MicroStrategy Incorporated
MICROSTRATEGY INC (Form: 10-Q, Received: 05/10/2006 15:57:57)
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

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

For the Quarterly Period Ended March 31, 2006

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 of incorporation)

1861 International Drive, McLean, VA

(Address of Principal Executive Offices)

22102

(Zip Code)

51-0323571

(I.R.S. Employer

Identification Number)

Registrant’s telephone number, including area code: (703) 848-8600

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   x   No   ¨

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

Large accelerated filer ¨

   Accelerated filer x    Non-accelerated filer ¨

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

The number of shares of the registrant’s class A common stock and class B common stock outstanding on May 1, 2006 was 10,085,669 and 3,240,475, respectively.

 



Table of Contents

MICROSTRATEGY INCORPORATED

FORM 10-Q

TABLE OF CONTENTS

 

          Page

PART I.

  

FINANCIAL INFORMATION

  

Item 1.

  

Financial Statements

  
  

Consolidated Balance Sheets as of March 31, 2006 (unaudited) and December 31, 2005 (audited)

   1
  

Consolidated Statements of Operations For the Three Months Ended March 31, 2006 (unaudited) and 2005 (unaudited)

   2
  

Consolidated Statements of Cash Flows For the Three Months Ended March 31, 2006 (unaudited) and 2005 (unaudited)

   3
  

Notes to Consolidated Financial Statements (unaudited)

   4

Item 2.

  

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

   12

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

   20

Item 4.

  

Controls and Procedures

   21

PART II.

  

OTHER INFORMATION

  

Item 1.

  

Legal Proceedings

   22

Item 1A.

  

Risk Factors

   23

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

   33

Item 5.

  

Other Information

   34

Item 6.

  

Exhibits

   34


Table of Contents

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

MICROSTRATEGY INCORPORATED

CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

 

    

March 31,

2006

   

December 31,

2005

 
     (unaudited)     (audited)  

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 42,744     $ 42,318  

Restricted cash and investments

     5,140       5,076  

Short-term investments

     28,037       53,761  

Accounts receivable, net

     37,699       43,052  

Prepaid expenses and other current assets

     6,854       6,209  

Deferred tax assets, net

     26,742       22,971  
                

Total current assets

     147,216       173,387  
                

Property and equipment, net

     11,305       12,031  

Capitalized software development cost, net

     3,139       3,669  

Deposits and other assets

     1,958       2,293  

Deferred tax assets, net

     78,480       86,393  
                

Total Assets

   $ 242,098     $ 277,773  
                

Liabilities and Stockholders’ Equity

    

Current liabilities:

    

Accounts payable and accrued expenses

   $ 18,077     $ 19,550  

Accrued compensation and employee benefits

     18,103       27,258  

Deferred revenue and advance payments

     59,550       45,874  
                

Total current liabilities

     95,730       92,682  
                

Deferred revenue and advance payments

     1,757       1,554  

Other long-term liabilities

     2,554       2,815  
                

Total Liabilities

     100,041       97,051  
                

Commitments and Contingencies

    

Stockholders’ Equity:

    

Preferred stock undesignated, $.001 par value; 5,000 shares authorized; no shares issued or outstanding

     —         —    

Class A common stock, $0.001 par value; 330,000 shares authorized; 13,390 shares issued and 10,080 shares outstanding, and 13,270 shares issued and 10,595 shares outstanding, respectively

     13       13  

Class B common stock, $0.001 par value; 165,000 shares authorized; 3,240 and 3,258 issued and outstanding, respectively

     3       3  

Additional paid-in capital

     433,085       428,062  

Treasury stock, at cost, 3,310 and 2,675 shares, respectively

     (195,613 )     (136,817 )

Accumulated other comprehensive income

     2,433       2,318  

Accumulated deficit

     (97,864 )     (112,857 )
                

Total Stockholders’ Equity

     142,057       180,722  
                

Total Liabilities and Stockholders’ Equity

   $ 242,098     $ 277,773  
                

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

 

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Table of Contents

MICROSTRATEGY INCORPORATED

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

 

     Three Months Ended
March 31,
 
     2006     2005  

Revenues:

    

Product licenses

   $ 23,133     $ 21,811  

Product support and other services

     46,365       38,175  
                

Total revenues

     69,498       59,986  
                

Cost of Revenues:

    

Product licenses

     704       1,277  

Product support and other services

     8,830       7,416  
                

Total cost of revenues

     9,534       8,693  
                

Gross Profit

     59,964       51,293  
                

Operating Expenses:

    

Sales and marketing

     19,969       17,234  

Research and development

     8,250       7,218  

General and administrative

     10,749       8,352  

Amortization of intangible assets

     18       18  
                

Total operating expenses

     38,986       32,822  
                

Income from Operations

     20,978       18,471  
                

Financing and Other Income:

    

Interest income

     862       872  

Interest expense

     (32 )     (15 )

Gain on investments

     —         18  

Other income (expense), net

     (151 )     258  
                

Total financing and other income

     679       1,133  
                

Income before income taxes

     21,657       19,604  

Provision for income taxes

     6,664       4,551  
                

Net Income

   $ 14,993     $ 15,053  
                

Basic earnings per share

   $ 1.11     $ 0.93  
                

Diluted earnings per share

   $ 1.05     $ 0.89  
                

Basic weighted average shares outstanding

     13,568       16,224  
                

Diluted weighted average shares outstanding

     14,304       16,965  
                

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

 

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MICROSTRATEGY INCORPORATED

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

     Three Months Ended
March 31,
 
     2006     2005  

Operating activities:

    

Net income

   $ 14,993     $ 15,053  

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

    

Depreciation and amortization

     2,070       2,373  

Bad debt provision (recovery)

     617       (134 )

Deferred taxes

     6,317       3,836  

Stock-based compensation

     404       —    

Excess tax benefits from stock-based payment arrangements

     (1,882 )     —    

Other, net

     —         (298 )

Changes in operating assets and liabilities:

    

Accounts receivable

     5,145       12,037  

Prepaid expenses and other current assets

     (556 )     214  

Deposits and other assets

     339       144  

Accounts payable and accrued expenses, compensation and employee benefits

     (11,133 )     (11,389 )

Deferred revenue and advance payments

     13,663       8,611  

Other long-term liabilities

     (151 )     50  
                

Net cash provided by operating activities

     29,826       30,497  
                

Investing activities:

    

Proceeds from maturities of short-term investments

     65,650       19,000  

Purchases of short-term investments

     (39,924 )     (49,293 )

Purchases of property and equipment, net

     (766 )     (537 )

Capitalized software development costs

     —         (926 )

Increase in restricted cash and investments

     (45 )     (5,061 )
                

Net cash provided by (used in) investing activities

     24,915       (36,817 )
                

Financing activities:

    

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

     2,384       2,407  

Excess tax benefits from stock-based payment arrangements

     1,882       —    

Purchases of treasury stock

     (58,796 )     —    
                

Net cash provided by (used in) financing activities

     (54,530 )     2,407  

Effect of foreign exchange rate changes on cash and cash equivalents

     215       (1,162 )
                

Net increase (decrease) in cash and cash equivalents

     426       (5,075 )

Cash and cash equivalents, beginning of period

     42,318       68,314  
                

Cash and cash equivalents, end of period

   $ 42,744     $ 63,239  
                

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

 

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MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(1) Basis of Presentation

Except for the consolidated balance sheet of MicroStrategy Incorporated (“MicroStrategy” or the “Company”) as of December 31, 2005, which is derived from audited financial statements, the accompanying consolidated financial statements are unaudited. In the opinion of management, all adjustments necessary for a fair statement of such financial position and results of operations have been included. All such adjustments are of a normal recurring nature. Interim results are not necessarily indicative of results for a full year.

The consolidated financial statements and notes are presented as required by Form 10-Q 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 Securities and Exchange Commission (“SEC”) in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

Certain prior year amounts in the consolidated financial statements have been reclassified to conform to the current year presentation.

(2) Recent Accounting Standards

The Company adopted SFAS No. 123 (revised) (“SFAS No. 123R”), “Share-Based Payment” as of January 1, 2006 using the modified prospective method. The adoption of SFAS No. 123R is further discussed in Note 10, “Share-Based Compensation”.

(3) Restricted Cash and Investments

On March 15, 2005, the Company entered into a security agreement with a bank under which the Company posted cash to secure existing letters of credit. These letters of credit are used as security deposits for office leases, including the office lease for the Company’s corporate headquarters. The Company may invest the cash collateral under the security agreement in certain permitted investments. As of each of March 31, 2006 and December 31, 2005, the Company had $4.2 million in cash collateral posted under the security agreement, all invested in money market funds that are included in restricted cash and investments in the accompanying balance sheets.

(4) Accounts Receivable

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

 

     March 31,
2006
    December 31,
2005
 

Billed and billable

   $ 71,722     $ 86,974  

Less: billed and unpaid deferred revenue

     (32,232 )     (42,407 )
                
     39,490       44,567  

Less: allowance for doubtful accounts

     (1,791 )     (1,515 )
                
   $ 37,699     $ 43,052  
                

The Company offsets its accounts receivable and deferred revenue for any billed and unpaid items included in deferred revenue and advance payments.

 

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MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(5) Investments

The Company had invested $18.0 million and $53.7 million in auction rate securities of varying maturities as of March 31, 2006 and December 31, 2005, respectively. Although the Company purchases these securities to hold for a short period of time, the underlying securities are long-term municipal and corporate bonds with maturities ranging from twenty to thirty years. The securities are repriced through a Dutch auction process, generally covering periods of between 7 and 49 days. The Company has determined that it may sell these securities prior to maturity, has classified them as available-for-sale and has recorded these investments at fair market value. There were no realized gains or losses on this investment recognized during the three months ended March 31, 2006.

On March 31, 2006, the Company invested $10.0 million in a fund that invests primarily in highly-rated, short-term U.S. dollar denominated instruments. The Company has classified this investment as available-for-sale and has recorded this investment at fair market value. There were no realized gains or losses on this investment recognized during the three months ended March 31, 2006.

(6) Deferred Revenue and Advance Payments

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

 

     March 31,
2006
    December 31,
2005
 

Current:

    

Deferred product licenses revenue

   $ 1,961     $ 2,990  

Deferred product support revenue

     75,694       72,645  

Deferred other services revenue

     13,341       11,780  
                
     90,996       87,415  

Less: billed and unpaid deferred revenue

     (31,446 )     (41,541 )
                
   $ 59,550     $ 45,874  
                

Non-current:

    

Deferred product licenses revenue

   $ 303     $ 174  

Deferred product support revenue

     2,219       2,228  

Deferred other services revenue

     21       18  
                
     2,543       2,420  

Less: billed and unpaid deferred revenue

     (786 )     (866 )
                
   $ 1,757     $ 1,554  
                

The Company offsets its accounts receivable and deferred revenue for any billed and unpaid items included in deferred revenue and advance payments.

(7) Litigation

(a) Business Objects Litigation

On October 2, 2001, the Company filed a lawsuit in the Virginia Circuit Court for Fairfax County against two field employees of Business Objects, S.A. This lawsuit alleged that these employees, who previously worked for the Company, breached their fiduciary and contractual obligations to the Company by, among other things, misappropriating the Company’s trade secrets and confidential information and soliciting the Company’s employees and customers. The complaint sought injunctive relief and monetary damages. On October 17, 2001, Business Objects filed suit against the Company in the United States District Court for the Northern District of California, claiming that our software infringes a patent issued to Business Objects relating to relational database access (the ‘403 patent). The suit sought injunctive relief and monetary damages.

