Microstrategy Inc (MSTR) 2003 Q3 法說會逐字稿

Good afternoon.

My name is Derek, and I will be your conference facilitator.

At this time, I would like to welcome everyone to the MicroStrategy third-quarter earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer period. (OPERATOR INSTRUCTIONS).

Mr. Saylor, you may begin your conference.

Thank you.

I want to thank everybody for being with us today.

I am Michael Saylor.

I'm the Chairman and CEO of MicroStrategy, and this is our third-quarter conference call.

First, Eric Brown, our President and CFO, is going to read the Safe Harbor statement and then review our financial results.

Then Sanju Bansal, our Vice Chairman and Executive Vice President and also Chief Operating Officer, is going to do a review of our sales and marketing activities during the quarter.

I am going to sum it up with a strategic overview, we will take questions and answers from the group, and then we will end our call today.

With that, I'm going to pass the floor to Eric Brown.

Thank you, Michael.

Various remarks that we may make about our future expectations, plans and prospects constitute forward-looking statements for purposes of the Safe Harbor provisions 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 registration statements and periodic reports filed with the SEC.

I would also like to add that we will post supplemental information regarding our financial results to the IR section of our Website, which is www.MicroStrategy.com.

This supplemental information will provide a detailed reconciliation of GAAP to pro forma results.

I would like to begin by describing the highlights of Q3 2003.

Revenue for Q3 was $42.8 million, which is up 28 percent versus the third quarter of 2002, and also exceeded the upper end of our revenues guidance for the quarter, which is 36 to 39 million.

This is the fourth consecutive quarter of year-over-year license growth.

Our GAAP EPS was a loss of $1.59 per share, due to a $30.2 million loss on the conversion of the remaining $53 million in convertible notes.

This nonrecurring, non-cash charge was expected and communicated last quarter.

Our adjusted or pro forma EPS of 37 cents per share exceeded the upper end of our earnings guidance, and also exceeded First Call consensus EPS of 20 cents by 17 cents.

This marks our eight consecutive quarter of positive adjusted net earnings.

We generated 9 million in cash flow from operations and 3.8 million in net cash flow for the quarter.

Our cash balance at the end of the quarter was 38.7 million, which is up from the 34.9 million at the end of Q2 2003.

During the quarter, we converted all outstanding principal and accrued interest on our $53 million note, and paid off the remaining 5 million of short-term debt that remained from the preferred stock refinancing.

The Company is now debt-free.

As a result of the debt conversion and extinguishment and continued operational improvement, our stockholders' equity has turned positive for the first time in the last three years.

Revenue in the third quarter is 42.8 million, again which exceeded the upper end of our guidance range, and was above consensus estimate of 39 million.

Total revenue was up by 28 percent versus Q3 '02, and down approximately 2 percent sequentially from Q2 of '03.

License revenue in the third quarter was 17.7 million, which is up 37 percent versus Q3 of 2002, again making this the fourth consecutive quarter of year-over-year license growth.

Our revenue mix was 41 percent license and 59 percent services.

The geographical revenue mix in Q3 '03 was 64 percent U.S. and 36 percent international.

Our four strongest vertical segments for the quarter were banking/financial, retail, government and information technology.

Gross profit margins continue to remain high, at 84 percent for Q3 2003, which is roughly the same as last quarter, and improved versus Q3 of last year, which was 80 percent.

Gross profit margin in the license business was 95 percent, and gross profit in the services business was 76 percent, which improved (technical difficulty) the end of Q3 was 832, and is comprised of the following -- 205 FTEs in cost and services, 280 FTEs in sales and marketing, 200 in R&D, and 147 in G&A.

Included in the numbers are 20 R&D employees in the Angel.com and Alarm.com business (technical difficulty).

Overall, total cost of revenue and operating expenses, excluding restructuring, intangible write-offs and other one-time items, were down by $1.5 million sequentially, and increased by 4.3 million versus Q3 of last year.

Compared to last quarter, we had lower sales and marketing costs due to lower commission payoffs and lower marketing spending in Q3.

Our R&D (technical difficulty) were lower than those of Q2, due to lower compensation expenses and 200K of capitalized software development costs.

G&A costs were higher in Q3, compared to Q2 2003, due to higher external legal fees.

In Q3 '03 we reported a GAAP loss of 24.4 million, which equates to $1.59 loss per share in terms of EPS.

We reported total adjusted net earnings of 6.2 million in Q3 2003, compared to 5.8 million in Q2 2003, and 1 million in Q3 2002.

The adjusted net EPS results for the quarter, using a diluted share count of 16,469,000 shares, was a profit of 30 cents per share, again exceeding First Call consensus and our Q3 guidance.

The First Call consensus estimate was 20 cents per share, and our guidance range was 10 to 20 cents for (technical difficulty).

The reconciliation of our GAAP earnings to pro forma is as follows.

First of all, starting with the reported GAAP net loss of 24.4 million, we add back 30.2 million for the nonrecurring, non-cash loss on the conversion of the remaining $53 million of class action notes, and we also add back 0.3 million for the non-cash discount amortization expense of the class action notes.

