Microstrategy Inc (MSTR) 2004 Q2 法說會逐字稿

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  • Operator

  • At this time, I would like to welcome everyone to the MicroStrategy Q2 2004 earnings 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).

  • At this time, I would like to turn the call over to Michael Saylor, Chairman and CEO of MicroStrategy.

  • Thank you, sir.

  • You may begin.

  • Michael Saylor - Founder, Chairman, CEO

  • Thank you.

  • I'd like to welcome everybody here to our Q2 2004 conference call.

  • We're happy to have you with us today.

  • We're going to start with Eric Brown, our President and CFO, who is going to read the Safe Harbor statement and provide a financial and operational overview.

  • Then Sanju Bansal, our Vice Chairman and Executive Vice President and Chief Operating Officer, is going to provide a sales and marketing review for the quarter.

  • I'll provide some summary comments, and then we'll take questions and answers from the audience and the analysts online.

  • Thank you, and here's Eric Brown.

  • Eric Brown - President, CFO

  • 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 note 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 from Q2 2004.

  • Revenue for Q2 was 49.9 million, which is up 14 percent versus Q2 2003.

  • Our GAAP diluted EPS was a positive 67 cents per share.

  • Our adjusted or pro forma EPS was 67 cents per share, exceeding the upper end of our earnings guidance of 20 to 40 cents, and it exceeded First Call consensus EPS of 50 cents.

  • This marks our eleventh consecutive quarter of positive adjusted net earnings.

  • Our operating income margin was 24 percent for Q2 2004, up from 11 percent in Q2 2003.

  • We generated 10.8 million in net cash flow for the quarter.

  • Our cash, cash equivalents, plus long-term investment positions at the end of the quarter, was 87.2 million, which is up from the 76.3 million at the end of Q1 2004.

  • Deferred revenue balances increased by approximately 2.6 million versus the prior quarter.

  • Revenue in the second quarter was 49.9 million, which exceeded the upper end of our revenue guidance range of 43 to 47, and was slightly above the consensus estimate of 49.2 million.

  • Total revenue was up 14 percent versus Q2 '03, and up 2 percent sequentially from Q1 2004.

  • License revenue in the second quarter was 18.3 million, which is down 7 percent versus Q2 of '03.

  • The declining year-over-year license revenue is attributable to the $4 million United States Postal Service license transaction we closed in Q2 2003.

  • Services revenue in the quarter was 31.6 million, which is up 32 percent versus Q2 '03.

  • The services revenue breakdown in Q2 was as follows -- maintenance, 20.9 million; consulting, 7.9; education and other, 2.8 million.

  • The Q2 2004 revenue mix was 37 percent license and 63 percent services.

  • Gross profit margins continued to remain high, at 84 percent for Q2 2004, which is the same as the prior quarter and Q2 of last year.

  • Gross profit margin in the license business was 95 percent, which was slightly lower than last quarter, and gross profit margin in the services business was 77 percent, which was the same as the prior quarter, and improved from Q2 of last year, which was 73 percent.

  • Our total headcount at the end of the second quarter was 887 people, and is comprised of the following -- 234 people in cost of services, 281 people in sales and marketing, 209 people in R&D, and 163 people in G&A.

  • Included in those numbers are 29 employees in the angel.com and alarm.com business units.

  • The GAAP line item comparison for operating costs for Q2 '04 versus Q1 '04 is as follows.

  • First of all, in terms of cost of services, we reported 8.1 million in Q2 versus 7.8 million in Q1 2004.

  • The cost increase of 300,000 is the result of higher headcount to support increased services revenue.

  • Sales and marketing in Q2 2004 was 15.5 million, versus 16.4 million in Q1 2004.

  • The $900,000 reduction in cost is due to lower variable field compensation.

  • R&D expenses in Q2 '04 were 6.5 million versus 6.7 million in Q1 '04.

  • The net change, a reduction of 200,000 in R&D costs, is a result of there being higher capitalized software expense in the second quarter versus the first quarter of 2004.

  • There is basically a $1 million capitalized R&D expense in Q2 '04 versus approximately 400,000 in Q1 '04.

  • SG&A costs in Q2 '04 were 7.5 million versus 8 million in Q1 '04.

  • The $500,000 cost reduction is primarily due to lower legal expenses in Q2 versus Q1.

  • Overall, total cost of revenue and operating expenses, excluding restructuring and intangible write-offs and other one-time items, decreased by $1.2 million sequentially, Q2 versus Q1 of 2004.

  • In Q2 '04, we reported GAAP net income of 11.4 million, which translates to 67 cents per share.

  • This is an increase compared to net income of 10.4 million in Q1 2004 and 5.8 million in Q2 2003.

  • On a diluted EPS basis, this is a fourfold increase compared to Q2 of 2003.

  • The adjusted net EPS result for the quarter, using a diluted share count of 17,128,000 shares, was a profit of 67 cents per share, again exceeding First Call consensus of 50 cents per share and our guidance range of 20 to 40 cents per share.

  • It is important to note that our reported GAAP EPS and pro forma EPS are the same, at 57 cents per share.

  • This indicates that the adjusted items have been reduced to a minimal level, and GAAP and pro forma results have converged, improving the transparency of our results.

  • There are only four minor reconciling items between GAAP and pro forma, which are as follows.

  • Starting with the reported GAAP income number of 11.427 million, we subtract 55,000 for minority interest, we subtract 63,000 for other nonrecurring items, we add back 85,000 for loss in investments and we add back 17,000 for amortization of intangibles, which nets out to 11.411 million Q2 adjusted net earnings.

  • We have provided GAAP results and additional financial information in the press release, to reconcile adjusted net earnings as discussed above.

  • Income tax expense for the quarter was 0.6 million, compared to 0.8 million in Q1 2004.

  • For the balance of 2004, we expect cash income taxes to be approximately 600,000 to 800,000 per quarter, excluding any potential adjustments to our deferred tax valuation allowance.

  • I will address tax rate assumptions during the financial outlook section of my commentary.

  • Turning to the balance sheet, I would like to note that our cash booked (ph) long-term investment balance increased by 10.8 million to 87.2 million versus last quarter.

  • During the second quarter, the Company purchased approximately 26.4 million worth of two-year US Treasuries.

  • This purchase is reflected in the long-term investment section of our balance sheet.

  • Total deferred revenue increased by 2.6 million versus the prior quarter.

  • Short-term deferred revenue increased from 37 million in Q1 '04 to 40.6 million in Q2 '04, and long-term deferred revenue decreased from 3.3 million in Q1 '04 to 2.3 million in Q2 '04.

  • Our Q2 DSO figure was 50 days, compared with 43 days in Q1 '04.

  • This DSO metric is within our expected range of 50 to 65 days.

  • For the second quarter, we reported adjusted EBITDA of 14.3 million.

  • This marks the thirteenth consecutive quarter of positive EBITDA.

  • On a trailing four-quarter basis, we have generated 50.2 million in EBITDA.