 

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MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

On August 29, 2003, the Court granted the Company’s motion for summary judgment and dismissed the lawsuit, ruling as a matter of law that our products do not infringe the ‘403 patent. Business Objects filed an appeal to the United States Court of Appeals for the Federal Circuit. On January 6, 2005, the Federal Circuit ruled that the district court had correctly construed the patent, that the Company does not literally infringe any of the asserted patent claims, and that Business Objects is legally barred from claiming that the Company’s products infringe two of the three asserted claims under the doctrine of equivalents. As a result of the Federal Circuit’s ruling, the case was remanded to the district court for further proceedings limited solely to Business Objects’ one remaining patent claim, and limited solely to the doctrine of equivalents. The Federal Circuit also reinstated all of the Company’s non-infringement and invalidity counterclaims brought against Business Objects that the district court had not needed to address or decide. On July 26, 2005, the district court granted the Company’s motion for summary judgment of non-infringement and dismissed the lawsuit. On August 19, 2005, Business Objects filed an appeal to the United States Court of Appeals for the Federal Circuit. Business Objects filed its opening appeal brief on December 15, 2005. The Company filed its principal appeal brief on March 13, 2006. Business Objects filed its reply brief on April 28, 2006.

On October 31, 2001, the Company filed suit against Business Objects, S.A. and its subsidiary, Business Objects Americas, Inc., in the United States District Court for the Eastern District of Virginia, claiming that Business Objects’ software infringes two patents held by the Company relating to asynchronous control of report generation using a web browser (the ‘033 patent) and a system and method of adapting automatic output of OLAP reports to disparate user output devices (the ‘050 patent). The complaint sought monetary damages and injunctive relief. On March 13, 2002, the Company voluntarily dismissed without prejudice our lawsuit pending in the Virginia Circuit Court for Fairfax County against the two field employees of Business Objects. The complaint against Business Objects was amended to add claims for violations of the federal Computer Fraud and Abuse Act, misappropriation of trade secrets, tortious interference with contractual relations and violations of the Virginia Conspiracy Act. As a result of pre-trial rulings, certain of these claims were dismissed. The Company’s claims for tortious interference and misappropriation of trade secrets proceeded to trial on October 20, 2003. On October 28, 2003, the Court dismissed the tortious interference claim. In July 2003, the United States Patent & Trademark Office confirmed the validity of all the claims in the ‘033 and ‘050 patents and terminated reexamination proceedings that Business Objects had requested as to those patents. The Company agreed to dismissal of the ‘033 patent claims without prejudice. On August 6, 2004, the Court granted Business Objects’ motion for summary judgment on the ‘050 patent claims, ruling that Business Objects had not infringed the Company’s patent. The Court ruled in the Company’s favor on the Company’s claims of trade secret misappropriation, finding that Business Objects had misappropriated certain of the Company’s trade secrets. On September 7, 2004, the Company filed a notice of appeal to the United States Court of Appeals for the Federal Circuit. Business Objects did not file a cross appeal. On November 17, 2005, the Federal Circuit reversed the District Court on the Company’s tortious interference claim and remanded that claim for further proceedings. The Federal Circuit affirmed the District Court on all other issues. On December 1, 2005, the Company filed a Combined Petition for Panel Rehearing and Rehearing En Banc. The Federal Circuit denied the Combined Petition on January 25, 2006.

On December 10, 2003, the Company filed a complaint for patent infringement against Crystal Decisions, Inc. in the United States District Court for the District of Delaware. The lawsuit alleged that Crystal Decisions willfully infringed three patents issued to the Company relating to: (i) asynchronous control of report generation using a web browser (the ‘033 patent); (ii) management of an automatic OLAP report broadcast system (the ‘796 patent); and (iii) providing business intelligence web content with reduced client-side processing (the ‘432 patent). The Company sought monetary damages and injunctive relief. Following the filing of the complaint, Crystal Decisions was acquired by Business Objects Americas, Inc. Business Objects Americas, Inc. answered the complaint, denying infringement and seeking a declaration that the patents in suit are invalid and not infringed by Business Objects Americas, Inc. The Company filed a motion for summary judgment of infringement of the ‘432, ‘796, and ‘033 patents on October 13, 2005. Business Objects filed motions for summary judgment of non-infringement and invalidity of the ‘432, ‘796, and ‘033 patents on October 13, 2005. On January 23, 2006, the Court denied the Company’s motion for summary judgment of infringement of the ‘432, ‘796, and ‘033 patents. The Court granted Business Objects’ motions for summary judgment of non-infringement of the ‘033 patent and of invalidity of the ‘432 and ‘796 patents.

 

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MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

The Court denied Business Objects’ motion for summary judgment of invalidity of the ‘033 patent and denied as moot Business Objects’ motion for summary judgment of non-infringement of the ‘432 and ‘796 patents. On February 7, 2006, the Court dismissed without prejudice Business Objects’ counterclaim for declaratory judgment of invalidity of the ‘033 patent. On February 23, 2006, the Court entered judgment in favor of Business Objects and against MicroStrategy. The Company filed a notice of appeal to the Federal Circuit on March 24, 2006. The Company’s opening brief on appeal is due June 5, 2006.

The outcome of the legal proceedings described above is not presently determinable.

(b) Other Matters

The Company is also involved in other legal proceedings through the normal course of business. Management believes that any unfavorable outcome related to these other proceedings will not have a material effect on the Company’s financial position, results of operations or cash flows.

(8) Treasury Stock

On July 28, 2005, the Company announced that its Board of Directors had authorized the Company’s repurchase of up to an aggregate of $300.0 million of its class A common stock from time to time on the open market (the “2005 Share Repurchase Program”). 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 has a five-year term, but may be suspended or discontinued by the Company at any time. The 2005 Share Repurchase Program may be funded using the Company’s working capital, as well as proceeds from any credit facilities and other borrowing arrangements which the Company may enter into in the future. During the three months ended March 31, 2006, the Company repurchased an aggregate of 635,526 shares of its class A common stock at an average price of $92.52 and an aggregate cost of $58.8 million pursuant to the 2005 Share Repurchase Program.

No shares were repurchased by the Company during the three months ended March 31, 2005.

During the period from April 1, 2006 through May 8, 2006, the Company repurchased an aggregate of 281,500 shares of class A common stock at an average price per share of $100.97 and an aggregate cost of $28.4 million under the 2005 Share Repurchase Program. As of May 8, 2006 $205.9 million remained available to repurchase shares under the 2005 Share Repurchase Program.

All of the amounts above relating to average price per share and aggregate cost include broker commissions.

 

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MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(9) Income Taxes

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

 

     March 31,
2006
    December, 31
2005
 

Deferred tax assets, net of deferred tax liabilities

   $ 113,849     $ 117,494  

Valuation allowance

     (8,627 )     (8,130 )
                

Deferred tax assets, net of valuation allowance

   $ 105,222     $ 109,364  
                

Short-term deferred tax assets, net

   $ 26,742     $ 22,971  

Long-term deferred tax assets, net

     78,480       86,393  
                

Total deferred tax assets, net

   $ 105,222     $ 109,364  
                

The valuation allowance as of March 31, 2006 and 2005 primarily relates to certain domestic capital loss carryforwards and foreign net operating loss carryforwards that the Company expects will expire unused.

As required under Accounting Principles Board (“APB”) Opinion No. 28, “Interim Financial Reporting”, the Company has estimated its annual effective tax rate for the full fiscal year 2006 and applied that rate to its income before income taxes in determining its provision for income taxes for the three months ended March 31, 2006. For the three months ended March 31, 2006 and 2005, the Company’s consolidated annualized effective tax rate was 30.8% and 23.2%, respectively.

The annualized effective tax rate for the three months ended March 31, 2005 includes a tax benefit related to an excess of cumulative foreign tax credits over the projected tax on undistributed earnings of foreign subsidiaries. As all of the Company’s previously undistributed foreign subsidiary earnings were distributed during the third quarter of 2005 under the foreign dividend reinvestment provisions of the American Jobs Creation Act of 2004, the annualized effective tax rate for the three months ended March 31, 2006 does not include any benefit related to foreign tax credits on undistributed earnings of foreign subsidiaries.

The Company plans to indefinitely reinvest the undistributed 2006 earnings of certain foreign subsidiaries. Accordingly, the annualized effective tax rate applied to our pre-tax income for the three months ended March 31, 2006 did not include any provision for U.S. federal and state taxes on the projected amount of these undistributed 2006 foreign earnings. The Company accrues applicable U.S. federal and state taxes (net of foreign tax credits) on projected undistributed foreign subsidiary earnings that it intends to repatriate.

In determining our provision for 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 both net operating loss carryforwards and capital loss carryforwards, applicable tax rates, transfer pricing methodologies 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 related to the utilization of net operating losses 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 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 utilize the net operating loss carryforwards, 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 period.

 

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MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(10) Share-Based Compensation

The Company adopted SFAS No. 123 (revised) (“SFAS No. 123R”), “Share-Based Payment” as of January 1, 2006 using the modified prospective method. Under the modified prospective method, the Company has not restated its prior period financial statements for the related share-based compensation amounts. The Company has applied SFAS No. 123R for any portion of awards that were granted and have not fully vested prior to December 31, 2005. The Company will apply SFAS No. 123R to all new awards granted after January 1, 2006.

Prior to adoption of SFAS No. 123R, the Company used the graded vesting method for determining compensation expense, and has carried that method over and continues to apply the graded vesting method for any portion of awards that were granted and have not fully vested prior to December 31, 2005. Upon adoption of SFAS No. 123R on January 1, 2006, the Company elected the straight-line method for any share-based awards that may be granted subsequent to adoption.

Since the adoption of SFAS No. 123R and through March 31, 2006, the Company has not granted any new share-based awards. In addition, the Company has not issued any material stock option or other share-based compensation awards since the first quarter of 2004.

SFAS No. 123R eliminates the intrinsic value method that was previously used by the Company as an alternative method of accounting for share-based awards. SFAS No. 123R also clarifies earlier guidance in several areas, including measuring fair value, classifying an award as equity or as a liability and attributing compensation cost to reporting periods. In addition, SFAS No. 123R amends SFAS No. 95, “Statement of Cash Flows,” to require that excess tax benefits be reported as a financing cash inflow and a reduction of taxes paid within operating cash flows.

The Company has adopted share-based compensation plans under which directors, officers, and other eligible employees have previously received stock options awards. All stock options granted under the Company’s stock plans have an exercise price equal to the market value of the underlying common stock on the date of grant, have terms of five to ten years, and vest ratably, generally within five years of the date of grant. Upon exercise, the Company generally issues new shares in the amount of the award exercised. The Company has 2.3 million shares of class A common stock authorized for option grants as of March 31, 2006.

In addition, a subsidiary of the Company maintains a share-based compensation plan for its employees that is based upon the equity of the subsidiary. The share-based awards and resultant expense under SFAS No. 123R for this subsidiary have not been material through March 31, 2006.

The fair value of each grant has been estimated using the Black-Scholes option-valuation model, and the resultant compensation expense is amortized over the requisite service period (generally the vesting period) using the graded-vesting method that recognizes compensation cost for each separately vesting tranche of the award as though the award were, in substance, multiple awards. During the three months ended March 31, 2006, the Company recorded total share-based compensation of $0.4 million and an insignificant amount of related income tax benefits in the Consolidated Statement of Operations. No compensation cost was capitalized as part of the cost of an asset.

 

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MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

The Company’s share-based compensation expense is included in the following areas in the Consolidated Statement of Operations, as of (in thousands):

 

     Three Months Ended
March 31, 2006

Cost of services

   $ 6

Sales and marketing

     104

Research and development

     64

General and administrative

     230
      

Total share-based compensation expense

   $ 404
      

No share-based employee compensation cost is reflected in net income during the three months ended March 31, 2005, as the Company measured compensation expense based upon the intrinsic value method allowed at that time. If compensation expense had been recorded based on the fair value of awards, the Company’s net income would have been adjusted to equal the pro forma amounts presented below (in thousands, except per share data):

 

     Three Months Ended
March 31, 2005
 

Net income, as reported

   $ 15,053  

Stock-based employee compensation expense under fair value based method, net of tax of 38.0%

     (978 )
        

Pro forma net income, net of tax

   $ 14,075  
        

Basic earnings per share, as reported

   $ 0.93  
        

Diluted earnings per share, as reported

   $ 0.89  
        

Basic earnings per share, pro forma

   $ 0.87  
        

Diluted earnings per share, pro forma

   $ 0.83  
        

At March 31, 2006, the total compensation cost of nonvested awards not yet recognized was $1.5 million, materially all of which is expected to be recognized over the next 3 years. The windfall tax benefits realized from the exercise of stock options was $2.2 million during the three months ended March 31, 2006.