This yields 6.2 million in adjusted net earnings.

We have provided GAAP results and additional financial information in the press release to help reconcile GAAP to adjusted (technical difficulty).

We apply the exact same methodology for the adjusted net earnings reconciling items, as in previous quarters.

And again, it's important to note that the adjusted EPS number is computed using 16,469,000 diluted shares.

Income tax expense for the quarter was 342,000, compared to a credit of 71,000 in Q2 '03.

The income tax charge for the quarter was primarily attributable to certain foreign subsidiaries.

Turning to the balance sheet, I would like to make a number of comments.

Our cash balance increased by 3.8 million to a total of 38.7 million, as of the end of Q3.

During Q3 2003, we also paid off a $5 million short-term note payable.

In terms of note repurchases and conversion, as previously disclosed, on June 23rd, 2003, we announced that we were electing to convert the remaining 53 million at face value.

Based on a conversion price of $32.26, the conversion resulted in the Company issuing approximately 1.65 million shares of Class A common stock on July 30th, 2003.

As a result of the conversion on July 30th, 2003, the Company incurred a non-recurring and non-cash charge of 30.2 million, which is equal to the difference between the fair market value of the conversion shares issued and the $39.8 million carrying value of the notes as of July 30th, 2003.

As a result of the note conversion, the elimination of all preferred stock and debt, combined with continued financial improvement over the last 24 months, stockholders' equity turned positive in Q3 '03.

Stockholders' equity at the end of Q3 was a positive 26.2 million, versus a negative 21.3 million in Q2 '03.

Total deferred revenue was up by 2.6 million versus the prior quarter, with an increase of 1.5 million in short-term deferred revenue and 1.1 million in long-term deferred revenue.

The increase is mainly due to maintenance, as we continue to see very strong renewal rates.

Our Q3 DSO figure was 60 days, compared with 61 days in Q2 '03.

This DSO metric is within the 50 to 65 day range that we typically expect.

For the third quarter, we reported adjusted EBITDA of $9.1 million.

This marks the 10th consecutive quarter of positive EBITDA.

And on a trailing four-quarter basis, we generated 32.7 million in EBITDA.

The overall cash balance, as noted earlier, increased by 3.8 million, bringing the ending cash balance to 38.7 million.

This marks the sixth consecutive quarter the Company generated positive cash flow from operations, excluding the large one-time accrued interest payment that we made in Q4 2002.

The reconciliation of cash flow is constructed as follows.

First of all, starting with the EBITDA of 9.1 million, which was detailed in the press release, we subtract 1.1 million for cash restructuring costs, we add back 2.5 million in cash from deferred revenue, and subtract 1.5 million from working capital, to net to 9 million of cash generated from operations.

Below that, we have a $5 million cash outflow for the short-term note payoff, 1.3 million in CapEx, a $1.7 million cash inflow from the stock option exercised in ESPP, capitalized software outflow adjustment of 0.2 million, and all other items representing an outflow of 0.4 million, which nets out to an overall change in cash of 3.8 million for the quarter.

Key operating metrics for Q3 are as follows.

The total number of new customers in this quarter was 116, which brings our total number of customers like (ph) to date to 2,337.

Our new-versus-existing customer revenue mix in Q3 was as follows -- 44 percent of revenue from new customers.

This is down a bit from last quarter, of 57 percent.

The breakdown of license deals in the quarters is as follows. 21 deals greater than 200,000; 20 deals greater than 250,000; 8 deals in excess of 500,000; and 4 deals in excess of 1 million.

Indirect revenue as a percent of overall revenue was 27 percent in the quarter, which is up slightly from 23 percent in the prior quarter.

We signed a total of 24 new channel partners in Q3 2003.

We had a total of 103 quota-carrying personnel at the end of Q3, compared to 105 quota-carrying personnel at the end of the prior quarter.

Total headcount at the end of Q3 was 832, and for the trailing 12 months, the attrition rate was 19 percent, which is slightly better than what we reported in the previous quarter, i.e. a 21 percent attrition rate.

We had a total of 283 license deals in Q3, compared to 317 last quarter and 256 in Q3 2002.

The average license deal size for the quarter was 83,000, which is up slightly versus the 80,000 average deal size in Q2 '03.

Gross margin for Q3 is 84 percent, the same as last quarter, and up versus the 80 percent reported in Q3 2002.

Again, the revenue mix for the U.S. versus international was 64 percent U.S. and 36 percent international.

In terms of share count at the end of Q3, we had 15,927,000 shares outstanding.

This is an increase of approximately 1.8 million shares from the end of Q2, which is due primarily to the conversion of the class-action notes.

The cause of the change in the period-ending share count is as follows.

First of all, starting with the Q2-ending share count of 14,158,000, we add 1,655,000 shares for the conversion of the class-action notes, and an additional 114,000 shares for options and ESPP plans, which nets to 15,927,000 at the end of Q3.

The GAAP weighted average number of shares outstanding for the quarter is 15,359,000 basic, and the same on a diluted basis, since we reported a GAAP loss.

