Microstrategy Inc

NASDAQ:MSTR

Earnings Call Transcript 2018-Q3

[Operator]

Good day ladies and gentlemen, and welcome to the MicroStrategy, Third Quarter 2018 Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this call 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, Chairman, President, CEO]

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 third quarter financial results. I’m here with our Chief Operating Officer and CFO, Phong Le.

First, I’d like to pass the floor to Phong, who is going to read the safe harbor statement and make some comments on our results for the third quarter.

[Phong Le, Chief Operating Officer, CFO]

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.

I’d like to start with financial highlights for the quarter. We delivered the initial version of our MicroStrategy 11 software in September with great new capabilities and improved ease of use performance, augmented analytics and artificial intelligence that Michael will highlight later. We are now working towards our MicroStrategy 2019 platform release, which we plan to launch in December this year.

We, as well as our customers and prospects are eagerly awaiting our first platform releases since June 2016 and are excited about our plan to annual platform release schedule going forward. This has been a significant journey in MicroStrategy’s transformation. Starting in 2014 with our transition to an agile development process, our MicroStrategy 10 release in 2015, our 10.4 platform release in 2016, and a release of Dossier MicroStrategy Workstation and MicroStrategy Library in 2017. We expect MicroStrategy 2019 to be our best offering ever.

Our customers continue to be happy with our software, consulting, education and customer service, as well as our new enterprise support program. We had another strong quarter of renewals while we continue to manage our renewal rates and discounting. Product support revenue increased 2% year-over-year.

We also returned a positive operating margin of $7.2 million or 6% as we actively managed our cost, especially in the area of discretionary marketing. With interest income and tax tailwinds our diluted earnings per share increased to $1.10.

Finally, our overall revenue trajectory continues to improve. After four consecutive quarters the double digit product license revenue decline, we saw a 12% quarter-over-quarter increase in Q2, 2018. In Q3 2018 we saw a 5% quarter-over-quarter increase, although this amount was impacted by FX and ASC 606 revenue recognition headwinds, which I’ll describe in detail shortly.

Now to our detailed financials. Total revenue for Q3, 2018 was $122.2 million, a $3.9 million or 3% decrease year-over-year and a $1.6 million or 1% increase quarter-over-quarter. Foreign currency effects in Q3, 2018 negatively impacted our total revenue by $2.4 million or 2%.

Product license revenue was $20.3 million in Q3, 2018, a $2.1 million or 9% decrease year-over-year and a $1.0 million or 5% increase quarter-over-quarter. Foreign currency effects in Q3, 2018 negatively impacted our product license revenues by $0.9 million or 4%. In addition Q3, 2017 product license revenue reflected an increase of $0.8 million due to the adoption of ASC 606.

Product license revenue continues to be strong internationally with 50% of our revenue contribution representing a 13% increase year-over-year. Additionally, worldwide we saw nine product license transactions with revenue greater than $500,000 in Q3, 2018, similar to our 10 transactions for the same period in 2017.

Our support revenue was $74.5 million in Q3, 2018, a 2% increase year-over-year, with foreign currency changes negatively impacting such revenue by $1.2 million or 2%. We continue to see strong customer support renewal rates and ongoing reflection of our highly engaged customer base.

Gross deferred revenue primarily composed of differed subscription and product support revenue decreased $20.6 million or 12% as compared to Q3, 2017. This was driven by strengthening U.S. dollar which reduced the U.S. dollar value of our international deferred revenue balances, and a strategic shift we've taken away from offer multiyear commitments with larger discounts.

Our other services revenue was $20.2 million in Q3, 2018, a 12% decrease year-over-year and a $0.1 million or 1% increase quarter-over-quarter. We are continuing to transition our consulting business from lower to a higher rate services. We are also continuing to evolve our enterprise support offerings into Prepackaged Assessments and Advisory Services.

Turning to cost, our strategy to invest in sales and marketing technology, our customers and our people is driving increases overall. Q3, 2018 cost of revenues was $23.4 million or $1.0 million, a 4% decrease year-over-year and a $1.7 million or 7% decrease quarter-over-quarter.

Previously capitalized software development costs related to MicroStrategy 10 became fully amortized in Q2, 2018. We did not further capitalize any software development costs in 2018. Q3 2018 operating expenses were $91.5 million, a 14% increase year-over-year and a 6% decrease quarter-over-quarter.

