Microstrategy Inc

NASDAQ:MSTR

Earnings Call Transcript 2018-Q4

[Operator]

Good day, ladies and gentlemen, and welcome to the MicroStrategy Fourth Quarter 2018 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference 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, CEO & President]

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 fourth 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's going to read the safe harbor statement and make some comments on our results for the fourth quarter.

[Phong Le, Senior EVP, COO & 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 the 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 will refer to certain non-GAAP financial measures. There is a reconciliation schedule showing GAAP versus non-GAAP results currently available in our press release issued after the close of market today, which is located on our website at www.microstrategy.com.

We entered 2018 with a plan to invest across sales, marketing, customers, technology and our people with the purpose of growing revenue across our business. We feel we executed well on our investment plan and are on the path to revenue growth. In sales, we strengthened our field resources placing field marketing, business development and global alliances people around the world. We also added new head of worldwide sales in April and head of international sales in December. In marketing, we launched a new campaign focused on three core product features, federated analytics, transformational mobility and HyperIntelligence; and three core concepts for the platform, moderated analytics, open architecture and an enterprise platform.

We added a new Chief Marketing Officer in July and a new head of worldwide demand generation in October. With respect to our customers, we launched and are delivering on our initiative to provide proactive outreach and support through an enterprise intelligence center assessment and follow-up advisory work. We also added a new head of worldwide consulting in September.

In technology, we launched our most significant MicroStrategy product release to date, MicroStrategy 2019, our first platform release since 2016. We reorganized our technology leadership and added over half a dozen key leaders to our technology team. We also hired a new CIO, who started in November.

Finally, with respect to our people, we invested in new facilities and systems and launched a new employer brand campaign inviting people to accept the challenge at MicroStrategy. Our worldwide recruiting initiatives are very successful as we added 312 MicroStrategists to the organization, ending 2018 with 2,528 employees, a 14% growth rate. About half of these people were added to our technology organization worldwide. We believe we now have the strongest leadership team and strongest set of employees ever in MicroStrategy. We're starting to see the benefits of these investments. Here are highlights of our Q4 2018 financials.

First, we had a strong product license revenue quarter. Product license revenue was $31.2 million in Q4 2018, a $0.7 million or 2% increase year-over-year and a $10.9 million or 54% increase quarter-over-quarter. Foreign currency effects negatively impacted our product license revenues by $1.5 million or 5%. Domestic product license revenues were very strong, contributing to 62% of our total product license revenue, and increasing 122% year-over-year. Product support revenue was $73.7 million in Q4 2018, a 2% decrease year-over-year with foreign currency effects negatively impacting such revenue by $1.6 million or 2%. We continue to see strong customer renewal rates an ongoing reflection of our highly engaged customer base.

Our deferred revenue balance was $183.0 million as of December 31, 2018. This represents a $22.1 million decrease from the same time a year ago. This was primarily driven by a decrease in deferred product support revenue, which is related to: one, foreign exchange changes negatively affecting our foreign currency valued deferred product support revenue; and two, system changes impacting our quoting and invoicing time lines. In the second half of 2018, we implemented a new customer quoting system. As a result of this implementation, we experienced delays in issuing product support renewal quotes and invoices in Q4 2018. This resulted in a reduced deferred product support revenue. We do not expect this delay to impact our ability to renew product support for our customers. We expect to return to our standard quoting time lines in the first half of 2019.

Other services revenue was $20.0 million in Q4 2018, a 10% decrease year-over-year with foreign currency effects negatively impacting such revenue by $0.5 million or 2%. We're continuing to transition our consulting business from lower to higher rate services.

Turning to cost. Our strategy to invest in sales, marketing, technology, our customers and our people is driving increases overall. Q4 2018 cost of revenues was $25.9 million, a $1.1 million or 5% increase year-over-year and a $2.5 million or 11% increase quarter-over-quarter. These increases are the result of more proactive product support offerings and other services to our customers, which included services to prepare customers for an upgrade to MicroStrategy 2019. These upgrade services will continue to be a focus area in 2019.

Sales and marketing expenses increased $6.0 million or 11% year-over-year and increased $12.4 million or 27% quarter-over-quarter. This quarter-over-quarter increase was primarily due to variable compensation due to improved product license revenues performance, marketing and translation fees and travel related to our launch of MicroStrategy 2019. Research and development expenses increased $6.6 million or 31% year-over-year and $2.2 million or 9% quarter-over-quarter. This was primarily due to additional hires where we saw an increase of 157 people, a 28% year-over-year and 28 people or 4% quarter-over-quarter. The quarter-over-quarter increase was largely due to a very successful campus recruiting effort in our Tysons Corner, Virginia headquarters location and our Hangzhou China technology center.