Had the Company been GAAP net income positive for the quarter, the fully-diluted weighted average share count would have been 16,469,000.

The additional 1.1 million shares are the impact of employee stock options.

For computing the adjusted or pro forma diluted EPS of 37 cents per share, one should use the fully-diluted weighted average share count of 16,469,000.

As previously noted, we have posted a complete reconciliation of GAAP to adjusted net earnings and the EPS and share count computations on the IR section of our Website.

We provided guidance in the press release.

The following statements concerning the financial guidance are subject to risks and uncertainties, described at the end of our earnings release itself.

Management guidance for Q4 2003, full year 2003 and full year 2004 is valid as of today only, and supersedes any previously-announced guidance as to the Company's expectations for financial results.

Q4 2003 revenues are expected to range from 39 million to 45 million.

Full-year 2003 revenue is expected to range from 162.9 million to 168.9 million.

Q4 2003 GAAP EPS is expected to range from 27 cents to 44 cents per share, and full-year 2003 GAAP EPS is expected to range from a loss of $1.09 to a loss of 94 cents per share.

Q4 2003 pro forma EPS is expected to range from 27 cents to 44 cents per share.

Full-year 2003 pro forma EPS is expected to range from a profit of $1.14 to $1.35 per share.

Full-year 2004 revenue is expected to range from 175 to 185 million.

Full-year 2004 GAAP EPS is expected to range from $1.50 to $1.70 per share, and full-year 2004 pro forma EPS is expected to range from $1.50 to $1.70 per share.

The Company also expects to have positive operating cash flow in both Q4 2003 and the year 2004.

In summary, Q3, which is typically a seasonally down quarter, was a very solid quarter, featuring good year-over-year operating metrics, an increase in our deferred revenue and improved cash balance, and the elimination of all long-term debt.

This concludes my remarks.

I will now turn the conference call over to Sanju Bansal.

Thank you, Eric.

Q3 was another successful quarter for MicroStrategy.

Our growing license revenues are indicative of a healthy software company, and our license revenues have grown at a robust clip for the fourth quarter in the row.

MicroStrategy continues to win significant deals with the most information-intensive companies in the world, and these companies are deploying our platform enterprise-wide.

They are building a large number, sometimes dozens or more, of applications that reach into all facets of their operations and deliver insight to thousands of users.

Increasing demand for BI applications and increasing BI user populations are fueling our vibrant license growth, and will continue to do so.

We believe the full potential of BI can only be realized when it's extended across our customers' entire enterprise.

MicroStrategy continues to offer the industry's only industrial-strength BI platform, and our technology leadership is the reason companies are migrating from our competitors' products to ours.

Here is a partial list of some of the customers we transacted business with in the third quarter.

CareerBuilder, Cascade Natural Gas Company, ConocoPhillips, Cox Communications, Fleet Boston, GE Medical Systems, Hannaford Brothers, Liquor Control Board of Ontario, Meredith Corporation, the National Institutes of Health, Oakwood Homes, Quixtar, Reinsurance Group of America, Toys "R" Us, TRX Data Services, Upsher-Smith Laboratories, Verispan and Wells Fargo Bank.

With that as introduction, let me provide a bit more detail about the quarter.

We had a very good number of new customer wins, at 116, and we had a very good total number of transactions, at 283.

In services, we maintained the consistent performance that we demonstrated all year.

We've upheld our high maintenance renewal rate worldwide.

Our technical advisory services offering has continued its momentum in Q3, with a significant uptick in sales, particularly in the United States.

We have also seen continued acceptance of our PEP education offering.

The third quarter has tended to be a tougher quarter for us, due to purchasing seasonality, so I am especially proud of our strong performance in this Q3.

Also in Q3, we entered into 24 relationships with systems integrators and original equipment manufacturing partners, including AC Technologies, Cadence Qwest, Cap Gemini Ernst & Young, Core Technologies, Covansys, CRS Retail Systems, Innovative Consulting and Thinkfast Consulting.

I'd like to briefly highlight a few noteworthy customer wins in the quarter.

First, we have Cascade Natural Gas Corporation.

After considering computing solutions from Hyperion and Crystal Decisions, Cascade Natural Gas chose MicroStrategy as its business intelligence standard.

Cascade selected MicroStrategy 7i due to its scalable architecture, Web-based user interface and extensive report formatting capabilities.

The first phase of the MicroStrategy deployment will enable Cascade to perform financial analysis and reduce the time required to deliver financial reporting to company management.

Users will be able to view core financial reports via the Web, and explore data by dimensions that were previously unavailable.

Cascade intends to build several additional business intelligence applications on the MicroStrategy platform.

The second customer that I would like to discuss is Cox Communications.

Cox Communications, the fourth-largest cable provider in the nation, has selected the MicroStrategy platform.

The company will utilize MicroStrategy 7i to track and assess business data across sales, billing and network engineering.

After an in-depth evaluation of many of the competing products in the industry, Cox selected MicroStrategy 7i for its easy-to-use Web interface and its ability to integrate with their existing systems.

The third customer I would like to discuss is Loblaw Companies.

