Microstrategy Inc (MSTR) Q3 2018 Earnings Conference Call Transcript
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Microstrategy Inc (NASDAQ: MSTR)
Q3 2018 Earnings Conference Call
Oct. 25, 2018, 5:00 p.m. ET
Contents:
Prepared Remarks
Questions and Answers
Call Participants
Prepared Remarks:
Operator
Good day, ladies and gentlemen, and welcome to the MicroStrategy Third Quarter 2018 Earnings Conference Call. (Operator Instructions)
I would now like to introduce your host for today's conference, Michael Saylor, Chairman, President and CEO. Sir, you may begin.
Michael J. Saylor -- Chairman, President and Chief Executive Officer
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 2018 third quarter financial results. I'm here with our Chief Operating Officer and CFO, Phong Le.
First, I'd like to pass the floor to Phong, who's going to read the safe harbor statement and make some comments on our results for the third quarter.
Phong Le -- Chief Operating Officer and Chief Financial Officer
Thank you, Michael, and good evening, everyone. Various remarks that we may make about our future expectations, plans and prospects may constitute forward-looking statements for purposes of the safe harbor provision under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in our most recent quarterly report on Form 10-Q filed with the SEC.
These statements reflect our views only as of today and should not be relied upon as representing our views as of any subsequent date. We anticipate that subsequent events and developments may cause the Company's views to change. While the Company may elect to update these forward-looking statements at some point in the future, the Company specifically disclaims any obligation to do so.
Also, during the course of today's call, we'll refer to certain non-GAAP financial measures. There's a reconciliation schedule showing GAAP versus non-GAAP results currently available in our press release issued after the close of the market today, which is located on our website at www.microstrategy.com.
I'd like to start with financial highlights for the quarter. We delivered the initial version of our MicroStrategy 11 software in September, with great new capabilities and improved ease of use performance, augmented analytics and artificial intelligence that Michael will highlight later. We're now working toward a MicroStrategy 2019 platform release, which we plan to launch in December of this year. We as well as our customers and prospects are c awaiting our first platform release this June 2016 and are excited about our planned annual platform release schedule going forward.
This has been a significant journey in MicroStrategy's transformation. Starting in 2014 with our transition to an agile development process, our MicroStrategy 10 release in 2015, our 10.4 platform release in 2016 and the release of dossier, MicroStrategy Workstation and MicroStrategy Library in 2017. We expect MicroStrategy 2019 to be our best offering ever.
Our customers continue to be happy with our software, consulting education and customer service as well as our new enterprise support program. We had another strong quarter renewals, while we continue to manage our renewal rates and discounting. Product support revenue increased 2% year-over-year. We also returned a positive operating margin of $7.2 million or 6% as we actively managed our cost, especially in the area of discretionary marketing. With interest income and tax tailwinds, our diluted earnings per share increased to $1.10.
Finally, our overall revenue trajectory continues to improve. After four consecutive quarters of double-digit product license revenue decline, we saw 12% quarter-over-quarter increase in Q2 2018. In Q3 2018, we saw 5% quarter-over-quarter increase, although this amount was impacted by FX and ASC 606 revenue recognition headwinds, which I will describe in detail shortly.
Now to our detailed financials. Total revenue for Q3 2018 was a $122.2 million, a $3.9 million or 3% decrease year-over-year and $1.6 million or 1% increase quarter-over-quarter. Foreign currency effects in Q3 2018 negatively impacted our total revenue by $2.4 million or 2%.
Product license revenue was $20.3 million in Q3 2018, a $2.1 million or 9% decrease year-over-year and $1.0 million or 5% increase quarter-over-quarter. Foreign currency effects in Q3 2018 negatively impacted our product license revenues by $0.9 million or 4%. In addition, Q3 2017 product license revenue reflected an increase of $0.8 million, due to the adoption of ASC 606.
