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MICROSTRATEGY INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) FORWARD-LOOKING INFORMATION This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). For this purpose, any statements contained herein that are not statements of historical fact, including without limitation, certain statements regarding industry prospects and our results of operations or financial position, may be deemed to be forward-looking statements. Without limiting the foregoing, the words "believes," "anticipates," "plans," "expects," and similar expressions are intended to identify forward-looking statements. The important factors discussed under "Part II. Item 1A. Risk Factors," among others, could cause actual results to differ materially from those indicated by forward-looking statements made herein and presented elsewhere by management from time to time. Such forward-looking statements represent management's current expectations and are inherently uncertain. Investors are warned that actual results may differ from management's expectations. Overview MicroStrategy® is a leading worldwide provider of enterprise software platforms. The Company's mission is to provide the most flexible, powerful, scalable, and user-friendly analytics and identity management platforms, offered either on premises or in the cloud. The MicroStrategy Analytics Platform™ empowers leading organizations to analyze vast amounts of data and distribute actionable business insight throughout an enterprise. Our analytics platform delivers reports and dashboards, and enables users to conduct ad hoc analysis and share insights anywhere, anytime, via mobile devices or the Web. It also combines the agility and productivity of self-service visual data discovery with the security, scalability, and governance features of enterprise-grade business intelligence. The MicroStrategy Analytics Platform is tightly integrated with MicroStrategy Analytics Desktop™, a standalone desktop tool designed to enable business users to analyze and understand their data. With MicroStrategy Analytics Desktop, business users can create stunning data visualizations and dashboards that provide new insight and new understanding in just minutes. MicroStrategy Mobile is designed to enable organizations to rapidly build information-rich applications that combine multimedia, transactions, analytics, and custom workflows, delivered on mobile devices. The powerful code-free platform approach is designed to reduce the costs of development and enable organizations to get powerful mobile business apps quickly and cost-effectively. MicroStrategy Mobile is an easy, fast, and cost-effective way to mobilize an organization's information systems, including its data warehouses, business intelligence, ERP, CRM, and Web applications that are currently accessible only on the desktop. Using MicroStrategy Mobile, customers can transform their entire workforce into a connected and more productive mobile workforce with mobile apps that are significantly more robust than their Web-only counterparts. With mobile access to critical corporate data and systems that drive the business, employees can have a virtual office in their hands at all times. MicroStrategy Cloud brings together enterprise analytics, analytical databases, and ETL capabilities in a high performance integrated environment. MicroStrategy Cloud offers on-demand access to the full breadth of the MicroStrategy Analytics Platform and MicroStrategy Mobile capabilities and is optimized for a variety of enterprise applications. Compared to traditional on-premises approaches, MicroStrategy Cloud is quicker to deploy, is more flexible, delivers consistent high-level performance and offers significant financial advantages. We offer MicroStrategy Cloud as a managed service to organizations that want the power of enterprise analytics and the ability to quickly build and deliver enterprise mobile apps that harness the potential of Big Data analytics. The MicroStrategy Identity Platform, branded as MicroStrategy Usher, is a mobile identity solution that can deliver biometric-enhanced security to applications and business processes across an enterprise. MicroStrategy Usher can replace ID cards, key cards, employee badges, and passwords with a single mobile identity that is biometrically linked to its owner, cryptographically linked to its owner's phone, and dynamically linked to the enterprise's existing identity repositories. MicroStrategy Usher's architecture leverages 21-------------------------------------------------------------------------------- Table of Contents three-factor authentication, out-of-band channels, time-limited codes, and bidirectional public key infrastructure encryption to offer enterprises increased protection against fraud and cybercrime. MicroStrategy Usher is designed to allow users to log in to applications, unlock doors, validate one another's identity, and authorize transactions more securely, using their MicroStrategy Usher mobile identities. Furthermore, MicroStrategy Usher uses the MicroStrategy Analytics Platform to support behavior monitoring and the detection of abnormal activity for even greater security. MicroStrategy Usher is offered as a subscription-based service. The MicroStrategy Analytics