Earnings Call Transcript - MSTR Q1 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the MicroStrategy Q1 2020 Earnings Call. At this time, all participant lines are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Michael Saylor, Chairman, President and CEO. Please go ahead.

Michael Saylor, Chairman and CEO

Hello. This is Michael Saylor. I'm the Chairman, President and CEO of MicroStrategy. I'd like to welcome all of you to today's conference call regarding our first quarter financial results. This has been quite an unusual and eventful quarter for the world; and for MicroStrategy, we’re about to share an update. I will start with the change in our leadership team. Lisa Mayr has decided to resign from MicroStrategy to pursue other opportunities. We wish her well. I’m happy to announce that in her place, Phong Le has agreed to resume his duties as CFO in addition to continuing his role as COO. He is here with me today, and we will start by sharing our Safe Harbor notice.

Phong Le, CFO

Thank you, Michael, and good evening, everyone. Some of the information we provide during today’s call regarding our future expectations, plans, and prospects may constitute forward-looking statements. Actual results may differ materially from those forward-looking statements due to various important factors, including the risk factors discussed in our most recent 10-Q filed with the SEC. We assume no obligation to update these forward-looking statements which speak only as of today. Also during today's call, we'll refer to certain non-GAAP financial measures. Reconciliations showing GAAP versus non-GAAP results are available in our earnings release which was issued today and is available on our website, www.microstrategy.com. I'd like to begin by saying we hope you and your families are staying safe and healthy in this difficult time. The COVID-19 pandemic is an unprecedented global emergency that’s fundamentally changed how our business is being done, at least in the near term. At MicroStrategy, we've successfully instituted a work from home initiative for all of our employees. I am pleased with how quickly we're able to make this transition. While working from home is not a perfect substitute for our normal working environment, it does present challenges. I want to thank all MicroStrategy employees for quickly adapting to the situation and their dedication to ensuring our customers' success. Before I review our first quarter results, I want to reiterate a few key points about MicroStrategy’s financial strength that we believe are particularly important in the current environment. As a management team, we will take the steps necessary to work through this economic and public health crisis, while also helping to ensure we're making the investments necessary to capitalize on our market strength. We have a strong balance sheet with more than $500 million of cash and short-term investments and no debt. MicroStrategy is a 30-year-old business that has experienced tough economic cycles before. We believe our debt-free balance sheet is a strategic asset for the company and provides us with significant flexibility in uncertain economic times. We have over $300 million in annualized subscription term and product support revenue. This is a stable, highly profitable source of recurring revenue for us and one of the key strengths in our financial model. We have high gross margins, a cost structure that's mostly variable or reasonably flexible and low capital investment requirements. This scalable and flexible cost structure enables us to react quickly in an uncertain environment. Today I'll provide a high-level overview of our first quarter performance, how the COVID-19 pandemic is impacting our business, provide an update on our strategic goals for 2020, discuss product updates and finish by discussing Q1 in more detail. We were on track to have strong first quarter license revenues through the middle of March. On average, we typically close about 50% of our license revenues in the last two weeks of each quarter. In March, we began to see some deals slippage as certain customers pulled back on investments given the high degree of uncertainty in the market as well as their need to focus on operational continuity for their employees and customers. Overall, I’d characterize our Q1 performance as reasonable given the environment at the end of the quarter. We continue to take steps to support our customers during this time and make it easier to do business with MicroStrategy. We're now providing free upgrades to the latest version of our platform MicroStrategy 2020. Over 1,000 customers are in MicroStrategy 2019 or 2020. Our customers appreciate having access to the latest software and the most comprehensive security features in MicroStrategy 2020, which help support their work from home initiatives. Proactive customer engagement is delivering good upgrade activity which we believe will help sustain high renewal rates and drive increased