mstr-10q_20180630.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2018

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to           

Commission File Number 000-24435

MICROSTRATEGY INCORPORATED

(Exact name of registrant as specified in its charter)

Delaware

(State or other jurisdiction of incorporation or organization)

51-0323571

(I.R.S. Employer

Identification Number)

1850 Towers Crescent Plaza, Tysons Corner, VA

(Address of Principal Executive Offices)

22182

(Zip Code)

(703) 848-8600

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer

 

Accelerated filer

Non-accelerated filer

(Do not check if a smaller reporting company)

Smaller reporting company

 

 

 

Emerging growth company

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  

The number of shares of the registrant’s class A common stock and class B common stock outstanding on July 16, 2018 was 9,432,210 and 2,035,184, respectively.

 

 


MICROSTRATEGY INCORPORATED

FORM 10-Q

TABLE OF CONTENTS

 

 

 

 

Page

PART I.

 

FINANCIAL INFORMATION

 

 

 

 

 

Item 1.

 

Financial Statements (unaudited)

1

 

 

 

 

 

 

Consolidated Balance Sheets as of June 30, 2018 and December 31, 2017

1

 

 

 

 

 

 

Consolidated Statements of Operations for the Three Months Ended June 30, 2018 and 2017

2

 

 

 

 

 

 

Consolidated Statements of Operations for the Six Months Ended June 30, 2018 and 2017

3

 

 

 

 

 

 

Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2018 and 2017

4

 

 

 

 

 

 

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2018 and 2017

5

 

 

 

 

 

 

Notes to Consolidated Financial Statements

6

 

 

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

20

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

35

 

 

 

 

Item 4.

 

Controls and Procedures

36

 

 

 

 

PART II.

 

OTHER INFORMATION

 

 

 

 

 

Item 1.

 

Legal Proceedings

37

 

 

 

 

Item 1A.

 

Risk Factors

37

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

49

 

 

 

 

Item 5.

 

Other Information

49

 

 

 

 

Item 6.

 

Exhibits

49

 

 

 

 


PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

MICROSTRATEGY INCORPORATED

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

 

 

 

June 30,

 

 

December 31,

 

 

 

2018

 

 

2017

 

 

 

(unaudited)

 

 

(as adjusted, unaudited)

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

90,427

 

 

$

420,244

 

Restricted cash

 

 

964

 

 

 

938

 

Short-term investments

 

 

609,167

 

 

 

254,927

 

Accounts receivable, net

 

 

125,115

 

 

 

165,364

 

Prepaid expenses and other current assets

 

 

27,863

 

 

 

19,180

 

Total current assets

 

 

853,536

 

 

 

860,653

 

Property and equipment, net

 

 

51,918

 

 

 

53,359

 

Capitalized software development costs, net

 

 

0

 

 

 

2,499

 

Deposits and other assets

 

 

7,112

 

 

 

7,411

 

Deferred tax assets, net

 

 

14,761

 

 

 

9,297

 

Total assets

 

$

927,327

 

 

$

933,219

 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable and accrued expenses

 

$

22,670

 

 

$

30,711

 

Accrued compensation and employee benefits

 

 

38,617

 

 

 

41,498

 

Deferred revenue and advance payments

 

 

175,358

 

 

 

198,734

 

Total current liabilities

 

 

236,645

 

 

 

270,943

 

Deferred revenue and advance payments

 

 

5,816

 

 

 

6,400

 

Other long-term liabilities

 

 

64,503

 

 

 

50,146

 

Deferred tax liabilities

 

 

4

 

 

 

4

 

Total liabilities

 

 

306,968

 

 

 

327,493

 

Commitments and Contingencies

 

 

 

 

 

 

 

 

Stockholders' Equity

 

 

 

 

 

 

 

 

Preferred stock undesignated, $0.001 par value; 5,000 shares authorized; no shares issued or outstanding

 

 

0

 

 

 

0

 

Class A common stock, $0.001 par value; 330,000 shares authorized; 15,837 shares issued and 9,432 shares outstanding, and 15,817 shares issued and 9,412 shares outstanding, respectively

 

 

16

 

 

 

16

 

Class B convertible common stock, $0.001 par value; 165,000 shares authorized; 2,035 shares issued and outstanding, and 2,035 shares issued and outstanding, respectively

 

 

2

 

 

 

2

 

Additional paid-in capital

 

 

570,502

 

 

 

559,918

 

Treasury stock, at cost; 6,405 shares

 

 

(475,184

)

 

 

(475,184

)

Accumulated other comprehensive loss

 

 

(8,111

)

 

 

(5,659

)

Retained earnings

 

 

533,134

 

 

 

526,633

 

Total stockholders' equity

 

 

620,359

 

 

 

605,726

 

Total liabilities and stockholders' equity

 

$

927,327

 

 

$

933,219

 

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

 

1


MICROSTRATEGY INCORPORATED

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

 

 

 

Three Months Ended

 

 

 

June 30,

 

 

 

2018

 

 

2017

 

 

 

(unaudited)

 

 

(as adjusted, unaudited)

 

Revenues:

 

 

 

 

 

 

 

 

Product licenses

 

$

19,292

 

 

$

17,728

 

Subscription services

 

 

7,584

 

 

 

8,346

 

Total product licenses and subscription services

 

 

26,876

 

 

 

26,074

 

Product support

 

 

73,676

 

 

 

70,766

 

Other services

 

 

20,050

 

 

 

22,380

 

Total revenues

 

 

120,602

 

 

 

119,220

 

Cost of revenues:

 

 

 

 

 

 

 

 

Product licenses

 

 

1,667

 

 

 

1,747

 

Subscription services

 

 

3,445

 

 

 

3,400

 

Total product licenses and subscription services

 

 

5,112

 

 

 

5,147

 

Product support

 

 

4,810

 

 

 

4,542

 

Other services

 

 

15,118

 

 

 

14,686

 

Total cost of revenues

 

 

25,040

 

 

 

24,375

 

Gross profit

 

 

95,562

 

 

 

94,845

 

Operating expenses:

 

 

 

 

 

 

 

 

Sales and marketing

 

 

50,978

 

 

 

41,626

 

Research and development

 

 

25,082

 

 

 

19,561

 

General and administrative

 

 

21,299

 

 

 

19,582

 

Total operating expenses

 

 

97,359

 

 

 

80,769

 

(Loss) income from operations

 

 

(1,797

)

 

 

14,076

 

Interest income, net

 

 

3,223

 

 

 

1,163

 

Other income (expense), net

 

 

4,461

 

 

 

(2,618

)

Income before income taxes

 

 

5,887

 

 

 

12,621

 

Provision for income taxes

 

 

1,059

 

 

 

2,668

 

Net income

 

 

4,828

 

 

 

9,953

 

Basic earnings per share (1)

 

$

0.42

 

 

$

0.87

 

Weighted average shares outstanding used in computing basic earnings per share

 

 

11,459

 

 

 

11,444

 

Diluted earnings per share (1)

 

$

0.42

 

 

$

0.86

 

Weighted average shares outstanding used in computing diluted earnings per share

 

 

11,493

 

 

 

11,592

 

 

(1)

Basic and fully diluted earnings per share for class A and class B common stock are the same.