Platform, MicroStrategy Mobile, and MicroStrategy Cloud together with related product and support services, continue to generate the vast majority of our revenue. During each of the three and nine months ended September 30, 2014 and 2013, we did not generate significant revenues from the MicroStrategy Identity Platform. The following table sets forth certain operating highlights (in thousands) for the three and nine months ended September 30, 2014 and 2013: Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 RevenuesProduct licenses and subscription services $ 39,962 $ 37,120 $ 107,525 $ 101,316 Product support 75,019 71,216 221,069 205,005 Other services 36,221 33,583 102,365 103,686 Total revenues 151,202 141,919 430,959 410,007 Cost of revenues Product licenses and subscription services 6,044 5,424 19,285 16,342 Product support 3,695 4,105 10,713 12,560 Other services 25,214 23,724 73,577 76,698 Total cost of revenues 34,953 33,253 103,575 105,600 Gross profit 116,249 108,666 327,384 304,407 Operating expenses Sales and marketing 58,195 50,798 178,028 154,198 Research and development 28,659 21,977 89,469 72,021 General and administrative 24,811 24,265 76,376 77,271 Restructuring costs 11,578 0 11,578 0 Total operating expenses 123,243 97,040 355,451 303,490 (Loss) income from continuing operations $ (6,994 ) $ 11,626 $ (28,067 ) $ 917 The analytics market is highly competitive and our results of operations depend on our ability to market and sell offerings that provide customers with greater value than those offered by our competitors. Within the analytics space we predominantly compete with two categories of vendors: 1) megavendors (IBM, SAP AG, and Oracle) that provide one or more analytics products as part of their enterprise product portfolio and typically compete for larger opportunities; and 2) independent data discovery vendors like Tableau Software, TIBCO Spotfire, and QlikTech that mainly compete for small to medium-size opportunities. Our success depends on the effectiveness with which we can differentiate our product from both the megavendors and the independent vendors across large, mid-sized, and small opportunities. Organizations have sought, and we expect may continue to seek, to standardize their various analytics applications around a single software platform. This trend presents both opportunities and challenges for our business. It offers us the opportunity to increase the size of transactions with new customers and to expand the size of our analytics installations with existing customers. On the other hand, it presents the challenge that we may not be able to penetrate accounts that a competitor has penetrated or in which a competitor is the incumbent analytics provider. 22-------------------------------------------------------------------------------- Table of Contents The market for mobile business apps is rapidly changing, highly competitive, and complex with many competitors and different offerings ranging from fully custom-coded applications to plug-and-play solutions. While organizations vary greatly in their approach to, and pace of adoption of, mobile solutions, they are increasingly accelerating the transition of their businesses onto mobile devices, such as tablets and smartphones. Over the next few years, we expect that organizations will continue to construct their information and systems to take advantage of the efficiencies and cost savings of mobile computing. Ultimately, we expect that the majority of routine business tasks and workflows will become available as mobile-optimized touch-enabled apps. In addition, there is increased market demand for analysis of a wider variety of data sources, including sensor data, social data, web log data, and other data types. These new data sources are driving massive increases in the volume of data that can potentially be analyzed ("Big Data"), which in turn is accelerating development of new storage technologies like Hadoop and NoSQL databases. The demand for analytics on Big Data represents an opportunity for MicroStrategy, as it opens up new potential applications and use cases for our technology. It also creates a challenge as we will need to continually enhance our technology to support emerging data sources; deliver faster performance necessary to support analysis against large scale data sets; and support analysis of a wider variety of data types, such as unstructured, semi-structured, and streaming data. We have undertaken a number of initiatives to address these opportunities and challenges, including: • a major simplification of our product packaging structure aimed at delivering the best end-to-end customer and partner experience, making it easier to acquire and deploy the MicroStrategy platform, and delivering free upgrades to premium capabilities for existing customers, empowering new and existing clients to realize the full potential of their analytical applications; • enhancement of our ability to support new enterprise-scale requirements for analytics, where we are currently a technology leader, with a focus on supporting more varied database platforms, providing higher performance, and providing greater ability to manage and administer large-scale analytics operations, such as our introduction of MicroStrategy PRIME™, a massively scalable, cloud-based, in-memory