spending from existing customers over time. Similarly, we made our online learning portal free to use through May 15th providing our customers access to hundreds of hours of training courses, certifications, and tutorials. We've seen a tremendous response from customers and partners with nearly over 15,000 unique user registrations since we announced the program. The free upgrades in education demonstrate our commitment to being a long-term partner focused on our customers' success, which we believe will benefit us in the future. Our field sales organization has quickly adapted to engaging with customers virtually. We have strategic and longstanding relationships with many of our customers, which makes it easier to engage virtually. We have also used this opportunity to simplify our sales and sales enablement processes so that we make it easier to sell our products and demonstrate a faster ROI to our customers. All of our marketing events have moved to virtual platforms. We're seeing significant benefits to this approach, including making it easier to organize and schedule customer events and being able to leverage our senior leadership and thought leaders more broadly. For example, we ran a virtual roundtable for our federal business, bringing together our best customers to discuss issues and challenges they're facing. The group was moderated by our Head of Marketing. In the past, we've had two of the top three highest attended webcasts in the history of our company. This combination of strong customer interest, greater flexibility, and significant cost savings encourages us to focus more on virtual marketing resources and events going forward. We continued our progress of selling our managed cloud platform in Q1 which as a reminder is at full parity with our enterprise-grade on-premise product. In today's environment, businesses are looking for fast, secure, and economical solutions, and that is how we are positioning our product. Our customers understand that by using our managed cloud platform, they can lower total cost of ownership and get data faster and more securely. Before turning to the financials, I'd like to review the highlights from our Annual MicroStrategy World User Conference in Orlando. This is one of the best-attended world events we've hosted with around 2,500 attendees. The highlight of the event was the introduction of MicroStrategy 2020, our latest platform release that builds on the tremendous innovation of MicroStrategy 2019. In particular MicroStrategy 2020 includes additional enhancements to hyperIntelligence, making it easier to gain insights from popular websites, applications, and devices people use every day including Chrome, Edge, and Outlook. Customers can now click on dynamic links within a HyperIntelligence card to take direct action, making it seamless for an insight interaction. We signed transactions with some great new HyperIntelligence customers including Pfizer, the General Services Administration, and Nu Skin Enterprises. Customer feedback on our new innovations and product roadmap has been very positive and underscores our position as a leader in the enterprise analytics market. It's not just our customers that are recognizing the strength in the MicroStrategy platform; MicroStrategy received the highest use case scores from Gartner in the Enterprise Analytics Use Case, 4.86 out of 5 and Embedded Analytics Use Case, 4.96 out of 5 in the Gartner 2020 Critical Capabilities for Analytics and Business Intelligence Platforms report. We're very proud of these scores and believe our breakthrough technology of HyperIntelligence satisfies the new customer use case for speed and agility that hasn't been addressed by traditional analytics and BI tools. Turning to our financial results in more detail, revenues for the quarter were $111.4 million, down 3.4% year-over-year and 1.7% on a constant currency basis. Product license revenues were $12.6 million in Q1 2020, a $5.7 million or 31.2% decrease year-over-year and 28.2% on a constant currency basis. As discussed, we had a number of deals within a few weeks of the first quarter related to the effects of the COVID-19 pandemic. However, as of the end of Q1, no major deals were lost due to COVID-19. We may experience decreased product license revenues compared to prior year periods until the effects of the pandemic have subsided. Subscription services revenue of $8 million in Q1 2020 was up 11.5% year-over-year and up 9.9% compared to the three months ending December 31, 2019. The growth of subscription services revenue reflects the growing portion of our product bookings that are related to our managed cloud platform. Product support revenues were $71.2 million in Q1 2020, a slight decrease year-over-year but a 1.2% increase on a constant currency basis. Our renewal rates remained strong this quarter. Although our product support revenues were not materially impacted by the COVID-19 pandemic, during Q1 2020, our product support