  • The overall cash and long-term investment balance increased by 10.8 million this quarter, bringing the Q2 ending cash and long-term investment balance to 87.2 million.

  • This also marks the ninth consecutive quarter the Company generated positive cash flow from operations, excluding the large one-time accrued interest payment in Q4 of 2002.

  • The reconciliation of cash flow is as follows.

  • First of all, starting with EBITDA of 14.3 million, which is detailed in the press release, we subtract 0.6 million for cash restructuring costs, we add back 2.9 million for deferred revenue, we subtract 3.9 million for change in working capital, which nets to 12.7 million of cash generated from operations.

  • From this, we subtract 1 million for CapEx, we add back 0.5 million for stock options in ESPP, and we subtract 1 million for cap software, which reconciles to the net change in cash and investment balances of 10.8 million for the quarter.

  • The key operating metrics for Q2 2004 are as follows.

  • The revenue mix for the business in Q2 '04 was 63 percent US and 37 percent international, compared to 57 percent US and 43 percent international last quarter.

  • The total number of new customers in this quarter was 118.

  • Our total number of customers live to date is 2,812.

  • Our new versus existing customer revenue mix in Q2 was as follows -- 41 percent of revenue was from new customers, and this is up slightly from last quarter, which was 39 percent.

  • The breakdown of license deals in the quarter is as follows -- 34 deals greater than 200,000; 28 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 product revenue was 22 percent in the quarter, which is up from 15 percent in Q1 2004.

  • We signed a total of 16 new channel partners in Q2.

  • We had a total of 99 quota-carrying personnel at the end of the quarter, which is essentially the same as the prior quarter, when we had 98 total quota-carrying individuals.

  • Total headcount for the Company at the end of Q2 was 887.

  • For the trailing 12 months ending Q2 2004, the attrition rate was 20 percent, which is the same as in the previous quarter.

  • We had a total of 369 license deals in the quarter, compared to 297 last quarter and 317 in Q2 of 2003.

  • The average license deal size for the quarter was 77,000.

  • This is a decrease from 88,000 in the prior quarter.

  • Gross margin for Q2 '04 was 84 percent, which is the same as last quarter and the same as Q2 2003.

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

  • Approximately 37 percent of worldwide license sales in the quarter were from the new products, which include Web Professional, OLAP Services, Report Services, MicroStrategy Office and MicroStrategy Universal Edition.

  • At the end of Q2 2004, we had 16,067,000 shares outstanding.

  • This is an increase of approximately 22,000 shares from the end of Q1 2004.

  • The GAAP weighted-average number of shares outstanding for the quarter was 16,056,000 basic and 17,128,000 on a diluted basis.

  • I would like to note that the MicroStrategy Board of Directors has authorized the repurchase of up to an aggregate of 35 million of the Company's Class A common stock over the next year.

  • The timing and amount of any shares repurchased will be based on market conditions and other factors.

  • The repurchase program may be suspended or discontinued at any time.

  • The repurchase program will be funded using the Company's working capital.

  • As of June 30, 2004, MicroStrategy had cash and long-term investments of approximately 87 million.

  • I would like to turn now to the guidance.

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

  • Management guidance for Q3 2004 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.

  • Q3 2004 revenue is expected to range from 43 million to 47.5 million.

  • Full-year 2004 revenue is expected to range from 190 million to 202 million.

  • We are increasing the upper end of the full-year 2004 revenue range slightly versus what we provided last quarter.

  • Q3 2004 GAAP EPS is expected to range from 15 cents per share to 40 cents per share, with a share count ranging from 17.1 million to 17.35 million.

  • Full-year 2004 GAAP EPS is expected to range from a profit of $1.95 per share to $2.20 per share.

  • We are increasing the full-year 2004 EPS range by 5 cents and 10 cents per share for the lower end and upper end, respectively, versus what we provided last quarter.

  • Our guidance assumes no significant adjusting items between GAAP and pro forma EPS, as we expect the two to converge, and no significant change in our tax rates, except for the impact of the possible release of all or a portion of our deferred tax valuation allowance, which I will discuss further momentarily.

  • The full-year diluted share count we are assuming is 17 million to 17.4 million shares.

  • The increase in our full-year guidance reflects the stronger-than-expected first-half performance, offset by some uncertainty as we head into what is traditionally our most difficult quarter, the third quarter, where we typically see sequential declines in our consulting/education/license business, due to the summer holiday season.

  • The guidance assumes income tax expense in the range of approximately $600,000 to $800,000 for each of Q3 and Q4 2004.

  • The guidance does not include any reductions in our deferred tax valuation allowance during 2004.

  • At this time, the Company is not in a position to give guidance on the amount of any such possible reduction.

  • Management will reassess the deferred tax valuation allowance prior to reporting Q3 2004 and Q4 2004 financial results.

  • Depending upon our Q3 and Q4 actual results, there may be sufficient evidence to support the conclusion that all or a portion of the Company's deferred tax valuation allowance should be reduced during the second half of 2004.

  • Any such release of the Company's method for tax valuation allowance is expected to have a material impact on the Company's consolidated balance sheet and statement of operations.

  • As of June 30, 2004, our deferred tax valuation allowance of net operating losses and certain other temporary differences was approximately $140.6 million.

  • In summary, our Q2 2004 results demonstrate that we're sustaining high operating margins and consistent cash flow generation.

  • Our new product releases, which include Report Services, MicroStrategy Office and the Universal Edition of Intelligence Server continue to drive demand in new and existing customers.

  • This concludes my remarks.

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

  • Sanju Bansal - EVP, COO

  • Great.

  • Thank you, Eric.

  • Q2 was indeed another very good quarter and a profitable quarter for MicroStrategy.

  • We continue to benefit directly and indirectly from a very strong new product cycle.

  • As many of you may know, we recently launched MicroStrategy 7i Universal Edition, which was our third successful new product launch in less than a year.

  • We introduced MicroStrategy Report Services last November, MicroStrategy Office in April and most recently MicroStrategy 7i Universal Edition in June.

  • Each of these new products represents a major step forward in bringing MicroStrategy's high-value business intelligence reporting and analytics to larger user populations, further fueling our revenue growth.

  • Here is a partial list of customers we conducted business with in the quarter -- ADS Alliance Data Systems, Bull Moose Tube Company, Carl Warren & Company, CNET Networks, Cryptologic, DuPont, Finali, Forest Laboratories, Henry Schein, iDine Reward Network, Kent Unified School District, KeyBank, KPMG, Liz Claiborne, Maersk, Meredith Corporation, Oakwood Homes, Ohio Department of Education, Playboy Enterprises, Raley's, Roundy's, Sage Telecom, Shaw Industries, Stage Stores, Supervalu, Sykes Enterprises and Temple-Inland.

  • In Q2, we had a very good number of new customer wins, at 118, and we also had a good total number of transactions, at 369.

  • As Eric noted, we also signed 16 new alliance agreements with alliance partners in the quarter.