The accompanying notes are an integral part of these Consolidated Financial Statements.


2


MICROSTRATEGY INCORPORATED

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2018

 

 

2017

 

 

 

(unaudited)

 

 

(as adjusted, unaudited)

 

Revenues:

 

 

 

 

 

 

 

 

Product licenses

 

$

36,593

 

 

$

40,374

 

Subscription services

 

 

15,246

 

 

 

16,118

 

Total product licenses and subscription services

 

 

51,839

 

 

 

56,492

 

Product support

 

 

148,091

 

 

 

141,278

 

Other services

 

 

43,639

 

 

 

43,682

 

Total revenues

 

 

243,569

 

 

 

241,452

 

Cost of revenues:

 

 

 

 

 

 

 

 

Product licenses

 

 

3,878

 

 

 

3,419

 

Subscription services

 

 

6,694

 

 

 

6,439

 

Total product licenses and subscription services

 

 

10,572

 

 

 

9,858

 

Product support

 

 

9,606

 

 

 

8,876

 

Other services

 

 

30,047

 

 

 

28,773

 

Total cost of revenues

 

 

50,225

 

 

 

47,507

 

Gross profit

 

 

193,344

 

 

 

193,945

 

Operating expenses:

 

 

 

 

 

 

 

 

Sales and marketing

 

 

102,313

 

 

 

81,208

 

Research and development

 

 

48,642

 

 

 

37,987

 

General and administrative

 

 

43,471

 

 

 

39,839

 

Total operating expenses

 

 

194,426

 

 

 

159,034

 

(Loss) income from operations

 

 

(1,082

)

 

 

34,911

 

Interest income, net

 

 

5,257

 

 

 

2,000

 

Other income (expense), net

 

 

2,867

 

 

 

(4,474

)

Income before income taxes

 

 

7,042

 

 

 

32,437

 

Provision for income taxes

 

 

541

 

 

 

6,927

 

Net income

 

 

6,501

 

 

 

25,510

 

Basic earnings per share (1)

 

$

0.57

 

 

$

2.23

 

Weighted average shares outstanding used in computing basic earnings per share

 

 

11,453

 

 

 

11,441

 

Diluted earnings per share (1)

 

$

0.57

 

 

$

2.20

 

Weighted average shares outstanding used in computing diluted earnings per share

 

 

11,488

 

 

 

11,593

 

 

(2)

Basic and fully diluted earnings per share for class A and class B common stock are the same.

 

The accompanying notes are an integral part of these Consolidated Financial Statements

 

3


MICROSTRATEGY INCORPORATED

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

 

 

 

Three Months Ended

 

 

 

June 30,

 

 

 

2018

 

 

2017

 

 

 

(unaudited)

 

 

(as adjusted, unaudited)

 

Net income

 

$

4,828

 

 

$

9,953

 

Other comprehensive income, net of applicable taxes:

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

 

(3,892

)

 

 

2,257

 

Total other comprehensive (loss) income

 

 

(3,892

)

 

 

2,257

 

Comprehensive income

 

$

936

 

 

$

12,210

 

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2018

 

 

2017

 

 

 

(unaudited)

 

 

(as adjusted, unaudited)

 

Net income

 

$

6,501

 

 

$

25,510

 

Other comprehensive income, net of applicable taxes:

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

 

(2,452

)

 

 

3,305

 

Unrealized loss on short-term investments

 

 

0

 

 

 

(30

)

Total other comprehensive (loss) income

 

 

(2,452

)

 

 

3,275

 

Comprehensive income

 

$

4,049

 

 

$

28,785

 

 

 

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

 

4


MICROSTRATEGY INCORPORATED

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

 

 

Six Months Ended

 

 

 

June 30,

 

 

 

2018

 

 

2017

 

 

 

(unaudited)

 

 

(as adjusted, unaudited)

 

Operating activities:

 

 

 

 

 

 

 

 

Net income

 

$

6,501

 

 

$

25,510

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

3,870

 

 

 

8,540

 

Bad debt expense

 

 

948

 

 

 

1,835

 

Deferred taxes

 

 

(5,758

)

 

 

(3,654

)

Share-based compensation expense

 

 

8,121

 

 

 

6,889

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

5,044

 

 

 

16,033

 

Prepaid expenses and other current assets

 

 

453

 

 

 

(992

)

Deposits and other assets

 

 

(344

)

 

 

(275

)

Accounts payable and accrued expenses

 

 

(7,775

)

 

 

(15,472

)

Accrued compensation and employee benefits

 

 

(3,015

)

 

 

(10,712

)

Deferred revenue and advance payments

 

 

10,502

 

 

 

11,058

 

Other long-term liabilities

 

 

4,780

 

 

 

(1,647

)

Net cash provided by operating activities

 

 

23,327

 

 

 

37,113

 

Investing activities:

 

 

 

 

 

 

 

 

Proceeds from redemption of short-term investments

 

 

245,680

 

 

 

151,860

 

Purchases of property and equipment

 

 

(2,644

)

 

 

(1,467

)

Purchases of short-term investments

 

 

(596,376

)

 

 

(216,602

)

Net cash used in investing activities

 

 

(353,340

)

 

 

(66,209

)

Financing activities:

 

 

 

 

 

 

 

 

Proceeds from sale of class A common stock under exercise of employee stock options

 

 

2,471

 

 

 

1,677

 

Payments on capital lease obligations and other financing arrangements

 

 

(9

)

 

 

(12

)

Net cash provided by financing activities

 

 

2,462

 

 

 

1,665

 

Effect of foreign exchange rate changes on cash, cash equivalents, and restricted cash

 

 

(2,240

)

 

 

5,246

 

Net decrease in cash, cash equivalents, and restricted cash

 

 

(329,791

)

 

 

(22,185

)

Cash, cash equivalents and restricted cash, beginning of period

 

 

421,182

 

 

 

402,712

 

Cash, cash equivalents and restricted cash, end of period

 

$

91,391

 

 

$

380,527

 

 

The accompanying notes are an integral part of these Consolidated Financial Statements.

 

 

 

5


MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(1) Summary of Significant Accounting Policies

(a)

Basis of Presentation

The accompanying Consolidated Financial Statements of MicroStrategy Incorporated (“MicroStrategy” or the “Company”) are unaudited.  In the opinion of management, all adjustments necessary for a fair statement of financial position and results of operations have been included.  All such adjustments are of a normal recurring nature, unless otherwise disclosed.  Interim results are not necessarily indicative of results for a full year.

Certain amounts in the prior year’s Consolidated Financial Statements have been restated upon the adoption of Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) and its subsequent amendments (“ASU 2014-09”), as discussed in Note 2, Recent Accounting Standards, to the Consolidated Financial Statements.  

