreased $0.9 million or 4% quarter-over-quarter. This is due to increases in IT systems implementation as well as recruiting and compensation cost.

We had a loss from operations of $1.8 million in Q2 2018 and an operating margin of negative 1% compared to 12% for the same period a year ago. We had net income of $4.8 million in Q2 2018 and diluted earnings per share of $0.42. Improvements in interest income as well as other income primarily from foreign exchange gains contributed to our increase in net income. We had cash, cash equivalents and short-term investments of $699.6 million at the end of Q2 2018 and continue to have no debt.

As we entered the second half 2018, we continue to target growth from product license to total revenue. However, due to the volatility of our revenue and the impacts of 2017 revenue of our adoption of ASC 606, growth in any particular quarter continues to be difficult to project. We believe that continued investment in field, sales empowerment, marketing leadership, customer focus, product excellence and inspired people are starting to show results internally in our business and externally with our customers and prospects. We also think the role out of version 11, the MicroStrategy Intelligent Enterprise platform, will be a driver for growth for the business and are excited about the opportunities all of these investments present for the future of MicroStrategy.

Now I'd like to turn it back to Michael Saylor.

[Michael Saylor, executive]

Thanks, Phong. Now that we're 1 year into our 3-year growth plan, I thought it'd be reasonable to provide an update on progress against that plan and talk about observations to provide everybody on the call with some color.

Let's start with the plan itself. It's 4-pronged: make targeted, focused investments in sales; make investments in marketing; make investments in our services programs; and make investments in our technology programs.

So to take them one at a time, with regard to sales, over the past year, I'm pleased with the way that we have focused our energies on an account basis. We've identified a clear set of named accounts, both prospects and customers, segmented those accounts, assigned those accounts and begun to drive more sophisticated, more mature account planning and customer support and account-based set of processes. We have organized our sales organization into regions around the world. And in each region, we've put in place a field marketing manager, and we've put in place a global alliances manager and we've aligned them with the general managers in each of the various regions. This has been a popular change, and I think the result is -- has been an improvement in our local field marketing activities and the engagement of marketing with sales. And we've also been able to improve our relationship with our partners and our engagement with our partner ecosystem as a result of these investments. We've implemented a general manager structure and a 360 degree review processes that are meant to improve team work and drive transparency while encouraging coordination at a local level. And so these investments, I believe, are starting to pay off in the form of focus, alignment and engagement everywhere in the world.

If we move on to the second prong of our strategy, marketing, we put in place some new marketing programs. One of them is a new set of field marketing programs, including a targeted outreach to CIOs and CDOs and CISOs and CFOs across our prospect base with accounts that we're not currently doing business with. And in the past 12 months, we've done more than 18 of these events in conjunction with marketing partners where we've been able to go out and speak and deliver the MicroStrategy message to groups of 50 to 150 of these CxOs. And we've seen these to be very effective ways for us to extend our brand and to start to build new relationships with prospects. And we're starting to build a pipeline off of these activities.

We've launched a red box campaign where we've upgraded and improved the quality of our outreach to executives in the prospect base, and we're building momentum in that area. We have aligned our marketing message around the Map of the Intelligent Enterprise and the corporate mission, which is to make every enterprise a more Intelligent Enterprise and that's resonating.

So in all, I feel like we're finding ways to reach our prospect community that we didn't have a year ago, and we've got a more polished executive-level message. And that seemed to be an indication, based upon our pipeline and the opportunities we're getting, that this is working and this will pay dividends in the future.

The third pillar of our strategy is invest into services, and we have over the last 12 months defined 12 strategic programs to help our customers. We've begun to build out those programs. We have engaged with more than 100 of our customers, providing them with assessment and advisory services to help them become more Intelligent Enterprises. We have modified and enhanced our sales account planning program so that we better integrate sales and services together as we seek to provide our customers with a tailored package of services to make them successful. And the preliminary reading on those programs is that we are managing to generate goodwill with our customers. We're having lots of successes in improving their configurations and their ability to get use out of the MicroStrategy platform. And we're generating pipeline that is creating new sales and new service opportunities for us. And so I'm pleased to see that program evolving.