A summary of the status of MicroStrategy’s share-based compensation plans is presented (in thousands, except per share data, and excluding immaterial share-based awards that were awarded by a subsidiary of the Company):

 

     Options Outstanding    Weighted
Average
   Options Exercisable
           Price per Share       Number
of Shares
   Weighted
Average
Exercise Price
     Shares     Range         

Balance, December 31, 2005

   1,559     $ 2.50    —      3,130.00    $ 90.22    919    $ 138.52

Granted

   —       $ —      —      —      $ —        

Exercised

   (104 )   $ 2.50    —      83.44    $ 22.83      

Canceled

   (8 )   $ 11.91    —      1,042.50    $ 82.52      
                                         

Balance, March 31, 2006

   1,447     $ 2.50    —      3,130.00    $ 95.11    1,002    $ 128.56

 

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MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

At March 31, 2006, the Company’s 1.4 million outstanding stock options (including fully vested and expected to vest options) had a weighted average remaining contractual term of 5.8 years; and its 1.0 million outstanding and exercisable stock options had a weighted average remaining contractual term of 5.3 years.

(11) Comprehensive Income

Comprehensive income includes foreign currency translation adjustments and unrealized gains and losses on short-term investments, net of related tax effects, that have been excluded from net income and reflected in stockholders’ equity as accumulated other comprehensive income.

The Company’s comprehensive income consisted of the following as of (in thousands):

 

     Three Months Ended
March 31,
 
     2006     2005  

Net income

   $ 14,993     $ 15,053  

Foreign currency translation adjustment

     (114 )     (455 )
                

Comprehensive income

   $ 14,879     $ 14,598  
                

(12) Earnings per Share

Basic earnings per share is determined by dividing net income by the weighted average number of common shares outstanding during the period. Diluted earnings per share is determined by dividing net income by the weighted average number of common shares and potential common shares outstanding during the period. Potential common shares are included in the diluted earnings per share calculation when dilutive. Potential common shares consisting of common stock issuable upon exercise of outstanding employee stock options and warrants are computed using the treasury stock method.

(13) Segment Information

The Company operates in one significant business segment – business intelligence. The Company’s total revenues and long-lived assets, excluding long-term investments and long-term deferred tax assets, consisted of the following according to geographic region (in thousands):

 

     Domestic    International    Consolidated

Three Months Ended March 31, 2006

        

Total revenues

   $ 42,339    $ 27,159    $ 69,498

Long-lived assets

     13,609      2,793      16,402

Three Months Ended March 31, 2005

        

Total revenues

   $ 34,546    $ 25,440    $ 59,986

Long-lived assets

     20,337      3,098      23,435

The domestic region consists of the United States and Canada. The international region consists of all other countries. Domestic intercompany software fee charges to international operations of $10.4 million and $11.4 million for the three months ended March 31, 2006 and 2005, respectively, have been excluded from the above tables and eliminated in the consolidated financial statements.

For the three months ended March 31, 2006, no individual country outside the United States accounted for 10% or more of total consolidated revenues. For the three months ended March 31, 2005, Germany accounted for 10.7% of total consolidated revenues. For the three months ended March 31, 2005, no other individual country outside the United States accounted for 10% or more of total consolidated revenues.

For the three months ended March 31, 2006 and 2005, no individual customer accounted for 10% or more of the Company’s total consolidated revenues.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

FORWARD-LOOKING INFORMATION

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. For this purpose, any statements contained herein that are not statements of historical fact, including without limitation, certain statements regarding industry prospects and our results of operations or financial position, may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes,” “anticipates,” “plans,” “expects,” and similar expressions are intended to identify forward-looking statements. The important factors discussed below under “Item 1A. Risk Factors,” among others, could cause actual results to differ materially from those indicated by forward-looking statements made herein. Such forward-looking statements represent management’s current expectations and are inherently uncertain. Investors are warned that actual results may differ from management’s expectations.

Overview

We are a worldwide provider of business intelligence software that enables companies to analyze the raw data stored across their enterprise to reveal the trends and insights needed to develop solutions to manage their business effectively. Our software delivers this information to workgroups, the enterprise and extranet communities via e-mail, web, fax, wireless and voice communication channels. Businesses can use our software platform to develop user-friendly solutions, proactively refine revenue-generating strategies, enhance cost-efficiency and productivity and improve customer relationships.

The MicroStrategy software platform enables users to query and analyze the most detailed, transaction-level databases, turning data into business intelligence and delivering boardroom quality reports and alerts about the users’ business processes. Our web-based architecture provides reporting, security, performance and standards that are critical for web deployment. With intranet deployments, our products provide employees with information to enable them to make better, more cost-effective business decisions. With extranet deployments, enterprises can use the MicroStrategy software platform to build stronger relationships by linking customers and suppliers via the Internet. We also offer a comprehensive set of consulting, education, technical support and technical advisory services for our customers and strategic partners.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States.

The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and equity and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates, particularly estimates relating to revenue recognition, valuation of net deferred tax assets, litigation and contingencies, have a material impact on our financial statements and are discussed in detail throughout our analysis of the results of operations discussed below.

In addition to evaluating estimates relating to the items discussed above, we also consider other estimates, including, but not limited to, those related to allowance for doubtful accounts, software development costs, intangible assets and provision for income taxes. We base our estimates on historical experience and various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets, liabilities and equity that are not readily apparent from other sources. Actual results and outcomes could differ from these estimates and assumptions.

 

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MicroStrategy does not have any material ownership interest in any special purpose or other entities that are not wholly-owned and/or consolidated into our consolidated financial statements. Additionally, MicroStrategy does not have any material related party transactions as defined under Statement of Financial Accounting Standards (“SFAS”) No. 57, “Related Party Disclosures.”

For a more detailed explanation of the judgments made in these areas and a discussion of our accounting policies, refer to “Critical Accounting Policies” included in Item 7 and “Summary of Significant Accounting Policies” (Note 2) included in Item 15 of our Annual Report on Form 10-K for the year ended December 31, 2005. Since December 31, 2005, there have been no significant changes to our critical accounting policies.

Results of Operations

Comparison of the three months ended March 31, 2006 and 2005

Revenues

Product licenses revenues. The following table sets forth product licenses revenues (in thousands) and percentage changes for the periods indicated:

 

     Three Months Ended March 31,       
     2006    2005    % Change  

Product Licenses Revenues:

        

Domestic (consists of the U.S. and Canada)

   $ 13,043    $ 10,990    18.7 %

International

     10,090      10,821    -6.8 %
                

Total product licenses revenues

   $ 23,133    $ 21,811    6.1 %
                

 

     Three Months Ended March 31,
     2006    2005

Product License Transactions with Revenue Recognized in the Applicable Period:

     

Greater than $1.0 million of revenue recognized

   4    2

Between $500,000 and $1.0 million of revenue recognized

   6    7
         

Total transactions with greater than $500,000 of revenue recognized

   10    9
         

Domestic:

     

Greater than $1.0 million of revenue recognized

   2    1

Between $500,000 and $1.0 million of revenue recognized

   3    6
         

Total domestic transactions with greater than $500,000 of revenue recognized

   5    7
         

International:

     

Greater than $1.0 million of revenue recognized

   2    1

Between $500,000 and $1.0 million of revenue recognized

   3    1
         

Total international transactions with greater than $500,000 of revenue recognized

   5    2
         

Product licenses revenues increased during the three months ended March 31, 2006, as compared to the same period in the prior year, due to increases in the total number of recognized product license transactions and high-dollar product license transactions.

Domestic product licenses revenues. Domestic product licenses revenues increased during the three months ended March 31, 2006, as compared to the same period in the prior year, due to increases in the total number of recognized product license transactions and the relative size and number of transactions with greater than $1.0 million in recognized revenue.

 

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International product licenses revenues. International product licenses revenues decreased during the three months ended March 31, 2006, as compared to the same period in the prior year, due to a decrease in average deal size, partially offset by increases in both the total number of recognized international product license transactions and the number of transactions with greater than $500,000 of recognized revenue.

International product licenses revenues were affected by unfavorable foreign currency fluctuations of 7.1% during the three months ended March 31, 2006, as compared to the same period in the prior year, and by favorable foreign currency fluctuations of 5.2% during the three months ended March 31, 2005, as compared to the same period in the prior year.

Product support revenues . The following table sets forth product support revenues (in thousands) and percentage changes for the periods indicated:

 

     Three Months Ended
March 31,
  

% Change

 
     2006    2005   

Product Support Revenues:

        

Domestic (consists of the U.S. and Canada)

   $ 19,258    $ 15,937    20.8 %

International

     12,466      10,361    20.3 %
                

Total product support revenues

   $ 31,724    $ 26,298    20.6 %
                

Product support revenues are derived from providing technical software support and software updates and upgrades to customers. Product support revenues are recognized ratably over the term of the contract, which in most cases is one year.

Both domestic and international product support revenues increased during the three months ended March 31, 2006, as compared to the same period in the prior year, due to increases in our installed base of software licenses customers (customers generally purchase product support services at the time of product license purchases) and high renewal rates for such contracts.

International product support revenues were affected by unfavorable foreign currency fluctuations of 7.5% during the three months ended March 31, 2006, as compared to the same period in the prior year, and by favorable foreign currency fluctuations of 5.7% during the three months ended March 31, 2005, as compared to the same period in the prior year.

Other services revenues. The following table sets forth other services revenues (in thousands) and percentage changes for the periods indicated:

 

     Three Months Ended
March 31,
  

% Change

 
     2006    2005   

Other Services Revenues:

   $ 14,641    $ 11,876    23.3 %

Other services revenues includes revenues from consulting to help customers plan and execute the deployment of our software. Other services revenues also includes revenues from education and training, which we provide to our customers to enhance their ability to fully utilize the features and functionality of our software. In addition, other services revenues includes service revenue from our non-core businesses, Angel.com and Alarm.com, in the aggregate amounts of $1.7 million and $0.6 million for the three months ended March 31, 2006 and 2005, respectively.

Consulting revenues increased during the three months ended March 31, 2006, as compared to the same period in the prior year, due to increases in the number of billable hours provided to our customers.

Education revenues increased during the three months ended March 31, 2006, as compared to the same period in the prior year, due to increases in the number of our training courses sold and students trained.

 

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Other services revenues were affected by unfavorable foreign currency fluctuations of 2.6% during the three months ended March 31, 2006, as compared to the same period in the prior year, and by favorable foreign currency fluctuations of 1.9% during the three months ended March 31, 2005, as compared to the same period in the prior year.

Costs and Expenses

Cost of revenues. The following table sets forth cost of revenues (in thousands) and percentage changes in cost of revenues for the periods indicated:

 

     Three Months Ended March 31,   

% Change

 
     2006    2005   

Cost of Revenues:

        

Product licenses

   $ 704    $ 1,277    -44.9 %

Product support

     1,963      1,984    -1.1 %

Other services

     6,867      5,432    26.4 %
                

Total cost of revenues

   $ 9,534    $ 8,693    9.7 %
                

Cost of product licenses revenues. Cost of product licenses revenues consists of amortization of capitalized software development costs and the costs of product manuals, media, and royalties paid to third-party software vendors. Capitalized software development costs are amortized over a useful life of three years.

Cost of product licenses revenues decreased during the three months ended March 31, 2006, as compared to the same period in the prior year, as our most significant cost of product licenses revenues, amortization of capitalized software development costs, decreased compared with the prior year. The decrease was primarily attributable to the fact that several of our products for which we recognized amortization expense during the three months ended March 31, 2005 were fully amortized prior to the period ended March 31, 2006.

Cost of product support revenues. Cost of product support revenues consists of product support personnel and related overhead costs.

Cost of product support revenues during the three months ended March 31, 2006, as compared to the same period in the prior year, did not change significantly.