The Consolidated Financial Statements and Notes to Consolidated Financial Statements are presented as required by the United States Securities and Exchange Commission (“SEC”) and do not contain certain information included in the Company’s annual financial statements and notes.  These financial statements should be read in conjunction with the Company’s audited financial statements and the notes thereto filed with the SEC in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.  There have been no significant changes in the Company’s accounting policies since December 31, 2017, except as discussed below with respect to the Company’s adoption of ASU 2014-09.

The accompanying Consolidated Financial Statements include the accounts of the Company and its subsidiaries.  All significant intercompany accounts and transactions have been eliminated in consolidation.  The Company is not aware of any subsequent event which would require recognition or disclosure.

(b) Revenue Recognition

The Company adopted ASU 2014-09 effective as of January 1, 2018 and has adjusted its prior period consolidated financial statements to reflect full retrospective adoption.  Refer to Note 2, Recent Accounting Standards, to the Consolidated Financial Statements for a summary of the significant changes in accounting principles and the impact to the Company’s previously reported consolidated financial statements.

Under ASU 2014-09, the Company recognizes revenue using a five-step model:

 

(i)

Identifying the contract(s) with a customer,

 

(ii)

Identifying the performance obligation,

 

(iii)

Determining the transaction price,

 

(iv)

Allocating the transaction price to the performance obligations in the contract, and

 

(v)

Recognizing revenue when, or as, the Company satisfies a performance obligation.

The Company has elected to exclude taxes assessed by government authorities in determining the transaction price, and therefore revenue is recognized net of taxes collected from customers.

Performance Obligations and Timing of Revenue Recognition

The Company primarily sells goods and services that fall into the categories discussed below. Each category contains one or more performance obligations that are either (i) capable of being distinct (i.e., the customer can benefit from the good or service on its own or together with readily available resources, including those purchased separately from the Company) and distinct within the context of the contract (i.e., separately identifiable from other promises in the contract), or (ii) a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer.  Aside from the Company’s term and perpetual software licenses, which are delivered at a point in time, the majority of the Company’s other services are delivered over time.

6


MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Product Licenses

The Company sells different types of on-premise business intelligence software, licensed on a term or perpetual basis.  Although license arrangements are sold with product support, the software is fully functional at the outset of the arrangement and is considered a distinct performance obligation.  Revenue from product license sales is recognized when control of the software license has transferred to the customer, which is the later of delivery or commencement of the license term.  The Company may also sell through resellers and original equipment manufacturers (“OEMs”) who purchase the Company’s products for resale.  In reseller arrangements, revenue is recognized when control of the product is transferred to the end user.  In OEM arrangements, revenue is recognized upon delivery to the OEM.

Subscription Services

The Company also sells access to its software through a subscription-based cloud offering, wherein customers access the software through a third-party hosting service. Control of the software itself does not transfer to the customer under this arrangement and is not considered a separate performance obligation.  Subscription services are regularly sold on a standalone basis with telephone support only.  Revenue related to this subscription service is recognized on a straight-line basis over the contract period, which is the period over which the customer has continuous access to the software.

Product Support

In all license arrangements, customers are required to purchase a standard product support package and may also purchase a premium product support package for a fixed annual fee.  All product support packages include both technical support and when-and-if-available software upgrades, which are treated as a single performance obligation as they are considered a series of distinct services that are substantially the same and have the same duration and measure of progress.  Revenue from product support is recognized on a straight-line basis over the contract period, which is the period over which the customer has continuous access to product support.

Consulting Services

The Company sells consulting services to help customers plan and execute deployment of the Company’s software.  Customers are not required to use consulting services to fully benefit from the software license.  Consulting services are regularly sold on a standalone basis and either (i) prepaid upfront or (ii) sold on a time and materials basis.  Consulting arrangements are each considered separate performance obligations because they do not integrate with each other or with other products and services to deliver a combined output to the customer, do not modify or customize (or are not modified or customized by) each other or other products and services, and do not affect the customer’s ability to use the other consulting offerings or other products and services.  Revenue under consulting arrangements is recognized over time as services are delivered.  For time and materials-based consulting arrangements, the Company has elected the practical expedient of recognizing revenue upon invoicing since the invoiced amount corresponds directly to the value of the Company’s service to date.  

Education Services

The Company sells various education and training services to its customers. Education services are sold on a standalone basis under three different arrangements: (i) prepaid bulk training units that may be redeemed on training courses based on standard redemption rates, (ii) an annual subscription to unlimited training courses, and (iii) individual courses purchased a la carte.  Education arrangements are each considered separate performance obligations because they do not integrate with each other or with other products and services to deliver a combined output to the customer, do not modify or customize (or are not modified or customized by) each other or other products and services, or affect the customer’s ability to use the other education offerings or other products and services. Revenue on prepaid bulk training units and individual course purchases are recognized when the courses are delivered. Revenue on the annual subscription is recognized on a straight-line basis over the contract period, which is the period over which the customer has continuous access to unlimited training courses.

Refer to Note 10, Segment Information, to the Consolidated Financial Statements for information regarding total revenues by geographic region.

7


MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Significant Judgments and Estimates

The adoption of ASU 2014-09 requires the Company to make significant judgments to determine the transaction price of a contract and subsequently allocate the transaction price based on an estimated standalone selling price (“SSP”). The Company is also required to make significant judgements with respect to capitalizing incremental costs to obtain a customer contract and determining the subsequent amortization period. These significant judgments and estimates are discussed further below.

Determining the Transaction Price

The transaction price includes both fixed and variable consideration. Variable consideration is included in the transaction price to the extent it is probable that a significant reversal will not occur.  The amount of variable consideration excluded from the transaction price was not material for the three and six months ended June 30, 2018 and 2017. The Company’s estimates of variable consideration are also subject to subsequent true-up adjustments and may result in changes to its transaction prices, but such true-up adjustments are not expected to be material.  The Company has the following sources of variable consideration:

 

 

(i)

Performance penalties – Subscription services and product support arrangements generally contain performance response time guarantees. For subscription services arrangements, the Company estimates variable consideration using a portfolio approach because performance penalties are tied to standard up-time requirements.  For product support arrangements, the Company estimates variable consideration on a contract basis because such arrangements are customer-specific.  For both subscription services and product support arrangements, the Company uses an expected value approach to estimate variable consideration based on historical business practices and current and future performance expectations to determine the likelihood of incurring penalties.

 

 

(ii)

Extended payment terms – The Company’s standard payment terms are generally within 180 days of invoicing. If extended payment terms are granted to customers, those terms generally do not exceed one year. For contracts with extended payment terms, the Company estimates variable consideration on a contract basis because such estimates are customer-specific, and uses an expected value approach to analyze historical business experience on a customer-by-customer basis to determine the likelihood that extended payment terms lead to an implied price concession.