analytics service designed to deliver high performance for complex analytical applications that have the largest data sets and highest user concurrency; • extension of the analytic breadth of our technology with greater statistical and predictive capabilities through integration with the "R" open source project, a widely-used statistical programming language; • extension of our technology to provide greater support for the latest trend in self-service analytics, which is often referred to as "visual data discovery" or "agile analytics," by adding new user interface flows, new visualizations, new exploration features, and new self-service capabilities for the preparation of data; • introduction of new channels to enable customers to access our analytics capabilities in the form of MicroStrategy Analytics Desktop; • enhancement of our mobile application platform for creating and deploying analytics applications to the expanding community of mobile device users; • expansion of our offerings to include the MicroStrategy Identity Platform, a platform derived from our software technology base; • increased sales and marketing activities to enhance corporate branding, obtain new customers, expand and strengthen our existing customer base, and establish MicroStrategy as a solution for mobile apps that extends significantly beyond mobile analytics, while retaining all of the benefits of our analytics platform heritage; 23 -------------------------------------------------------------------------------- Table of Contents • maintenance of a dedicated performance engineering team and conduct of research and development focused on providing our customers with the highest levels of performance for analytics applications of all sizes; • further enhancement of our MicroStrategy Mobile product suite to empower our customers with a toolset to enable them to build consequential and durable mobile business apps; and • continued investment in the company's differentiated cloud offerings of business intelligence, data hosting, and data integration capabilities, enabling a robust selection of self-managed and fully-managed cloud offerings across five continents and in over 10 global data centers, as well as the Amazon Elastic Compute Cloud (Amazon EC2), allowing us to penetrate new markets and customer bases. In the third quarter of 2014, we committed to a restructuring plan (the "2014 Restructuring Plan") to streamline our workforce and spending to better align our cost structure with our business strategy. We implemented a significant portion of the 2014 Restructuring Plan in the third quarter of 2014 and expect substantially all of the plan to be completed by the end of the fourth quarter of 2014. The 2014 Restructuring Plan resulted in a pre-tax restructuring charge of $11.6 million in the third quarter of 2014, and we expect to incur an additional pre-tax restructuring charge of $6.8 million related to the 2014 Restructuring Plan in the fourth quarter of 2014. See Note 6, Restructuring, to the Consolidated Financial Statements for further detail on the 2014 Restructuring Plan. We expect that the 2014 Restructuring Plan will deliver annualized pre-tax savings of approximately $73.4 million. In addition to the 2014 Restructuring Plan, we plan to implement other internal cost-savings initiatives that we expect will deliver additional annualized pre-tax savings. We generated a loss from continuing operations, net of tax, for each of the three and nine months ended September 30, 2014. If our revenues are not sufficient to offset our operating expenses or we are unable to further adjust our operating expenses in response to any shortfall in anticipated revenue in a timely manner, we may continue to incur operating losses on a quarterly or annual basis. As of September 30, 2014, we had a total of 3,125 employees, of whom 1,412 were based in the United States and 1,713 were based internationally. Of our 3,125 employees, 827 were engaged in sales and marketing, 965 in research and development, 916 in subscription, product support, consulting, and education services, and 417 in finance, administration, and corporate operations. We expect to reduce our workforce by approximately 530 employees by the end of the fourth quarter of 2014 in connection with the implementation of the remaining portion of the 2014 Restructuring Plan. As of December 31, 2013, we were leasing approximately 190,000 square feet of office space at a location in Northern Virginia that began serving as our corporate headquarters in October 2010. In April 2014, we leased an additional 43,000 square feet of office space at our corporate headquarters location (the "April 2014 leased space"). The term of the amended lease expires in December 2020. In the third quarter of 2014, as part of the 2014 Restructuring Plan, we gave written notice of our intent to terminate the lease with respect to approximately 19,000 square feet of the April 2014 leased space effective February 2015. We never used the terminated lease space and it will remain vacant until it is terminated in February 2015. We have recognized and paid all related lease termination costs associated with this terminated lease space during the third quarter of 2014. We recognize lease expense on continuing operating leases ratably over the term of the lease. 