Loblaw, Canada's largest food distributor, with over 120,000 employees, has expanded its deployment of MicroStrategy for sales reporting, merchandising and category management applications.

Initial MicroStrategy users include senior executives, category managers and store personnel, and the number of MicroStrategy users is projected to grow sharply to several thousand as the MicroStrategy platform's deployment is expanded.

Loblaw plans numerous additional MicroStrategy applications, including supplier analysis and reporting, to improve vendor relationships.

Lastly, I would like to highlight Telephia.

Telephia, the leading provider of market intelligence to the mobile industry, has chosen MicroStrategy to power its client portal.

Telephia will utilize the MicroStrategy 7i platform to provide marketing and service-quality data to wireless carriers.

MicroStrategy will enable Telephia to efficiently and precisely convey its vast market and industry information to its mobile industry customers.

MicroStrategy continued to win awards in Q3 2003 for its BI software and its market success.

In September, MicroStrategy won the 2003 Software Business Industry Award for Best Product Development.

This award, sponsored by Software Business Magazine, recognizes software companies that have displayed industry-wide leadership with their products.

Software Business Magazine's managing editor said, "Growing in popularity, we received hundreds of nominations for this year's software industry award, making for fierce competition.

We selected MicroStrategy for Best Product Development because MicroStrategy's business intelligence platform has consistently stood out as an industry-leading solution.

MicroStrategy's business intelligence platform is the only platform flexible enough to suit every business need.

Also in September, Computerworld Brazil honored MicroStrategy Brazil with its number-one ranking among BI vendors in the Brazilian market.

MicroStrategy won this top ranking as part of Computerworld Brazil's annual top 100 IT companies listing.

This is the second consecutive year that MicroStrategy Brazil has appeared on the list.

In terms of BI applications, many of our customers are going well beyond their first few MicroStrategy-based apps, and we're seeing some MicroStrategy customers put in place 10, 20, even 50 BI applications using MicroStrategy.

The amount of data that is being captured for reporting and analysis is growing dramatically, and the number of users is also growing dramatically.

These trends will likely further drive our revenue growth, because our competitors have product architectural limitations that tend to constrain their software deployments to smaller databases and user populations.

We believe MicroStrategy will be the natural product choice as BI deployments grow.

Next month, we will further enhance our industry-leading technology with the release of our new enterprise reporting engine, aptly called Report Services.

I encourage all of you to participate in our worldwide Webcast launch taking place in three weeks on November 18th.

This will mark a great milestone for MicroStrategy, as we firmly extend our technology leadership into the enterprise reporting arena.

And with that, I would like to turn the floor over to Michael Saylor.

Thank you, Sanju.

I guess I will just summarize with some high-level thoughts on the Company's position in the marketplace.

I think, if we work from the inside out, over the past 12 months, we have gone from a Company with a balance sheet laden with approximately $150 million in either preferred equities or debt instruments that were all senior to the common stock shareholders, and that $150 million has gone to 0.

So as of now, we have eliminated $150 million of senior securities that, of course, were getting preferences over the common stock shareholders.

And I think that's good for the common shareholders.

We have also gone from a company with an annual interest and dividend load of $15 million to 0.

Again, another example of a drag on the P&L of the Company which we've eliminated, and that bodes good things for the future.

Our gross margins overall and our service margins have both improved, and we're very happy and excited about that.

And the P&L in general has gotten stronger, and you can see that, of course, in our expansion of our income from operations over the last 12 months.

So, in addition to strengthening the balance sheet, I think we have improved the operating model of the business on a quarter-by-quarter basis.

If we move on to technology, our technology silhouette has strengthened.

We continue to expand our technology silhouette, and will continue to do so over the next 12 months, allowing us to meet a greater percentage of the needs of the large IT organization within the global 2000 company.

I believe that our product line, over the next few months, is going to expand its silhouette again, and this will allow us to compete even more effectively against Business Objects, their Crystal division, and Cognos, for more customer share and wallet share.

And then finally, at the market level, I believes that the marketplace consolidation is a benefit to us.

It's clarifying many things for customers.

There are fewer confusing messages.

Our messages, I think, are not being drowned out as badly as they were many years ago, when we had 15 to 25 vendors in this space.

I think that we have been on message with regard to our focus upon enterprise industrial-strength business intelligence platform for the global 2000.

We have been on that message for a number of years now.

It's beginning to sink in.

We are beginning to see some dividends come out of that throughout the marketplace and the channel.

I think, when you put all these things together, it translates to a customer base that's looking to make a commitment that has fewer and clearer choices that are more clearly differentiated than ever.

And when they look at us as a choice, they see a company that has strong technology, the strongest technology in the industry.

They see our technology getting even stronger by the quarter.

They also see a company with a dramatically strengthening balance sheet and a very strong quarter-by-quarter business model.

And I think that gives them a greater degree of confidence than at any time in the past few years, in making larger commitments to us.

I think, when you put all these things together, it bodes good things for the business.

We feel very comfortable with the business right now, and we're looking forward to 2004.

So with that, I'm going to go ahead and open the floor for questions and answers.