 

 

(iii)

Sales and usage-based royalties – Certain product license arrangements include sales or usage-based royalties, covering both the software license and product support.  In these arrangements, the Company uses an expected value approach to estimate and recognize revenue for royalty sales each period, utilizing historical data on a contract-by-contract basis.  True-up adjustments are recorded in subsequent periods when royalty reporting is received from the OEM partners.  

 

The Company provides a standard software assurance warranty to repair, replace, or refund software that does not perform in accordance with documentation. The standard software assurance warranty period is generally less than one year.  Assurance warranty claims were not material for the three and six months ended June 30, 2018 and 2017.

 

The Company does not adjust the transaction price for significant financing components where the time period between cash payment and performance is one year or less.  However, there are circumstances where the timing between cash payment and performance may exceed one year.  These circumstances generally involve prepaid multi-year product support and subscription services arrangements where the customer determines when the service is utilized (e.g., when to request on-call support services or when to use and access the software on the cloud).  In these circumstances, the Company has determined no significant financing component exists because the customer controls when to utilize the service and because there are significant business purposes behind the timing difference between payment and performance (e.g., maximizing profit in the case of product support services and ensuring collectability in the case of subscription services).

Allocating the Transaction Price Based on Standalone Selling Prices

The Company allocates the transaction price to each performance obligation in a contract based on its relative SSP.  The SSP is the price at which the Company sells the product or service on a standalone basis at contract inception.  In circumstances where SSP is not directly observable, the Company estimates SSP using the following methodologies:

 

 

(i)

Product licenses – Product licenses are not sold on a standalone basis and pricing is highly variable.  The Company establishes SSP of product licenses using a residual approach after first establishing the SSP of standard product support.  Standard product support is sold on a standalone basis within a narrow range of the net license fee, and because an economic relationship exists between product licenses and standard product support, the Company has concluded that the residual method to estimate SSP of product licenses sold on both a perpetual and term basis is a fair allocation of the transaction price.

8


MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

 

 

(ii)

Subscription services – Given the highly variable selling price of subscription services, the Company establishes the SSP of its subscription services arrangements using a similar residual approach after first establishing the SSP of consulting and education services. The Company has concluded that the residual method to estimate SSP of its subscription services is a fair allocation of the transaction price.

 

 

(iii)

Standard product support – The Company establishes SSP of standard product support as a percentage of the stated net license fee, given such pricing is consistent with its normal pricing practices and there exists sufficient history of customers renewing at similar percentages.  Each quarter, the Company tracks renewal rates negotiated when standard product support is initially sold with a perpetual license in order to determine the SSP of standard product support within each geographic region for the upcoming quarter. If the stated standard product support fee falls within the SSP range, the specific rate in the contract will be used to estimate SSP. If the stated fee is above or below SSP, the highest or lowest end of the range, respectively, will generally be used to estimate SSP of standard product support.

 

 

(iv)

Premium product support, consulting services, and education services –SSP of premium product support, consulting services, and education services is established by using a bell-shaped curve approach to define a narrow range within each geographic region in which the services are discounted off of the list price on a standalone basis.

The Company often provides options to purchase future products or services at a discount. The Company analyzes the option price against the previously established SSP of the goods or services to determine if the options represent material rights that should be accounted for as separate performance obligations.  In general, options sold at or above SSP are not considered separate performance obligations because the customer could have received that right without entering into the contract.  If a material right exists, revenue associated with the option is recognized when the future goods or services are transferred, or when the option expires. During the three and six months ended June 30, 2018 and 2017, rights arising from future purchase options have not been material.

 

Incremental Costs to Obtain Customer Contracts

 

Incremental costs incurred to obtain contracts with customers include certain variable compensation (e.g., commissions and bonuses) paid to the Company’s sales team.  Although the Company may bundle its goods and services into one contract, commissions are individually determined on each distinct good or service in the contract.  The Company expenses as incurred those amounts earned on consulting and education services, which are generally performed within a one-year period and primarily sold on a standalone basis. The Company also expenses as incurred those amounts earned on product license sales, since the amount is earned when the license is delivered. The Company capitalizes those amounts earned on product support and amortizes the costs over a period of time that is consistent with the pattern of transfer of the product support to the customer, which the Company has determined to be a period of three years. Although the Company typically sells product support for a period of one year, a majority of customers renew their product support arrangements.  Three years is generally the period after which platforms are no longer supported by the Company's support team and when customers generally choose to upgrade their software platform.  The Company does not pay variable compensation on product support renewals.  Variable compensation earned on subscription cloud services are expensed as incurred due to their immaterial nature. As of June 30, 2018 and December 31, 2017, capitalized costs to obtain customer contracts, net of accumulated amortization, were $4.0 million and $4.5 million, respectively, and are presented within “Deposits and other assets” in the Consolidated Balance Sheets.  During the three and six months ended June 30, 2018 and 2017, amortization expense related to these capitalized costs were $0.4 million and $1.1 million, and $0.7 million and $1.4 million, respectively.  

 

 

(2) Recent Accounting Standards

Revenue from contracts with customers

The Company adopted ASU 2014-09 effective as of January 1, 2018 and adjusted prior period consolidated financial statements to reflect full retrospective adoption.  In adopting ASU 2014-09, the Company has made the following significant changes in accounting principles:

 

(i)

Timing of revenue recognition for term license sales. Under ASU 2014-09, the Company now recognizes product licenses revenue from term licenses upon delivery of the software.  Previously, this revenue was recognized over the term of the arrangement.

9


MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

 

(ii)

Timing of revenue recognition for sales to channel partners.  Under ASU 2014-09, the Company now recognizes revenue from sales made to OEMs when control of the products transfers to the OEM, less adjustments for returns or price protection.  Previously, this revenue was not recognized until the product was sold by the OEM to the end user. Revenue from sales made to resellers continues to be recognized when control of the product has transferred to the end user.

 

(iii)

Allocating the transaction price to the performance obligations in the contract.  Under ASU 2014-09, the Company will allocate the transaction price to the various performance obligations in the contract based on their relative SSP.  Except for SSP of product support, the Company’s methodologies for estimating SSP of its various performance obligations are generally consistent with the Company’s previous methodologies used to establish vendor specific objective evidence of fair value on multiple element arrangements.  The SSP of product support will result in a difference in the allocation of the transaction price between product support and product license performance obligations. The impact from SSP-based allocations was not material to the Company’s prior or current period financial statements and is not expected to be material in future periods.

 

(iv)

Material rights. The Company’s contracts with customers may include options to acquire additional goods and services at a discount.  Under ASU 2014-09, certain of these options may be considered material rights if sold below SSP and would be treated as separate performance obligations and included in the allocation of the transaction price. Previously, none of the Company’s options were considered material rights. The impact from material rights was not material to the Company’s prior or current period financial statements and is not expected to be material in future periods.