Product license revenue continues to be strong internationally with 50% of our revenue contribution, representing a 13% increase year-over-year. Additionally, worldwide, we saw a nine product license transactions with revenue greater than $500,000 in Q3 2018, similar to our 10 transactions for the same period in 2017.
Our support revenue was $74.5 million in Q3 2018, a 2% increase year-over-year. With foreign currency changes negatively impacting such revenue by $1.2 million or 2%, we continue to see strong customer support renewal rates and ongoing reflection of our highly engaged customer base. Gross deferred revenue primarily composed of deferred subscription and product support revenue decreased $20.6 million or 12% as compared to Q3 2017. This was driven by a strengthening US dollar, which reduced the US dollar value of our international deferred revenue balances and a strategic shift we've taken away from offering multi-year commitments with larger discounts.
Our other services revenue was $20.2 million in Q3 2018, a 12% decrease year-over-year and a $0.1 million or 1% increase quarter-over-quarter. We're continuing the transition our consulting business from lower to higher rate services. We're also continuing to evolve our enterprise support offerings into pre-packaged assessments and advisory services.
Turning to costs, our strategy to invest in sales and marketing technology, our customers and our people is driving increases overall. Q3 2018 cost of revenues was $23.4 million, $1.0 million or 4% decrease year-over-year and a $1.7 million or 7% decrease quarter-over-quarter. Previously capitalized software development costs related to MicroStrategy 10 became fully amortized in Q2 2018. We did not further capitalize any software development costs in 2018.
Q3 2018 operating expenses were $91.5 million, a 14% increase year-over-year and 6% decrease quarter-over-quarter. Sales and marketing expenses increased $3.4 million or 8% year-over-year and decreased by $5.5 million or 11% quarter-over-quarter. This quarter-over-quarter decline was due to an increased focus on investing in marketing channels and tactics that return more immediate and tangible benefits.
Sales and marketing headcount increased by 64 people or 10% year-over-year and 12 people or 2% quarter-over-quarter. We believe our sales and marketing costs in headcount already generally appropriate level to grow our business going forward. Research and development expenses increased $6.5 million or 33% year-over-year and $0.7 million or 3% quarter-over-quarter.
Headcount accelerated in our key development centers, with an increase of 149 people or 28% year-over-year and 37 people or 6% quarter-over-quarter. In a highly competitive recruiting environment in technology, we continue to find our efforts to attract, develop and retain top talent to be quite successful worldwide. We believe this headcount growth will help with the functionality, scalability and quality of our 2019 product release and beyond. Otherwise we will continue to ramp our investment in research and development throughout the remainder of 2018 and into 2019. We will focus more in lower cost areas worldwide like China and Poland.
General and administrative expenses increased $1.2 million or 6% year-over-year and decreased by $1.0 million or 5% quarter-over-quarter. The year-over-year increase is primarily due to higher consulting and advisory fees. We had income from operations of $7.2 million in Q3 2018 and an operating margin of 6% compared to 17% for the same period a year ago and negative 1% in Q2 2018.
We had net income of $12.7 million in Q3 2018 and diluted earnings per share of $1.10. We had net interest income of $3.4 million, other income of $0.8 million, which primarily consisted of foreign exchange gains and a benefit from income taxes of $1.2 million. The income tax benefit was primarily due to discrete items, such as the adjustment to the transition tax recorded in Q3 2018. We had cash, cash equivalents and short-term investments of approximately $700 million at the end of Q3 2018 and continue to have no debt.
As we continue through Q4 2018 and into 2019, we expect to see the results of our increased sales and marketing activities benefit us overall. As mentioned previously, we plan to launch on MicroStrategy 2019 product in December, 2018. Which will be an exceptionally significant platform release, customers are excited to migrate to this new release to gain improved benefits like Federated analytics transformational mobility and hyper-intelligence to the masses. Our enterprise support offerings will focus on upgrading customers MicroStrategy 2019. Our continued product license volatility along consulting business trajectory we'll make overall revenue growth challenging in 2018. That said, we are optimistic about our business trajectory and our ability to improve revenues and margins in 2019.