24-------------------------------------------------------------------------------- Table of Contents As discussed in Note 11, Share-based Compensation, to the Consolidated Financial Statements, we have outstanding stock options to purchase shares of our class A common stock under our amended 2013 Stock Incentive Plan (the "2013 Plan"). Share-based compensation expense (in thousands) from these stock option awards was recognized in the following operating expense line items in our Consolidated Statements of Operations for the periods indicated: Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 Sales and marketing $ 200 $ 0 $ 324 $ 0 Research and development 407 74 1,025 74 General and administrative 3,272 370 7,212 370 Total share-based compensation expense $ 3,879 $ 444 $ 8,561 $ 444 As of September 30, 2014, we estimate that approximately $50.2 million of additional share-based compensation expense for options granted under the 2013 Plan will be recognized over a remaining weighted average period of 3.3 years. We base our internal operating expense forecasts on expected revenue trends and strategic objectives. Many of our expenses, such as office leases and certain personnel costs, are relatively fixed. We may be unable to adjust spending quickly enough in any particular period to offset any unexpected revenue shortfall in that period. Accordingly, any shortfall in revenue may cause significant variation in our operating results. We therefore believe that quarter-to-quarter comparisons of our operating results may not be a good indication of our future performance. Non-GAAP Financial Measures We are providing a supplemental financial measure for income (loss) from continuing operations that excludes the impact of our share-based compensation arrangements and restructuring activities. This financial measure is not a measurement of financial performance under generally accepted accounting principles in the United States ("GAAP") and, as a result, this financial measure may not be comparable to similarly titled measures of other companies. Management uses this non-GAAP financial measure internally to help understand, manage, and evaluate our business performance and to help make operating decisions. We believe that this non-GAAP financial measure is also useful to investors and analysts in comparing our performance across reporting periods on a consistent basis because it excludes a significant non-cash share-based compensation expense that we believe is not reflective of the Company's general business performance and significant restructuring charges that we believe are not reflective of ongoing operating results. In addition, accounting for share-based compensation arrangements requires significant management judgment and the resulting expense could vary significantly in comparison to other companies. Therefore, we believe the use of this non-GAAP financial measure can also facilitate comparison of our operating results to those of our competitors. Non-GAAP financial measures are subject to material limitations as they are not in accordance with, or a substitute for, measurements prepared in accordance with GAAP. For example, we expect that share-based compensation expense, which is excluded from our non-GAAP financial measure, will continue to be a significant recurring expense over the next four years and is an important part of the compensation provided to certain executives and directors. Our non-GAAP financial measure is not meant to be considered in isolation and should be read only in conjunction with our Consolidated Financial Statements, which have been prepared in accordance with GAAP. We rely primarily on such Consolidated Financial Statements to understand, manage, and evaluate our business performance, and use the non-GAAP financial measure only supplementally. 25-------------------------------------------------------------------------------- Table of Contents The following is a reconciliation of our non-GAAP financial measure to its most directly comparable GAAP measure (in thousands) for the periods indicated: Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 Reconciliation of non-GAAP income (loss) from continuing operations: (Loss) income from continuing operations $ (6,994 ) $ 11,626 $ (28,067 ) $ 917 Share-based compensation expense 3,879 444 8,561 444 Restructuring costs 11,578 0 11,578 0 Non-GAAP income (loss) from continuing operations $ 8,463 $ 12,070 $ (7,928 ) $ 1,361 Critical Accounting Policies Our discussion and analysis of our financial condition and results of operations are based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of our Consolidated Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and equity and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates, particularly estimates relating to revenue recognition, allowance for doubtful accounts, valuation of property and equipment, accrued restructuring costs, litigation and contingencies, valuation of net deferred tax assets, share-based compensation, and fair value measurements of our derivative financial instruments have a material impact on our financial statements and are discussed in detail throughout our analysis of the results of operations discussed below. In some cases, changes in accounting estimates