 

(v)

Presentation of accounts receivable, contract assets, and contract liabilities (deferred revenue). Under ASU 2014-09, the Company’s rights to consideration are presented separately depending on whether those rights are conditional (“contract assets”) or unconditional (“accounts receivable”). See Note 4, Contract Balances, to the Consolidated Financial Statements for further discussion on balance sheet presentation.  Under ASU 2014-09, the Company cannot net accounts receivable with contract liabilities (“deferred revenue”) and the Company no longer offsets its accounts receivable and deferred revenue balances for unpaid items that are included in the deferred revenue balance. Previously, this offsetting of accounts receivable and deferred revenue balances for unpaid amounts was applied in the Company’s prior period financial statements.

 

(vi)

Deferral of incremental direct costs to obtaining a contract with a customer.  Under ASU 2014-09, the Company now capitalizes certain variable compensation payable to its sales force and subsequently amortizes the capitalized costs over a period of time that is consistent with the transfer of the related good or service to the customer, which the Company has determined to be three years. Previously, the Company elected to expense these incremental direct costs as incurred.

Upon adoption of ASU 2014-09, the Company recorded a cumulative $13.0 million increase to its 2016 beginning retained earnings balance, offset by a $12.9 million decrease in gross deferred revenues, a $5.2 million decrease in deferred tax assets, net of deferred tax liabilities, a $4.4 million increase in other non-current assets, and a $0.9 million increase in other current assets.

The following line items as of December 31, 2017 and for the three and six months ended June 30, 2017 have been adjusted in the Consolidated Financial Statements to reflect the adoption of ASU 2014-09:

 

 

December 31, 2017

 

Consolidated Balance Sheet

As Reported (audited)

 

 

Effect of the Adoption of ASU 2014-09 (unaudited)

 

 

As Adjusted (unaudited)

 

Accounts receivable, net

$

69,500

 

 

$

95,864

 

 

$

165,364

 

Prepaid expenses and other current assets

 

18,002

 

 

 

1,178

 

 

 

19,180

 

Deposits and other assets

 

2,868

 

 

 

4,543

 

 

 

7,411

 

Deferred tax assets, net

 

13,391

 

 

 

(4,094

)

 

 

9,297

 

Deferred revenue and advance payments

 

112,649

 

 

 

86,085

 

 

 

198,734

 

Deferred revenue and advance payments, non-current

 

10,181

 

 

 

(3,781

)

 

 

6,400

 

Accumulated other comprehensive loss

 

(5,968

)

 

 

309

 

 

 

(5,659

)

Retained earnings

 

511,755

 

 

 

14,878

 

 

 

526,633

 

 

10


MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

 

 

Three Months Ended June 30, 2017

 

Consolidated Statement of Operations:

As Reported (unaudited)

 

 

Effect of the Adoption of ASU 2014-09 (unaudited)

 

 

As Adjusted (unaudited)

 

Product licenses revenue

$

19,118

 

 

$

(1,390

)

 

$

17,728

 

Sales and marketing expenses

 

41,419

 

 

 

207

 

 

 

41,626

 

Provision for income taxes

 

3,142

 

 

 

(474

)

 

 

2,668

 

Net income

 

11,076

 

 

 

(1,123

)

 

 

9,953

 

Diluted earnings per share

 

0.96

 

 

 

(0.10

)

 

 

0.86

 

 

 

Six Months Ended June 30, 2017

 

Consolidated Statement of Operations:

As Reported (unaudited)

 

 

Effect of the Adoption of ASU 2014-09 (unaudited)

 

 

As Adjusted (unaudited)

 

Product licenses revenue

$

40,130

 

 

$

244

 

 

$

40,374

 

Product support revenues

 

141,256

 

 

 

22

 

 

 

141,278

 

Sales and marketing expenses

 

80,829

 

 

 

379

 

 

 

81,208

 

Provision for income taxes

 

6,607

 

 

 

320

 

 

 

6,927

 

Net income

 

25,943

 

 

 

(433

)

 

 

25,510

 

Diluted earnings per share

 

2.24

 

 

 

(0.04

)

 

 

2.20

 

 

 

Three Months Ended June 30, 2017

 

Consolidated Statement of Comprehensive Income:

As Reported (unaudited)

 

 

Effect of the Adoption of ASU 2014-09 (unaudited)

 

 

As Adjusted (unaudited)

 

Net income

$

11,076

 

 

$

(1,123

)

 

$

9,953

 

Foreign currency translation adjustment

 

2,218

 

 

 

39

 

 

 

2,257

 

Comprehensive income

 

13,294

 

 

 

(1,084

)

 

 

12,210

 

 

 

Six Months Ended June 30, 2017

 

Consolidated Statement of Comprehensive Income:

As Reported (unaudited)

 

 

Effect of the Adoption of ASU 2014-09 (unaudited)

 

 

As Adjusted (unaudited)

 

Net income

$

25,943

 

 

$

(433

)

 

$

25,510

 

Foreign currency translation adjustment

 

3,030

 

 

 

275

 

 

 

3,305

 

Comprehensive income

 

28,943

 

 

 

(158

)

 

 

28,785

 

 

 

Six Months Ended June 30, 2017

 

Consolidated Statement of Cash Flows:

As Reported (unaudited)

 

 

Effect of the Adoption of ASU 2014-09 (unaudited)

 

 

As Adjusted (unaudited)

 

Net income

$

25,943

 

 

$

(433

)

 

$

25,510

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

 

7,133

 

 

 

1,407

 

 

 

8,540

 

Deferred taxes

 

(4,015

)

 

 

361

 

 

 

(3,654

)

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

 

 

 

Prepaid expenses and other current assets

 

(699

)

 

 

(293

)

 

 

(992

)

Deposits and other assets

 

(274

)

 

 

(1

)

 

 

(275

)

Accrued compensation and employee benefits

 

(9,685

)

 

 

(1,027

)

 

 

(10,712

)

Deferred revenue and advance payments

 

11,072

 

 

 

(14

)

 

 

11,058

 

 

11


MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Intra-entity asset transfers

In October 2016, the FASB issued Accounting Standards Update No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory (“ASU 2016-16”), to improve the accounting for income tax effects of intra-entity transfers of assets other than inventory. Under ASU 2016-16, the deferral of the income tax consequences of intra-entity transfers of assets other than inventory is eliminated. Entities will be required to recognize the income tax consequences of intra-entity transfers of assets other than inventory when the transfers occur. The standard requires a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption using a modified retrospective approach. The Company adopted this guidance effective as of January 1, 2018.  The adoption of this guidance did not have a material impact on the Company’s consolidated financial position, results of operations, or cash flows.  No cumulative-effect adjustment to retained earnings was made.