General and administration expenses increased $1.1 million or 5% year-over-year and increased $2.1 million or 10% quarter-over-quarter. The increases were primarily due to increased recruiting headcount and associated cost. We had an operating loss of $2.2 million in Q4 2018, as we invested in and ramped up our team for MicroStrategy 2019 launch.

For the full year 2018, we had operating income of $4.0 million, resulting in an operating margin of 1%. We had net income of $3.3 million in Q4 2018 and diluted earnings per share of $0.30. We had net interest income of $3.2 million, other income of $1.0 million, which primarily consisted of foreign exchange gains and a benefit from income taxes of $1.3 million.

I also want to provide a quick update on our stock repurchase program. During the fourth quarter of 2018, $111 million was used to purchase 880,667 shares of the company's common stock as part of our previously announced stock repurchase program. The repurchases resulted in an ending balance of cash, cash equivalents and short-term investments of approximately $576 million. We continue to have no debt. As mentioned previously, in the second half of 2018, we implemented a new quoting system on the Force.com platform. As we tested the general information technology controls and the implementation of this system, we identified deficiencies in the areas of user access, program change management and project implementation over certain information technology systems that support the company's financial reporting process. As a result, we expect to report a material weakness in our internal control over financial reporting as of December 31, 2018, in our upcoming annual report on Form 10-K for the year ended 2018. I want to emphasize that no misstatements have been identified in the financial statements as a result of the material weakness, and we expect to file our 10-K in a timely manner. While we're still completing our assessment of the effectiveness of internal controls over financial reporting, remediation efforts related to this identified material weakness have begun. However, this material weakness will not be considered fully remediated until the applicable controls operate for a sufficient period of time, and management concludes, through testing, that these controls are operating effectively. We expect remediation to be completed prior to the end of this year.

As we enter 2019, our objective is to grow our revenue across all areas of our business and scale back the pace of investments, maintaining generally flat operating expenses to expand operating margin. We expect our MicroStrategy 2019 product to drive upgrade cycles across our customer base in the next 18 months. Customers are already showing enthusiasm for our new products, especially our HyperIntelligence feature, which brings Zero-Click Intelligence to developers and data analyst as well as business users and executives across the enterprise. We also expect to increase efficiency in our sales and marketing organization with increases in account executive productivity and marketing return on investments. A lower pace of hiring and lower employee turnover is expected to help decrease our general and administrative costs. Technology recruits, especially campus hires, arriving in the spring and fall, as part of a very successful 2018 recruiting process, may cause incremental increases in technology cost.

We believe our strategic investments in 2018 across the organization, new leadership and improved integration and our new 2019 products set us up for a promising 2019.

Now, I would like to turn it back to Michael Saylor.

[Michael Saylor, Chairman, CEO & President]

Thank you, Phong. I would like to elaborate on Phong's comments with a few thoughts about 2018 and then speak about our plans for 2019. As I look back on 2018, I think we made great progress, strengthening the talent pool at MicroStrategy, adding hundreds of very, very talented professionals all around the world, including a large pool of talented engineers in the technology organization. And I think that was a great success for the company. I'm also pleased with the way we strengthened our executive team in 2018, adding a new head of sales, a new head of marketing, a new head of IT, a new head of worldwide consulting, a new head of international sales, a new head of Latin America and a new head of international -- of enterprise support, and a new head of direct marketing and demand generation. They were all seminal achievements for the company. We're extraordinarily pleased with the talent that we've been able to attract and the engagement of these new executives, and they're already making a big difference here at the firm.

In 2018, we also made good strides strengthening our systems. And although, it's not without a few growing pains, I think, the implementation of our CPQ system and new quotation system and sales force was a big step forward in integrating all of our sales and marketing systems together in a common environment. And we also implemented Workday, which will lay down a very strong modern platform for all of our HR systems going forward. As Phong mentioned, we delivered MicroStrategy 2019 at the end of the year, and we dramatically strengthened our product offering, the biggest product release in three years. And we returned $111 million of capital to the shareholders and that's also a material achievement. We're very pleased with that.

As I look at 2019 and assess our prospects going forward and the plan, I'd just like to highlight to the shareholders, the 2019 product is the best platform we've ever created at MicroStrategy. It's a modern analytics, open architecture, enterprise platform. And that makes it quite interesting and quite valuable in the marketplace. MicroStrategy 2019 is going to appeal to a lot of people because there are many that have modern analytics but they don't have an open architecture. There are many with open architecture but they're not modern in their analytic approach. And then often times there are desktop analytics, or specialty tools but they're not enterprise-grade platforms. So to put together the modern, the open and the enterprise characteristics in a single offering gives us unique spot in the marketplace. We believe that there are some really unique solutions that we can deliver with the 2019 platform. Federated analytics is clearly one of the key ones, the ability to use the tools that you love but on the platform that you trust.