Now I'd like to turn it back to Michael.
Michael J. Saylor -- Chairman, President and Chief Executive Officer
Thanks, Phong. MicroStrategy is a modern, multiplatform enterprise, analytics and mobility platform. We're focused upon being open, being unified in our architecture, supporting all the types of tools that data scientists, application developers and analysts used throughout the enterprise, supporting every type of data source, application and the cloud, enterprise applications, NoSQL sources, MDX sources, Hadoop sources in the like. And I think that that what defines MicroStrategy is the commitment to that modern analytics platform combined with a commitment to a methodology for enterprise success. And we call that methodology our intelligence center program, and we have package that as part of our enterprise support program and we've been building that throughout the past 12 months.
Recently, I flew around the world to meet with dozens of our customers and I spent time Vienna and Milan and Warsaw, I went to Riyadh, I went to Dubai, I was in Hong Kong, Shenzhen, I went to Seoul Korea, Tokyo, and then I went south to Sydney, Australia before returning to Washington D.C. And I engaged in half a dozen conversations in every city I went to with our customers and with prospective customers. And I was very, very excited to hear from them and came back with a conviction that they want things from us, that they just can't get with desktop analytics tools, like Tableau or with departmental analytics tools like Microsoft's Power BI.
Specifically, there are three things that are really compelling and exciting for the enterprises around the world in the year 2019 that they want that I don't think they can get with other tools. The first one is federated analytics. Everybody wants to be able to deploy a common data infrastructure, what we call a single version of the truth, and they want to be able to deploy these common datasets on top of a heterogeneous set of enterprise systems. They want those common datasets to be available to developers and analysts throughout the enterprise. I met with one banking customer that had 1,400 developers that they want to have to working simultaneously on different applications on a single enterprise data model.
There's an incredible thirst for that, I really haven't met a company that didn't want to do better federation of their data, and they wanted a platform that would do that. Tableau doesn't do that. Power BI doesn't do that. MicroStrategy has a great product to support federated datasets and we do it well and we do it efficiently. And I feel that's going to be a great theme from MicroStrategy 2019 in the coming year.
The second big desire in our customer base is the transformational mobility. They like to convert insights into action or as a customer say, insights worth penny and actions worth a dollar. What's the next best action to take with the given customer? What's the next best customer to contact to take action with? What should I do now? What should I do next? Well, to do that, you need to inject analytics right into mobile applications into point-of-sale, into communication. You need support for transaction. You need support for authentication. And that's another thing that we do well. Tableau doesn't support transactional mobile applications. And with regard to Power BI, they haven't integrated the identity, the transaction, the authentication in the same way that we have. So we have a great opportunity there as well.
The third major theme is hyper-intelligence. Hyper-intelligence means real-time zero-click insights that are all around us, intelligence like vapor. And the MicroStrategy 2019 platform is going to be exciting and probably memorable to every single prospective customer or actual customer due to its hyper-intelligence capabilities. We're really excited about the ability to deploy hyper-intelligence to tens of thousands of users across an enterprise and embedded into Office 365, embedded into web browsers, embedded into business documents, embedded into video walls, So that you can turn a television set into a magic mirror where you can walk up to it, it recognizes you and you can talk to it, and you can actually get insight. So hyper-intelligence is extraordinarily exciting in the context of augmented intelligence or augmented reality, because we've now got MicroStrategy customers that are building applications that they put on mobile devices where they've actually integrated the analytics for MicroStrategy with the camera of the mobile phone or the iPad. They can walk down on a supermarket shelf and they can scan the products get the KPIs and do it all with zero clicks.
Zero clicks real-time intelligence requires a couple of things. It requires integrated identity. It requires a really scalable back in. And it requires personalized very intelligent security. So that I understand exactly what I should be showing any given person and these are things that MicroStrategy is strong at because of our traditional enterprise security model and metadata focus. So MicroStrategy 2019 is going to be the platform to provide these three things. And I think it's not only a great platform for allowing us to expand our presence and sell new types of licenses in our installed base. It's also a good platform for us to win new customers and to carve out a position in the installed base of companies, like Microsoft and Tableau.