are reasonably likely to occur from period to period. In addition to evaluating estimates relating to the items discussed above, we also consider other estimates and judgments, including, but not limited to, software development costs, provision for income taxes, and other contingent liabilities, including liabilities that we deem not probable of assertion. We base our estimates on historical experience and various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets, liabilities, and equity that are not readily apparent from other sources. Actual results and outcomes could differ from these estimates and assumptions. We do not have any material ownership interest in any special purpose or other entities that are not wholly-owned and/or consolidated into our Consolidated Financial Statements. Additionally, we do not have any material related party transactions. The section "Critical Accounting Policies" included in Item 7 and the section "Summary of Significant Accounting Policies" (Note 2) included in Item 15 of our Annual Report on Form 10-K for the year ended December 31, 2013 provide a more detailed explanation of the judgments made in these areas and a discussion of our accounting estimates and policies. There have been no significant changes in such estimates and policies since December 31, 2013, other than the addition of accounting policies related to "Restructuring Costs", as disclosed in Note 1, Summary of Significant Accounting Policies, to the Consolidated Financial Statements. 26 -------------------------------------------------------------------------------- Table of Contents Impact of Foreign Currency Exchange Rate Fluctuations on Results of Operations We conduct a significant portion of our business in currencies other than the U.S. dollar, the currency in which we report our Consolidated Financial Statements. As currency rates change from quarter to quarter and year over year, our results of operations may be impacted. The table below summarizes the impact (in thousands) of fluctuations in foreign currency exchange rates on certain components of our Consolidated Statements of Operations by showing the increase (decrease) in revenues or expenses, as applicable, from the same period in the prior year. The term "international" refers to operations outside of the United States and Canada. Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 International product licenses and subscription services revenues $ (199 ) $ (70 ) $ (483 ) $ (967 ) International product support revenues (239 ) 33 56 (692 ) International other services revenues (85 ) (125 ) 109 (698 ) Cost of product support revenues 34 (39 ) 87 (120 ) Cost of other services revenues 21 11 337 (134 ) Sales and marketing expenses (71 ) (73 ) 16 (859 ) Research and development expenses 23 181 323 342 General and administrative expenses (49 ) (64 ) (86 ) (204 ) For example, if there had been no change to foreign currency exchange rates from 2013 to 2014, international product licenses and subscription services revenues would have been $16.4 million rather than $16.2 million and $44.4 million rather than $43.9 million for the three and nine months ended September 30, 2014, respectively. If there had been no change to foreign currency exchange rates from 2013 to 2014, general and administrative expenses would have been $24.9 million rather than $24.8 million and $76.5 million rather than $76.4 million for the three and nine months ended September 30, 2014, respectively. 27-------------------------------------------------------------------------------- Table of Contents Results of Operations Comparison of the three and nine months ended September 30, 2014 and 2013 Revenues Except as otherwise indicated herein, the term "domestic" refers to operations in the United States and Canada, and the term "international" refers to operations outside of the United States and Canada. Product licenses and subscription services revenues. The following table sets forth product licenses and subscription services revenues (in thousands) and related percentage changes for the periods indicated: Three Months Ended Nine Months Ended September 30, % September 30, % 2014 2013 Change 2014 2013 Change Product Licenses and Subscription Services Revenues: Product Licenses Domestic $ 18,534 $ 23,890 -22.4 % $ 49,411 $ 58,696 -15.8 % International 15,435 9,863 56.5 % 41,797 34,030 22.8 % Total product licenses revenues 33,969 33,753 0.6 % 91,208 92,726 -1.6 % Subscription Services 5,993 3,367 78.0 % 16,317 8,590 90.0 % Total product licenses and subscription services revenues $ 39,962 $ 37,120 7.7 % $ 107,525 $ 101,316 6.1 % The following table sets forth a summary, grouped by size, of the number of recognized product licenses transactions for the periods indicated: Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 Product Licenses Transactions with Recognized Licenses Revenue in the Applicable Period: More than $1.0 million in licenses revenue recognized 5 4 11 10 Between $0.5 million and $1.0 million in licenses revenue recognized 8 4 20 23 Total 13 8 31 33 Domestic: More than $1.0 million in licenses revenue recognized 3 4 9 9 Between $0.5 million and $1.0 million in licenses revenue recognized 3 4 8 17 Total 6 8 17 26 International: More than $1.0 million in licenses revenue recognized 2 0 2 1 