Sales and marketing expenses increased $3.4 million or 8% year-over-year and decreased $5.5 million or 11% quarter-over-quarter. This quarter-over-quarter decline was due to an increased focus on investing in marketing channels and tactics that return more immediate and tangible benefits.

Sales and marketing head count increased by 64 people or 10% year-over-year and 12 people or 2% quarter-over-quarter. We believe our sales and marketing costs and headcount are at a generally appropriate level to grow our business going forward.

Research and development expenses increased $6.5 million or 33% year-over-year and $0.7 million or 3% quarter-over-quarter. Headcount accelerated in our key development centers, with an increase of 149 people or 28% year-over-year and 37 people or 6% quarter-over-quarter.

In a highly competitive recruiting environment and technology, we continue to find our efforts to attract, develop and retain top talent to be quite successful worldwide. We believe this headcount growth will help with the functionality, scalability and quality of 2019 product release and beyond. We’ll continue to ramp our investment in research and development throughout the remainder of 2018 and into 2019. We will focus more on lower cost areas worldwide like China and Poland.

General and administrative expenses increased $1.2 million or 6% year-over-year and decreased $1.0 million or 5% quarter-over-quarter. The year-over-year increase is primarily due to higher consulting and advisory fees.

With income from operations of $7.2 million in Q3 2018 and an operating margin of 6% compared to 17% for the same period a year ago, and negative 1% in Q2 2018. We had net income of $12.7 million in Q3 2018 and diluted earnings per share of $1.10.

We had net interest income of $3.4 million; other income of $0.8 million, which primarily consisted of foreign exchange gains, and a benefit from income taxes of $1.2 million.

The income tax benefit was primarily due to discrete items such as the adjustment to the transition tax recorded in Q3 2018.

We had cash, cash equivalents and short term investments of approximately $700 million at the end of Q3 2018 and continue to have no debt. As we continue through Q4 2018 and into 2019, we expect to see the results of our increased sales and marketing activities benefit to us overall.

As mentioned previously, we plan to launch our MicroStrategy 2019 product in December 2018, which will be an exceptionally significant platform release. Customers are excited to migrate to this new release to gain improved benefits like Federated Analytics, Transformational Mobility and hyper intelligence to the masses. Our Enterprise Support Offerings will focus on upgrading customers for MicroStrategy in 2019.

Our continued product license volatility, along with consulting business trajectory will make overall revenue growth challenging in 2018. That said, we are optimistic about our business trajectory and our ability to improve revenues and margins in 2019.

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

[Michael Saylor, Chairman, President, CEO]

Thanks Phong. MicroStrategy is a modern, multiplatform enterprise, analytics and mobility platform. We are focused upon being open, being unified and our architecture supporting all the types of tools that data scientist, application developers and analysts use throughout the enterprise. Supporting every type of data source application in the Cloud, enterprise applications, NoSQL sources, MDX sources, Hadoop sources and the like.

And I think that what defines MicroStrategy is a commitment to that modern analytics platform combined with a commitment to methodology for enterprise success and we call that methodology our Intelligence Center Program and we have packaged that as part of our enterprise support program and we've been building that throughout the past 12 months.

Recently I flew around the world to meet with dozens of our customers and I spent time in Vienna and Milan and Warsaw. I went to Riyadh, I went to Dubai. I was in Hong Kong, Shin Shin. I went to South Korea, Tokyo and then I went south to Sydney, Australia before returning to Washington DC.

And I engaged in half a dozen conversations in every city I went to, with our customers and with perspective customers and I was very, very excited to hear from them and came back with a conviction that they want things from us that they just can't get with desktop analytics tools like Tableau or with departmental analytics tools like Microsoft’s Power BI. Specifically there are three things that are really compelling and exciting for the enterprises around the world in the year 2019 that they want, that I don't think they can get with other tools.

The first one is Federated Analytics. Everybody wants to be able to deploy a common data infrastructure, what we call a single version of the truth and they want to be able to deploy these common data sets on top of a heterogeneous set of enterprise systems. They want those common data sets to be available to developers and analysts throughout the enterprise.

I met with one banking customer that had 1,400 developers that they want to have working simultaneously on different applications on a single enterprise data model. There is an incredible thirst for that. I really haven't met a company that didn't want to do better federation of their data and they wanted a platform that would do that.

Tableau doesn't do that; Power BI doesn't do that. MicroStrategy has a great product to support federated data sets and we do it well and we do it efficiently and I feel that's going to be a great theme from MicroStrategy 2019 in the coming year.