So I'm really enthusiastic about that. Most of our customers right now are on Version 10.4, which we shipped in June 2016. And in my experience, they're reluctant to make big commitments based upon functionality and a feature release. And so we've shipped releases 10.5, 10.6, 10.7, 10.8, 10.9, 10.11, that have the pieces of this functionality, but really it's all going to come together at the end of the quarter here with Version 11.1, which we will then market as the MicroStrategy 2019 platform for the coming year. I think that that's just a really nice watershed for us and will be a dramatic leap forward in the product offering we're putting into the marketplace.
Moving past product capabilities, I want to talk a little bit about services. In all of my conversations with customers, our customers want help and they want advice and a couple of areas. They want us to provide them with best practice for how to configure their intelligence environments. And especially, this is an important with the advent of new cloud capabilities from AWS and from Azure. There are so many ways you can configure your intelligence network in order to provide optimal performance and inelastic intelligence power. And they want us to help them figure out how to upgrade and configure and deploy these environments.
All of our customers want help with applications -- enterprise applications. How do I design them? How do I deploy them? How do I orchestrate the collaboration between analysts, developers and architects, so that you can have dozens or hundreds of analysts and developers building dozens of applications on a common enterprise framework of datasets and application logic and security. And just like just like yin and yang, order and chaos, degrees of freedom and degrees of constraint, every enterprise is defined by its common security framework, application framework and data framework and yet it is always struggling to innovate at the periphery, at the edge across dozens of business units. And so balancing the need for innovation with the need for order and governance is what makes the MicroStrategy offering special. It's not just the technology challenge, it's very much of organizational and methodology challenge. So our customers want us to help them overcome that challenge, and we do it with a combination of our applications, programs and our analytics methodology program. That's the third area of incredible demand. Our customers want to ask to provide them with a methodology for deploying federated analytics throughout their enterprise. And finally, there is a huge demand for mobility, our customers want help with our methodology for deploying mobile apps across the enterprise and how to integrate them on various devices against various mobile device managers and then build the optimal intelligence back end and determine how to do the whole lifecycle management of these applications.
So our advisory programs are ramping up. They continue to grow rapidly quarter-over-quarter. I've gotten nothing but the favorable response, and I think we'll probably do about 1,000 of these engagements in the coming 12 months. And so it's becoming material. I expect it will drive services and software sales in 2019. And I think it positions us at the high-end in the market where the enterprise-grade vendor that has the enterprise methodology as well as the enterprise platform for some organization that wants to engage in a serious endeavor to link all of the disparate tools in their enterprise, like Excel and Tableau and Power BI and Xcode and Swift code and Visual Studio and Python and I could go on and on.
They want to integrate all the tools, all the functional roles like data scientists, developers and analysts and power users, against its single version of the truth, an enterprise grade platform plugged into dozens or hundreds of their systems of record. That is a -- it's a different value proposition than selling a downloadable desktop analytics tool, and its different than even selling a departmental tool like Microsoft, where you get to support lots of applications, but to a more constrained user base without the aspirations of federation.
And if I were to roll the clock back three years, I would say, on the Version 10.4 or previous versions, we didn't really have the connectors in order to make good on that promise of being open every tool, every type of user, every back-end system. But the MicroStrategy 2019 platform really does offer the openness on the front-end and the power on the back-end and the performance in the middle, combined with the methodology for success, in order to make enterprises successful as they pursue this federation vision.
In Q4, our attention is going to be focused upon the MicroStrategy 2019 launch and all the marketing programs that go along with it. Our attention is going to be focused upon services execution and how do we make sure that we're delivering the best services in the most efficient manner everywhere in the world. And then, we're going to be focused on a continuing strengthening of our sales, services and marketing teams worldwide, so that we can realize the potential that we can see in this tremendous MicroStrategy 2019 platform. I think we'll enter the year with the strongest technology and the strongest methodology and the most organized systems, programs and the most talented team that we've had in the history of the company. So I'm optimistic about what the future holds and looking forward to it.