(OPERATOR INSTRUCTIONS).

David Hilal, Friedman Billings.

It is Daniel.

How's it going, guys?

Two questions -- first, some of the M&A activity that we have seen in the BI landscape -- could you comment if you are seeing any more jump balls (ph), specifically from the Bob Jay (ph) front, any disruption happening there?

Are you referring to the impact of the M&A activity on the sales cycles in the marketplace out there?

Yes.

Yes;

I think that the shuffling of Brio going to Hyperion and Crystal going to Business Objects has caused a lot of people in the marketplace to reconsider their long-term strategies.

I think it's inevitable that whenever you shuffle technology assets into different corporate shelves, you're going to see some dislocation.

We see that as good for us.

We have seen opportunity.

People that would have been secure and sat with their Crystal implementation, for example, now would reconsider, because there's a question about where that is headed and how well that will be supported by Business Objects.

People that might have sat on their business intelligence implementation from Business Objects now may reconsider because they think that perhaps Business Objects will switch over their support to Crystal.

Of course, no one really knows what will happen, but there's always 5 to 10 percent of the marketplace that is concerned about these things.

And that uncertainty on the margin will take people into a different decision-making cycle where their view is, if I have to consider switching from, say, Crystal to Business Objects or from Business Objects to Crystal, maybe I should just consider switching to Cognos or to MicroStrategy.

And so, when they put together a shortlist of considerations, on that shortlist, the three largest companies are going to be Cognos, Business Objects and MicroStrategy.

That's a good thing for us; that means we're getting drawn into more of those discussions.

I think that another benefit of the M&A activity is some dislocation of executive personnel.

A lot of the senior staff, we know personally, and have heard through the channel that a number of senior Crystal decisions executives are leaving the company, and I would presumed that would ripple into the sales forces of the respective companies, or Brio or other places.

And with that shuffling, normally, the loyalty patterns that are imbued in the customer base get a little bit shaken up.

And all of those things together just allow us opportunities, either to get in the door with a customer we didn't have a chance to get in the door before, or the customer will pick up the phone and call us when they probably wouldn't have thought to do anything for another year.

So that's a good thing for us.

As for the exact impact, we'll see that over the next 12 months.

It normally takes a little bit of time for these things to play themselves out, and they can have subtle impacts, even in our own existing customer base, in the way our existing customers view us.

A question for Eric.

On G&A, can you quantify the legal costs in the quarter?

Yes.

Q3 compared to Q2, the sequential increase is approximately $800,000 to $900,000.

Mark Murphy, First Albany.

Great quarter.

Eric, just to clarify what the guidance -- am I looking at the guidance correctly, and seeing that you are raising guidance above the First Call consensus for revenue and earnings, for both 2003 and 2004?

What do you show as consensus revenue for '03 and '04?

Let's make sure we're looking at the same set of numbers, Mark.

I show 165 and 177.

Well, what we have done is we have put a band, obviously, for the 2003 revenue, as well as the 2004 revenue.

And I think that if you look at roughly the center points of the band, it's more or less consistent with the consensus numbers that you cited.

And then a question for Michael.

Qualitatively, how is the Q4 pipeline of business shaping up, and are you more encouraged by what you're seeing in Europe or in North America?

We are comfortable with the business right now, and I think that if we look at the trending over the last four to eight quarters, I think every quarter we feel a little bit more comfortable with the business.

I wouldn't suggest that there are any major shifts on a sequential basis from one quarter to the next, but we think that Q4 is as strong a quarter as our previous quarters.

And so we wouldn't have any concerns one way or the other.

It's pretty consistent, I'd say.

Michael, another question.

From time to time, some of your competitors will try to position MicroStrategy as overly focused on the retail vertical.

But I noticed, when you had listed out the vertical contributing segments, retail was actually listed second.

So I'm curious; does the rank actually correlate to the revenue contribution of those top four verticals?

And more broadly, what are we seeing, as the Company evolves over time?

Do you feel that you are becoming more deeply focused on the retail sector, or is it actually the opposite?

Mark, this is Eric.

I'll take the first half of that question.

The way that we rank order the verticals this quarter, and the way that we have done it in prior quarters consistently is based on license revenue from each of the segments.

And traditionally, we find retail in the top, number-one, -two or -three slot.

And that's just consistent with your observation that we have a strong installed base, and historically, retailers were very early adopters of data warehousing technology, and natural consumers of BI platform technology.

As for the future evolution of our sales pattern within the industry segments, I'll defer to either Sanju or Mike, and let them comment on what they see out there in the future.

Sure.

This is Sanju.

I think that certainly, retail historically has been pretty strong for us, but today, we're very well diversified.

And you'll note that we list amongst our clients a very strong roster of financial service companies, pharmaceutical companies, government agencies, manufacturers.

And so retailing, while it tends to be a strong part of our business, is not the focus of our business; it just happens to be one good segment of our business.

I would echo Sanju's comments.

I think that we are pretty comfortable with the uptake of the technology across about a half-dozen to a dozen different industries.

They are all doing well, and we were pretty excited about a number of developments outside the retail industry in the past quarter.