The second you know big desire in our customer base is the Transformational Mobility. They’d like to convert insight into action or as customers say, insights worth a penny and actions worth a dollar. What's the next best action to take with a given customer? What's the next best customer to contact to take action with? What should I do now? What should I do next?

Well to do that you need to inject analytics right into mobile application, into point of sales, into communications. You need to support the transactions, you need support for authentication and that's another thing that we do well. Tableau doesn't support transactional mobile application and with regard to Power BI, they haven’t integrated the identity, the transaction, the authentication in the same way that we have. So we have a great opportunity there as well.

The third major theme is Hyper Intelligence. Hyper Intelligence means real time zero click insights that are all around us, intelligence like vapor, and the MicroStrategy 2019 platform is going to be exciting and probably memorable to every single prospective customer or actual customers due to its hyper intelligence capabilities.

We're really excited about the ability to deploy hyper intelligence to tens of thousands of users across an enterprise and embed it into Office 365, embed it into web browsers, embed it into business documents, embed it into video walls, so that you can turn a television set into a magic mirror where you can walk up to it, it recognizes you and you can talk to it and you can actually get insight.

So hyper intelligence is extraordinarily exciting in the context of augmented intelligence or augmented reality, because we've now got MicroStrategy customers that are building applications that they put on mobile devices where they've actually integrated the analytics for MicroStrategy with the camera of the mobile phone or the iPad. They can walk down a supermarket shelf and they can scan the products, get the KPIs and do it all with zero clicks.

Zero clicks real time intelligence requires a couple things. It requires integrated identity, it requires a really scalable backend and it requires personalized very intelligent security, so that I understand exactly what I should be showing any given person. And these are the things that MicroStrategy is strong and because of our traditional enterprise security model and metadata focus.

So MicroStrategy 2019 is going to be the platform to provide these three things and I think it's not only – it's not only a great platform for allowing us to expand our presence and sell new types of licenses in our installed base. It’s also a good platform for us to win new customers and to carve out a position in the installed base of companies like Microsoft and Tableau, so I'm really enthusiastic about that.

Most of our customers right now are on version 10.4 which we shipped in June 2016, and in my experience they were reluctant to make big commitments based upon functionality and a feature release and so we’ve shipped releases 10.5, 10.6, 10.7, 10.8, 10.9, 10.10, 10.11 that have pieces of this functionality, but really it's all going to come together at the end of the quarter here with Version 11.1 which we will then market as the MicroStrategy 2019 Platform for the coming year. I think that that’s just a really nice watershed for us and will be a dramatic leap forward in the product offering we are putting into the marketplace.

Moving past product capabilities, I want to talk a bit about services. In all of my conversations with customers, our customers want help and they want advice in a couple of areas. They want us to provide them with best practice for how to configure their intelligence environments and especially this is important with the advent of new Cloud capabilities from AWS and from Azure. There is so many ways you can configure your intelligence network in order to provide optimal performance and elastic intelligence power. And they want us to help them figure out how to upgrade and configure and deploy these environments.

All of our customers want help with applications, enterprise applications. How do I design them? How do I deploy them? How do I orchestrate the collaboration between analysts, developers and architects, so that you can have dozens or hundreds of analysts and developers building dozens of applications on a common enterprise framework of data sets and application logic and security.

And just like, just like yin and yang order and chaos, degrees of freedom and degrees of constraint, every enterprise is defined by its common security framework, application framework and data framework and yet it is always struggling to innovate at the periphery or at the edge across dozens of business units. And so balancing the need for innovation with the need for order and governance is what the MicroStrategy is offering special.

It’s not just the technology challenge. It's very much an organizational and methodology challenge. So our customers want us to help them overcome that challenge and we do it with a combination of our applications, programs and our analytics methodology program, that's the third area of incredible demand. Our customers want us to provide them with the methodology for deploying federated analytics throughout their enterprise.

And finally, there's a huge demand for mobility. Our customers want help with methodology for deploying mobile apps across the enterprise and how to integrate them on various devices against various mobile device managers and then build the optimal intelligence back end and determine how to do the full lifecycle management of these applications.

So, our advisory programs are ramping up. They continue to grow rapidly quarter-over-quarter. I've gotten nothing, but favorable response and I think we'll probably do about 1000 of these engagements in the coming 12 months and so it's becoming material.