The final pillar of our strategy is technology, and our technology strategy is to continue to build on top of the MicroStrategy platform but make it even more open, make it easier, faster, simpler, more flexible, more powerful. And I believe that we are building excitement with these technology programs, especially with the promise of some of the new capabilities that we're delivering with our version 11 release.

People are really excited about the potential for hyper intelligence. They're excited about our very agile ability to build and deploy dossiers. They're excited about our new geospatial and collaboration capabilities. And they're very excited about the integration of identity and presence awareness into their applications. And so that's an overall auspicious things.

As Phong had mentioned, we've added about 125 professionals for the technology organization. We've successfully launched an engineering center in Warsaw that's got multiple development teams all working to support the core platform. We've managed to recruit a decent number of very talented product managers and engineering managers that are complementary and additive to our technology efforts. And I believe that our commitment to this business plan has made MicroStrategy a more attractive place to work. We're finding really bright executives coming to us from our competitors and from other companies in the space that are really enthusiastic about supporting this mission of powering the Intelligent Enterprise.

As Phong had mentioned, we're on target for a major platform release in the fourth quarter, and we've settled in to a one-year release cycle and that means that each year, we'll release a full platform release to our customer base. And that's a development that has been very enthusiastically received by our customers.

So all in all, we're still only 1 year into a 3-year plan. And I believe that we need to continue to stay committed to these things and to tailor and to manage each of these programs in order to realize the full potential of these investments, but there are a lot of reasons to be optimistic right now.

I would like to say a few words about our organization as well. We're continually working to grow our organization. I've been really excited to see some of the new talent that we've attracted into MicroStrategy. Marge Breya joining as our new Chief Marketing Officer, we believe, is just a really great thing for the company. She brings some extraordinary experience leading marketing functions at BEA, Business Objects and Informatica. And I believe that she's going to help us as we work to execute world-class, account-focused enterprise marketing programs.

In the area of sales, Kevin Norlin is now settling in to the role of Head of Worldwide Sales after about 3 months, and we're adding additional senior executives in the sales organization to help us execute on our sales programs and deliver good sales engagements to our customers. And so I feel like that organization is strengthening.

In services, Steve Holdridge enters this fourth quarter running our Worldwide Services organization. And likewise, we're adding additional talented executives in the services organization to help us execute on our program vision and on our enterprise support mission. Technology has benefited from an influx of new senior executives across product management and across a number of other technology programs, and this is consistent with our increased commitment and focus on driving the platform.

And then finally, I'm pleased to announce that Phong Le has now assumed the role of Chief Operating Officer at the company, and he has a mandate to drive operational efficiency and effectiveness across all our key corporate programs. His job is going to be to integrate sales, services, marketing and technology on a day-to-day basis and keep us all focused on driving revenue growth.

Our focus as a company for the rest of the year is going to be on delivering the version 11 platform release, on polishing our key service programs, scaling up our enterprise support activity and intensifying our account-focused marketing activities and we're excited to see all of this come together.

So with that, I guess I'll go ahead and open up the call for questions from the analysts.

[Operator]

[Operator Instructions] Our first question comes from Karl Keirstead with Deutsche Bank.

[Karl Keirstead, analyst]

Michael, Phong articulated continued -- sort of reaffirmed the plan for product license growth in 2018. I think in the first half you're minus 9%, so you're going to need actually some fairly solid growth in the second half to hit that aspirational target. And I'm just wondering how you feel about that and if it's a function really of the sales changes and marketing changes you've made bearing fruit. Are you sensing that perhaps the end market demand is picking up on the back of a better economy and you can benefit from that as well? Maybe a little color on the second half to give us some comfort that you can hit that target on product license.

[Phong Le, executive]

Karl, I'll start, and I'm sure Michael will add to this. We had a stronger second quarter when it comes to product license revenue growth and a tougher first quarter as you mentioned. Michael walked through all the things that we've done in the organization from a sales and services and marketing and technologies perspective, and we're seeing improvement in our pipeline as a result of those activities. So we're going to go into the second half feeling good about growing our revenue. But as I mentioned, there's always volatility that is more difficult to predict in any particular quarter. But I think the positivity is more related to what we've done internally than any external factors.