But at the same time, retailers continue to support us quite well.

And I think that our momentum in the retail market will continue, and it is very heartening.

We're getting to the point in the retail business where we are the overwhelming dominant choice there, and it never hurts to have that situation.

But at the same time, we are seeing really, really good business coming from other areas; for example, like the credit card business, where I can think of a number -- not one, not two, three or more -- really nice deals we did in Q3 with credit card vendors or credit card analytics.

And so I think that we will continue to see more opportunities like that take place in the next year or two.

Frank Sparacino, First Analysis.

First question -- Eric, on the services line, looking at Q4, do you think the number you have is sustainable going into Q4?

Should we expect a sequential increase in the December quarter?

What we typically do, Frank -- our philosophy and our practice, in terms of providing guidance is to pick kind of a center point and then put kind of a band around that.

We have a slightly broader band with respect to the Q4 revenue guidance, because typically, it's the quarter where we have the opportunity to take dollars in expiring IT budgets prior to the renewal over the next budget year.

So the midpoint of our Q4 revenue guidance of 39 to the 45 -- the mid point is roughly 42; it's about the same as Q3.

So I think that, on the heels of a stronger-than-expected Q3, we are looking at, broadly speaking, kind of flat performance, if you take the center point.

So I think it's kind of -- the quarter-over-quarter comparison is the way it is more as a function of the unexpected upside, revenue-wise, in terms of Q3 performance.

I was more focused on the mix, Eric, in terms of the services line.

And maybe another way to ask it would be, was there anything unusual in the September quarter in the services number?

Yes.

Actually, I think that services did better than expected.

Seasonally, we see a downtick on the services line, because we have less billable hours available to deliver, particularly in the international portion of our business and in EMEA, specifically.

So I think that we had a very strong services performance in Q3; it was up a bit from Q2.

So that was a positive development, from our perspective.

And then maybe Sanju or Mike, on the sales front, you hired a number of people going into the end of last year.

And those guys have been on board for a couple of quarters now.

I don't know if there's anything qualitatively you can provide, or qualitatively, in terms of how you feel those reps are performing, in terms of productivity?

Well, you are right.

We have hired some additional sales reps.

We've simultaneously brought in some new ones, and then we've had some leave the Company who weren't as good a fit.

As you can see from the P&L and the revenue and the earnings numbers, and if you look at the margins, et cetera, if you look at the sales and marketing expense line versus our license revenues, you can do some back-of-the-envelope calculations and see that we sort of feel like our sales and marketing efficiency is improving.

Given a dollar of investment in a salesperson, I think our revenue is increasing versus this time last year, and it tends to be trending in the right direction.

So I do think that we are managing our sales operations more efficiently.

I think that that's coming from a variety of factors, obviously.

What is going on in the market is helping us.

What is going on in the competition is helping us.

Our technology is helping us.

Our focus on message is helping us.

The stock price increasing by a factor of 10 doesn't hurt us.

There are lots of things, including we're just getting smarter about how we sell enterprise business intelligence.

It would be difficult for me to decompose them all, but to say that yes, I'm feeling that our sales efficiency is increasing.

Our revenue generation per selling head and in both our service lines and our software lines is going up, and we're hopeful that we can continue that trend.

Okay.

And then maybe lastly, it appears the international business this quarter was up sequentially a healthy amount, somewhat unusual, given the seasonality.

But was there anything that drove that?

Yes.

A couple of comments.

I think that international felt a bit soft in Q2, and so I think that we did execute better in Q3.

Also, I think that we probably had a bit more of a currency benefit in Q3 versus Q2, as well, so that helped in terms of the translation of the GAAP numbers.

So it's really a combination of a couple of different factors.

And also, where typically we expect a bit of a drop-off in overall activity, both in terms of sales cycles and services delivery, in Europe in Q3, we did a bit better than we expected per our own internal forecast.

So it's really a combination of those three things that made the sequential comparison favorable.

Thanks, guys.

Nice job.

Robert Mattson, Janney Montgomery.

Congratulations on the quarter, guys.

A quick question -- I don't know who, maybe this is for Mike or Sanju.

On the services business, as you're looking out, you are guiding for some pretty good growth.

On the different services you offer, talking about the capacity, do you have the capacity to address that?

Will you need to scale up, and you can scale up fast enough?

I just want to get some thoughts behind that.

I'll take that.

It's Michael Saylor.

I think that the key point to note is when you look at our services line, and then if you look at the cost of services, which is, I think, just slightly south of 6 million versus revenue and services, which was, what, 25 million, we have got a very strong gross margin in services.

This is obviously not commodity stuff we're doing; we're not selling heads in a body shop.

So if we were in a volume business like a huge body shop or a system integrator, we would be pretty concerned about capacity, and we would also be running 20 or 30 percent margins, not the kind of margins we are running.

Our services that we focus on are education, education plans.

We sell subscriptions, for example, to education to our customers, and education if we can fill every classroom is very lucrative.

If we leave our classrooms empty, or we only put five people in a classroom, it's not lucrative.