Most organizations are interested in deploying a single version of the truth. Now with MicroStrategy 2019, we can offer them the go to do that and yet keep their existing tools like Tableau or Power BI while they deploy MicroStrategy datasets, and we're really excited about the federated analytics potential. Transformational mobility is another unique offering that we have because we're offering the ability to very rapidly deploy mobile applications that may also have custom functionality or transactional characteristics embedded in them. And that supports the digital transformation that most enterprises are seeking to go through.

And then the third major unique selling point of the MicroStrategy 2019 platform is HyperIntelligence. And HyperIntelligence is more than just a feature. It's certainly more than just a unique attribute or a unique solution. HyperIntelligence represents the next wave of enterprise intelligence. And indeed, it's truly the beginning of a paradigm shift. If we look back to the founding year of the company, 1989, it was the beginning of a wave of PC intelligence, and the exciting thing was using personal computers with graphical interfaces in order to deploy intelligence throughout enterprises. And for 10 years, we saw lots and lots of innovation and expansion and growth in the PC intelligence era. And by about 1999, we moved into the web intelligence era. And people started thinking about deploying intelligence apps using web browsers. And that opened up a lot of new use cases and a lot of new constituencies and new projects. And we saw another 10 years of very strong growth in the industry up until 2009. And 2009 was the beginning of the mobile intelligence era with the advent of iOS and android and mobile devices starting to get embraced by enterprises. And now, we are in 2019. Each of these previous eras has been about 10 years. Now we're moving in an era of HyperIntelligence. And HyperIntelligence is profound and very interesting because it's technology that gives you the answer to the question before you knew to ask the question. And it's technology that gives you the answer to the question within seconds instead of minutes, hours, days or weeks. And so as you inject intelligence into much more routine operational business processes, you find new constituencies, new use cases, new executive sponsors and new value propositions. I don't think this is going to be a simple feature. I don't think it's going to be a 1 or 2 year fad. I think the era of HyperIntelligence is going to go on for the next decade just like these previous waves. And MicroStrategy 2019 positions us uniquely to take advantage of this trend. We're arriving to this stage of the marketplace early and with a mature product that's enterprise-grade. And so certainly HyperIntelligence will be a big part of our marketing theme. And as the rest of the marketplace starts to realize just how powerful this is, I think this will be good for all of us.

As we go into 2019, in addition to accentuating federated analytics, transformational mobility and HyperIntelligence, we also have a very powerful cloud offering on either AWS or Azure. And I think that the trend of the marketplace to embrace the public cloud sources, like AWS and Azure, is going to be a good one for us. We've really focused on an enterprise-grade, open, flexible architecture for taking advantage of these public cloud sources. And we're getting good feedback from our customers. Those of them that weren't enthusiastic in the early days of cloud or didn't want a single source are a lot more interested now that they have choices. And their cloud offerings are more mature.

As I look forward, my agenda for 2019 is, first and foremost, to market the MicroStrategy 2019 product offering to all of our customers and to all of our prospects and make sure that they understand the kind of unique solutions that we can bring to bear. Our second agenda item is to aggressively move to upgrade our customers and pilot the new capabilities of MicroStrategy 2019 across the customer base and the prospect base, so that people can touch and feel and see with their own eyes the kind of value we can bring to bear with this new technology. The third agenda item is to sell new products and services, and the MicroStrategy 2019 product offers some new product lines like the HyperCard client that we believe we can begin to license to our existing customers and to prospects, and new application clients and new mobile clients and so -- and new platform software and servers for the various public cloud platforms like AWS and Azure. So we have new product to sell, and we have new services to offer in conjunction with those products. And we intend to sell both. And finally, when we take all of this in its entirety, the goal, of course, is to grow revenue and margin.

And so with that, I would like to go ahead and open up the floor for questions from the analysts.

[Operator]

[Operator Instructions]. And our first question comes from the line of Karl Keirstead with Deutsche Bank.

[Austin Dietz, Deutsche Bank]

This is Austin Dietz on for Karl. Phong, I had a couple questions for you. Just first on the 2019 platform release, was there any pause in customer buying ahead of the early 2019 platform release this quarter? And then second, how should we think about the revenue contribution or a revenue lift from the 2019 platform release? Could it be a little bit more pronounced than the first half? Perhaps, if there is one, would it be a little more, kind of, gradual, kind of, throughout the year? And then I had a follow-up.