  • Now, I'd like to briefly highlight some of our customer wins during the quarter.

  • First, we have the US Department of Education.

  • The US Department of Education Office of Federal Student Aid has expanded their use of MicroStrategy to support both existing and new applications.

  • The Office of Federal Student Aid purchased MicroStrategy software licenses and maintenance services valued at about $885,000.

  • This purchase is part of a broader effort to provide visibility into and to consolidate the Department of Education's direct loan servicing functions, loan consolidation processes and collection activities for its $96 billion in student loan obligations.

  • Next, we have American Healthways.

  • American Healthways is the nation's largest provider of comprehensive disease management, care enhancement and high-risk health management services.

  • American Healthways recently expanded its use of MicroStrategy to include two of our newer products, OLAP Services and Report Services.

  • Users will perform customer reporting and outcomes improvement research against the 2.5 terabyte Oracle data warehouse containing both clinical and financial data.

  • Third, we have DuPont.

  • DuPont Crop Protection provides products for the grain, specialty crop, forestry and vegetation management sectors.

  • DuPont selected MicroStrategy to provide visibility into its compound development data warehouse, which is used for reporting, analyzing and managing field development trials for crop protection chemicals.

  • DuPont now has over 150 business users, and generates over 4,000 reports a month using MicroStrategy 7i.

  • Fourth, we have Liz Claiborne.

  • Liz Claiborne, a leading designer of apparel and accessories for women and men, is using MicroStrategy to extend its business intelligence capabilities within both its wholesale and retail divisions.

  • With MicroStrategy, business people can dynamically report on product performance per stockkeeping unit, and perform trend analyses on stores sales and inventory.

  • This application will allow Liz Claiborne to refine product assortments and retail account forecasts, thereby improving customer service.

  • Fifth, we have The Container Store, which is the nation's largest retailer of storage and organization products, and they selected MicroStrategy as their enterprise standard for reporting and analytics.

  • Business users in areas ranging from merchandising, marketing, logistics and finance will be able to report on and analyze data contained in The Container Store's 1 terabyte data warehouse.

  • The Container Store anticipates that MicroStrategy will help accelerate its development and promotion of innovative new products and services.

  • And finally, we have AmerisourceBergen, which is one of the largest pharmaceutical services companies in the US, and they selected MicroStrategy as the Company's preferred technology for reporting on and analyzing data contained in its enterprise data warehouse.

  • After an in-depth evaluation of many of the competing products in the industry, AmerisourceBergen selected the MicroStrategy platform for its scalability, functionality and easy-to-use Web interface.

  • Now, I'd like to turn attention back to MicroStrategy 7i's Universal Edition and discuss its potential for our business.

  • As an introduction, MicroStrategy 7i Universal Edition expands our market reach by giving us the ability to serve customers committed to running their BI servers on UNIX.

  • Also, as a 64-bit BI server, it delivers improved reporting performance for all users.

  • Universal Edition benefits small and large VI shops alike.

  • Small shops can now run their MicroStrategy Intelligence Server, MicroStrategy web server and their data warehouse database on a single UNIX machine, reducing administration and hardware costs.

  • Large shops can take advantage of our 64-bit architecture, in order to increase the number of BI applications and the number of users hosted on a single BI server, again reducing administration and hardware costs.

  • And all organizations can benefit from the increased performance the 64-bit reporting provides, thanks to faster data transfer rates and increases in addressable RAM.

  • Universal Edition continues MicroStrategy's commitment to deliver all five styles of business intelligence on a single unified architecture, through a single organically developed code base.

  • By providing high-performance enterprise reporting and analysis, it will permit thousands of additional business users to reap the benefits of business intelligence.

  • Here's what several analysts are saying about Universal Edition.

  • Dan Vesset, Research Director of IDC, said, "IDC estimates that approximately 22 percent of the BI market is based on UNIX.

  • The new Universal Edition of MicroStrategy 7i opens up a significant sector of the BI marketplace for MicroStrategy.

  • Equally important is the fact that MicroStrategy 7i now runs in full 64-bit mode, extending MicroStrategy's already high scalability to deliver even better reporting and analytics performance."

  • Additionally, Wayne Eckerson, Director of Research at the Data Warehousing Institute, commented, "Many organizations today are trying to standardize on an enterprise business intelligence platform driven by the need to reduce costs and expand the number of knowledge workers, including customers and suppliers.

  • With the Universal Edition of MicroStrategy 7i, a 64-bit application server that can run on UNIX, MicroStrategy has taken its scalable, high-performance BI platform to a new level."

  • MicroStrategy 7i Universal Edition again demonstrates that MicroStrategy's commitment to pushing the envelope of innovation in the BI market again is unparalleled.

  • We're the first guys out now with a fully functional 64-bit server, and we are optimistic that Universal Edition, like other recent offerings such as MicroStrategy Report Services, will fuel our revenues in coming quarters.

  • With that, what I'd like to do is turn the floor over to Mike Saylor.

  • Michael Saylor - Founder, Chairman, CEO

  • Thank you, Sanju.

  • I think I'd just like to end this management review by noting that we are very focused upon enterprise business intelligence.

  • And for us, that means we're making investments in our technology function in order to meet the needs of our high-end enterprise customers, and we're focusing upon building a sales channel to reach those global 2000 customers.

  • As we look to the future, we intend to continue to invest so as to be the low-cost, high-value supplier to our target market segment.

  • And that target market segment is that sort of customers who have the highest scalability requirements, requirements for sophistication and requirements for functionality and in their enterprise BI platform.

  • In order to be successful in that mission, we need to listen to our customers very carefully, and we also need to manage our business and manage the services we provide them very carefully.

  • Ultimately, our goal is to build a franchise that is profitable and predictable, based upon a defensible differentiated and proprietary software platform.

  • With that, I'm going to go ahead and open up the floor for questions from the audience.

  • Operator

  • (OPERATOR INSTRUCTIONS).

  • David Hilal, Friedman Billings Ramsey.

  • David Hilal - Analyst

  • I've got a few questions.

  • First, in terms of sales headcount, it looks like you added one body.

  • I think you plan was to maybe add 10 people this year, and I wanted to understand if that was still your goal and, if so, when do you expect those net 10 adds to come on board?

  • Michael Saylor - Founder, Chairman, CEO

  • We're continually reevaluating the number of salespeople we want to have in the field.

  • We would like to make some increases in our sales headcount during the coming year.

  • We don't have a hard and fast date for a number of people we'll add by a certain date.

  • We tend to make those decisions based upon the quality of the people we're able to find, and business circumstances in various geographic jurisdictions as they evolve.

  • But we do intend to grow our sales headcount.

  • David Hilal - Analyst

  • A question I'm sure somebody is going to ask -- given that this is such a tough order for the group, and you guys managed to do well, did you see any softness in your business but yet you still got through it, or did you guys feel insulated from some of the malaise that we saw out there?