Between $0.5 million and $1.0 million in licenses revenue recognized 5 0 12 6 Total 7 0 14 7 28 -------------------------------------------------------------------------------- Table of Contents The following table sets forth the recognized revenue (in thousands) attributable to product licenses transactions, grouped by size, and related percentage changes for the periods indicated: Three Months Ended Nine Months Ended September 30, % September 30, % 2014 2013 Change 2014 2013 ChangeProduct Licenses Revenue Recognized in the Applicable Period: More than $1.0 million in licenses revenue recognized $ 7,130 $ 11,838 -39.8 % $ 16,567 $ 18,896 -12.3 % Between $0.5 million and $1.0 million in licenses revenue recognized 5,541 2,781 99.2 % 13,146 15,466 -15.0 % Less than $0.5 million in licenses revenue recognized 21,998 19,134 15.0 % 61,495 58,364 5.4 % Total 34,669 33,753 2.7 % 91,208 92,726 -1.6 % Domestic: More than $1.0 million in licenses revenue recognized 4,024 11,838 -66.0 % 13,461 17,819 -24.5 % Between $0.5 million and $1.0 million in licenses revenue recognized 1,919 2,781 -31.0 % 5,349 11,395 -53.1 % Less than $0.5 million in licenses revenue recognized 12,591 9,271 35.8 % 30,601 29,482 3.8 % Total 18,534 23,890 -22.4 % 49,411 58,696 -15.8 % International: More than $1.0 million in licenses revenue recognized 3,106 0 n/a 3,106 1,077 188.4 % Between $0.5 million and $1.0 million in licenses revenue recognized 3,622 0 n/a 7,797 4,071 91.5 % Less than $0.5 million in licenses revenue recognized 8,707 9,863 -11.7 % 30,894 28,882 7.0 % Total $ 15,435 $ 9,863 56.5 % $ 41,797 $ 34,030 22.8 % Product licenses revenues increased $0.2 million and decreased $1.5 million for the three and nine months ended September 30, 2014, respectively, as compared to the same period in the prior year. For the three months ended September 30, 2014 and 2013, product licenses transactions with more than $0.5 million in recognized revenue represented 37.3% and 43.3%, respectively, of our product licenses revenues. For the nine months ended September 30, 2014, our top three product licenses transactions totaled $6.2 million in recognized revenue, or 6.8% of total product licenses revenues, compared to $10.4 million, or 11.2% of total product licenses revenues, for the nine months ended September 30, 2013. Domestic product licenses revenues. Domestic product licenses revenues decreased $5.4 million for the three months ended September 30, 2014, as compared to the same period in the prior year, primarily due to a decrease in the number and average deal size of transactions with more than $1.0 million in recognized revenue and a decrease in the number and average deal size of transactions with recognized revenue between $0.5 million and $1.0 million, partially offset by an increase in the average deal size of transactions with less than $0.5 million in recognized revenue. Domestic product licenses revenues decreased $9.3 million for the nine months ended September 30, 2014, as compared to the same period in the prior year, primarily due to a decrease in the number of transactions with recognized revenue between $0.5 million and $1.0 million and a decrease in the average deal size of transactions with more than $1.0 million in recognized revenue, partially offset by an increase in the average deal size of transactions with less than $0.5 million in recognized revenue. International product licenses revenues. International product licenses revenues increased $5.6 million for the three months ended September 30, 2014, as compared to the same period in the prior year, primarily due to an increase in the number of transactions with recognized revenue between $0.5 million and $1.0 million and an increase in the number of transactions with more than $1.0 million in recognized revenue, partially offset by a decrease in the number of transactions with less than $0.5 million in recognized revenue. International product licenses revenues increased $7.8 million for the nine months ended September 30, 2014, as compared to the same period in the prior year, primarily due to an increase in the number of transactions with recognized revenue between $0.5 million and $1.0 million, an increase in the number and average deal size of transactions with more than $1.0 million in recognized revenue, and an increase in the average deal size of transactions with less than $0.5 million in recognized revenue. Subscription services revenues. Subscription services revenues are derived primarily from MicroStrategy Cloud services offerings that are recognized on a subscription basis over the service period of the contract. Subscription services revenues increased $2.6 million for the three months ended September 30, 2014, as compared to the same period in the prior year, primarily due to an increase in the 29 -------------------------------------------------------------------------------- Table of Contents number of new customers as our MicroStrategy Cloud business has continued to grow. Subscriptions services revenues increased $7.7 million for the nine months ended September 30, 2014, as compared to the same period in the prior year, primarily due to the recognition of $1.0 million in previously deferred revenue for one large customer and an increase in the number of new customers as our