[Phong Le, Senior EVP, COO & CFO]

Austin, thanks for the question. I think it's fair to say that in the second half of 2018, we saw some customers who may have taken a little time on their purchasing decision to see the 2019 platform and test it out. I don't know that I can quantify the amount that, that impacted our second half revenue in 2018. As far as 2019 goes, we started to aggressively market our 2019 product starting on January 7, which was our external launch. We have our MicroStrategy world event coming up next week in Phoenix, Arizona, which is another major milestone for us to be able to communicate to our customers about the 2019 platform. And so I'd expect over the course of the year, as we upgrade customers and we get our marketing message out, that we should see uplift in terms of our product license revenue.

[Austin Dietz, Deutsche Bank]

I agree. And then the domestic product license business, I think it had been declining plus 20% in the past few quarters, but certainly it flipped this quarter. So maybe just what seemed to change, kind of, in the quarter, what you'd maybe call out there?

[Phong Le, Senior EVP, COO & CFO]

We had good large deal activity in North America. And it obviously was a positive for us to see that business start to rebound. I wouldn't call out anything specific about Q4. I think we're starting to see the team get their legs back underneath them and see some of the leadership hires and some of the management hires and account executives that we brought in, whether it'd be 12 or 24 months ago, start to see their traction take place. So overall, it was a positive quarter for North America for sure.

[Operator]

[Operator Instructions]. And our next question comes from the line of Tyler Radke with Citi.

[Tyler Radke, Citigroup]

Phong or Michael, I was wondering if you could comment on your outlook for 2019. Do you -- you've obviously made a lot of investments. Your headcount is up nicely. It sounds like you're getting things going in terms of execution here in North America. And you have a major product release coming. So what can we expect in terms of license revenue growth in 2019?

[Phong Le, Senior EVP, COO & CFO]

Yes, I think, Tyler, as I mentioned in my prepared remarks and Mike reiterated, we're very optimistic about the prospects for the year 2019 for some of the reasons you mentioned. 2018 was, as we had stated at the beginning of the year, our investment year. And you saw that both in our cost and our operating income. As I think we entered 2019, we're looking to grow product license revenue, frankly, revenue across all our major line items. I'm not going to comment specifically as to the magnitude of the growth. But we did mention we'd like to see revenue grow for the overall business. And we'll start to see operating margin expansion as our investment activity and our investment acceleration that you saw in 2018 start to scale back a little bit.

[Tyler Radke, Citigroup]

Great. And a follow-up on maintenance revenue. I know you talked about some invoicing delays and changes based on the new system as well as some currency headwinds. I'm just curious from a -- if we look at deferred maintenance revenue, it looks like that was down, on a year-over-year basis, kind of for three quarters now. Is there any way you can, kind of, quantify what those impacts were? I mean, what would have maintenance revenue or maintenance deferred grown excess in tax? And do you expect maintenance revenue to return to a growth rate -- nice growth rate next year?

[Phong Le, Senior EVP, COO & CFO]

Yes, I think on a constant currency basis, Tyler, for the full year, we saw our maintenance revenues grow by about 2% year-over-year on a full year basis. And any particular quarter, there's some ups and downs related to when we close large maintenance deals. So I wouldn't read too much into the fact that we were, on a constant currency basis, flat year-over-year in Q4. And your question in terms of deferred product support revenue and deferred revenue overall, there were two main factors that I stated. One is a portion of that deferred revenue that's in foreign currency saw a depreciation just due to the strengthening of the dollar. And the second piece, as I mentioned, is related to a system that we put in place that caused us to delay a little bit our ability to send out quotes and invoice, and as a result, put deferred revenue on the balance. I don't expect that to be a long-term effect. So I don't expect it to affect our ability to collect the maintenance from our customers and ultimately, recognize and receive product support revenue. But I think over the course of the first half of the year, 2019, you'll see that amount start to stabilize on a year-over-year basis again.

[Tyler Radke, Citigroup]

Okay. And last question for me. I know you addressed briefly the buyback in the quarter. But just curious what the motivation was behind that. I think in the past you've talked about potentially deploying capital as you get more confidence in the business and the business stabilizing. So curious what you're seeing there. And what your outlook for buybacks going forward is?

[Phong Le, Senior EVP, COO & CFO]

It's a good question, Tyler. And I appreciate the curiosity. As you know and we've talked about in the past, there's quite a few different factors that would address our decision making on the buyback, and I wouldn't point to any particular factor. I mean, the most important part is, we wanted to return capital to our investors. And so that's what we did, and you'll see in our 10-K a more fulsome disclosure on that as we file that and in future SEC filings.

[Operator]

And ladies and gentlemen, this concludes today's Q&A session. I would now like to turn the call back over to Mr. Saylor for any closing remarks.

[Michael Saylor, Chairman, CEO & President]

I'd like to thank everybody for being with us today, and we appreciate your support. We look forward to speaking with you again in three months. All the best.

[Operator]

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