So when you look at the profitability of education or the profitability of technical advisory services, and we're coming into provide customers with strategic advice.

Or if you look at the profitability and the capacity we have in premium support or other support offerings, they are not really so much capacity-driven as they are sales- and marketing-driven.

And it's more important that we have the right programs, and we communicate that properly to customers, and then we manage those programs properly.

It's unlikely that we are, for example, going to not be able to find a way to teach twice as many classes, or put an extra five chairs in a class.

We can figure that out.

So we're not terribly concerned about capacity constraints in the services business in the next 12 months.

Obviously, if you go out more than a year, then we just always are reviewing these things.

But for the next few quarters, I think we're quite comfortable with our capacity, and we are pleasantly surprised and happy about the way that the service business is working.

Eric, any expectations on the capitalized software for next quarter, or is it still a moving target?

I can give you a rough point estimate.

We think that we'll capitalize approximately $1.2 million worth of R&D expense in Q4.

I'm assuming, since the reporting service is coming out, and it looks like it will be next month, it's not likely to shift off a quarter, then?

Just maybe the magnitude of the capitalization might be different?

Yes; there may be some movement plus or minus a couple of days as a shift date, but at this point in time, we're quite comfortable with a November launch date of Report Services.

And last, I know you discussed some issues in the pipeline.

There has been some discussion that maybe some deals in general -- that you are starting to see some increases in deal size.

I wanted to get your thoughts on that.

I don't know if you mentioned that before.

And if there is, you are seeing something, is it falling into particular categories, due to types of projects or geographies or something like that, to see if there's a pattern in there?

Yes.

This is Eric again.

I'll make a comment.

I think that we reported, in this quarter, four transactions of $1 million or greater.

And again, it's not as though there were any significant multimillion dollar deals.

And so I don't think it's reasonable for us to say, at this point in time, that there's any kind of change in the big deal outlook, looking across the pipeline.

It's still fairly consistent, from our perspective.

So really nothing to add there.

I think, for us, what we'd like to see is we are (ph) focused right now in Q4 on the launch of Report Services.

We're spending a lot of time, obviously, on the marketing front, a lot of time on the sales front.

We're going back to existing accounts and prospective accounts with the messaging that we have in enterprise-class integrated report-writing product.

And what we're trying to do is make sure that people are appropriately budgeting for incremental new purchases.

And so perhaps at the end of all that, when budgets are set and dollars start to be spent in 2004, we might see kind of a change in either the average deal size or the large deal environment.

But for us, we really can't say definitively that we see anything at this point in time.

Quickly, Siebel made an announcement about using their products again from Inquire (ph) coming into the space.

Have you seen them at all?

This is Michael Saylor.

I'm not really aware of any competition from Siebel right now.

I probably have heard, or talked to people about 100, 200 different deals out there in the marketplace.

I don't think anybody has brought up Siebel even once to me in the past 12 weeks.

So I certainly know they make a lot of noise on AnalytiX, and I don't dispute that they must be selling it somewhere.

But I suspect it's probably more in the installed base, because our market segment tends to be merchant analytics, and I hear a lot of business objects and a lot of Cognos.

But I just really don't really hear the name Siebel.

Eric?

I would just add that we have heard that they are securing referenceable customers.

I think there is some discussion of those, a disclosure of those referenceable customers in the last, say, four to six weeks.

But we also hear that the referenceable customers may not necessarily have had kind of the traditional expected ASPs for the AnalytiX, and there may have been some bundling or kind of packaging, in order to at least kind of get the install and get the customer reference itself.

So it's really not a factor in terms of what we see in our sales pipeline.

Great, and congratulations on the quarter again.

Patrick Mason, Pacific Growth.

Most of my questions have been answered, but as far as just a couple, shoring up a couple things, do you expect the service margin to stay up in the 76 percent range?

I'm just trying to -- from a modeling aspect?

Or should it drop back down?

We think that it's toward kind of the higher end of what we expect to sustain long term, so I don't see it really going much higher in the short term.

We are probably at a fairly constant level.

And on the capitalized software, you mentioned in Q4, you thought about year end, 1.2 million.

Do you expect that to continue out into '04, or is it going to -- are you going to go back to -- is it kind of like a sine wave, or is it (multiple speakers)?

Good question.

The capitalized software costs are linked directly to the Report Services launch, and this is a major product release for us.

So you'll have this Q4 effect; we'll launch Report Services, and then it will, of course, just amortize through license cost of goods over three years.

And then, what we will do next quarter is we'll talk in a bit more detail about our 2004 technology release plans.

Maybe at that point in time, we can at least comment on the period of the sine wave, because it is, again, going to have product GA-date (ph) specific capitalization effects, and it's not going to be straight line, by any stretch of the imagination.

All right.

And then on just the legal costs, is there any timing on when that might -- you you said that 800,000 or 900,000.

Should we just continue with that, or is there a timing situation where that's going to go away?

Yes.

We had a pickup, Q3 versus Q2, and that was expected.

We were gearing up our activities in preparation for our core cases, specifically Business Objects.

Our Business Objects trial went -- or commenced, I should say -- in Q4.