Cost of product support revenues was affected by favorable foreign currency fluctuations of 1.4% during the three months ended March 31, 2006, as compared to the same period in the prior year, and by unfavorable foreign currency fluctuations of 1.4% during the three months ended March 31 2005, as compared to the same period in the prior year.

Cost of other services revenues. Cost of other services revenues consists of consulting and education personnel and related overhead costs. In addition, cost of other services revenues includes costs of service revenue from our non-core businesses, Angel.com and Alarm.com, in the aggregate amounts of $0.8 million and $0.1 million for the three months ended March 31, 2006 and 2005, respectively.

The increase in cost of other services revenues during the three months ended March 31, 2006, as compared to the same period in the prior year, was primarily attributable to an increase in staffing levels to ensure an adequate workforce to support our larger customer and revenue base.

Cost of other services revenues were affected by favorable foreign currency fluctuations of 2.5% during the three months ended March 31, 2006, as compared to the same period in the prior year, and by unfavorable foreign currency fluctuations of 2.2% during the three months ended March 31, 2005, as compared to the same period in the prior year.

 

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Operating expenses. The following table sets forth operating expenses (in thousands) and percentage changes in operating expenses for the periods indicated:

 

     Three Months Ended
March 31,
  

% Change

 
     2006    2005   

Operating Expenses:

        

Sales and marketing

   $ 19,969    $ 17,234    15.9 %

Research and development

     8,250      7,218    14.3 %

General and administrative

     10,749      8,352    28.7 %

Amortization of intangible assets

     18      18    0.0 %
                

Total operating expenses

   $ 38,986    $ 32,822    18.8 %
                

Sales and marketing expenses. Sales and marketing expenses consists of personnel costs, commissions, office facilities, travel, advertising, public relations programs and promotional events, such as trade shows, seminars and technical conferences.

The increase in sales and marketing expenses during the three months ended March 31, 2006, as compared to the same period in the prior year, was primarily attributable to an increase in staffing levels of our sales and marketing personnel to expand our footprint both domestically and internationally.

Sales and marketing expenses were affected by favorable foreign currency fluctuations of 2.7% during the three months ended March 31, 2006, as compared to the same period in the prior year, and by unfavorable foreign currency fluctuations of 2.0% during the three months ended March 31, 2005, as compared to the same period in the prior year.

Research and development expenses. Research and development expenses consists of the personnel costs for our software engineering personnel, depreciation of equipment and other related costs.

The following table summarizes research and development expenses and amortization of capitalized software development costs (in thousands) for the periods indicated:

 

     Three Months Ended
March 31,
 
     2006    2005  

Gross research and development expenses:

     

Core research and development activities

   $ 7,709    $ 7,734  

Non-core research and development activities

     541      410  

Capitalized software development costs

     —        (926 )
               

Total research and development expenses

   $ 8,250    $ 7,218  
               

Amortization of capitalized software development costs included in cost of product licenses revenues

   $ 531    $ 888  
               

The increase in research and development expenses during the three months ended March 31, 2006, as compared to the same period in the prior year, was primarily attributable to a decrease in capitalized software development costs during the three months ended March 31, 2006, resulting in a higher expense for that period.

As of March 31, 2006, our research and development resources were allocated to the following projects: 21% to MicroStrategy 8, 47% to new product initiatives, and 32% to other research and development, including our non-core businesses, Angel.com and Alarm.com .

 

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General and administrative expenses. General and administrative expenses includes personnel and other costs of our executive, finance, human resources, information systems and administrative departments as well as third-party consulting, legal and other professional fees.

The increase in general and administrative expenses during the three months ended March 31, 2006, as compared to the same period in the prior year, was primarily attributable to an increase in compensation costs and staffing levels of our general and administrative personnel, an increase in variable compensation costs at the executive level, including a variable compensation plan for our CEO that was adopted in the third quarter of 2005, and an increase in travel and entertainment expenses related to increased expenditures on employee rewards and client entertainment, partially offset by decreases in external accounting, auditing and legal fees.

General and administrative expenses were affected by favorable foreign currency fluctuations of 1.3% during the three months ended March 31, 2006, as compared to the same period in the prior year, and by unfavorable foreign currency fluctuations of 0.8% during the three months ended March 31, 2005, as compared to the same period in the prior year.

Provision (Benefit) for Income Taxes . Our consolidated annualized effective tax rate was 30.8% and 23.2% for the three months ended March 31, 2006 and 2005, respectively.

The annualized effective tax rate for the three months ended March 31, 2005 includes a tax benefit related to an excess of cumulative foreign tax credits over the projected tax on undistributed earnings of foreign subsidiaries. As all of the Company’s previously undistributed foreign subsidiary earnings were distributed during the third quarter of 2005 under the foreign dividend reinvestment provisions of the American Jobs Creation Act of 2004, the annualized effective tax rate for the three months ended March 31, 2006 does not include any benefit related to foreign tax credits on undistributed earnings of foreign subsidiaries.

We plan to indefinitely reinvest the undistributed 2006 earnings of certain foreign subsidiaries. Accordingly, the annualized effective tax rate applied to our pre-tax income for the three months ended March 31, 2006 did not include any provision for U.S. federal and state taxes on the projected amount of these undistributed 2006 foreign earnings. We accrue applicable U.S. federal and state taxes (net of foreign tax credits) on projected undistributed foreign subsidiary earnings that we intend to repatriate.

Deferred Revenue and Advance Payments . Deferred revenue and advance payments represents product support and other services fees that are collected in advance and recognized over the contract service period and product licenses revenues relating to multiple element software arrangements that include future deliverables.

 

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The following table summarizes deferred revenue and advance payments (in thousands), as of:

 

     March 31,
2006
    December 31,
2005
 

Current:

    

Deferred product licenses revenue

   $ 1,961     $ 2,990  

Deferred product support revenue

     75,694       72,645  

Deferred other services revenue

     13,341       11,780  
                
     90,996       87,415  

Less: billed and unpaid deferred revenue

     (31,446 )     (41,541 )
                
   $ 59,550     $ 45,874  
                

Non-current:

    

Deferred product licenses revenue

   $ 303     $ 174  

Deferred product support revenue

     2,219       2,228  

Deferred other services revenue

     21       18  
                
     2,543       2,420  

Less: billed and unpaid deferred revenue

     (786 )     (866 )
                
   $ 1,757     $ 1,554  
                

We offset our accounts receivable and deferred revenue for any billed and unpaid items included in deferred revenue and advance payments.

The increase in deferred revenue and advance payments for the three months ended March 31, 2006, as compared to the same period in the prior year, was primarily attributable to an increase in product support contracts associated with new product licenses sales and our high renewal rates of such contracts during the period.

Including billed and unpaid deferred revenue, we expect to recognize $91.0 million of deferred revenue and advance payments over the next 12 months; however, the timing and ultimate recognition of our deferred revenue and advance payments depend on our performance of various service obligations, and the amount of deferred revenue and advance payments at any date should not be considered indicative of revenues for any succeeding period.

During the three months ended March 31, 2006, we entered into certain agreements that include future commitments by our customers to purchase products, product support or other services over multi-year periods. Revenue relating to such future commitments by our customers is not included in our deferred revenue balances.

We do not expect that revenue from multi-year arrangements will constitute a substantial percentage of our total revenue in future periods. Revenue relating to such agreements will be recognized during the period in which all revenue recognition criteria are met. The timing and ultimate recognition of any revenue from such customer purchase commitments depend on our customers’ meeting their future purchase commitments and our meeting our associated performance obligations related to those purchase commitments.

Liquidity and Capital Resources

Our principal sources of liquidity are cash, cash equivalents, investments, and on-going collection of our accounts receivable. Management believes that existing capital resources and cash anticipated to be generated by operations will be sufficient to meet working capital requirements and anticipated capital expenditures for at least the next twelve months. Based upon our cash position, we do not currently expect to borrow money to finance our operations, although we may borrow money for other endeavors, including the repurchase of our own class A common stock. Our liquidity and capital resources and ability to generate revenues are subject to various business and economic risks discussed under “Item 1A. Risk Factors.”

 

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On March 15, 2005, we entered into a security agreement with a bank under which we posted cash to secure existing letters of credit. These letters of credit are used as security deposits for office leases, including the office lease for our corporate headquarters. We may invest the cash collateral under the security agreement in certain permitted investments. As of March 31, 2006, we had $4.2 million in cash collateral posted under the security agreement, all invested in money market funds.

On July 28, 2005, we announced that our Board of Directors had authorized our repurchase of up to an aggregate of $300.0 million of our class A common stock from time to time on the open market pursuant to the 2005 Share Repurchase Program. The timing and amount of any shares repurchased will be determined by our management based on its evaluation of market conditions and other factors. The 2005 Share Repurchase Program has a five-year term, but may be suspended or discontinued by us at any time. The 2005 Share Repurchase Program may be funded using our working capital, as well as proceeds from any credit facilities and other borrowing arrangements which we may enter into in the future. During the three months ended March 31, 2006, we repurchased an aggregate of 635,526 shares of our class A common stock at an average price of $92.52 and an aggregate cost of $58.8 million pursuant to the 2005 Share Repurchase Program.

During the period from April 1, 2006 through May 8, 2006, the Company repurchased an aggregate of 281,500 shares of class A common stock at an average price per share of $100.97 and an aggregate cost of $28.4 million under the 2005 Share Repurchase Program. As of May 8, 2006 $205.9 million remained available to repurchase shares under the 2005 Share Repurchase Program.

On July 27, 2004, we announced that our Board of Directors had authorized our repurchase of up to $35.0 million of our class A common stock pursuant to the 2004 Share Repurchase Program. On April 26, 2005, our Board of Directors modified the 2004 Share Repurchase Program to increase, from $35.0 million to $130.0 million, the aggregate amount of class A common stock that we were authorized to repurchase. We did not repurchase any shares pursuant to the 2004 Share Repurchase Program during the three months ended March 31, 2005. Including repurchase activity from all periods, we repurchased an aggregate of 2,577,752 shares of class A common stock at an average price per share of $50.39 and an aggregate cost of $129.9 million under the 2004 Share Repurchase Program. As repurchases under the 2004 Share Repurchase Program reached the aggregate authorized limit, the 2004 Share Repurchase Program was completed in the second quarter of 2005.

All of the amounts above relating to average price per share and aggregate cost include broker commissions.

The Company leases office space and computer and other equipment under operating lease agreements. In addition to base rent, the Company is responsible for certain taxes, utilities and maintenance costs, and several leases include options for renewal or purchase. Future minimum payments under noncancellable operating leases and agreements with initial terms of greater than one year consist of the following, net of total future minimum rentals to be received under noncancellable sublease agreements (in thousands):

 

Twelve Months Ended March 31,

   Amount

2007

   $ 10,725

2008

     9,331

2009

     8,617

2010

     7,407

2011

     2,311

Thereafter

     1,288
      
   $ 39,679
      

Net Cash Provided by Operating Activities. The decrease in net cash provided by operating activities during the three months ended March 31, 2006, as compared to the same period in the prior year, was primarily attributable to a relative decrease in accounts receivable balances as of March 31, 2006, as compared to the changes in those balances during the three months ended March 31, 2005, and the recognition in net cash provided by operating activities, for the first time, of the excess tax benefits from share-based payment arrangements in the amount of $1.9 million during the three months ended March 31, 2006 as a result of the adoption of SFAS No. 123R.

 

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This decrease in operating cash flow was partially offset by an improvement in operating results, our utilization of deferred tax assets, and increases in our deferred revenue balances.

Net Cash Provided by (Used in) Investing Activities. The increase in net cash provided by investing activities during the three months ended March 31, 2006, as compared to the same period in the prior year, was primarily attributable to proceeds from sales and maturities of short term investments of $65.7 million.

Net Cash Used in (Provided by) Financing Activities. The increase in net cash used in financing activities during the three months ended March 31, 2006, as compared to the same period in the prior year, was primarily attributable to our repurchases of class A common stock in the amount of $58.8 million during the period.