So with that, I would be happy to open the floor for questions.
Questions and Answers:
Operator
(Operator Instructions) Your first question comes from Tyler Radke with Citi. Your line is open.
Tyler Radke -- Citi -- Analyst
Hi, thank you. Thanks for taking the question. Maybe start off, Michael -- so it sounds like a lot of excitement around version 11. I'm just curious how you're thinking about the impact of version 11 on 2019 license revenue growth. It seems like with version 10, there is obviously a lot of excitement. But certainly, customers want to wait until stable releases out in the market before they migrate. So just how you're thinking about this? Is it going to be version 2 or version 3 when you really see the meaningful migration and just how you're thinking about that catalyzing license revenue growth in 2019?
Michael J. Saylor -- Chairman, President and Chief Executive Officer
I think we learned a lot from our version 10 launch and the production release of version 10 was 10.4. So I don't think we've managed it as well as we could have. And we took the lessons learned as we thought about version 11, and we folded them into our plan. So the version of 11.1 will be the production release and we've spent quite a bit of time hardening that version and already putting the features out in the market. So I think that version 11.1 will actually be a very solid release and I expect that our customers will upgrade to that version in large numbers and we should start to -- we should see benefit in 2019 and it should drive revenue growth for us in the license side.
Tyler Radke -- Citi -- Analyst
Okay, great. And you also mentioned 1,000 -- I think you said 1,000 engagements in the coming months. Could you just elaborate on that? Is that with...
Michael J. Saylor -- Chairman, President and Chief Executive Officer
I said 1,000 engagements in the coming year. And what that means is we're now getting to the point where we're engaging about 200, 250 places in any given quarter with our customers to provide them with advisory services, we've been ramping that up. So I think at the rate that we're ramping up, we should see in 2019 engagements that are providing intelligent enterprise advisory services at least 1,000 of them.
Tyler Radke -- Citi -- Analyst
Okay. And then just lastly on the product side. The -- kind of its vision around having MicroStrategy being able to connect to other analytics tools like Tableau or data science platforms, I'm just curious how you're strategizing the go-to-market to that (ph). I mean it seems like -- are you thinking about this is like a meaningful change from what you're used to? And I know in 10.9 I think you release kind of some connectors to Tableau already. So I'm just curious how that vision kind of compares to what's out there today and how you're thinking about the go-to-market on that as well?
Michael J. Saylor -- Chairman, President and Chief Executive Officer
We've released some technology and we tested the technology in order to get more comfortable with it. And so we won't be releasing the technology for the first time with 11.1. We've actually got some decent experience. What we have done is spent a lot of time working with customers to understand what they need in the area of federated analytics. And I think that summary would be federated analytics will be a major -- one of our three major themes and the year 2019 and is a major theme for the MicroStrategy platform in 2019. And the promise of deploy a set of common datasets to any tool in the enterprise is a promise that all customers resonate with. I mean, why wouldn't you like that, right. It solves a lot of problems. Nobody in a corporation, not the CEO, not anybody from the Executive Vice President and up can dictate and tell people what single tool values. They're going to use a bunch of different tools. If I told them they had to use Excel, they wouldn't. If I told them they had to use Tableau, they wouldn't. If I told them they can't use it, they would. And so you have this heterogeneous situation. And what we've realized over time is it doesn't make sense to spend a lot of time trying to tell someone why the tool of choice they have isn't the best one. A much better idea is to be a corporate citizen and support their tool by give them a single version of the truth with security. In fact, there's almost no pushback from analysts or developers. If you say to them, hey, I've got this one data as a service served up as RESTful APIs or I've got this data service and you can just plug into it from Excel, Tableau, Power BI whatever. There's no pushback from that. Everybody's happy to clean enterprise certified data. The pushback is when I tell someone that uses Xcode, they got to use Swift; or when they Swift, they've got to use Visual Studio, or when they use Visual Studio; they've got to use Python, or when they use Python; they've got to use Tableau, and when they use Tableau, they've got to use Power BI. Nobody wants to switch that tool that they got comfortable with at the end use, but everybody wants to avoid fishing for data in a very complicated fashion and they don't want to reinvent the wheel. So we believe that the federated analytics message is one that will resonate and will allow us to take market share and to work side-by-side with a heterogeneous set of tools that are going to flow out there for quite a while.