revenues may be negatively impacted in future periods to the extent that customers require extended payment terms or determine not to renew their product support arrangements as part of their efforts to reduce expenses. Finally, you'll note that other services, which is largely our consulting services, increased 6.7% year-over-year, and 8.1% on a constant currency basis. We've been delighted with our consulting organization’s ability to continue to effectively deliver services remotely to our customers, and we are expecting that remote delivery trend to continue. This is a great example of our operational agility and focus on serving our customers. Although our consulting revenues were not materially impacted by the COVID-19 pandemic during the first quarter of 2020, we may experience declines in our consulting revenues in future periods as our customers continue operating in remote work environments and aim to reduce expenses. Total deferred revenue and advance payments at March 31, 2020 were $188.6 million. This was down 3.1% year-over-year, but there are two factors that play here. First, there is a relatively large foreign exchange impact of 1.7%, particularly impacting our product support deferred revenue. Secondly, we had an unusually high rate of renewals in our managed cloud platform business that slipped into early April primarily due to customer administrative delays. These renewals have since closed. One other thing to note within deferred revenue, as we begin to see more existing customers convert to our managed cloud platform, there is a shift for deferred product support revenue to deferred subscription services revenue. Turning to cost, gross margin for the quarter improved slightly to 78% compared to 77.3% in the same period last year, partly due to improved consulting utilization. Total operating expenses were $87.0 million in Q1 2020, a 12.7% decrease year-over-year and down 12.4% quarter-over-quarter. The year-over-year cost decrease is driven by efficiency in staffing, reductions in corporate travel, and a reduction in the number of in-person events mostly related to marketing. We also had a one-time benefit from the cancellation of our sales employee awards event which was required as a result of the COVID-19 pandemic. Driving efficiencies across the company is a key strategic focus for us, and we continue to balance making investments in the business that will enhance our growth opportunities with identifying opportunities to cut costs. We're confident that we can improve both top-line growth and margins over time. Turning toward our balance sheet, we ended the quarter with $539 million in cash and short-term investments. You will note that during the quarter, we repurchased approximately 355,000 shares of MicroStrategy class A common stock for $50.7 million. We'll continue to be opportunistic in our share repurchase activity, which is one component of how we think about long-term capital allocation. As a reminder, our policy is not to discuss our buyback intentions in advance. Looking ahead, the emergence of the COVID-19 pandemic has significantly impacted the world. Like most companies, we're evaluating the financial impact on our business. From a demand perspective, we're seeing the positive impact from our product and go-to-market investments over the past 18 months and our pipeline for product license and cloud subscription sales. In a normalized environment, I would be feeling confident in our ability to generate constant currency revenue growth. However, given the high level of uncertainty in the market due to the COVID-19 pandemic, the associated economic disruption, and the deal slippage we experienced at the end of March, we expect our ability to convert this pipeline to sign deals to be more challenging. Right now, there is simply a wide range of outcomes for product sales in Q2 and the balance of the year. We also expect to see some modest headwinds to our product support and consulting revenues over the rest of the year. We have a highly diverse customer base and consistently high renewal rates. We do have some customers with extreme challenges in their business that we believe may lead to some payment lapses or delays, leading to some pressure on renewal rates. We are expecting some pressure on consulting revenues as some customers look for ways to reduce spending to manage their near-term expenses. With regard to expenses, as we discussed last quarter, we believe we have right-sized the organization to allow us to continue to invest in our business. Our prior initiatives, including driving greater productivity in sales and moving some of our R&D and overhead functions to lower-cost locations. Now, with the recent changes to our marketing programs and reductions in travel, we believe we have the ability to offset a potential drop in revenues. Our objective is to deliver positive operating margin and positive free cash flow in 2020. Now, I'd like to turn it back to Michael Saylor.