  • Michael Saylor - Founder, Chairman, CEO

  • We tend to just manage our business day by day, and there are some parts of our business that feel easy, and some parts of our business that feel hard.

  • I think that changes from quarter to quarter, as it has for the past few years.

  • But in general, I think it's sort of business as usual, and we just continue to manage our business to where we have been managing it.

  • I don't think we can say that we won't be impacted by any macrodynamic that impacts the rest of the software industry, but we can't say that we will be, either.

  • David Hilal - Analyst

  • And, Eric, on the model, I think you had really good cost controls.

  • And I know you walked through some of the reasons.

  • In terms of modeling going forward, specifically on R&D and G&A, I'm assuming on R&D, the amortization came in because of the release of the product, but how should we think about R&D going forward?

  • And then in G&A, you had less legal expenses -- any reason legal ticks back up and causes G&A to tick up, or are those pretty much in the rearview mirror?

  • Eric Brown - President, CFO

  • In terms of the overall headcount profile of the business, as you can see, it's creeped up a bit, Q2 versus Q1.

  • I think this is consistent with what we've said in previous quarters, in that we are indeed looking to expand the field where we see opportunities.

  • We've also made some modest increases to the R&D headcount.

  • The big variable for R&D expenses running through the P&L, of course, will be software expenses which are capitalized.

  • As you know, we released a major product in Q2, MicroStrategy Intelligence Server Universal, and that led to about 1 million of R&D costs being capitalized in Q2.

  • So that is certainly an increase of about 600,000 versus what we had capitalized in Q1 of 2004.

  • As to what it might be in the future, this is very difficult to predict.

  • We're more focused on making sure of meeting the product rollout delivery dates, and making sure that the team is staffed accordingly.

  • So we don't intend to forecast at a granular level, you know, capitalized R&D.

  • The rest of the business -- I would just say that our theme, in terms of cost of services -- again, most of those costs are driven by headcount.

  • Those are people providing consulting and technical support services.

  • And as you know, we're looking to manage that business more along contribution margin and contribution dollars.

  • And so, there, what we are looking to do is grow profitably while keeping kind of net margins more or less at a reasonable level.

  • David Hilal - Analyst

  • And then I'll ask a final question on stock buyback.

  • You announced it here for the stock at $35 or so.

  • Should we assume you are buyers at these levels?

  • Michael Saylor - Founder, Chairman, CEO

  • David, I think the share buyback is indicative of the fact that the company has been generating cash consistently for the past few quarters.

  • And as responsible custodians for the public shareholders, we need to consider how to properly use the cash.

  • Certainly, one use of the cash is we can let it sit in short-term money markets, which is a safe and low-risk choice.

  • Another use of the cash is a two-year T-bill.

  • Another use of the cash would be to buy back the stock.

  • How we use the money is really just a function of how we believe we can create shareholder value, and of course that varies from time to time, depending upon external circumstances.

  • We're going to just evaluate that during the coming year, and try to make the best decision we can.

  • This announcement of this program gives us just one more option in order to create shareholder value, and I wouldn't read anything into it another than just that.

  • Operator

  • Mark Murphy, First Albany.

  • Mark Murphy - Analyst

  • Congratulations on the quarter.

  • Eric, I'm curious with the tax situation.

  • What is it that is causing you to reevaluate that status here in Q3 and Q4, where I think previously we had been under an assumption that this is not up for consideration until after the end of the year?

  • Eric Brown - President, CFO

  • The reality is that in the first half of 2004, we've done certainly better than we had expected, and the key test here that we are looking at more closely is one of kind of timing, where we hit on a cumulative rolling kind of three-year basis of sustained statutory profitability, excluding any adjusting items.

  • And given the strong performance, like I said, in Q1 and Q2, it's possible that this re-evaluation will occur in Q3 of this year, as opposed to Q4 of this year.

  • And we need to alert everyone to that fact.

  • So obviously, we can't handicap it; we can just say that it is a possibility based upon the strong first-half performance of this year.

  • Mark Murphy - Analyst

  • As a follow-up, for Michael, I think a 24 percent operating margin is certainly impressive; it's the best in the business intelligence industry, and you are also putting up a more profitable quarter here than SAP did last quarter.

  • I recall back at the analyst day in January, you had set a target of eventually -- I think, over three years or five years -- of catching up to SAP in terms of profitability.

  • Is there any comment or any revision on your ultimate goal here, in terms of profitability?

  • Michael Saylor - Founder, Chairman, CEO

  • Yes.

  • Well, Mark, we try to set these goals, and we're definitely happy with our results from this quarter.

  • I would say that interest rates in the US had been low, and the dollar has been weak versus the euro, and that's a benefit to an American company, and SAP is a German company, so it's possible that they've been swimming against the tide, and we've just been swimming with that tide.

  • I would be hesitant to make any forward-looking statements about what our operating margins will be because, again, there is uncertainty in the macroenvironment, and then there's just always uncertainty in the future.

  • But I would say that we are carefully managing the business, and I think we expect to continue to carefully manage the business, and we will do the best we can for the business, given whenever external impacts take place.

  • Mark Murphy - Analyst

  • Eric, in trying to gauge here, in the context of whether or not we would expect the buyback to be accretive, is there anything you can share with us in terms of what type of interest rate have you been realizing on the cash?

  • And is there any effect there of the buyback being contemplated in the guidance?

  • Eric Brown - President, CFO

  • Yes.

  • Just in terms of -- I think Michael described this best as an option in terms of things we could look at.

  • Currently, if you look at the options we had available to us in terms of investing our capital, money markets -- very liquid, risk-free instruments yielding anywhere from 80 to 100 basis points.

  • We purchased two-year US Treasuries, which yield approximately 280 to 285 basis points.

  • And so that's just kind of a statement of fact about kind of short-term interest rates, and those are really the only two data points I can offer up.

  • Mark Murphy - Analyst

  • One last one -- I'm just curious if you had a year-over-year growth rate for the maintenance revenue stream.

  • Michael Saylor - Founder, Chairman, CEO

  • We don't break out our maintenance versus our consulting versus our education.

  • We qualitatively believe that maintenance, of course, is the largest component of our services business, and you can see the year-over-year growth in the services business.

  • And I suppose you could look at the cost of the our services and come to some broad-brush opinion about how much of it is maintenance and how much is otherwise.

  • But there are a lot of other factor factors that go into this, so it's difficult to pin it down exactly.

  • Operator

  • Frank Sparacino, First Analysis.

  • Frank Sparacino - Analyst

  • I wanted to pick up on Mark's question on the maintenance.

  • Eric, you did give me that break down the last couple of quarters, I believe.

  • Is that correct?

  • Eric Brown - President, CFO

  • Yes, we do -- (indiscernible) give that breakdown, and the answer to that question is 34 percent Q2 this year versus Q2 '03.

  • Frank Sparacino - Analyst

  • In terms of year-over-year growth?

  • Eric Brown - President, CFO

  • Yes.