Off-Balance Sheet Arrangements. We did not enter into any off-balance sheet arrangements during the three months ended March 31, 2006. As of March 31, 2006, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future impact on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Recent Accounting Standards

The Company adopted SFAS No. 123R as of January 1, 2006 using the modified prospective method. Additional information regarding this matter is included above under Item 1. Note 10, “Share-Based Compensation.”

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The following discussion about our market risk exposures involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements.

We are exposed to the impact of both interest rate changes and foreign currency fluctuations.

Interest Rate Risk. Our exposure to risk for changes in interest rates relates primarily to our investments. We generally invest our excess cash in short-term, highly-rated, fixed rate financial instruments. These fixed rate investments are subject to interest rate risk and may fall in value if interest rates increase.

As of March 31, 2006, we held auction rate securities and investment funds that could expose us to interest rate risk. Although the Company purchases auction rate securities to hold for a short period of time, the underlying securities are long-term municipal and corporate bonds with maturities ranging from twenty to thirty years. The securities are repriced through a Dutch auction process, generally covering periods of between 7 and 49 days.

A 10% change in interest rates would not have a material impact on our financial position, results of operations, and cash flows.

Foreign Currency Risk . We conduct a significant portion of our business in currencies other than the U.S. dollar, the currency in which we report our consolidated financial statements. International sales accounted for 39.1% and 42.4% of our total revenues for the three months ended March 31, 2006 and 2005. We anticipate that international revenues will continue to account for a significant portion of our total revenues. The functional currency of each of our foreign subsidiaries is the local currency.

Assets and liabilities of our subsidiaries are translated into U.S. dollars at exchange rates in effect as of the applicable balance sheet date and any resulting translation adjustments are included as an adjustment to stockholders’ equity. Revenues and expenses generated from these subsidiaries are translated at average monthly exchange rates during the quarter the transactions occur. Gains and losses from transactions in local currencies are included in net income.

 

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Historically, we have generated a significant portion of our revenues and incurred a significant portion of our expenses in euro, and the British pound sterling. As a result of transacting in multiple currencies and reporting our financial statements in U.S. dollars, our operating results may be adversely impacted by currency exchange rate fluctuations in the future. Further information on the impact of foreign currency exchange rate fluctuations on current and comparable periods is further described in Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

We cannot predict the effect of exchange rate fluctuations upon our future results. We attempt to minimize our foreign currency risk by converting our excess foreign currency held in foreign jurisdictions to U.S. dollar denominated cash and investment accounts. To date, we have not hedged the risks associated with foreign exchange exposure. Although we may do so in the future, we cannot be sure that any hedging techniques will be successful or that our business, results of operations, financial condition and cash flows will not be materially adversely affected by exchange rate fluctuations.

As of March 31, 2006, a 10% adverse change in foreign exchange rates versus the U.S. dollar would have decreased our reported cash and cash equivalents, restricted cash and investments, and short-term investments by 1.4%.

 

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures. Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of March 31, 2006. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of March 31, 2006, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in internal controls. No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended March 31, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

Business Objects Litigation

On October 2, 2001, we filed a lawsuit in the Virginia Circuit Court for Fairfax County against two field employees of Business Objects, S.A. This lawsuit alleged that these employees, who previously worked for us, breached their fiduciary and contractual obligations to us by, among other things, misappropriating our trade secrets and confidential information and soliciting our employees and customers. The complaint sought injunctive relief and monetary damages. On October 17, 2001, Business Objects filed suit against us in the United States District Court for the Northern District of California, claiming that our software infringes a patent issued to Business Objects relating to relational database access (the ‘403 patent). The suit sought injunctive relief and monetary damages. On August 29, 2003, the Court granted our motion for summary judgment and dismissed the lawsuit, ruling as a matter of law that our products do not infringe the ‘403 patent. Business Objects filed an appeal to the United States Court of Appeals for the Federal Circuit. On January 6, 2005, the Federal Circuit ruled that the district court had correctly construed the patent, that we do not literally infringe any of the asserted patent claims, and that Business Objects is legally barred from claiming that our products infringe two of the three asserted claims under the doctrine of equivalents. As a result of the Federal Circuit’s ruling, the case was remanded to the district court for further proceedings limited solely to Business Objects’ one remaining patent claim, and limited solely to the doctrine of equivalents. The Federal Circuit also reinstated all of our non-infringement and invalidity counterclaims brought against Business Objects that the district court had not needed to address or decide. On July 26, 2005, the district court granted our motion for summary judgment of non-infringement and dismissed the lawsuit. On August 19, 2005, Business Objects filed an appeal to the United States Court of Appeals for the Federal Circuit. Business Objects filed its opening appeal brief on December 15, 2005. MicroStrategy filed its principal appeal brief on March 13, 2006. Business Objects filed its reply brief on April 28, 2006.

On October 31, 2001, we filed suit against Business Objects, S.A. and its subsidiary, Business Objects Americas, Inc., in the United States District Court for the Eastern District of Virginia, claiming that Business Objects’ software infringes two patents held by us relating to asynchronous control of report generation using a web browser (the ‘033 patent) and a system and method of adapting automatic output of OLAP reports to disparate user output devices (the ‘050 patent). The complaint sought monetary damages and injunctive relief. On March 13, 2002, we voluntarily dismissed without prejudice our lawsuit pending in the Virginia Circuit Court for Fairfax County against the two field employees of Business Objects. The complaint against Business Objects was amended to add claims for violations of the federal Computer Fraud and Abuse Act, misappropriation of trade secrets, tortious interference with contractual relations and violations of the Virginia Conspiracy Act. As a result of pre-trial rulings, certain of these claims were dismissed. Our claims for tortious interference and misappropriation of trade secrets proceeded to trial on October 20, 2003. On October 28, 2003, the Court dismissed the tortious interference claim. In July 2003, the United States Patent & Trademark Office confirmed the validity of all the claims in the ‘033 and ‘050 patents and terminated reexamination proceedings that Business Objects had requested as to those patents. We agreed to dismissal of the ‘033 patent claims without prejudice. On August 6, 2004, the Court granted Business Objects’ motion for summary judgment on the ‘050 patent claims, ruling that Business Objects had not infringed our patent. The Court ruled in our favor on our claims of trade secret misappropriation, finding that Business Objects had misappropriated certain of our trade secrets. On September 7, 2004, we filed a notice of appeal to the United States Court of Appeals for the Federal Circuit. Business Objects did not file a cross appeal. On November 17, 2005, the Federal Circuit reversed the District Court on our tortious interference claim and remanded that claim for further proceedings. The Federal Circuit affirmed the District Court on all other issues. On December 1, 2005, we filed a Combined Petition for Panel Rehearing and Rehearing En Banc. The Federal Circuit denied the Combined Petition on January 25, 2006.

On December 10, 2003, we filed a complaint for patent infringement against Crystal Decisions, Inc. in the United States District Court for the District of Delaware. The lawsuit alleged that Crystal Decisions willfully infringed three patents issued to us relating to: (i) asynchronous control of report generation using a web browser (the ‘033 patent); (ii) management of an automatic OLAP report broadcast system (the ‘796 patent); and (iii) providing business intelligence web content with reduced client-side processing (the ‘432 patent).

 

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We sought monetary damages and injunctive relief. Following the filing of the complaint, Crystal Decisions was acquired by Business Objects Americas, Inc. Business Objects Americas, Inc. answered the complaint, denying infringement and seeking a declaration that the patents in suit are invalid and not infringed by Business Objects Americas, Inc. We filed a motion for summary judgment of infringement of the ‘432, ‘796, and ‘033 patents on October 13, 2005. Business Objects filed motions for summary judgment of non-infringement and invalidity of the ‘432, ‘796, and ‘033 patents on October 13, 2005. On January 23, 2006, the Court denied our motion for summary judgment of infringement of the ‘432, ‘796, and ‘033 patents. The Court granted Business Objects’ motions for summary judgment of non-infringement of the ‘033 patent and of invalidity of the ‘432 and ‘796 patents. The Court denied Business Objects’ motion for summary judgment of invalidity of the ‘033 patent and denied as moot Business Objects’ motion for summary judgment of non-infringement of the ‘432 and ‘796 patents. On February 7, 2006, the Court dismissed without prejudice Business Objects’ counterclaim for declaratory judgment of invalidity of the ‘033 patent. On February 23, 2006, the Court entered judgment in favor of Business Objects and against MicroStrategy. MicroStrategy filed a notice of appeal to the Federal Circuit on March 24, 2006. MicroStrategy’s opening brief on appeal is due June 5, 2006.

The outcome of the legal proceedings described above is not presently determinable.

Other Proceedings

We are also involved in other legal proceedings through the normal course of business. Management believes that any unfavorable outcome related to these other proceedings will not have a material effect on our financial position, results of operations or cash flows.

Item 1A. Risk Factors

You should carefully consider the risks described below before making an investment decision. The risks and uncertainties described below are not the only ones facing MicroStrategy. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations.

If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected. In such case, the trading price of our class A common stock could decline and you may lose all or part of your investment.

Our quarterly operating results, revenues and expenses may fluctuate significantly, which could have an adverse effect on the market price of our stock

For a number of reasons, including those described below, our operating results, revenues and expenses have in the past varied and may in the future vary significantly from quarter to quarter. These fluctuations could have an adverse effect on the market price of our class A common stock.

Fluctuations in Quarterly Operating Results. Our quarterly operating results may fluctuate, in part, as a result of:

 

    the size, timing, volume and execution of significant orders and shipments;

 

    the mix of products and services of customer orders, which can affect whether we recognize revenue upon the signing and delivery of our software products or whether revenue must be recognized as work progresses or over the entire contract period;

 

    the timing of new product announcements by us or our competitors;

 

    changes in our pricing policies or those of our competitors;

 

    market acceptance of business intelligence software generally and of new and enhanced versions of our products in particular;

 

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    the length of our sales cycles;

 

    changes in our operating expenses;

 

    personnel changes;

 

    our use of direct and indirect distribution channels;

 

    utilization of our consulting and education services, which can be affected by delays or deferrals of customer implementation of our software products;

 

    changes in foreign currency exchange rates;

 

    our profitability and expectations for future profitability and its effect on our deferred tax assets and net income for the period in which any adjustment to our net deferred tax asset valuation allowance may be made;

 

    seasonal factors, such as our traditionally lower pace of new sales in the summer; and

 

    changes in customer budgets.

Limited Ability to Adjust Expenses. We base our operating expense budgets on expected revenue trends. Many of our expenses, such as office leases and certain personnel costs, are relatively fixed. We may be unable to adjust spending quickly enough to offset any unexpected revenue shortfall. Accordingly, any shortfall in revenue may cause significant variation in operating results in any quarter.

Based on the above factors, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. It is possible that in one or more future quarters, our operating results may be below the expectations of public market analysts and investors. In that event, the trading price of our class A common stock may fall.

The trading price for our class A common stock has been and may continue to be volatile

The trading price of our class A common stock historically has been volatile and may continue to be volatile. The trading price of our class A common stock may fluctuate widely in response to various factors, some of which are beyond our control. These factors include:

 

    quarterly variations in our results of operations or those of our competitors;

 

    announcements by us or our competitors of acquisitions, new products, significant contracts, commercial relationships or capital commitments;

 

    the emergence of new sales channels in which we are unable to compete effectively;

 

    our ability to develop and market new and enhanced products on a timely basis;

 

    commencement of, or our involvement in, litigation;

 

    any major change in our board or management;

 

    changes in governmental regulations or in the status of our regulatory approvals;

 

    recommendations by securities analysts or changes in earnings estimates;

 

    announcements about our earnings that are not in line with analyst expectations, the likelihood of which may be enhanced because it is our policy not to give guidance relating to our anticipated financial performance in future periods;

 

    announcements by our competitors of their earnings that are not in line with analyst expectations;

 

    the volume of shares of class A common stock available for public sale;

 

    sales of stock by us or by our stockholders;

 

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    short sales, hedging and other derivative transactions involving shares of our class A common stock; and

 

    general economic conditions and slow or negative growth of related markets.

In addition, the stock market in general, and the market for technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. These broad market and industry factors may seriously harm the market price of our class A common stock, regardless of our actual operating performance.