So that's probably going to produce an additional step-up there.

At some point in time, it runs its natural course, and I would assume that it steps back down.

But we can't predict the timeline at this juncture.

So what we're assuming for modeling purposes is another slight step-up, Q4 versus Q3, in that G&A line item.

Okay.

That is it.

I guess, just on an operating basis, it looks like you guys -- on a pro forma basis, it looked like you had about a 16 percent operating margin.

Am I reading that correctly?

You should be -- what I would refer you to, Pat, is the disclosure schedules that we're posting up on our Website.

That will give you a very clear reconciliation of kind of pro forma, either operating or net income versus revenue.

All right.

Good quarter.

Oh, wait.

One last thing; sorry. (indiscernible).

Pro forma tax number -- did you give -- I thought you mentioned that;

I just may have missed it.

Certainly.

For Q4, we expect a tax expense of approximately 400,000.

Nathan Schneiderman, Wedbush Morgan.

A couple of questions for you guys.

Last quarter, there was a $4 million license deal from a single customer.

I was just curious what your biggest license deal was this quarter.

It was much less than $4 million.

It was, I think, in the $1.5 million range.

So it sounds like the combination of those $4 million deals was fairly comparable to the two deals last quarter?

I wouldn't say that.

I mean, a $4 million license transaction is exceptionally large, just in the BI sector overall.

No.

I meant in terms of the cumulative dollar value, the four deals this quarter versus the two deals last quarter.

I would say that the $4 million deals this quarter are kind of comparable to the $4 million deal last quarter.

So I'd look at it that way.

Okay.

Can you talk about, from -- looking at the competitive environment, could you describe, from a competition point of view, the percent of times you're seeing different vendors in your sales cycles?

And maybe a comment on how that has changed over the past few quarters, if it has?

Sure.

This is Sanju.

We certainly have, over the last year and a half, reported that Cognos and Business Objects were the two vendors that we saw most frequently in sales cycles, and that has continued.

I think there has probably been a little bit of a shift in who we see a bit more often.

A year and a half ago, it would have been Business Objects, and as of today, we probably see Cognos a bit more than we do Business Objects.

So, while they are still number one and number two, I think their relative positions have switched, and that seems to have occurred over the last three to nine months.

Do you see SAS instituted to any extent?

Rarely.

SAS is out there, but it's more of a not-in-kind as opposed to an in-kind competitor, because they rely upon a set of proprietary data structures, and most of our customers have made huge monetary and technical commitments to relational database repositories and data warehouses, from either IBM or NCR or Oracle.

And so, when they make those commitments, they want a toolset which is going to exploit all of the capabilities of those relational database architectures.

SAS's toolset generally consists of a comprehensive set of tools that work against a set of data structures that are extracted from relational databases into the SAS formats, so you'll see them more in departmental levels and very, very technical tasks.

If someone has a need for a Web reporting tool or a business intelligence interface to their data warehouse, it's not so likely they'll think of SAS first.

The database vendors appear to be moving to support technologies that result in faster queries against large data volumes.

What are your thoughts on that, and the expected impact on your business?

That's a good thing, and we have been encouraging them to do that every year for the past ten years or so.

And every single year, they do a bit more.

And I think that will continue for the next 10 years.

Probably -- one thing that everybody is in agreement about today is that the only thing we see in the future is more data and more queries, and more complexity of queries?

People might have debated that 10 years ago or five years ago, but today every retailer, every bank, every credit card company, they know they are going to be collecting the transaction log, or even some transaction information, and they are going to be clearing it, and they are going to be distributing that query capability to more people, and they are going to be running more intricate analysis, which all, of course, is putting a huge load on the database vendor and the hardware vendors.

The hardware guys sort of like it, because it sells more hardware.

The database people, of course, are caught in the middle, because they are getting hit hard with customer requirements.

I don't think there is any silver bullet.

I think that, as database power increases, it means that they are not so much likely to be the bottleneck in the system, which means that a customer that would have deployed to 500 can now deploy to 5,000; and when they do deploy to 5,000, it means more demand for our software and our services.

So that's a good thing for us; we are happy to see the trend.

We expect it will continue, and it's one of the fundamental drivers of our market dynamic.

Final question for you.

In past quarters, you've given the percent contribution of OLAP, your Web Server or Web Professional, Web Universal, as a percent of license revenue.

I was curious what that number was this quarter, and then, any comments you may have on those individual products.

Okay.

Eric is going to answer that question.

The answer to the question is that approximately -- again, looking at a detailed analysis of our U.S. license sales, approximately 34 percent of license sales in Q3 2003 were from the new 7i products, Web Professional and OLAP services.

So I think that this number is pretty consistent with what we forecasted, say, 12 to 15 months ago, as kind of like the long-term cash rate for the new products.

So this is more or less what we had expected.

Well, with that, I want to thank everybody for being with us on the call today.

And I wish you are happy holiday season, and we will be back speaking with you when we have our Q4 results conference call in January.

Have a good evening.

This concludes today's MicroStrategy third-quarter earnings conference call.

You may now disconnect.