[Karl Keirstead, analyst]

Okay. And then maybe one for you, Phong, just to follow up. Most of the metrics were actually pretty good revenue growth: maintenance support growth of 4%, as you guys have highlighted; license growth of 9%. The deferred revenue balance, or DR balance, was minus 7%. And I'm wondering why we would see some good growth on a lot of the income statement metrics but the DR balance might have been down. Maybe there's something funky in terms of the billing invoicing to call out.

[Phong Le, executive]

Yes, part of that -- the deferred revenue balance drop was actually because of our product support line item, not so much our product license. And we tend to see that happen in the second quarter of the year because we have a large amount of maintenance revenue that comes in, in the first quarter. And so that's the biggest driver. Nothing specific about the business that concerns me when I look at deferred revenue. And there are some ins and outs that are hard to follow because of the 606 implementation from 2017. And if you look at our Q, we'll actually -- we actually line itemed out the impact on each of the deferred revenue line items related to 606.

[Operator]

And our next question comes from Tyler Radke with Citi.

[Tyler Radke, analyst]

I was wondering if you could talk about the large deals in 2Q. It seems like from your disclosure in the 10-Q that those ticked up. I'm just curious if there was anything to call out there, whether it's changes that you've been making to the organization. Or what drove that outperformance?

[Phong Le, executive]

Yes, I think, Tyler -- I mean, if you look at it on a year-over-year basis, we had a pretty tough year -- tough quarter in Q2 of last year as it relates to large deals. And so what you saw this quarter should be more indicative of the type of business we want to run. That said, we had very good activity internationally as it relates to deals over 500k and over $1 million, and -- so that bolstered our business and a lot of that is due to the hard work of the sales and marketing teams and the field teams over the last few years. So we were happy with their large deal output this quarter.

[Tyler Radke, analyst]

And as you think about heading into next year, obviously there's still some uncertainty. In the next 2 quarters, you'll see positive overall revenue or license growth. What are -- just what are your thoughts, high level, heading into next year? I mean, obviously the -- I imagine that the plan is to grow. But could we expect something in terms of double-digit license growth? Or is it the kind of high single digits like we saw in 2Q?

[Phong Le, executive]

Yes, we don't provide any particular guidance as it comes to revenue growth in 2019. I think what we've talked about is as we enter this 3-year journey, our aspiration is to get to greater than double-digit revenue growth over the period of time. But I think it would be premature to predict anything in particular as it relates to 2019.

[Tyler Radke, analyst]

Got it. So 3 years would be more of a 2020 comment given you started the initiatives in 2017?

[Phong Le, executive]

Somewhere along that 3-year journey.

[Tyler Radke, analyst]

Okay. And then just to follow up on the, and I apologize if this was answered, on the deferred revenue. It looked like the maintenance deferred declined year-over-year. And then also, do you kind of calculate maintenance billing? It looks like that was down as well. Was there anything you'd call out there? Any change in maintenance renewal rate?

[Phong Le, executive]

No. In fact, in -- Karl had asked a similar question. I think there's 2 factors there. One is related to our implementation of the new accounting standard. And the second is -- our first quarter is our largest maintenance renewal quarter. And so as we close out a lot of sort of back renewals in the first quarter, it causes our product support deferred revenue balance to drop in the second quarter. So there's a bit of seasonality there when you go from Q1 to Q2. Overall, as I mentioned, our maintenance business has been extremely strong. And in fact, Q1 of this year, we had some of our best renewal rates that I've seen in my tenure here. And so we're pretty happy about the results of our renewal rates at this point. And that points to a lot of the work that we've done improving our product, improving how we service our customers holistically across sales, marketing and our support team and the continued importance of our product in the operations of many of our customers' businesses.

[Tyler Radke, analyst]

Okay. And last question, just on the services. I think you talked about lower bookings that contributed to lower revenue. Are you proactively doing something to address that? Just trying to understand how high in the priority list services are. Obviously, they're lower gross margin and you'd prefer to sell software all day. But just curious if you think like that had an impact on either your growth outlook or potentially signing more license deals?