  • Frank Sparacino - Analyst

  • Would it be possible to just get the absolute figures for Q2 of last year?

  • Eric Brown - President, CFO

  • Sure.

  • Briefly, to recap, 15.6 million in maintenance.

  • Frank Sparacino - Analyst

  • Okay.

  • And the other two line items, Eric -- consulting and education?

  • Eric Brown - President, CFO

  • Sure.

  • Consulting, 6.1, and education/other, 2.3.

  • Frank Sparacino - Analyst

  • On the maintenance side, we've obviously seen some dramatic growth over the last couple of quarters.

  • This quarter --

  • Michael Saylor - Founder, Chairman, CEO

  • Frank, could I just interrupt?

  • I think there's some confusion.

  • I thought that the last question was regarding forward-looking breakdowns, not backward-looking breakdowns of maintenance versus consulting.

  • And so I think that Eric is correct on the backward-looking numbers.

  • But as to the forward-looking numbers, we don't have an opinion, or we don't have a precise forecast (ph) of that.

  • But please don't let me interrupt anymore; you can continue.

  • Frank Sparacino - Analyst

  • Eric, just in terms of the sequential growth in maintenance this quarter, more modest than it has been, and just wondering if you can provide any insight there?

  • Eric Brown - President, CFO

  • Well, I would say, and go back to some of the comments we made probably 12 months ago, where it's where we started to be a bit more disciplined in terms of implementing CPI and cost-of-services-related price increases, and it's taken effectively at least a full year for all of that to kind of work its way through the system and renewals.

  • And so I think that what we are -- we are a year plus into this program, so one would expect that you might have a change in growth rates there.

  • Frank Sparacino - Analyst

  • And then, Eric, if I look at the guidance, just from an operating expense standpoint, it looks like you are modeling in a $2 million increase in operating expenses, and I'm just wondering what are the assumptions behind that?

  • Michael Saylor - Founder, Chairman, CEO

  • Before Eric answers, I just want to make a point on guidance, which is as we look forward, we think there's some uncertainty in the currency environment.

  • And if currencies change, if the interest rates start to go up, which everybody expects they will, then I think it's going to impact the dollar strength.

  • And if that impacts the dollar strength, it's going to change a little bit some of our numbers.

  • And so there's currency risk, there some interest rate uncertainty.

  • There certainly some uncertainty in the political environment with the election coming up.

  • And, given the different opinions of the Republican versus Democratic parties, a little bit of uncertainty in the tax environment.

  • And if you put all those four components together, that could create a change in the operating environment for us, with regard to our largest customers.

  • And so we struggle to have precision with regard to those forecasts, which is why there is sometimes a range in our future guidance statements.

  • But having said that, I think I'll pass it to Eric.

  • Eric Brown - President, CFO

  • Yes.

  • Frank, one thing to keep in mind is that we did indeed capitalize approximately 1 million of R&D expenses in Q2 2004, and again, this is related to the release of MicroStrategy Intelligence Server Universal Edition, which is a very significant release.

  • It's not just a UNIX port; it's 64-bit multi-OS-capable, backwards-compatible BI operating system, and so it was a significant undertaking.

  • I think it's reasonable to assume that we don't have anything of that magnitude in the near-term pipeline.

  • And so I think one of things to think about is that R&D expenses shown on the P&L would increase Q3-Q4, certainly versus Q2, when in fact we had a full $1 million worth of capitalized costs.

  • So I would look at that line.

  • Frank Sparacino - Analyst

  • Maybe Michael or Sanju, there's obviously a lot of talk around standardization.

  • And I'm just curious, over the last couple of quarters and maybe this quarter in particular, how you think you are faring in that battle, and some of the dynamics that come into play when companies are making that decision.

  • Sanju Bansal - EVP, COO

  • I think that in customers where we currently have footprint, we're doing pretty well with the additional Report Services, and expanding our footprint to cover reporting in addition to the analytics strength that we traditionally have had.

  • And so I feel like people generally view us as a platform you can standardize on, and so we are benefiting, I think, nicely in our current customer base.

  • I think that certainly there are a lot of companies right now who have other products -- Cognos, Business Objects, Crystal -- and they are making standardization decisions.

  • And we are picking up some of that; that is, there are people who are fleeing those other platforms and are looking for a more scalable, easier-to-use platform than maybe what they currently have.

  • So we are picking up some of that traffic.

  • But I would say, generally, we are faring very well within our installed base.

  • And we are also seeing, as people are migrating up their deployment -- that is, they have an expansion desire -- they are actually migrating to MicroStrategy.

  • So I think we're doing pretty well, and if there is anything that I would like more of, certainly it would be to have even a larger installed base to go after.

  • But right now, I think we're doing very well.

  • Michael Saylor - Founder, Chairman, CEO

  • I would add to that comment, I think that we are helping customers make standardization decisions on our platform with our release of first OLAP Services and Web Professional, which gave us some important functionality solutions for customers, OLAP Services being a good OLAP solution.

  • And I think the Report Services product gave us a full-fledged report writer, which helped a lot to check that box that people need to see checked to standardize.

  • And I think the last really big box that we just checked recently here is the UNIX box.

  • With support now for AIX and Solaris and a declared commitment to UNIX, I think that's helped a lot of corporations view us as being a really responsible corporate IT citizen.

  • And so I think we're doing the right things technically to win that standardization decision, and I think now our job is just to go out there and continue to sell in the market.

  • I think we are pleased with our platform vis-a-vis our competitors' platforms, though, and we like our technology position.

  • Frank Sparacino - Analyst

  • Thanks, guys.

  • Nice job.

  • Operator

  • Patrick Mason, Pacific Growth Equities.

  • Patrick Mason - Analyst

  • Mine is more kind of around the guidance again.

  • If I throw back an extra $1 million for the capitalized software, I still get something like 52 cents, and you guys at the high end of your guidance, around 40 cents.

  • So does that mean your sales and marketing and G&A are going to go up another couple of million dollars?

  • Michael Saylor - Founder, Chairman, CEO

  • You know, Pat, one thing we have observed over the past many years in the enterprise software business is that typically, Q1 and Q3 are the weaker quarters and Q2 and Q4 are the stronger quarters.

  • And if I had to pick one quarter which I think is probably the most difficult for the past 10 years running, it's generally Q3, because August is a very, very slow month in Europe and even in the US; many people take vacations.

  • And when you throw in that August and also some July vacations, it means your pool of available hours to sell in the consulting business has shrunk a bit, because your consultants take vacations, and the customers take vacations, so they don't want to show up to a training class, and so you your ability to sell training days is a little bit more difficult.

  • The decision-makers in purchasing and contracts take vacations on the customer side, so transaction volume slows down a bit.

  • And invariably, it's just a little bit more tricky, or fewer good selling days and fewer good servicing days in Q3.

  • So, if you are looking at a business like ours, I don't think you would want to just straight-line out results and expect that every single quarter would be linear.

  • There is a bit of seasonality, and we have to consider that.