I expect it will drive services and software sales in 2019 and I think it positions us at the high end of the market where the enterprise grade vendor that has the enterprise methodology, as well as the enterprise platform for some organization that wants to engage in a serious endeavor to link all of the disparate tools in their enterprise like Excel and Tableau and Power BI and Xcode and Swift code and Visual Studio and Python and I could go on and on.

They want to integrate all the tools, all the functional roles like data scientists, developers and analysts and power users against its single version of the truth, an enterprise grade platform plugged into dozens or hundreds of their systems of record.

That is a – it’s a different value proposition and selling a downloadable desktop analytics tool and it's different than even selling a departmental tool like Microsoft where you're going to support lots of applications, but to a more constrained user base without the aspirations of federation.

If I were to roll the clock back three years, I would say on the version 10.4 or previous versions, we didn't really have the connectors in ordered to make good on that promise of being open to every tool, very type of user, every backend system. But the MicroStrategy 2019 platform really does offer the openness on the front end and the power on the back end and the performance in the middle, combined with methodology for success, in order to make enterprise as successful as they pursue this federation vision.

In Q4 our attention is going to be focused upon the MicroStrategy 2019 launch and all the marketing programs to go along with it. Our attention is going to be focused upon services execution, and how do we make sure that we're delivering the best services in the most efficient manner everywhere in the world and then we're going to be focused on the continuing strengthening of our sales, services and marketing teams worldwide, so that we can realize the potential that we can see in this tremendous MicroStrategy 2019 platform.

I think we’ll enter the year with the strongest technology and the strongest methodology and the most organized systems, programs and the most talented team that we've had in the history of the company. So I'm optimistic about what the future holds and looking forward to it.

So with that, I would be happy to open the floor for questions.

[Operator]

Thank you [Operator Instructions]. Your first question comes from Tyler Radke with Citi. Your line is open.

[Tyler Radke, Citi]

Hi, thank you, thanks for taking the question. Maybe we’ll start off Michael, so it sounds like a lot of excitement around Version 11. I'm just curious how you're thinking about the impact of Version 11 on 2019 license revenue growth? You know it seems like with Version 10 there was obviously a lot of excitement, but certainly customers want to wait until stable release is out in the market before they migrate. So just how you’re thinking about this? Is it going to be a Version 2 or Version 3 when you really see the meaning migrations and just how you are thinking about that catalyzing license revenue growth in 2019?

[Michael Saylor, Chairman, President, CEO]

You know, I think we learned a lot from our Version 10 launch and the production release of Version 10 was 10.4 and so I don't think we managed it as well as we could have and we took the lessons learned as we thought about Version 11 and we folded them into our plan.

So Version 11.1 will be the production release and we’ve spent quite a bit of time hardening that version and already putting the features out in the market. So I think that Version 11.1 will actually be a very solid release and I expect that our customers will upgrade to that version in large numbers and we should see benefit in 2019 and it should drive revenue growth for us in a license side.

[Tyler Radke, Citi]

Okay, great. And you also mentioned a 1000 – I think you said 1000 engagements in the coming months. Could you just elaborate on that? Is that with both new and…

[Michael Saylor, Chairman, President, CEO]

I said 1000 engagements in the coming year. What that means is we are now getting to the point where we’re engaged in about 200, 250 places in any given quarter with our customers to provide them with advisory services, we've been ramping that up. So I think at the rate that we’re ramping up, we should see in 2019 engagements that are providing intelligent enterprise advisory services, at least 1000 of them.

[Tyler Radke, Citi]

Okay. And then just lastly on the product side, the kind of its vision around having MicroStrategy being able to connect to other analytics tools like Tableau or Data Science platforms. I'm just curious how you’re strategizing the go-to-market of that? I mean it seems like – are you thinking about this as like a meaningful change from what you're used to and I know in 10.9 I think you released kind of some connectors the Tableau already. So I'm just curious how like – you know how that vision kind of compared to what's out there today and how you're thinking about the go-to-market on that as well?

[Michael Saylor, Chairman, President, CEO]

You know we released some technology and we tested the technology in order to get more comfortable with it and so we won't be releasing the technology for the first time with 11.1; we've actually got some decent experience.

What we have done is spent a lot of time working with customers to understand what they need in the area of federated analytics and I think that the summary would be federated analytics will be a major, you know one of our three major themes in the year 2019 and it’s a major theme for the MicroStrategy platform in 2019 and the promise of deploying a set of common data sets to any tool in the enterprise is a promise that all customers you know resonate with. I mean why wouldn't you like that, right. I mean it solves a lot of problems.