Michael Saylor, Chairman and CEO

Thanks, Phong. Yes, as Phong said, there are challenging times, but we feel pretty good about the path ahead. We're a seasoned company. We’ve been around for 30 years. We've lived through a number of other crises. About every 10 years, there's normally a difficult time. I think our balance sheet is a great asset. We're sitting on all cash with no debt, so we can calmly think about how we want to move forward. I think we've made the right structural decisions over the last few years to create a very efficient P&L. We're structured to generate cash flow. We've got very stable recurring revenues. We've got a flexible cost structure. I'm enthusiastic about the fact that we have a modern open platform. What we're seeing in 2020 is a major digital transformation and certainly one transformation is to work remotely via Zoom. And the other transformation is work out of the cloud. We're really looking at what I'll think of as an explosive virtual wave of change. We’re positioned well with it because our platform runs equally well on AWS or Azure, and because we support Windows and Linux, we can move seamlessly between the enterprise and the cloud, and we're well positioned to bring online Google support later this year. I believe that we're going to see an increasing number of companies wanting the ability to move between AWS, Azure, and Google as they become more dependent upon cloud bandwidth. Our Enterprise Intelligent offering is in more demand than ever, I think. Our HyperIntelligence, mobile intelligence, and web intelligence, all still resonate very, very well with the marketplace. We've got a good remote delivery model. We can deliver our software remotely and have. We’ve learned that we can deliver services remotely. We restructured our education fairly quickly to eliminate all of our classrooms and physical sessions and go to virtual sessions. We've rebuilt our education offering so that we could offer on-demand education. We lifted our limits from 20 users a class to 200 users a class. In some cases, we've been teaching 400 people in the same classroom. We found that our education could scale nicely. We also were able to switch all of our consulting engagements from on-premises to remote fairly quickly. Probably half of them were already remote going into the COVID crisis, but the other half were able to go remote in a very quick period of time. We were very, very impressed with the dexterity of the entire consulting team to do that. Our support and our cloud operations are performing smoothly and effectively in a remote mode. And so, as I look forward, our method for monetizing the brand is we ship software and we ship services. If we can deliver the software, the education, the consulting, and the cloud services, all in a remote model, then that puts us in a good position regardless of what shape the evolving post-COVID world takes. We've also seen that our agile analytics model works really, really well in this environment. We've moved through a number of very intricate corporate business reviews, and we’re able to do them with a combination of Zoom calls, MicroStrategy dossiers, and MicroStrategy HyperCards. If you just put the MicroStrategy dossier onto the screen in the middle of a Zoom call, you can have 12 people in 12 different locations all working on the same information. By hovering over any particular line item, a HyperCard comes up in a split second and you're able to get the information you need at your fingertips while zooming around anywhere. It's a really, really elegant model for running a business. It’s a differentiator for us. We think we do it better than anybody. I think that this explosion in demand for Zoom will apply really well to our actual analytics strengths. We've learned that we can not only operate sophisticated business reviews using Zoom, plus dossiers, and HyperCards, but in many of these cases, we can change the dossier construction in the 24 hours before the meeting, and we can change the HyperCard within 24 hours before the meeting. So it's easy and it's fast and it's agile. This is really, really a good place to be as we look forward. More and more businesses need to find a way to operate in a virtual environment. Normally that means, how do I create something useful in a matter of hours and deploy it to people all over the world and do it with a sub-second response? We didn't just put this together in the past few weeks, we've always been working on it for the past five years as part of the MicroStrategy 2020 platform. I think that 2020 passed a lot of operating tests with flying colors over the past month. We’re really happy about that. Finally, of course, our biggest asset is our customer base. We have enterprise-class customers, and that includes lots of banks, healthcare companies, telcos, governments, technology companies, and retailers. Some retailers are right in the thick of this crisis, the major supermarkets shipping food and are essential. Other retailers in the fashion luxury segment are a bit more hit by this. The good news is that the great majority of our customers are either critical and essential to their various economies, or they have extraordinary balance sheets. Even if they are impacted by COVID, they’ll continue as going concerns and entities. So while we can't assume that we won't actually suffer some compression or our customers will suffer some deleterious outcomes because of the COVID crisis, all-in-all, we feel that our customer base is better positioned than most; and our business model combined with our balance sheet, combined with our products and service offerings, is better positioned than most to do well as we move into a virtual environment. And so with that, I think we'd be happy to take questions from analysts.