We face the risk of a decrease in our cash balances and losses in our investment portfolio

Our cash balances are held in numerous locations throughout the world. A portion of our cash is invested in marketable securities as part of our investment portfolio. Among other factors, changes in interest rates, foreign currency fluctuations and macroeconomic conditions could cause our cash balances to fluctuate and losses in our investment portfolio. Most amounts held outside the United States could be repatriated to the United States, but, under current law, would be subject to U.S. federal income tax, less applicable foreign tax credits.

Revenue recognition accounting pronouncements may adversely affect our reported results of operations

We continuously review our compliance with all new and existing revenue recognition accounting pronouncements. Depending upon the outcome of these ongoing reviews and the potential issuance of further accounting pronouncements, implementation guidelines and interpretations, we may be required to modify our reported results, revenue recognition policies or business practices, which could have a material adverse effect on our results of operations. Our existing revenue recognition policies are described in “Critical Accounting Policies” included in Item 7 and “Summary of Significant Accounting Policies” (Note 2) included in Item 15 of our Annual Report on Form 10-K for the year ended December 31, 2005.

We may have exposure to greater than anticipated tax liabilities

We are subject to income taxes and non-income taxes in a variety of jurisdictions and our tax structure is subject to review by both domestic and foreign taxation authorities. Moreover, in the ordinary course of a multinational business, there are many intercompany transactions and calculations where the ultimate tax determination is uncertain.

In determining our provision for 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 both net operating loss carryforwards and capital loss carryforwards, applicable tax rates, transfer pricing methodologies 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 related to the utilization of net operating losses 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 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 utilize the net operating loss carryforwards, 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 period.

 

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As a result of these factors, the ultimate amount of tax obligations owed may differ from the amounts recorded in our financial statements and any such difference may materially affect our financial results in future periods.

If the market for business intelligence software fails to grow as we expect, or if businesses fail to adopt our products, our business, operating results and financial condition could be materially adversely affected

Nearly all of our revenues to date have come from sales of business intelligence software and related technical support, consulting and education services. We expect these sales to account for a large portion of our revenues for the foreseeable future. Although demand for business intelligence software has grown in recent years, the market for business intelligence software applications is still emerging. Resistance from consumer and privacy groups to increased commercial collection and use of data on spending patterns and other personal behavior and European and other governmental restrictions on the collection and use of personal data may impair the further growth of this market, as may other developments. We cannot be sure that this market will continue to grow or, even if it does grow, that businesses will adopt our solutions. We have spent, and intend to keep spending, considerable resources to educate potential customers about business intelligence software in general and our solutions in particular. However, we cannot be sure that these expenditures will help our products achieve any additional market acceptance. If the market fails to grow or grows more slowly than we currently expect, our business, operating results and financial condition would be materially adversely affected.

Business disruptions could affect our operating results

A significant portion of our research and development activities and certain other critical business operations are concentrated in a single geographic area. We are also a highly automated business and a disruption or failure of our systems could cause delays in completing sales and providing services. A major earthquake, fire, act of terrorism or other catastrophic event that results in the destruction or disruption of any of our critical business operations or information technology systems could severely affect our ability to conduct normal business operations and as a result our future operating results could be materially and adversely affected.

We use strategic channel partners and if we are unable to maintain successful relationships with them, our business, operating results and financial condition could be materially adversely affected

In addition to our direct sales force, we use strategic channel partners such as value-added resellers, system integrators and original equipment manufacturers to license and support our products. For the three months ended March 31, 2006 and the year ended December 31, 2005, channel partners accounted for 15.4% and 21.8%, respectively, of our total product licenses revenues. Our channel partners generally offer customers the products of several different companies, including products that compete with ours. Because our channel partners generally do not have an exclusive relationship with us, we cannot be certain that they will prioritize or provide adequate resources to selling our products. Moreover, divergence in strategy or contract defaults by any of these channel partners may materially adversely affect our ability to develop, market, sell or support our products.

Although we believe that direct sales will continue to account for a majority of product licenses revenues, we seek to maintain a significant level of indirect sales activities through our strategic channel partners. There can be no assurance that our strategic partners will continue to cooperate with us when our distribution agreements expire or are up for renewal. In addition, there can be no assurance that actions taken or omitted to be taken by such parties will not adversely affect us. Our ability to achieve revenue growth in the future will depend in part on our success in maintaining successful relationships with our strategic partners. If we are unable to maintain our relationships with these strategic partners, our business, operating results and financial condition could be materially adversely affected.

 

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Our recognition of deferred revenue and advance payments is subject to future performance obligations and may not be representative of revenues for succeeding periods

Our current and long-term deferred revenue and advance payments were $61.3 million as of March 31, 2006. The timing and ultimate recognition of our deferred revenue and advance payments depend on various factors, including our performance of various service obligations. Because of the possibility of customer changes in development schedules, delays in implementation and development efforts and the need to satisfactorily perform product support services, deferred revenue and advance payments at any particular date may not be representative of actual revenue for any succeeding period.

We may not be able to sustain or increase profitability in the future

We generated net income for each of the three months ended March 31, 2006, and the year ended December 31, 2005; however, we may not be able to sustain or increase profitability on a quarterly or annual basis in the future. As of March 31, 2006, our accumulated deficit was $97.9 million. If operating expenses exceed our expectations or cannot be adjusted accordingly or revenues fall below our expectations, our business, results of operations and financial condition may be materially and adversely affected. We have significant deferred tax assets, and if we are unable to sustain profitability, we may be required to establish a valuation allowance against these deferred tax assets, which would result in a charge that would adversely affect net income in the period in which the charge is incurred.

Managing our international operations is complex and our failure to do so successfully or in a cost-effective manner could have a material adverse effect on our business, operating results and financial condition

We receive a significant portion of our total revenues from international sales from foreign direct and indirect operations. International sales accounted for 39.1% and 42.4% of our total revenues for the three months ended March 31, 2006 and 2005, respectively. Our international operations require significant management attention and financial resources.

There are certain risks inherent in our international business activities including:

 

    changes in foreign currency exchange rates;

 

    unexpected changes in regulatory requirements;

 

    tariffs, export restrictions and other trade barriers;

 

    costs of localizing products;

 

    lack of acceptance of localized products;

 

    longer accounts receivable payment cycles;

 

    difficulties in and costs of staffing, managing and operating our international operations;

 

    tax issues, including restrictions on repatriating earnings;

 

    weaker intellectual property protection;

 

    economic weakness or currency related crises;

 

    the burden of complying with a wide variety of laws (including labor laws);

 

    generally longer payment cycles and greater difficulty in collecting accounts receivable;

 

    our ability to adapt to sales practices and customer requirements in different cultures; and

 

    political instability in the countries where we are doing business.

These factors may have a material adverse effect on our future international sales and, consequently, on our business, operating results and financial condition.

 

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We may lose sales, or sales may be delayed, due to the long sales and implementation cycles for our products, which could reduce our revenues

To date, our customers have typically invested substantial time, money and other resources and involved many people in the decision to license our software products and purchase our consulting and other services. As a result, we may wait nine months or more after the first contact with a customer for that customer to place an order while it seeks internal approval for the purchase of our products and/or services. During this long sales cycle, events may occur that affect the size and/or timing of the order or even cause it to be canceled. For example, our competitors may introduce new products, or the customer’s own budget and purchasing priorities may change.

Even after an order is placed, the time it takes to deploy our products and complete consulting engagements can vary widely. Implementing our product can take several months, depending on the customer’s needs, and may begin only with a pilot program. It may be difficult to deploy our products if the customer has complicated deployment requirements, which typically involve integrating databases, hardware and software from different vendors. If a customer hires a third party to deploy our products, we cannot be sure that our products will be deployed successfully.

Our customers include the U.S. government and a number of other U.S. state and local governments or agencies

Procurement. Contracting with public sector customers is highly competitive and can be time-consuming and expensive, requiring that we incur significant upfront time and expense without any assurance that we will win a contract.

Budgetary Constraints and Cycles. Demand and payment for our products and services are impacted by public sector budgetary cycles and funding availability, with funding reductions or delays adversely impacting public sector demand for our products and services.

Modification or Cancellation of Contracts. Public sector customers often have contractual or other legal rights to terminate current contracts for convenience or due to a default. If a contract is cancelled for convenience, which can occur if the customer’s product needs change, we may only be able to collect for products and services delivered prior to termination. If a contract is cancelled because of default, we may only be able to collect for products and services delivered, and we may be forced to pay any costs incurred by the customer for procuring alternative products and services.

Governmental Audits. U.S. government and other state and local agencies routinely investigate and audit government contractors. If these audits determine that we have failed to comply with any of the complex laws and regulations relating to the formation, administration or performance of government contracts, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of fees, fines and suspensions or debarment from future government business.

We face intense competition, which may lead to lower prices for our products, reduced gross margins, loss of market share and reduced revenue

The markets for business intelligence software, analytical applications and information delivery are intensely competitive and subject to rapidly changing technology. In addition, many companies in these markets are offering, or may soon offer, products and services that may compete with MicroStrategy products.

MicroStrategy faces competitors in several broad categories, including business intelligence software, analytical processes, query and web-based reporting tools, and report delivery. Our competitors that are primarily focused on business intelligence products include, among others, Actuate, Business Objects, Cognos, Hyperion Solutions, Information Builders and the SAS Institute. We also compete with large software corporations, including suppliers of enterprise resource planning software that provide one or more capabilities competitive with our products, including IBM, Microsoft, Oracle, SAP AG and others.

 

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Many of our competitors have longer operating histories, significantly greater financial, technical, marketing or other resources, and greater name recognition than we do. In addition, many of our competitors have strong relationships with current and potential customers and extensive knowledge of the business intelligence industry. As a result, they may be able to respond more quickly to new or emerging technologies and changes in customer requirements or devote greater resources to the development, promotion and sale of their products than we can. Increased competition may lead to price cuts, reduced gross margins and loss of market share. We may not be able to compete successfully against current and future competitors and the failure to meet the competitive pressures we face may have a material adverse effect on our business, operating results and financial condition.

Current and future competitors may also make strategic acquisitions or establish cooperative relationships among themselves or with others. By doing so, they may increase their ability to meet the needs of our potential customers. Our current or prospective indirect channel partners may establish cooperative relationships with our current or future competitors. These relationships may limit our ability to sell our products through specific distribution channels. Accordingly, new competitors or alliances among current and future competitors may emerge and rapidly gain significant market share. These developments could limit our ability to obtain revenues from new customers and to maintain technical support revenues from our installed customer base.

We depend on technology licensed to us by third parties, and the loss of this technology could impair our software, delay implementation of our products, or force us to pay higher license fees

We license third-party technologies that we incorporate into our existing products. There can be no assurance that the licenses for such third-party technologies will not be terminated or that we will be able to license third-party software for future products. In addition, we may be unable to renegotiate acceptable third-party license terms. Changes in or the loss of third party licenses could lead to a material increase in the costs of licensing or to our software products becoming inoperable or their performance being materially reduced, with the result that we may need to incur additional development costs to ensure continued performance of our products, and we may experience a decreased demand for our products.

We depend on revenue from a single suite of products

Our MicroStrategy 8 suite of products accounts for a substantial portion of our revenue. Because of this revenue concentration, our business could be harmed by a decline in demand for, or in the prices of, our MicroStrategy 8 software as a result of, among other factors, any change in our pricing model, increased competition, a maturation in the markets for these products or other risks described in this document.

If we are unable to recruit or retain skilled personnel, or if we lose the services of any of our key management personnel, our business, operating results and financial condition could be materially adversely affected

Our future success depends on our continuing ability to attract, train, assimilate and retain highly skilled personnel. Competition for these employees is intense. We may not be able to retain our current key employees or attract, train, assimilate or retain other highly skilled personnel in the future. Our future success also depends in large part on the continued service of key management personnel, particularly Michael J. Saylor, our Chairman, President and Chief Executive Officer, and Sanju K. Bansal, our Vice Chairman, Executive Vice President and Chief Operating Officer. If we lose the services of one or both of these individuals or other key personnel, or if we are unable to attract, train, assimilate and retain the highly skilled personnel we need, our business, operating results and financial condition could be materially adversely affected.