You know nobody in a corporation, not the CEO, not anybody from the Executive Vice President can dictate and tell people what single tool they’ll use. They are going to use a bunch of different tools. If I told them they had to use Excel, they wouldn't; if I told them they had to use Tableau, they wouldn’t. If I told them they can’t use it, they would, and so you have this heterogeneous situation and what we've realized over time is it doesn't make sense to spend a lot of time trying to tell someone why you know the tool of choice they have you know isn't the best one. A much better idea is to be a corporate citizen and support their tool, but give them a single version of the truth with security.

In fact, there is almost no push back from analyst or developers. If you say to them “Hey, I've got this one data as a service, served up as restful APIs or I’ve got this data service and you can just plug into it from Excel, Tableau, Power BI whatever, now there is no push back from that. Everybody is happy to clean enterprise certified date.

The push back is when I tell someone that uses Excode they got to use Swift or when the use Swift they got to use Visual Studio or when they use Visual Studio they got to use Python or when they use Python they got to use Tableau, and when they use Tableau they got to use Power BI. Nobody wants to switch that tool that they got comfortable with at the end use, but everybody wants to avoid you know fishing for data in a very complicated fashion and they don't want to reinvent the wheel.

So we believe that the federated analytics message is one that will resonate and will allow us to take market share and to work side by side with a heterogeneous set of tools that are going to flow out there for quite a while.

[Tyler Radke, Citi]

Okay, and then last one for me, Phong on expenses. I think you talked about sales and marketing investments, kind of where – you know at a level that you think is good going forward. Could you just talk about the other lines where we are on the ramp?

[Phong Le, Chief Operating Officer, CFO]

Yeah, so and your right and you saw a start to reduce our marketing expenses a little bit from Q2 2018 to Q3 2018 as we focus our activities a bit more on our 2019 launch. On the R&D side we’ll continue to grow that organization. We've been growing at a pretty aggressive click and we’ve been happy with the success we've had there hiring around the world.

I think the majority of our incremental hiring going forward will be in some of our lower cost areas like China and Warsaw and we’ll still hire some folks here in the headquarters, but we won’t see substantial cost increases. And on the G&A side, generally speaking we're trying to keep that as an organization flat going forward.

[Tyler Radke, Citi]

Okay, thank you.

[Operator]

Thank you. Your next question comes from Frank Sparacino with First Analysis. Your line is open.

[Frank Sparacino, First Analysis]

Hi Phong. Maybe to start with you. Just on the deferred revenue explanation you gave, can you give a little more detail in terms of the movement away towards the multi-year agreements?

[Phong Le, Chief Operating Officer, CFO]

Yeah, we found historically we would offer multi-year agreements to customers, let’s say two or three years at pretty steep discounts, call it greater than 5%. And we found that given our renewal rates, that that just wasn't necessary and so we've moved more to sort of single year, one or two year agreements with a flatter, no discount model and as a result, that causes are deferred revenue balance to decrease over time.

[Frank Sparacino, First Analysis]

Okay and then maybe lastly just looking at 2019 for Mike, you know in terms of the sales force and strategy, sort of the go-to-market, is there going to be any changes, meaningful changes around the sales part?

[Michael Saylor, Chairman, President, CEO]

I think that the sales organization is going to be catalyzed and charged up with the 2019 product, because it's a comprehensive platform release and the first one they had in nearly three years and it checks all the boxes of what’s hot in the market place right now. We will continue to build out and add additional sales leadership from time-to-time and different places.

I believe that our sales approach is a bit more services lead or methodology rich than it has been in the past. I think our sales organization is getting much more confident assuming the role of trusted advisors with the map of the intelligent enterprise and the MicroStrategy Intelligence programs than they were a year ago and as that program grows, I think it positions them to a much more prescriptive sale than we've had before. But otherwise, no particular thing I would choose to highlight.

[Operator]

Thank you. [Operator Instructions] And I am showing no further questions at this time. I would like to turn the call back over to Michael Saylor for closing remarks.

[Michael Saylor, Chairman, President, CEO]

Okay, I would like to thank everyone for your support. We are really excited about what’s going to happen during the final quarter of the year. I'm looking forward to the release of MicroStrategy 2019 and I’ll look forward to speaking with all of you again in 12 weeks.

Have a great day! Bye.

[Operator]

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