  • Patrick Mason - Analyst

  • Do you expect any more legal expense?

  • It obviously declined by 500,000 or whatever it was this quarter.

  • What do you see as far as that goes, for Q3?

  • Eric Brown - President, CFO

  • Yes.

  • I will just comment that, again, for the last couple of quarters, we have talked about looking to manage down G&A as a percent of sales.

  • I think we have made some good progress there over the last, certainly, 2 quarters, possibly 2.5 to 3 quarters, and we will attempt to continue to manage G&A as a percent of revenue down to a lower level.

  • But again, we can't kind of control events and timing, and so that's actually a bit difficult for us, candidly, to forecast.

  • But you should just understand the we're looking to bring those costs down and just run a more efficient G&A structure.

  • Patrick Mason - Analyst

  • And I guess just on the 7i Universal Edition, can you guys comment or a little color around that?

  • Obviously, you just launched it.

  • When do you expect maybe to receive some significant revenue contribution?

  • Would that be more in '05, or do you think you might see something as early as Q4?

  • Michael Saylor - Founder, Chairman, CEO

  • I think, generally, with products like this, we layer them into the marketplace.

  • And we've already seen some sales of the Universal product, and we're happy about that, and I think will continue to see some more.

  • It will be difficult to properly gauge how big a part of our product line this is going to be for another few quarters.

  • We'll certainly have a pretty decent idea 12 months hence.

  • Sanju?

  • Sanju Bansal - EVP, COO

  • I agree with Mike.

  • Certainly, it's going to be difficult to predict, and we have had a history where it takes a while for products generally to be excepted by the market.

  • The notable exception is the Report Services, which came out of the gate strong.

  • I think it will take a little bit of time.

  • I'd also say, though, we are hopeful that people are going to pick up on the 64-bit architecture and maybe accelerate the adoption of that.

  • I think that as that message winds through our sales force and into the market, we should start to see some adoption.

  • But at this point, it's a bit too early to tell.

  • Patrick Mason - Analyst

  • Do the ASPs -- do you think they are going to be -- where are those going to fall out?

  • If you had to gauge our range, would it be like higher than where you currently are?

  • Eric Brown - President, CFO

  • I think that our positioning for Universal in the marketplace is that it's roughly one-third higher, on a comparable basis, than the corresponding NT 32-bit of Intelligence Server.

  • And so, to the extent that you have the higher list price, we would expect, all of the things being equal, a slight uptick in those ASPs.

  • Michael Saylor - Founder, Chairman, CEO

  • And it's also possible that it will just be -- I don't think ASP will go down, but it may go up just a bit more, because as people license the product on a CPU basis, they may license it on a slower clock speed machine or something.

  • So it's a little bit tricky to know exactly where the ASP will move, until we have a sense of what demand will be.

  • I think that in the macro, we would expect over the long term that a better product and a more scalable product will support larger installations.

  • But that's a function of the customer deployment, as a well as a function of our product, as well.

  • So I think we'll have to watch that evolve over time.

  • Operator

  • Mark Verbeck, Smith Barney.

  • Mark Verbeck - Analyst

  • Congratulations on the quarter.

  • Luckily, you guys struggle with not only the precision of your forecast but the accuracy, as well.

  • So nice upside.

  • I wanted to follow up a little bit more on the universal server.

  • It seems that you haven't had much problem penetrating accounts without having a UNIX solution to date.

  • Can you give me an idea of are those sales to existing customers that were waiting for this platform, or do you sense there's some pipeline for that?

  • Michael Saylor - Founder, Chairman, CEO

  • I think, traditionally, that there have been some accounts that are true blue and they are very committed to, say, AI action.

  • There are others that are just hard-core Solaris shops or hard-core UNIX shops.

  • And that's not the majority, but let's say there's 10 percent or 20 percent of the IT organizations out there that have an extremely religious bias, or a strong structural bias toward a particular platform.

  • And so, I think that the addressable market for us probably goes from 80 to 90 percent, more to 90 to 95 percent or something, and so I think there's been a -- it's a material change.

  • And I think the other thing that's going on is that many places where we sell -- you know, we sell to places like a very big multinational bank or a multinational manufacturer, where there are dozens of IT organizations within the manufacturer, or maybe even 100 places where they have servers installed.

  • And we were installed in three places, and there's 13 other places where it would be difficult for us to get installed.

  • And by being NT only, you would slow down the diffusion through that organization.

  • They might decide to use you, but have to host you in one of five IT departments instead of all 10.

  • And now, with all these different flavors of platform as a solution, it just makes it much easier for our advocates within those global 2000 companies to diffuse us throughout their company, and it removes one more objection.

  • So I think that in summary, it helps us get to new customers, but it also helps us diffuse and sell into existing customers.

  • And as for what that mix will be on a dollar basis, it's kind of unclear right now, but it's qualitatively a good thing; we are sure of that.

  • Mark Verbeck - Analyst

  • Earlier, you had said that you didn't see a lot of demand for you to support Linux.

  • Any change in your view on that, Michael?

  • Michael Saylor - Founder, Chairman, CEO

  • I think we hear a couple of customers out there that are asking for Linux, and so we just try to gauge this over time.

  • One of the nice things about our business is we don't really have to do a lot of guessing when it comes to customer requirements; we are in a direct, high-touch relationship with our 1,000 largest customers that amount to 90 percent plus of our revenue.

  • So, that being the case, we just ask them.

  • And when I hear something once or twice, it's interesting, and when you hear it 10 times, it's probably something you've got to deal with, and when you hear it 20 or 30 times, it's a moneymaking idea.

  • And so, with regard to all these platforms, there's other UNIX platforms, and then of course there's various degrees of support for the platform.

  • What we try to do in, I think, our product development organization is just listen very carefully to customers tabulate their concerns and test the market.

  • And then, when we get a critical mass of demand for something, we go ahead and put a development plan in place and do it.

  • Mark Verbeck - Analyst

  • Okay.

  • And then when final question.

  • On the use of the cash for the share repurchase, one thing you didn't mention as a possible use for the cash is making acquisitions.

  • Does this mean that you have kind of taken a look at the landscape and decided that there's nothing interesting out there?

  • Michael Saylor - Founder, Chairman, CEO

  • I think we try to keep all of our options open at all times, in order to make sure that we do the right thing for the shareholders, and the thing that maximizes enterprise value.

  • It turns out that with regard to the share buyback option, it's important that we announce it to the public shareholders in order to act properly, and so we are doing that at this time.

  • But there are always options in the future, and I think that we just try to evaluate the market environment to make sure that we are doing the right thing with our assets.

  • Operator

  • Nate Schneiderman, Wedbush Morgan.

  • Nate Schneiderman - Analyst

  • Nice upside to the quarter.

  • I was hoping you could address what is going on with maintenance pricing and, in particular, the efforts to shift some of your customer base from pricing that was based on the net transaction price to pricing based on list.

  • Is that having a negative effect on renewal rates at this point?