If we are unable to develop and release product enhancements and new products to respond to rapid technological change in a timely and cost-effective manner, our business, operating results and financial condition could be materially adversely affected

 

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The market for our products is characterized by rapid technological change, frequent new product introductions and enhancements, changing customer demands and evolving industry standards. The introduction of products embodying new technologies can quickly make existing products obsolete and unmarketable. We believe that our future success depends largely on three factors:

 

    our ability to continue to support a number of popular operating systems and databases;

 

    our ability to maintain and improve our current product line; and

 

    our ability to rapidly develop new products that achieve market acceptance, maintain technological competitiveness and meet an expanding range of customer requirements.

Business intelligence applications are inherently complex, and it can take a long time and require significant research and development expenditures to develop and test new products and product enhancements. In addition, customers may delay their purchasing decisions because they anticipate that new or enhanced versions of our products will soon become available. We cannot be sure that we will succeed in developing and marketing, on a timely and cost-effective basis, product enhancements or new products that respond to technological change or new customer requirements, nor can we be sure that any new products and product enhancements will achieve market acceptance. Moreover, even if we introduce such a product, we may experience a decline in revenues of our existing products that is not fully matched by the new product’s revenue. In addition, we may lose existing customers who choose a competitor’s product rather than migrate to our new product. This could result in a temporary or permanent revenue shortfall and materially affect our business.

The emergence of new industry standards may adversely affect the demand for our existing products

The emergence of new industry standards in related fields may adversely affect the demand for our existing products. This could happen, for example, if new web standards and technologies emerged that were incompatible with customer deployments of our products. MicroStrategy currently supports SQL and MDX standards in database access technology. If we are unable to adapt our products on a timely basis to new standards in database access technology, the ability of MicroStrategy’s products to access customer databases could be impaired. In addition, the emergence of new standards in the field of operating system support could adversely affect the demand for our existing products. MicroStrategy technology is currently compatible with nearly all major operating systems, including, among others, Windows Server, Sun Solaris, IBM AIX, HP’s HP-UX and Red Hat Linux AS. If a different operating system were to gain widespread acceptance, we may not be able to achieve compatibility on a timely basis, resulting in an adverse effect on the demand for our products.

The nature of our products makes them particularly vulnerable to undetected errors, or bugs, which could cause problems with how the products perform and which could in turn reduce demand for our products, reduce our revenue and lead to product liability claims against us

Software products as complex as ours may contain errors and/or defects. Although we test our products extensively, we have in the past discovered software errors in our products after their introduction. Despite testing by us and by our current and potential customers, errors may be found in new products or releases after commercial shipments begin. This could result in lost revenue, damage to our reputation or delays in market acceptance, which could have a material adverse effect upon our business, operating results and financial condition. We may also have to expend resources and capital to correct these defects.

Our license agreements with customers typically contain provisions designed to limit our exposure to product liability, warranty and other claims. It is possible, however, that these provisions may not be effective under the laws of certain domestic or international jurisdictions and we may be exposed to product liability, warranty and other claims. A successful product liability claim against us could have a material adverse effect on our business, operating results and financial condition.

 

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Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products, services and brand

We rely on a combination of copyright, patent, trade secrets, confidentiality procedures and contractual commitments to protect our proprietary information. Despite our efforts, these measures can only provide limited protection. Unauthorized third parties may try to copy or reverse engineer portions of our products or otherwise obtain and use our intellectual property. Any patents owned by us may be invalidated, circumvented or challenged. Any of our pending or future patent applications, whether or not being currently challenged, may not be issued with the scope of the claims we seek, if at all. In addition, the laws of some countries do not provide the same level of protection of our proprietary rights as do the laws of the United States. If we cannot protect our proprietary technology against unauthorized copying or use, we may not remain competitive.

Third parties may claim we infringe their intellectual property rights

We periodically receive notices from others claiming we are infringing their intellectual property rights, principally patent rights. We expect the number of such claims will increase as the number of products and competitors in our industry segments grows, the functionality of products overlap, and the volume of issued software patents and patent applications continues to increase. Responding to any infringement claim, regardless of its validity, could:

 

    be time-consuming, costly and/or result in litigation;

 

    divert management’s time and attention from developing our business;

 

    require us to pay monetary damages or enter into royalty and licensing agreements that we would not normally find acceptable;

 

    require us to stop selling or to redesign certain of our products; or

 

    require us to satisfy indemnification obligations to our customers.

If a successful claim is made against us and we fail to develop or license a substitute technology, our business, results of operations, financial condition or cash flows could be adversely affected.

On October 2, 2001, we filed a lawsuit in the Virginia Circuit Court for Fairfax County against two field employees of Business Objects, S.A. This lawsuit alleged that these employees, who previously worked for us, breached their fiduciary and contractual obligations to us by, among other things, misappropriating our trade secrets and confidential information and soliciting our employees and customers. The complaint sought injunctive relief and monetary damages. On October 17, 2001, Business Objects filed suit against us in the United States District Court for the Northern District of California, claiming that our software infringes a patent issued to Business Objects relating to relational database access (the ‘403 patent). The suit sought injunctive relief and monetary damages. On August 29, 2003, the Court granted our motion for summary judgment and dismissed the lawsuit, ruling as a matter of law that our products do not infringe the ‘403 patent. Business Objects filed an appeal to the United States Court of Appeals for the Federal Circuit. On January 6, 2005, the Federal Circuit ruled that the district court had correctly construed the patent, that we do not literally infringe any of the asserted patent claims, and that Business Objects is legally barred from claiming that our products infringe two of the three asserted claims under the doctrine of equivalents. As a result of the Federal Circuit’s ruling, the case was remanded to the district court for further proceedings limited solely to Business Objects’ one remaining patent claim, and limited solely to the doctrine of equivalents. The Federal Circuit also reinstated all of our non-infringement and invalidity counterclaims brought against Business Objects that the district court had not needed to address or decide. On July 26, 2005, the district court granted our motion for summary judgment of non-infringement and dismissed the lawsuit. On August 19, 2005, Business Objects filed an appeal to the United States Court of Appeals for the Federal Circuit. Business Objects filed its opening appeal brief on December 15, 2005. MicroStrategy filed its principal appeal brief on March 13, 2006. Business Objects filed its reply brief on April 28, 2006.

On October 31, 2001, we filed suit against Business Objects, S.A. and its subsidiary, Business Objects Americas, Inc., in the United States District Court for the Eastern District of Virginia, claiming that Business Objects’ software infringes two patents held by us relating to asynchronous control of report generation using a web browser (the ‘033 patent) and a system and method of adapting automatic output of OLAP reports to disparate user output devices (the ‘050 patent).

 

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The complaint sought monetary damages and injunctive relief. On March 13, 2002, we voluntarily dismissed without prejudice our lawsuit pending in the Virginia Circuit Court for Fairfax County against the two field employees of Business Objects. The complaint against Business Objects was amended to add claims for violations of the federal Computer Fraud and Abuse Act, misappropriation of trade secrets, tortious interference with contractual relations and violations of the Virginia Conspiracy Act. As a result of pre-trial rulings, certain of these claims were dismissed. Our claims for tortious interference and misappropriation of trade secrets proceeded to trial on October 20, 2003. On October 28, 2003, the Court dismissed the tortious interference claim. In July 2003, the United States Patent & Trademark Office confirmed the validity of all the claims in the ‘033 and ‘050 patents and terminated reexamination proceedings that Business Objects had requested as to those patents. We agreed to dismissal of the ‘033 patent claims without prejudice. On August 6, 2004, the Court granted Business Objects’ motion for summary judgment on the ‘050 patent claims, ruling that Business Objects had not infringed our patent. The Court ruled in our favor on our claims of trade secret misappropriation, finding that Business Objects had misappropriated certain of our trade secrets. On September 7, 2004, we filed a notice of appeal to the United States Court of Appeals for the Federal Circuit. Business Objects did not file a cross appeal. On November 17, 2005, the Federal Circuit reversed the District Court on our tortious interference claim and remanded that claim for further proceedings. The Federal Circuit affirmed the District Court on all other issues. On December 1, 2005, we filed a Combined Petition for Panel Rehearing and Rehearing En Banc. The Federal Circuit denied the Combined Petition on January 25, 2006.

On December 10, 2003, we filed a complaint for patent infringement against Crystal Decisions, Inc. in the United States District Court for the District of Delaware. The lawsuit alleged that Crystal Decisions willfully infringed three patents issued to us relating to: (i) asynchronous control of report generation using a web browser (the ‘033 patent); (ii) management of an automatic OLAP report broadcast system (the ‘796 patent); and (iii) providing business intelligence web content with reduced client-side processing (the ‘432 patent). We sought monetary damages and injunctive relief. Following the filing of the complaint, Crystal Decisions was acquired by Business Objects Americas, Inc. Business Objects Americas, Inc. answered the complaint, denying infringement and seeking a declaration that the patents in suit are invalid and not infringed by Business Objects Americas, Inc. We filed a motion for summary judgment of infringement of the ‘432, ‘796, and ‘033 patents on October 13, 2005. Business Objects filed motions for summary judgment of non-infringement and invalidity of the ‘432, ‘796, and ‘033 patents on October 13, 2005. On January 23, 2006, the Court denied our motion for summary judgment of infringement of the ‘432, ‘796, and ‘033 patents. The Court granted Business Objects’ motions for summary judgment of non-infringement of the ‘033 patent and of invalidity of the ‘432 and ‘796 patents. The Court denied Business Objects’ motion for summary judgment of invalidity of the ‘033 patent and denied as moot Business Objects’ motion for summary judgment of non-infringement of the ‘432 and ‘796 patents. On February 7, 2006, the Court dismissed without prejudice Business Objects’ counterclaim for declaratory judgment of invalidity of the ‘033 patent. On February 23, 2006, the Court entered judgment in favor of Business Objects and against MicroStrategy. MicroStrategy filed a notice of appeal to the Federal Circuit on March 24, 2006. MicroStrategy’s opening brief on appeal is due June 5, 2006.

The outcome of the legal proceedings described above is not presently determinable.

Pending or future litigation could have a material adverse impact on our results of operation and financial condition

In addition to intellectual property litigation, from time to time, we have been subject to other litigation. Where we can make a reasonable estimate of the liability relating to pending litigation and determine that it is probable, we record a related liability. As additional information becomes available, we assess the potential liability and revise estimates as appropriate. However, because of uncertainties relating to litigation, the amount of our estimates could be wrong. In addition to the related cost and use of cash, pending or future litigation could cause the diversion of management’s attention and resources.

 

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Because of the rights of our two classes of common stock, and because we are controlled by our existing holders of class B common stock, these stockholders could transfer control of MicroStrategy to a third party without the approval of our Board of Directors or our other stockholders, prevent a third party from acquiring MicroStrategy, or limit your ability to influence corporate matters

We have two classes of common stock: class A common stock and class B common stock. Holders of our class A common stock generally have the same rights as holders of our class B common stock, except that holders of class A common stock have one vote per share while holders of class B common stock have ten votes per share. As of May 1, 2006, holders of our class B common stock owned 3,240,475 shares of class B common stock, or 76.3% of the total voting power. Michael J. Saylor, our Chairman, President and Chief Executive Officer, beneficially owned 235,800 shares of class A common stock and 2,789,430 shares of class B common stock, or 66.2% of the total voting power, as of May 1, 2006. Accordingly, Mr. Saylor is able to control MicroStrategy through his ability to determine the outcome of elections of our directors, amend our certificate of incorporation and by-laws and take other actions requiring the vote or consent of stockholders, including mergers, going-private transactions and other extraordinary transactions and their terms.