Lease accounting

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, Leases (Topic 842) (“ASU 2016-02”), which requires lease assets and lease liabilities be recognized for all leases, in addition to the disclosure of key information to enable users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from an entity’s leasing arrangements.  ASU 2016-02 defines a lease as a contract, or part of a contract, that conveys both (i) the right to obtain economic benefits from and (ii) direct the use of an identified asset for a period of time in exchange for consideration.  Under ASU 2016-02, leases are classified as either finance or operating leases. For finance leases, a lessee shall recognize in profit or loss the amortization of the lease asset and interest on the lease liability.  For operating leases, a lessee shall recognize in profit or loss a single lease cost, calculated so that the remaining cost of the lease is allocated over the remaining lease term, generally on a straight-line basis.  ASU 2016-02 requires the recognition and measurement of leases at the beginning of the earliest period presented using a modified retrospective approach and is effective for interim and annual periods beginning January 1, 2019. Early adoption is permitted. The Company is currently evaluating the impact of this guidance on its consolidated financial position, results of operations, and cash flows and continues to re-evaluate its inventory of leases, including reviewing other contracts for potential embedded leases.  The Company’s current leases are primarily related to office space in the United States and foreign locations and are classified as operating leases under generally accepted accounting principles. The Company plans to elect the package of practical expedients described in ASU 2016-02, which includes not reassessing the lease classification on these existing leases.  The Company has also selected a lease management system and is currently validating the completeness and accuracy of the relevant lease information within the system.

 

 

(3) Short-term Investments

The Company periodically invests a portion of its excess cash in short-term investment instruments.  Substantially all of the Company’s short-term investments are in U.S. Treasury securities, and the Company has the ability and intent to hold these investments to maturity.  The stated maturity dates of these investments are between three months and one year from the purchase date.  These held-to-maturity investments are recorded at amortized cost and included within “Short-term investments” on the accompanying Consolidated Balance Sheets.  The fair value of held-to-maturity investments is determined based on quoted market prices in active markets for identical securities (Level 1 inputs).

The amortized cost, carrying value, and fair value of held-to-maturity investments at June 30, 2018 were $609.2 million, $609.2 million, and $608.6 million, respectively.  The amortized cost, carrying value, and fair value of held-to-maturity investments at December 31, 2017 were $254.9 million, $254.9 million, and $254.8 million, respectively.  The gross unrecognized holding gains and losses were not material for each of the three and six months ended June 30, 2018 and 2017.  No other-than-temporary impairments related to these investments have been recognized as of June 30, 2018 and December 31, 2017.  

 

 

(4) Contract Balances

The Company invoices its customers in accordance with billing schedules established in each contract.  The Company’s rights to consideration from customers are presented separately in the Company’s Consolidated Balance Sheets depending on whether those rights are conditional or unconditional.  

The Company presents unconditional rights to consideration from customers within “Accounts receivable, net” in its Consolidated Balance Sheets.  All of the Company’s contracts are generally non-cancellable and/or non-refundable and therefore an unconditional right generally exists when the customer is billed or amounts are billable per the contract.  

 

12


MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

Accounts receivable (in thousands) consisted of the following, as of:

 

 

 

June 30,

 

 

December 31,

 

 

 

2018

 

 

2017

 

 

 

 

 

 

 

(as adjusted)

 

Billed and billable

 

$

129,034

 

 

$

169,554

 

Less: allowance for doubtful accounts

 

 

(3,919

)

 

 

(4,190

)

Accounts receivable, net

 

$

125,115

 

 

$

165,364

 

 

The Company maintains an allowance for doubtful accounts which represents its best estimate of probable losses inherent in the accounts receivable balances.  The Company evaluates specific accounts when it becomes aware that a customer may not be able to meet its financial obligations due to deterioration of its liquidity or financial viability, credit ratings, or bankruptcy.  In addition, the Company periodically adjusts this allowance based on its review and assessment of the aging of receivables. For the three and six months ended June 30, 2018 and 2017, the Company’s bad debt expense and write-offs totaled $0.8 million and $0.9 million, and $0.8 million and $1.8 million, respectively.

In contrast, rights to consideration that are subject to a condition other than the passage of time are considered contract assets and presented within “Prepaid expenses and other current assets” in the Consolidated Balance Sheets since the rights to consideration are expected to become unconditional and transfer to accounts receivable within one year.  Contract assets generally consist of accrued sales and usage-based royalty revenue.  In these arrangements, consideration is not billed or billable until the royalty reporting is received, generally in the subsequent quarter, at which time the contract asset will transfer to accounts receivable and a true-up adjustment will be recorded to revenue.  During the three and six months ended June 30, 2018 and 2017, there were no significant impairments to the Company’s contract assets, nor were there any significant changes in the timing of the Company’s contract assets being reclassified to accounts receivable. Contract assets included in “Prepaid expenses and other current assets” in the Consolidated Balance Sheets consisted of $0.5 million and $1.2 million in accrued sales and usage-based royalty revenue, as of June 30, 2018 and December 31, 2017, respectively.

Contract liabilities are amounts received or due from customers in advance of the Company transferring the products or services to the customer.  Revenue is subsequently recognized in the period(s) in which control of the products or services are transferred to the customer.  The Company’s contract liabilities are presented as either current or non-current “Deferred revenues and advance payments” in the Consolidated Balance Sheets, depending on whether the products or services are expected to be transferred to the customer within the next year.  

Deferred revenue and advance payments (in thousands) from customers consisted of the following, as of:

 

 

 

June 30,

 

 

December 31,

 

 

 

2018

 

 

2017

 

 

 

 

 

 

 

(as adjusted)

 

Current:

 

 

 

 

 

 

 

 

Deferred product licenses revenue

 

$

1,819

 

 

$

3,760

 

Deferred subscription services revenue

 

 

13,847

 

 

 

17,324

 

Deferred product support revenue

 

 

151,909

 

 

 

168,185

 

Deferred other services revenue

 

 

7,783

 

 

 

9,465

 

Total current deferred revenue and advance payments

 

$

175,358

 

 

$

198,734

 

 

 

 

 

 

 

 

 

 

Non-current:

 

 

 

 

 

 

 

 

Deferred product licenses revenue

 

$

794

 

 

$

820

 

Deferred subscription services revenue

 

 

9

 

 

 

126

 

Deferred product support revenue

 

 

3,950

 

 

 

4,826

 

Deferred other services revenue

 

 

1,063

 

 

 

628

 

Total non-current deferred revenue and advance payments

 

$

5,816

 

 

$

6,400

 

13


MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

During the three and six months ended June 30, 2018 and 2017, the Company recognized revenues of $56.8 million and $131.3 million, and $55.7 million and $130.5 million, respectively, from amounts included in the total current deferred revenue and advance payments balances at the beginning of the respective year.  For the three and six months ended June 30, 2018 and 2017, there were no significant changes in the timing of revenue recognition on the Company’s deferred balances.

As of June 30, 2018, the Company had an aggregate transaction price of $181.2 million allocated to unsatisfied performance obligations related to product support, subscription services, other services, and product licenses contracts.  The Company expects to recognize $175.4 million within the next year and $5.8 million thereafter.

 

 

(5) Commitments and Contingencies

(a) Commitments

From time to time, the Company enters into certain types of contracts that require it to indemnify parties against third-party claims.  These contracts primarily relate to agreements under which the Company assumes indemnity obligations for intellectual property infringement, as well as other obligations from time to time depending on arrangements negotiated with customers and other third parties.  The conditions of these obligations vary.  Thus, the overall maximum amount of the Company’s indemnification obligations cannot be reasonably estimated.  Historically, the Company has not been obligated to make significant payments for these obligations and does not currently expect to incur any material obligations in the future.  Accordingly, the Company has not recorded an indemnification liability on its balance sheets as of June 30, 2018 or December 31, 2017.