[Phong Le, executive]

I don't think it's a predictor so much of license deals or revenue. Obviously, we want to grow across all line items of our business, including services. We were -- weren't happy with our results in Q2, and we're doing everything we can to try to understand what's driving that and how to improve it. That said, our bill rates are improving, and so I believe we're providing the right types of services to our customers. And one potential view is our focus on improving bill rates and margins is, is impacting our revenue slightly. But it's an important part of our business, and I think we'll continue to focus on ways to improve that part.

[Operator]

[Operator Instructions] Our next question comes from Frank Sparacino with First Analysis.

[Frank Sparacino, analyst]

Just 2 questions for me. First is on the domestic performance this quarter. I recognize the business is lumpy quarter-to-quarter. But in terms of the product license number, which was just under $8 million, which is fairly low going back, I think, a couple of years, is there anything you would call out just in terms of potential disruption in North America versus international internally? Or is it just all external market related?

[Phong Le, executive]

You're right, Frank. Our domestic business has been declining at a rather steady rate in the last 2 years or so. I wouldn't point out anything in particular internally that's driving that. There are some -- the competitive factors in our business are challenging, especially in North America, and I think that's a factor. But we're doing everything we can along with our sales leadership and our services leadership to identify ways to turn around that business, and it's a big focus of ours.

[Frank Sparacino, analyst]

And maybe just one follow-up, in terms of the goal of getting back to, at some point, kind of double-digit overall software growth. I'd be curious, I mean, you can obviously look at external industry reports and get a sense of where the overall market is growing. I'd be curious, from your perspective, right, I mean, where you think the market's at, where it's growing? And obviously you guys are going to be below that now, but I don't know what that delta is and I don't know what kind of the internal view is.

[Michael Saylor, executive]

Yes, I think when we look at the marketplace, where we see a lot of excitement and enthusiasm in the mobile space is building. There's a lot of enthusiasm with regard to embedding analytics into existing applications, what we call embedded intelligence and the like. When you look at the overall market numbers, you could say, "Well, the market's growing. We're not growing as fast." I think the key to keep in mind, too, though is, is the market is also fragmenting and there's lots of new entrants coming into the marketplace and they're all getting their piece of the pie. So it tends to be a fairly complicated dynamic between all that various entrants and also the shifting of value up and down the value chain between all the various types of service providers, infrastructure providers and the like. We are -- we have confidence in our plan. I think nothing takes place in 12 weeks. You normally have to be committed to something for about 3 years before you start to see the impact of it. And we're starting to see the impact of some investments we're making in technology and investments we're making in services that are both enhancing our relationship with our customer and they're also increasing opportunities for us to go and sell more product and more services. So I think the real key here is to stay committed to delivering an integrated package of product and services and stay focused on our particular segment of the market and our particular value proposition, and maybe not get distracted by other things that could be noisy. Because there's certainly more noise in the marketplace today than there was 10 years ago or 20 years ago and there's more energy. And so I think it's important for us every single day just to stay focused and keep all of our people focused on the same mission, on the same platform, on the same programs.

[Frank Sparacino, analyst]

And Mike, just following up on that. I mean, if you look at the win rates today versus 6 months ago or 12 months ago, is there a discernible improvement in those win rates?

[Michael Saylor, executive]

I think if we look at where we're winning, there's a lot of things to be very excited about, enthusiastic about, because we have been seeing large wins that are indicative of customers' enthusiasm about the investments we're making in the platform. We're seeing large wins over existing analytic tool, vendors like Tableau. We're seeing large wins to extend applications by embedding intelligence into custom apps. And we're seeing large wins to deploy large analytics installations on top of the AWS cloud. And so we're getting serious commitments from sophisticated, world-class customers after extremely competitive buy cycles where they're buying into our vision and our value proposition and our actual product and service mix. So I got to figure if you can do a million-dollar-plus deal with one and you can do many, many more. So that just means that we've got the right thing. We just need to focus upon scaling it up, and that's what our operational initiatives are meant to do.

[Operator]

This concludes today's Q&A session. I would now like to turn the call back over to Michael Saylor, Chairman, President and CEO, for closing remarks.

[Michael Saylor, executive]

I want to thank all of our shareholders on the call, and thanks for everybody for your support. We'll look forward to speaking with you again in 12 weeks. Have a good evening.

[Operator]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a great day.