MicroStrategy Cloud business has continued to grow. Product support revenues. The following table sets forth product support revenues (in thousands) and related percentage changes for the periods indicated: Three Months Ended Nine Months Ended September 30, % September 30, % 2014 2013 Change 2014 2013 Change Product Support Revenues: Domestic $ 43,364 $ 40,595 6.8 % $ 127,743 $ 117,953 8.3 % International 31,655 30,621 3.4 % 93,326 87,052 7.2 % Total product support revenues $ 75,019 $ 71,216 5.3 % $ 221,069 $ 205,005 7.8 % Product support revenues are derived from providing technical software support and software updates and upgrades to customers. Product support revenues are recognized ratably over the term of the contract, which is generally one year. Product support revenues increased $3.8 million and $16.1 million for the three and nine months ended September 30, 2014, respectively, as compared to the same periods in the prior year, primarily due to an increase in the number of new product support contracts and more timely renewals at quarter-end. Other services revenues. The following table sets forth other services revenues (in thousands) and related percentage changes in these revenues for the periods indicated: Three Months Ended Nine Months Ended September 30, % September 30, % 2014 2013 Change 2014 2013 Change Other Services Revenues: Consulting Domestic $ 20,391 $ 19,010 7.3 % $ 54,660 $ 57,887 -5.6 % International 12,421 10,755 15.5 % 36,850 33,910 8.7 % Total consulting revenues 32,812 29,765 10.2 % 91,510 91,797 -0.3 % Education 3,409 3,818 -10.7 % 10,855 11,889 -8.7 % Total other services revenues $ 36,221 $ 33,583 7.9 % $ 102,365 $ 103,686 -1.3 % Consulting revenues. Consulting revenues are derived from helping customers plan and execute the deployment of our software. Consulting revenues increased for the three months ended September 30, 2014, as compared to the same period in the prior year, primarily due to an increase in billable hours with customers in the domestic and EMEA regions and an increase in revenue from the completion of two large client engagements. Consulting revenues decreased slightly for the nine months ended September 30, 2014, as compared to the same period in the prior year, primarily due to a decrease in billable hours with customers in the domestic region, partially offset by an increase in billable hours with customers in the EMEA region. Education revenues. Education revenues are derived from the education and training that we provide to our customers to enhance their ability to fully utilize the features and functionality of our software. These offerings include self-tutorials, custom course development, joint training with customers' internal staff, and standard course offerings, with pricing dependent on the specific offering delivered. Education revenues decreased for the three and nine months ended September 30, 2014, as compared to the same periods in the prior year, primarily due to lower overall contract values, a decrease in private and custom courses delivered, and shifting demand from traditional classroom training to virtual training in the domestic, Latin America, and Asia Pacific regions. 30 -------------------------------------------------------------------------------- Table of Contents Costs and Expenses Cost of revenues. The following table sets forth cost of revenues (in thousands) and related percentage changes for the periods indicated: Three Months Ended Nine Months Ended September 30 % September 30 % 2014 2013 Change 2014 2013 Change Cost of Revenues: Product licenses and subscription services: Product licenses $ 1,542 $ 1,336 15.4 % $ 5,456 $ 4,550 19.9 % Subscription services 4,502 4,088 10.1 % 13,829 11,792 17.3 % Total product licenses and subscription services 6,044 5,424 11.4 % 19,285 16,342 18.0 % Product support 3,695 4,105 -10.0 % 10,713 12,560 -14.7 % Other services: Consulting 23,841 22,342 6.7 % 68,830 72,002 -4.4 % Education 1,373 1,382 -0.7 % 4,747 4,696 1.1 % Total other services 25,214 23,724 6.3 % 73,577 76,698 -4.1 % Total cost of revenues $ 34,953 $ 33,253 5.1 % $ 103,575 $ 105,600 -1.9 % Cost of product licenses revenues. Cost of product licenses revenues consists of amortization of capitalized software development costs and the costs of product manuals, media, and royalties paid to third-party software vendors. Capitalized software development costs are generally amortized over a useful life of three years. Cost of product licenses revenues increased $0.2 million for the three months ended September 30, 2014, as compared to the same period in the prior year, primarily due to a $0.1 million increase in referral fees related to channel partners. Cost of product licenses revenues increased $0.9 million for the nine months ended September 30, 2014, as compared to the same period in the prior year, primarily due to a $1.4 million increase in amortization of capitalized software development costs related to the release of MicroStrategy 9.4 in October 2013 and a $0.6 million increase in referral fees related to channel partners, partially offset by a $0.8 million decrease in amortization of capitalized software development costs related to MicroStrategy 9.2, which became fully amortized in March 2014, and a $0.4 million decrease in amortization of capitalized software