  • What is your outlook for that?

  • Can you explain what's going on in general?

  • Michael Saylor - Founder, Chairman, CEO

  • We've got strong maintenance renewal rates, and we are happy with them and continue to be happy with them.

  • We are very proud of our support offering and the technologies we deliver and the technologies we intend to deliver.

  • We have occasional negotiations with customers; it's part of our business.

  • We resolve them at a steady rate, and I think with regard to maintenance and the business overall, I think the results speak for themselves.

  • And we try to take into account every piece of data that flows our way, and just do the right thing for the customer and for the Company on a daily basis.

  • Nate Schneiderman - Analyst

  • There has been some speculation or rumors that some of your customers have been hit with fairly substantial increases in maintenance fees, perhaps doubling, tripling of fees.

  • Can you scale that for us?

  • To what extent is this true, and how widespread across your customer base?

  • Michael Saylor - Founder, Chairman, CEO

  • I can't really comment on any specifics, Nate.

  • I would say that, again, occasionally we have maintenance agreements that come up for renewal, and are in negotiations with customers.

  • And, just like most B2B businesses or enterprise software businesses, our negotiations stretch for a bit of time.

  • The great majority of them all get resolved in a fairly routine way, and in this particular case I can't really speculate as to what will happen in the future.

  • I think we just try to manage each one of these things in a responsible, prudent fashion in order to make sure that everybody is being treated fairly.

  • Nate Schneiderman - Analyst

  • Eric, the sequential decline in sales and marketing -- is this new level at Q2 sustainable, or are there any unusual drivers of that decline?

  • And what is the absolute level of capitalized software you are expecting in Q3?

  • Eric Brown - President, CFO

  • I think that's a multipart question, Nate, so if I could break it down into a couple of pieces, starting with the last portion, capitalized software.

  • Just to be clear, we capitalized approximately $1 million worth of R&D expenses in Q2, compared with 400,000 of R&D expenses in Q1 of 2004.

  • So in fact, that's a change of 600,000 quarter to quarter.

  • The first part of your question was, what about the level of marketing spend, Q2 versus Q1?

  • Again, our aggregate sales and marketing costs came down quarter to quarter.

  • But again, you've got a couple of things in there.

  • It's not just marketing spend managed by, for example, Sanju and his group; it's also sales, which is a whole function of -- it's headcount, it's base salaries, it's T&E expense, it's variable commissions, et cetera.

  • Our general rule of thumb is that we want to manage both the sales and marketing expenditures against certain metrics.

  • We think we need to spend enough marketing to roll out new products, maintain awareness, generate a certain amount of leads, and that's the marketing department's charter.

  • And as far as the field is concerned, we'd like to increase the size of the sales force.

  • We haven't given any specifics.

  • We haven't yet achieved any significant net additions of headcounts just yet.

  • So I wouldn't try to extrapolate in any way, shape or form off of Q2 versus Q1 to say that, for example, one component -- i.e., marketing or advertising expenditure -- is going down, because that wouldn't necessarily be correct.

  • Nate Schneiderman - Analyst

  • To clarify on your comment on capitalized software, just to be a little more specific here, do you expect capitalized software to decline from 1 million back to about 400,000, or do you expect it to go closer to 0 in Q3?

  • Eric Brown - President, CFO

  • Just to follow up on some of the comments we made earlier on a previous question, the $1 million of capitalized R&D expense in Q2 is, by comparison, fairly high.

  • Again, the Universal Edition of Intelligence Server represented a pretty significant engineering undertaking.

  • And so, we had a larger number of people working on it and, hence, a larger amount of dollars going into cap software.

  • In the near term, we don't have a product of that magnitude and scope, per se, in the pipeline.

  • And so, it's reasonable to assume, looking out at Q3 and Q4, that capitalized software will come down and, hence, reported R&D expense in the P&L will go up versus Q2.

  • Nate Schneiderman - Analyst

  • Okay.

  • Finally, could you give us an update on partner relationships?

  • You have a new go-to-market relationship with IBM.

  • Not too long ago, you formed a global alliance with Cap Gemini, if I recall correctly.

  • So how are those relationships working?

  • Any particularly exciting, in terms of revenue potential?

  • Sanju Bansal - EVP, COO

  • Yes, I think that the alliances that we've developed over the last six months have continued to wind up.

  • I think that, as I stated before, we had a relatively weak channel partnership strategy and set of alliances last year.

  • I think this is just a legacy coming out of our corporate history, where a lot of alliance partners weren't sure what to do with us, and whether or not we were going to be stable.

  • I think, now that the company is very stable and the technology is very strong, we've seen a lot of interest and a resurgence of interest in MicroStrategy.

  • In particular, the IBM relationship has been very positive.

  • You may have seen that they put out a press release last week where they have announced that they are going to bundle MicroStrategy into a DB2 bundle that they are going to be offering.

  • And so, we are very excited about that, so they are going to be reselling our software as part of a DB2 bundle, out in their SMB market.

  • We don't know if that's going to generate material revenue; we have to wait and see.

  • But at least the fact that they have gotten past just the basic marketing relationship now to a sales relationship, we think, is a positive movement.

  • Certainly, our ability to get on both Solaris and AIX has helped our co-marketing with Sun and with IBM, and so both of them are out there helping us right now generate awareness for the new product, so we think that's positive.

  • So, generally I would say the momentum is better.

  • We are getting more referrals from alliance partners, so even if they are not reselling, they are actually referring deals to us again.

  • And so, overall, our view at the beginning of this year is that rebuilding our alliances is going to take 12 to 18 months.

  • I think right now, we've done a pretty good job of getting those people to come back to MicroStrategy.

  • Operator

  • Patrick Walravens, JMP Securities.

  • Patrick Walravens - Analyst

  • Can you tell us what your largest deal was in the quarter?

  • Eric Brown - President, CFO

  • We can't be specific about the exact size; that's not exactly referenceable in that context.

  • But certainly, we did not have any deal of the magnitude of what we had in Q2 of 2003, where we had a $4 million transaction with the United States Postal Service.

  • Patrick Walravens - Analyst

  • And maybe you can share this on the valuation allowance.

  • If you hit the top end of your guidance for 2004, would you need to reduce the valuation allowance in the second half?

  • Eric Brown - President, CFO

  • Again, we really can't say at this point in time.

  • We are giving GAAP guidance.

  • The whole discussion and decision about the valuation allowance is really dependent upon the statutory book income, and we haven't given any statutory-based tax guidance, and so we really can't say at this point in time.

  • Patrick Walravens - Analyst

  • And then last one.

  • Do you expect to return to positive license revenue growth next quarter?

  • Michael Saylor - Founder, Chairman, CEO

  • We've managed the entire business holistically right now, and I think our number-one objective, as I mentioned, was a profitable but predictable franchise.

  • And so, license revenue in and of itself is profitable, sometimes.

  • Many companies actually spend more money to sell licenses than they actually generate licenses.