The Company leases office space and computer and other equipment under operating lease agreements.  Under the lease agreements, in addition to base rent, the Company is generally responsible for certain taxes, utilities and maintenance costs, and other fees.  Several of these leases include options for renewal or purchase.  The Company does not have any material capital leases.  The Company leases approximately 214,000 square feet of office space at a location in Northern Virginia that began serving as its corporate headquarters in October 2010. In January 2018, the Company amended the lease to extend the lease term through December 2030. The amended lease also provides for certain tenant allowances and incentives. At June 30, 2018 and December 31, 2017, deferred rent of $27.3 million and $8.5 million, respectively, was included in other long-term liabilities.

As a result of the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”), the Company estimated and recorded a one-time $40.3 million tax expense related to the mandatory deemed repatriation transition tax (“Transition Tax”) during the year ended December 31, 2017.  At June 30, 2018, $32.5 million of the Transition Tax was unpaid and was included in “Other long-term liabilities.”

(b) Contingencies

The Company is involved in various legal proceedings arising in the normal course of business. Although the outcomes of these legal proceedings are inherently difficult to predict, management does not expect the resolution of these legal proceedings to have a material adverse effect on the Company’s financial position, results of operations, or cash flows.

The Company has contingent liabilities that, in management’s judgment, are not probable of assertion.  If such unasserted contingent liabilities were to be asserted, or become probable of assertion, the Company may be required to record significant expenses and liabilities in the period in which these liabilities are asserted or become probable of assertion.

 

 

(6) Treasury Stock

The Board of Directors previously authorized the Company’s repurchase of up to an aggregate of $800.0 million of its class A common stock from time to time on the open market through April 29, 2018 (the “2005 Share Repurchase Program”).  In April 2018, the Board of Directors extended the term of the 2005 Share Repurchase Program through April 29, 2023, although the program may be suspended or discontinued by the Company at any time.  The timing and amount of any shares repurchased will be determined by the Company’s management based on its evaluation of market conditions and other factors.  The 2005 Share Repurchase Program may be funded using the Company’s working capital, as well as proceeds from any other funding arrangements that the Company may enter into in the future.  During the three and six months ended June 30, 2018 and 2017, the Company did not repurchase any shares of its class A common stock pursuant to the 2005 Share Repurchase Program.  As of June 30, 2018, the Company had repurchased an aggregate of 3,826,947 shares of its class A common stock at an average price per share of $90.23 and an aggregate cost of $345.3 million.  The average price per share and aggregate cost amounts disclosed above include broker commissions.

14


MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

 

 

(7) Income Taxes

The Company and its subsidiaries conduct business in the United States and various foreign countries and are subject to taxation in numerous domestic and foreign jurisdictions.  As a result of its business activities, the Company files tax returns that are subject to examination by various federal, state and local, and foreign tax authorities.  With few exceptions, the Company is no longer subject to U.S. federal, state and local, or foreign income tax examination by tax authorities for years before 2014.  However, due to its use of state net operating loss (“NOL”) and federal tax credit carryovers in the United States, U.S. tax authorities may attempt to reduce or fully offset the amount of state NOL or federal tax credit carryovers from tax years ended 2006 and forward that were used in later tax years.  The Company’s major foreign tax jurisdictions and tax years that remain subject to potential examination are Germany for tax years 2016 and forward, Poland and China for tax years 2013 and forward, Spain for tax years 2014 and forward, and the United Kingdom for tax years 2016 and forward. To date there have been no material audit assessments related to audits in any of the applicable foreign jurisdictions.

As of June 30, 2018, the Company had unrecognized tax benefits of $4.1 million, which are recorded in “Other long-term liabilities” in the Company’s Consolidated Balance Sheets.  If recognized, $3.6 million of these unrecognized tax benefits would impact the effective tax rate.  The Company recognizes estimated accrued interest related to unrecognized income tax benefits in the provision for income tax accounts.  Penalties relating to income taxes, if incurred, would also be recognized as a component of the Company’s provision for income taxes.  Over the next 12 months, the amount of the Company’s liability for unrecognized tax benefits is not expected to change by a material amount.  As of June 30, 2018, the amount of cumulative accrued interest expense on unrecognized income tax benefits was approximately $0.7 million.

The following table summarizes the Company’s deferred tax assets, net of deferred tax liabilities and valuation allowance (in thousands), as of:

 

 

 

June 30,

 

 

December 31,

 

 

 

2018

 

 

2017

 

 

 

 

 

 

 

(as adjusted)

 

Deferred tax assets, net of deferred tax liabilities

 

$

15,772

 

 

$

10,308

 

Valuation allowance

 

 

(1,015

)

 

 

(1,015

)

Deferred tax assets, net of deferred tax liabilities and valuation allowance

 

$

14,757

 

 

$

9,293

 

 

The valuation allowance as of June 30, 2018 and December 31, 2017 related to certain foreign tax credit carryforwards that, in the Company’s present estimation, more likely than not will not be realized.

The Company has estimated its annual effective tax rate for the full fiscal year 2018 and applied that rate to its income before income taxes in determining its provision for income taxes for the six months ended June 30, 2018.  The Company also records discrete items in each respective period as appropriate.  The estimated effective tax rate is subject to fluctuation based on the level and mix of earnings and losses by tax jurisdiction, foreign tax rate differentials, and the relative impact of permanent book to tax differences (e.g., non-deductible expenses).  Each quarter, a cumulative adjustment is recorded for any fluctuations in the estimated annual effective tax rate as compared to the prior quarter.  As a result of these factors, and due to potential changes in the Company’s period-to-period results, fluctuations in the Company’s effective tax rate and respective tax provisions or benefits may occur.

For the six months ended June 30, 2018, the Company recorded a provision for income taxes of $0.5 million that resulted in an effective tax rate of 7.7%, as compared to a provision for income taxes of $6.9 million that resulted in an effective tax rate of 21.4% for the six months ended June 30, 2017. The change in the effective tax rate in 2018 is mainly due to the change in the expected proportion of U.S. versus foreign income and the decrease in U.S. corporate tax rate.

The Tax Act reduced the U.S. corporate tax rate from 35% to 21%, effective January 1, 2018.  Additionally, the Tax Act requires certain Global Intangible Low Taxed Income (“GILTI”) earned by controlled foreign corporations (“CFCs”) to be included in the gross income of the CFCs’ U.S. shareholder.  GAAP allows the Company to either: (i) treat taxes due on future U.S. inclusions in taxable income related to GILTI as a current-period expense when incurred (the “period cost method”); or (ii) factor such amounts into its measurement of deferred taxes (the “deferred method”).  The Company has elected the period cost method. The Tax Act allows a U.S. corporation a deduction equal to a certain percentage of its foreign-derived intangible income (“FDII”).  The Company

15


MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

estimated the impact of the GILTI tax and FDII deduction in determining its 2018 annual effective tax rate that is reflected in its provision for income taxes for the six months ended June 30, 2018.  The Company will continue to refine its calculation for the GILTI tax and FDII deduction in future quarters. The Tax Act also imposes a Transition Tax on previously untaxed accumulated and current earnings and profits (“E&P”) of certain foreign subsidiaries of the Company.