Tyler Radke -- Citi -- Analyst
Okay. And then last one from me is on expenses. I think you talked about sales and marketing investments kind of where at a level that you think is good going forward. Could you just talk about the other lines where we are on the ramp?
Michael J. Saylor -- Chairman, President and Chief Executive Officer
You're right, and you saw start to reduce our marketing expenses a little bit from Q2 2018 to Q3 2018 as we focus our activities a bit more on our 2019 launch. On the R&D side, we'll continue to grow that organization. We've been growing at a pretty aggressive clip, and we've been happy with the success we've had there, hiring around the world. The majority of our incremental hiring going forward will be in some of our lower cost areas, like China and Warsaw. And we will still hire some folks here at headquarters, but we won't see substantial cost increases. And on the G&A side, generally speaking, we're trying to keep that as an organization flat going forward.
Tyler Radke -- Citi -- Analyst
Okay, thank you.
Operator
Your next question comes from Frank Sparacino with First Analysis. Your line is open.
Frank Sparacino -- First Analysis -- Analyst
Hi, Phong. Maybe to start with you, just on the deferred revenue explanation you gave, can you give a little more detail in terms of the movement away toward the multiyear agreements?
Phong Le -- Chief Operating Officer and Chief Financial Officer
Yes. We found, historically, we would offer multiyear agreements to customers, let's say, two or three years at pretty steep discounts, call it, greater than 5%. And we found given our renewal rate that, that just wasn't necessary. And so we moved more to sort of single year, one or two year agreements with the flat or no discount model. And as a result that causes deferred revenue balance to decrease over time.
Frank Sparacino -- First Analysis -- Analyst
And then maybe lastly just looking at 2019, Phong or Mike, in terms of the sales force and strategy sort of the go-to-market. Is there going to be any changes -- meaningful changes around the sales part?
Phong Le -- Chief Operating Officer and Chief Financial Officer
I think that the sales organization is going to be catalyzed and charged-off with the 2019 product, because it's a comprehensive platform release and the first one they've had in nearly three years and it checks all the boxes and what's hot in the marketplace right now. We will continue to build out and add additional sales leadership from time-to-time and in different places. I believe that our sales approach is a bit more services led or methodology rich than it has been in the past. I think our sales organization is getting much more confident, assuming the role of trusted advisors with the map of the Intelligent Enterprise and the MicroStrategy Intelligence programs than they were a year ago. And as that program grows, I think it positions them to a much more prescriptive sale than we've had before. But otherwise, no particular thing I'd choose to highlight.
Operator
Thank you. (Operator Instructions) And I am showing no further questions at this time. I would like to turn the call back over to Mr. Michael Saylor for closing remarks.
Michael J. Saylor -- Chairman, President and Chief Executive Officer
Okay. I'd like to thank everybody for your support. We're really excited about what's going to happen during final quarter of the year. I'm looking forward to the release of MicroStrategy 2019. And I'll look forward to speaking with all of you again in 12 weeks. Have a great day. Bye.
Operator
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you all may disconnect. Everyone, have a wonderful day.
Duration: 36 minutes
Call participants:
Michael J. Saylor -- Chairman, President and Chief Executive Officer
Phong Le -- Chief Operating Officer and Chief Financial Officer
Tyler Radke -- Citi -- Analyst
Frank Sparacino -- First Analysis -- Analyst
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