Operator, Operator

Thank you. Our first question comes from the line of Tyler Radke with Citi. Your line is now open.

Tyler Radke, Analyst

Maybe you could start with you Phong, appreciate the color on some of the trends that you're seeing out in the field. Maybe if you could just elaborate in terms of, if there's particular verticals or a segment of customers that you're seeing those deal slippages come from; are those the same customers that you perhaps anticipate renewal rates to be pressured? And do you have any sense on when those headwinds could reverse? I am just trying to understand if you anticipate the renewal rates to be worse? Are they turning off MicroStrategy or are they just going off support? Maybe it would just be helpful to clarify that. Thanks.

Phong Le, CFO

Hey, Tyler. Thanks for the question, and I hope you're doing well too. As far as the deal slippage from Q1, as I mentioned, a lot of it happened in the last few weeks of the quarter, and it wasn't necessarily any particular industry or segment. A lot of what we heard from customers who are still very interested in our software and incremental purchases was especially, 'Hey, we're just really focused on business continuity right now,' so where an IT department was ready to implement increased usage for MicroStrategy, they were now just figuring out how to make sure every one of their employees had locked laptops so they could work offline or work from home. And that isn't particularly in any industry. It was really just a lot of customers that would have had to turn and focus on that sort of immediate first couple of weeks. Those cases, we're continuing those discussions now, and most of them have gotten through the first two to four weeks of disruption. I think those deal cycles are looking positive. On the renewal rates, I think it's early to tell. Certainly, there's some impact from customers who are seeing revenues decrease in areas like travel and hospitality and restaurants and those areas. But it's not sort of a predominant case of where our customers are concentrated. Nor are we in a place where we can say we're predicting a trend yet. I think as we're seeing in the world and we're seeing sort of in the macroeconomic sort of environment, I think Q2 will tell us and tell a lot of our customers a lot about sort of where this is all going to go. So as I mentioned in sort of our prepared remarks, it's still early to predict how this will impact our product support revenue streams. But as Mike mentioned, I mentioned, we're well prepared to be reactive and proactive with our customers.

Tyler Radke, Analyst

To follow up on that, looking at the deferred product support revenue, I understand there were several dynamics regarding invoicing and delays, though it’s unclear whether that was related to the subscription or product support line. With the deferred product support down about 5 million year-over-year, are you observing concerns regarding potential headwinds in reported revenue, or is there something in the pipeline that has led to caution about support rates?

Phong Le, CFO

Yes, I think the only thing that you really point to as far as actual financial impacts is our product license revenue. And as I mentioned, that's because we pick up a lot of that in the last couple of weeks of the quarter. The slight decline in product support revenue was primarily related; one, to FX impact, which we continue to see some headwinds there; and two, some of that revenue moving from product support over to subscription. So nothing immediate. We definitely are having conversations, right, like even in the last few weeks with customers who are asking for delayed payment terms. We're seeing a lot of that, right? Our standard payment terms are 30 days, and we have customers asking for 90 days, 180 days. And then we do have a small section of distressed customers who are asking for relief on their maintenance. So nothing sort of in the actual Q1 financials I’d point to, but more conversations we're having with customers through our customer success channels and through our sales channels.

Tyler Radke, Analyst

Great. I apologize for joining the call a couple of minutes late. Could you discuss the CFO transition? I think it surprised many given Lisa Mayr's short tenure. Are there any specific details on that, and do you have plans to hire another full-time CFO? What are your thoughts on this transition?