Our certificate of incorporation allows holders of class B common stock, almost all of whom are current employees or former employees of our company or related parties, to transfer shares of class B common stock, subject to the approval of stockholders possessing a majority of the outstanding class B common stock. Mr. Saylor or a group of stockholders possessing a majority of the outstanding class B common stock could, without the approval of our Board of Directors or our other stockholders, transfer voting control of MicroStrategy to a third party. Such a transfer of control could have a material adverse effect on our business, operating results and financial condition. Mr. Saylor or a group of stockholders possessing a majority of the outstanding class B common stock will also be able to prevent a change of control of MicroStrategy, regardless of whether holders of class A common stock might otherwise receive a premium for their shares over the then current market price. In addition, this concentrated control limits your ability to influence corporate matters and, as a result, we may take actions that our non-controlling stockholders do not view as beneficial. As a result, the market price of our class A common stock could be adversely affected.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The following table provides information about our repurchases of equity securities during the periods indicated that are registered by us pursuant to Section 12 of the Exchange Act:

 

Period

  

(a)

Total Number
of Shares
(or Units)
Purchased

  

(b)

Average Price
Paid per Share
(or Unit) (1)

  

(c)

Total Number of
Shares (or Units)
Purchased as Part of
Publicly Announced
Plans or
Programs (2)

  

(d)

Maximum Number
(or Approximate Dollar
Value) of Shares
(or Units) that May Yet
Be Purchased Under
the Plans or
Programs (2)

January 1, 2006 – January 31, 2006

   0      N/A    N/A    293,075,192

February 1, 2006 – February 28, 2006

   635,526    $ 92.52    635,526    234,279,343

March 1, 2006 – March 31, 2006

   0      N/A    N/A    234,279,343

Total:

   635,526    $ 92.52    635,526    234,279,343

(1) The Average Price Paid per Share includes broker commissions.

 

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(2) On July 28, 2005, we announced that our Board of Directors had authorized our repurchase of up to an aggregate of $300.0 million of our class A common stock from time to time on the open market, pursuant to the 2005 Share Repurchase Program. The timing and amount of any shares repurchased is determined by our management based on its evaluation of market conditions and other factors. The 2005 Share Repurchase Program has a five-year term, but may be suspended or discontinued by us at any time. The 2005 Share Repurchase Program may be funded using our working capital, as well as proceeds from any credit facilities and other borrowing arrangements which we may enter into in the future.

 

ITEM 5. OTHER INFORMATION

The Board of Directors has set the date and location of the Company’s Annual Meeting of Stockholders for 2006. The meeting will be held on Wednesday, May 31, 2006, at MicroStrategy’s offices, 1861 International Drive, McLean, Virginia 22102 at 10:00 a.m., local time.

 

ITEM 6. EXHIBITS

 

Exhibit
Number
  

Description

  3.1      Second Restated Certificate of Incorporation of the registrant (filed as Exhibit 3.1 to the registrant’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2003 (File No. 000-24435) and incorporated by reference herein).
  3.2      Amended and Restated By-Laws of the registrant (filed as Exhibit 3.2 to the registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003 (File No. 000-24435) and incorporated by reference herein).
  4.1      Form of Certificate of Class A Common Stock of the registrant (filed as Exhibit 4.1 to the registrant’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2003 (File No. 000-24435) and incorporated by reference herein).
  4.2      Warrant Agreement, dated as of January 11, 2001, by and between the registrant and American Stock Transfer & Trust Company, included as Exhibit E to the Stipulation of Settlement regarding the settlement of the class action lawsuit, dated as of January 11, 2001 (filed as Exhibit 10.29 to the registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000 (File No. 000-24435) and incorporated by reference herein).
10.1†    2006 Vice President Compensation Plan for Eduardo S. Sanchez.
31.1      Certification pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Chairman of the Board of Directors, President and Chief Executive Officer.
31.2      Certification pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Vice President, Finance and Chief Financial Officer.
32         Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

Certain portions of this Exhibit were omitted by means of redacting a portion of the text. This Exhibit has been filed separately with the Secretary of the Commission with such text pursuant to our Application for Confidential Treatment under Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

All other items included in this Quarterly Report on Form 10-Q are omitted because they are not applicable or the answers thereto are “none.”

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

   

 

MICROSTRATEGY INCORPORATED
By:  

/s/ Michael J. Saylor

  Michael J. Saylor
  Chairman of the Board of Directors,
  President and Chief Executive Officer
By:  

/s/ Arthur S. Locke, III

  Arthur S. Locke, III
  Vice President, Finance and Chief Financial Officer

Date: May 10, 2006

 

35

Exhibit 10.1

Confidential Materials omitted and filed separately with the

Securities and Exchange Commission. Asterisks denote omissions.

LOGO

Vice President

Compensation Plan

2006

Name: Eduardo Sanchez

Effective Date: 1 January 2006

Annual Bonus Potential: $250,000

Contribution Bonus Rate at Plan: [**]%

Contribution Bonus Rate above Plan: [**]%

Maintenance Bonus Rate: [**]%

As a MicroStrategy Vice President (“Plan Participant”), you are eligible to earn a bonus based on the financial performance of your Franchise while you are an active employee of MicroStrategy. A bonus may be paid in addition to your base salary.

I. Contribution Targets for 2006

 

In USD

   Q1-06    Q2-06    Q3-06    Q4-06    Total

Contribution Budget Target

   $ [**]    $ [**]    $ [**]    $ [**]    $ [**]

Contribution Plan Target

   $ [**]    $ [**]    $ [**]    $ [**]    $ [**]

II. Contribution Calculation

Contribution will be calculated based on the [**] for the quarter less the [**] for the quarter using the formula: Contribution = ([**] – [**]). Any Contribution amount less than the Contribution Budget Target in a quarter will be distributed equally and added to both the Contribution Budget Target and Contribution Plan Target over the remaining quarters. Although the quarterly targets will increase as a result of any shortfall, the Plan Participant will have the ability to earn their full bonus if they achieve their original Contribution Plan Target for the full year.

III. Contribution Bonus

Your Contribution Bonus shall be calculated by multiplying the quarterly Contribution in excess of the quarterly Contribution Budget Target by the Contribution Bonus Rate at Plan.

Your Contribution Bonus Rate at Plan equals Annual Bonus Potential / (Contribution Plan Target – Contribution Budget Target.

Your Contribution Bonus Rate above Plan is applied to any contribution amount above the Contribution Plan Target.

IV. Quote System Compliance As Precondition For Payment Of Any Bonus

No Plan Participant is eligible for the payment of any bonus for any transaction unless: (a) a formal quote was submitted using the MicroStrategy Quote System that clearly describes each term and condition of the proposed transaction and is in full compliance with MicroStrategy Quote System Policy; (b) the submitted quote was approved in advance of any discussion with the customer about the terms and conditions of that transaction; (c) all pricing communications with customer include the official quote approved in the quote system; and (d) the final transaction is identical in all respects to the approved quote.

V. Maintenance Bonus

 

    You will have the opportunity to earn an additional bonus at the end of the calendar year for any increase on the Maintenance Contract value in the customer base of your territory.

 

    Finance, in its sole discretion, will calculate the [**] value of Maintenance contracts at the end of 2005 and compare this to the [**] value of Maintenance Contracts at the end of 2006.

 

    Your Maintenance Bonus will by computed by multiplying the Maintenance Bonus Rate times the increase, if any, of the [**] Maintenance Contract value between the end of 2005 and the end of 2006 in your territory.

VI. General Terms

 

1. MicroStrategy reserves the right to modify, suspend, or terminate this Plan or any bonus payment in whole or in part, at any time, with or without prior notice or reason. If a Plan Participant is no longer employed by MicroStrategy (regardless of the reason or cause of the employment termination), no bonus shall be earned by or paid to the Plan Participant.

 

MicroStrategy Confidential and Proprietary    Page 1 of 2


LOGO

 

2. Revenue means revenue and earnings consistent with United States Generally Accepted Accounting Principles (“GAAP”) generated by transactions in a given time period. GAAP Revenue will include: License Revenue, Maintenance Revenue, Consulting Revenue and Education Revenue for your Franchise. GAAP Revenue shall be adjusted by subtracting:

(a) Revenue recognized in the current quarter generated by Sales that have not been completed according to the following Company policies: MicroStrategy Code of Conduct; Revenue Recognition Policy; Quote System Policy; and Contracts Approval, Execution, and Processing Policy.

 

3. Cost means the total direct accounting cost (as reported in a MicroStrategy Profit and Loss Report) attributable to the Regional Franchise.

(a) GAAP Costs will include compensation expenses accrued for your Franchise at the actual pay out rates, as well as bad debt charges, unrecovered expenses, and any relevant Franchise overhead cost allocations.

(b) GAAP Costs will not include costs associated with corporate field overheads and commission costs associated with certain OEM transactions.

 

4. The timing of bonus payments is subject to the finalization and verification of GAAP Revenue, GAAP Costs, and Contribution achievement as determined by MicroStrategy.

 

5. Bonus payments are contingent upon:

 

  (1) The Plan Participant fully complies with all MicroStrategy policies, including but not limited to the MicroStrategy Code of Conduct, Revenue Recognition Policy, Quote System Policy, Field Operations Policy and the Contracts, Approval, Execution, and Processing Policy.

 

  (2) Completion of all activities in the Field Sales Portal.

 

  (3) The Plan Participant accurately and timely completes and submits all required Representation Letters and Sales Portal Disclosure Questions.

 

6. MicroStrategy reserves the right to delay, withhold or suspend any bonuses pending MicroStrategy’s determination of whether each of the above requirements (and all other bonus eligibility requirements set forth herein) has been met. MicroStrategy may recover any bonuses paid to any Plan Participant if MicroStrategy subsequently determines that a Plan Participant did not meet one or more of the eligibility requirements described in this Plan, or otherwise should not have received the bonus payment.

 

7. MicroStrategy shall have sole responsibility for the administration, interpretation, and implementation of this Plan. Plan Participants must raise with the Vice President Corporate Development any issues they have concerning their commission statement within 60 days from receipt of the statement. All decisions and determinations by MicroStrategy relating to the Plan and any commissions shall, however, be final.

 

8. A Vice President may propose a commission split among more than one Account Manager or Account Executive within his/her region that is subject to approval from MicroStrategy. The company shall approve all inter-region commission splits.

 

9. This Plan is not a contract and does not guarantee or create any expectation of employment. Employment with MicroStrategy is “at will” and, therefore, either you or MicroStrategy may terminate the employment relationship at any time with or without notice or reason. Participation in this Plan does not grant you the right to continued employment or any right to continuation in your job assignment.

I acknowledge and accept this document as my compensation package for 2006.

Approved by MicroStrategy Incorporated on March 31, 2006.

Acknowledged by Eduardo Sanchez on April 4, 2006.

 

MicroStrategy Confidential and Proprietary    Page 2 of 2

Exhibit 31.1

CERTIFICATIONS

I, Michael J. Saylor, certify that:

 

  1. I have reviewed this quarterly report on Form 10-Q of MicroStrategy Incorporated;

 

  2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

  3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

  4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

  5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Dated: May 10, 2006

   

/s/ Michael J. Saylor

   

Michael J. Saylor

   

Chairman of the Board of Directors,

   

President and Chief Executive Officer

Exhibit 31.2

CERTIFICATIONS

I, Arthur S. Locke, III, certify that:

 

  1. I have reviewed this quarterly report on Form 10-Q of MicroStrategy Incorporated;

 

  2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

  3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

  4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

  a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

  5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Dated: May 10, 2006

   

/s/ Arthur S. Locke, III

   

Arthur S. Locke, III

   

Vice President, Finance and

   

Chief Financial Officer

Exhibit 32

CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report on Form 10-Q of MicroStrategy Incorporated (the “Company”) for the period ended March 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned, the Chief Executive Officer of the Company and the Chief Financial Officer of the Company, each hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to his knowledge on the date hereof:

(1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

Dated: May 10, 2006

   

/s/ Michael J. Saylor

   

Michael J. Saylor

   

Chairman of the Board of Directors,

   

President and Chief Executive Officer

Dated: May 10, 2006

   

/s/ Arthur S. Locke, III

   

Arthur S. Locke, III

   

Vice President, Finance and

   

Chief Financial Officer