  • So, when you take the license line and subtract the sales and marketing line, that number may or may not be positive, if you look across a bunch of enterprise software companies.

  • In our case it is, but in some companies it isn't.

  • So, licenses may be profitable.

  • They certainly have a high gross margin.

  • It's not always clear they have a high net margin.

  • We believe that our other services, especially things like maintenance, are definitely very profitable, because we don't have to incur the same amount of ongoing sales and marketing expense and effort and transaction risk in order to get them.

  • So, if we have to make a trade-off -- and generally, we don't, but on certain occasions we get a chance to make a trade-off between are we going to incur a license revenue or are we going to incur a downline annuity stream, a future commitment for services of some sort that's not recognizable upfront.

  • We try to maximize the overall cash flow to the shareholders into the Company, and our ultimate view is that over a multiyear time period -- not 10 years but not 10 months, either -- we would like to maximize the cash flows to the business.

  • And we are less focused upon whether we call that cash flow a multiyear education contract, or a multiyear technical services contract, or a multiyear support contract, or a multiyear premium support contract, or whether we call it a license revenue.

  • And so we just have to always consider these things.

  • So I wouldn't be fixated upon license growth, per se.

  • We don't view it as being a measure of the health of the Company.

  • I know that probably half the people in the industry that follow software think that license revenue is extremely important.

  • I've seen analysts write praises like "the all-important license number."

  • I think the other half of the industry would disagree, and they would take a different point of view.

  • All I would say is that we just try to holistically manage the business, in order to maximize the cash flows to the business over the midterm.

  • Operator

  • Douglas Crook, Moors & Cabot.

  • Douglas Crook - Analyst

  • I'd like to segueway off of the prior question.

  • It sounds like you cut it off when the number was made.

  • Is that correct?

  • Eric Brown - President, CFO

  • I'm sorry; could you clarify your question?

  • I don't understand.

  • Douglas Crook - Analyst

  • If you're managing the business holistically, I'm reading into that, and I'm wondering if a different way of saying it is the expectations for the Company were met, the license revenue was not needed, because perhaps the maintenance and services overperformed.

  • So, perhaps some license business was left on the table for next quarter.

  • Eric Brown - President, CFO

  • I would not make that inference, and I would suggest that you not even make that comment to me, to suggest that kind of management of results or revenue.

  • It's inappropriate; we have zero tolerance for that type of thing.

  • I think you should construe Michael's comments about holistically managing the business as, when you have the opportunity to do a deal with an enterprise customer, typically we are in negotiations for two to four separate line-item purchases, which include not just license but technical support.

  • It could be a one-year, it could be a multiyear contract, it could be different forms of consulting services, different levels of technical support and education packages.

  • And so what we are focused on doing is putting together the best overall transaction for the customer to meet their needs.

  • We ourselves do not go in and we don't tell our sales force to go in and say the ratio of revenue in a given deal should be between X and Y percent.

  • And so that's what we mean by looking holistically at the business, and you shouldn't infer anything else from that.

  • Douglas Crook - Analyst

  • Are the salespeople incented to sell software as opposed to services?

  • Eric Brown - President, CFO

  • The sales force is incented to sell all offerings -- license, technical support, consulting services of different format, et cetera.

  • And so I'm not for sure if I understand your question.

  • They are compensated to sell everything.

  • Douglas Crook - Analyst

  • But is there, on a margin, greater compensation to selling software licenses?

  • Michael Saylor - Founder, Chairman, CEO

  • The compensation percentages vary.

  • As it turns out, the amount of margin we give on software license is a function of the price of the software.

  • So, depending upon how much discounting we do, we would change the commission we pay a sales rep.

  • But I wouldn't say that they are commissioned more highly on software.

  • I think we have a fairly balanced compensation program.

  • In some cases, it's advantageous for them to sell more services than it is to sell software.

  • It really just depends on the customer.

  • Douglas Crook - Analyst

  • There were a lot of questions around this during the call, but I'll just ask flat out.

  • Is there any reason margins should contract in the third quarter?

  • The operating margin expansion has been very significant, holding.

  • Michael Saylor - Founder, Chairman, CEO

  • I think that our margins will be a function of costs, and it will also be a function of revenue.

  • And so the revenue could vary, especially the license numbers, as I said before.

  • License revenues can be seasonal in this business, because of the short-selling quarter and the August hiatus when people go on vacation, oftentimes.

  • And the service numbers, the revenue numbers could change because of vacations, and also because people don't have as much time in the office.

  • And so there is some seasonality, and that rolls through the cost line, but it also rolls through the revenue line.

  • For that reason, I don't think that we can give an accurate prediction, or at least we certainly can't make a representation that operating margins will stay constant.

  • Eric Brown - President, CFO

  • I'll make a couple of additional comments.

  • We talked about the cost structure.

  • One of the things we can talk about is the fact that R&D expenses, as reported, were lower in Q2 due to the capitalization of expense associated with the Universal release.

  • Okay, that's done, that's behind us, that was a major piece of work.

  • We don't have anything comparable in the pipeline in the near term.

  • And again, as far as the seasonality of our business is concerned, I think if you go back and you look at the last three or four years, what you will find is that Q3 is one of our toughest quarters.

  • We will have less billable hours, because of vacations taken by not just our personnel but our customers', less selling cycles and holding headcount constant.

  • You have to carry those costs, assuming no other changes, throughout Q3.

  • So it is going to be -- it's a more challenging quarter, typically, and our expectation is that the upcoming Q3 looks challenging, like the other Q3's we have seen before.

  • Douglas Crook - Analyst

  • I have a thematic question, and that is, how does the Company approach the task of setting guidance?

  • What I'm trying to understand is, how should I read the value add of providing guidance so far below consensus?

  • Michael Saylor - Founder, Chairman, CEO

  • We just try to give our best estimate based upon our understandings, and we give a range based upon conservative and optimistic views of the quarter.

  • We certainly don't look at the consensus when we set our guidance; we look at our business, and we consider it as best we can, based upon all the factors that we think might modify our performance -- again, as best we can.

  • Douglas Crook - Analyst

  • Okay.

  • Then one final question.

  • If there is a change to the valuation allowance, can you confirm for me that any changes would be a non-cash event?

  • Eric Brown - President, CFO

  • Yes.

  • Any changes would be a non-cash event.

  • Just to be clear, though, the change in the period in which we released the valuation allowance reserve, or a portion of it -- that entry, as it were, would be a non-cash event.

  • But let's be clear -- the value of the tax loss carryforwards has a real cash benefit to the Company and the stockholders long term, because we won't be paying those taxes until we've completely exhausted and burned through those NOLs.

  • Michael Saylor - Founder, Chairman, CEO

  • Okay.

  • Well, thank you.

  • I believe that completes the Q&A session, and I'd just like to thank everybody for being with us today, and I'll look forward to seeing you all again in 12 more weeks.

  • Have a good day.

  • Operator

  • That concludes today's conference.

  • You may disconnect at this time.