Phong Le, CFO

Nothing as far as the transition itself. Lisa resigning and going on to look for other opportunities is worth expansion. I did this job six months ago for four years. I'm actually looking forward to doing it again. So fortunately for her, maybe, unfortunately for all of you, you get to talk to me again and more. As far as our plans going forward, we're not immediately planning on searching for a CFO. I think the nice part is as I ramped up in the second half of last year with sales and consulting, I was able to put in a pretty strong leadership team and a deep bench. We've promoted a bunch of people from within, so I feel like the leadership in sales and consulting has really stepped up, which allows me to better split my time between finance and operations. I'm actually really looking forward to it, and hopefully you guys all are too.

Operator, Operator

Next question comes from the line of Hamed Khorsand with BWS Financial. Your line is now open.

Hamed Khorsand, Analyst

So a few questions here. Is there any risk of less usage of customers having employees working from home? Would they need less services in consulting?

Phong Le, CFO

Yes, a good question Hamed, and it's maybe two parts. In terms of the use of our software, I think the answer is no. If you look at studies sort of previous downturns in the economy, we noticed that people using our software for operational purposes, especially, tends to increase, not decrease. As people work from home, we'll see more of a move to the cloud. If supply chains get more complex, I would say more scrutiny, I think our software will increase in usage too. So on a per-customer basis, they're still operating. I'm not too worried there. On the consulting side, I do think when people are working from home, there is less of an interest in spinning up large consulting engagements and major IT improvements and capital spend associated with consulting. We saw a little bit of that towards the end of Q1 and we're seeing some of that in Q2. So I do expect for the period of the COVID-19 disruption to impact our consulting revenues.

Hamed Khorsand, Analyst

And then how you're navigating this environment as far as sales go and hitting quotas, if quotas exist at this point just given that everyone you would be targeting is working from home?

Phong Le, CFO

It's interesting; if you'd asked me six weeks ago, I would've said we're still figuring it all out. Fortunately, we've been in an environment where all of our salespeople generally speaking, are working remotely anyways. So it's not as if it's a major change to how they operate. The differences instead of meeting a customer in an office in the middle of Manhattan or London or in the Bay area, they're doing it remotely via Zoom or WebEx and actually it gives them an opportunity to increase productivity so that they're not traveling three or four hours a day, and they're able to meet 3 to 4x the number of customers. We've actually seen some pleasant outcomes there. And the customers are getting used to it too. On the side of quotas, yes, when you're down 30% year-over-year in product license revenue, I think salespeople look at Q1 and do worry about their ability to make money. As I sort of mentioned earlier, the pipeline is strong. I think people see positive outcomes as we go through the rest of the year. Our hope is that our customers start to transition from a reactionary focus on business continuity mode to a proactive take advantage of the situation and really start to invest in analytics again. I think that'll be positive for our sales folks. So I think we'll learn a lot as to how our customers and our sales folks will react in Q2.

Hamed Khorsand, Analyst

And last question, though, any upgrades that get done when companies have employees working remotely? I mean what’s the enticement to do anything?

Phong Le, CFO

The pleasant surprise with our business has been the overwhelming response to our free education initiative, where we initially expected only a few thousand customers to participate, but over 15,000 unique customers and partners signed up. We've realized that while people are working from home, they have more time to enhance their skills and update their resumes. Since the upgrades are free, they serve as a perfect alternative to capital investments in software or services. We have improved our ability to facilitate remote upgrades, leading to positive outcomes and increased upgrade activity. These scenarios allowed us to give back to our customers effectively. Customers who educate themselves on MicroStrategy and upgrade to our latest platform show high engagement with our software. When the time is right, they are likely to invest in more education, services, and software. We are pleased with our ability to adapt in this way, and customers view our efforts positively during this challenging time.

Operator, Operator

Thank you. We have no further questions at this time. I would like to turn the call back over to Michael Saylor for closing remarks.

Michael Saylor, Chairman and CEO

I want to thank everybody for your support over the past 12 weeks. I want to wish you all the best to come. I know it's a very difficult time. We appreciate you being with us today, and all the best. We'll speak with you in 12 more weeks. Thank you.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.