The SEC staff issued Staff Accounting Bulletin (“SAB”) 118, which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the related accounting under ASC 740, Accounting for Income Taxes. In accordance with SAB 118, a company must disclose the income tax effects of the Tax Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but reasonable estimates can be determined, it must record provisional estimates in the financial statements. If a company cannot determine provisional estimates to be included in the financial statements, it should continue to apply ASC 740 based on the tax laws that were in effect immediately before the enactment of the Tax Act.

The Company’s accounting for certain elements of the Tax Act was incomplete as of December 31, 2017 and remains incomplete as of June 30, 2018. However, the Company was able to make reasonable estimates of certain tax effects and recorded provisional estimates for these items. In connection with its initial analysis of the impact of the Tax Act, the Company recorded a provisional discrete net tax expense of $40.3 million, of which $32.5 million and $36.8 million were recorded in “Other long-term liabilities” in the Company’s Consolidated Balance Sheets as of June 30, 2018 and December 31, 2017, respectively, related to the one-time Transition Tax. To determine the Transition Tax, the Company must determine the amount of post-1986 accumulated E&P of the relevant subsidiaries, as well as the amount of non-U.S. income taxes paid on such earnings. The Company has not made any further measurement period adjustments related to the Transition Tax. However, the Company expects to revise its estimates of E&P and associated non-U.S. income taxes throughout 2018 as the Company continues to analyze the impact of foreign exchange gains or losses and gathers support for non-U.S. income taxes paid.  As the Company accumulates and processes data to finalize the underlying calculations, and as regulators issue further guidance, the Company’s estimates may change during 2018.  The Company will continue to refine such amounts within the measurement period allowed, which it expects to complete no later than December 31, 2018.  Likewise, while the Company was able to make a reasonable estimate of the impact of the reduced U.S. corporate tax rate, its effective tax rate may be affected by other aspects of the Tax Act, including, but not limited to, the impact of the Tax Act on state taxes.

Except as discussed below, the Company intends to indefinitely reinvest its undistributed earnings of all of its foreign subsidiaries.  U.S. federal tax laws require the Company to include in its U.S. taxable income certain investment income earned outside of the United States in excess of certain limits (“Subpart F deemed dividends”).  Because Subpart F deemed dividends are already required to be recognized in the Company’s U.S. federal income tax return, the Company regularly repatriates Subpart F deemed dividends to the United States and no additional tax is incurred on the distribution.  As of June 30, 2018 and December 31, 2017, the amount of cash and cash equivalents and short-term investments held by the Company’s U.S. entities was $300.1 million and $293.8 million, respectively, and by the Company’s non-U.S. entities was $399.5 million and $381.4 million, respectively.  If the cash and cash equivalents and short-term investments held by the Company’s non-U.S. entities were to be repatriated to the United States, after taking into account the $40.3 million Transition Tax recorded during the year ended December 31, 2017, the Company does not expect such repatriation to generate any additional U.S. federal taxable income to the Company.

In determining the Company’s provision for or benefit from income taxes, net deferred tax assets, liabilities, and valuation allowances, management is required to make judgments and estimates related to projections of domestic and foreign profitability, the timing and extent of the utilization of NOL carryforwards, applicable tax rates, transfer pricing methods, and prudent and feasible tax planning strategies. As a multinational company, the Company is required to calculate and provide for estimated income tax liabilities for each of the tax jurisdictions in which it operates. This process involves estimating current tax obligations and exposures in each jurisdiction, as well as making judgments regarding the future recoverability of deferred tax assets. Changes in the estimated level of annual pre-tax income, changes in tax laws, particularly changes related to the utilization of NOLs in various jurisdictions, and changes resulting from tax audits can all affect the overall effective income tax rate which, in turn, impacts the overall level of income tax expense or benefit and net income.

Judgments and estimates related to the Company’s projections and assumptions are inherently uncertain. Therefore, actual results could differ materially from projections. The timing and manner in which the Company will use research and development tax credit carryforward tax assets, alternative minimum tax credit carryforward tax assets, and foreign tax credit carryforward tax assets in any year, or in total, may be limited by provisions of the Internal Revenue Code regarding changes in the Company’s ownership.  Currently, the Company expects to use the tax assets, subject to Internal Revenue Code limitations, within the carryforward periods.  Valuation allowances have been established where the Company has concluded that it is more likely than not that such deferred tax assets are not realizable.  If the Company is unable to sustain profitability in future periods, it may be required to increase the valuation allowance against the deferred tax assets, which could result in a charge that would materially adversely affect net income in the period in which the charge is incurred.

16


MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

 

 

(8) Share-based Compensation

The Company’s 2013 Stock Incentive Plan (as amended, the “2013 Equity Plan”) authorizes the issuance of various types of share-based awards to the Company’s employees, officers, directors, and other eligible participants.  In March 2018, the Board of Directors authorized, and in May 2018 the Company’s stockholders approved, a further amendment to the 2013 Equity Plan to, among other things, increase the total number of shares of the Company’s class A common stock authorized for issuance under the 2013 Equity Plan from 1,700,000 shares to 2,300,000 shares. As of June 30, 2018, there were 565,000 shares of class A common stock reserved and available for future issuance under the 2013 Equity Plan.

Stock option awards

During the second quarter of 2018, stock options to purchase an aggregate of 102,500 shares of class A common stock were granted pursuant to the 2013 Equity Plan. As of June 30, 2018, there were options to purchase 1,481,233 shares of class A common stock outstanding under the 2013 Equity Plan.  

The following table summarizes the Company’s stock option activity (in thousands, except per share data and years) for the three months ended June 30, 2018:

 

 

 

Stock Options Outstanding

 

 

 

 

 

 

 

Weighted Average

 

 

Aggregate

 

 

Weighted Average

 

 

 

 

 

 

 

Exercise Price

 

 

Intrinsic

 

 

Remaining Contractual

 

 

 

Shares

 

 

Per Share

 

 

Value

 

 

Term (Years)

 

Balance as of April 1, 2018

 

 

1,463

 

 

$

140.83

 

 

 

 

 

 

 

 

 

Granted

 

 

103

 

 

 

128.27

 

 

 

 

 

 

 

 

 

Exercised

 

 

(21

)

 

 

121.13

 

 

$

196

 

 

 

 

 

Forfeited/Expired

 

 

(64

)

 

 

163.25

 

 

 

 

 

 

 

 

 

Balance as of June 30, 2018

 

 

1,481

 

 

$

139.26