development costs related to MicroStrategy Mobile, which became fully amortized in June 2013. We expect to amortize the remaining balance of our products' capitalized software development costs as of September 30, 2014 ratably over the applicable remaining amortization periods as follows: Capitalized Software Development Costs, Net, Remaining as of September 30, 2014 Amortization Period (in thousands) (in months) MicroStrategy 9.3 $ 2,580 12 MicroStrategy 9.4 3,624 24 Analytics product development 2,254 n/a Total capitalized software development costs $ 8,458 During the three months ended September 30, 2014, we also recorded $2.3 million in capitalized software development costs associated with development efforts related to the MicroStrategy Analytics Platform. Upon an updated version of this product becoming generally available, we will begin to amortize its costs over the estimated product life of 36 months. All of the above software form part of the MicroStrategy Analytics Platform. Cost of subscription services revenues. Cost of subscription services revenues consists of equipment, facility and other related support costs, and personnel and related overhead costs. Cost of subscription services revenues increased $0.4 million for the three months ended September 30, 2014, as compared to the same period in the prior year, due to a $1.0 million increase in compensation and 31 -------------------------------------------------------------------------------- Table of Contents related costs due to an increase in staffing levels, partially offset by a $0.4 million decrease in equipment, facility, and other related support costs and a $0.2 million decrease in consulting and advisory costs. Subscription services headcount increased 69.4% to 61 at September 30, 2014 from 36 at September 30, 2013. Cost of subscription services revenues increased $2.0 million for the nine months ended September 30, 2014, as compared to the same period in the prior year, due to a $2.5 million increase in compensation and related costs due to an increase in staffing levels, partially offset by a $0.4 million decrease in consulting and advisory costs and a $0.1 million decrease in facility and other related support costs. Cost of product support revenues. Cost of product support revenues consists of product support personnel and related overhead costs. Cost of product support revenues decreased $0.4 million for the three months ended September 30, 2014, as compared to the same period in the prior year, due to a $0.4 million decrease in compensation and related costs due to a decrease in staffing levels. Product support headcount decreased 13.3% to 144 at September 30, 2014 from 166 at September 30, 2013. Cost of product support revenues decreased $1.8 million for the nine months ended September 30, 2014, as compared to the same period in the prior year, primarily due to a $1.4 million decrease in compensation and related costs due to a decrease in staffing levels, a $0.2 million decrease in facility and other related support costs, and a $0.1 million decrease in travel and entertainment expenditures. Cost of consulting revenues. Cost of consulting revenues consists of personnel and related overhead costs. Cost of consulting revenues increased $1.5 million for the three months ended September 30, 2014, as compared to the same period in the prior year, primarily due to a $1.7 million increase in subcontractor costs and a $0.3 million increase in travel and entertainment expenditures, partially offset by a $0.2 million decrease in compensation and related costs due to a decrease in staffing levels and a $0.1 million decrease in facility and other related support costs. Consulting headcount decreased 4.1% to 676 at September 30, 2014 from 705 at September 30, 2013. Cost of consulting revenues decreased $3.2 million for the nine months ended September 30, 2014, as compared to the same period in the prior year, primarily due to a $3.3 million decrease in compensation and related costs due to a decrease in staffing levels, a $0.8 million decrease in travel and entertainment expenditures, and a $0.5 million decrease in facility and other related support costs, partially offset by a $1.6 million increase in subcontractor costs. Cost of education revenues. Cost of education revenues consists of personnel and related overhead costs. Cost of education revenues decreased less than $0.1 million for the three months ended September 30, 2014, as compared to the same period in the prior year, primarily due to a $0.2 million decrease in compensation and related costs due to a decrease in staffing levels, partially offset by a $0.1 million increase in subcontractor costs. Education headcount decreased 2.8% to 35 at September 30, 2014 from 36 at September 30, 2013. Cost of education revenues increased $0.1 million for the nine months ended September 30, 2014, as compared to the same period in the prior year, due to a $0.3 million increase in subcontractor costs, partially offset by a $0.2 million decrease in facility and other related support costs. Sales and marketing expenses. Sales and marketing expenses consists of personnel costs, commissions, office facilities, travel, advertising, public relations programs, and promotional events, such as trade shows, seminars, and technical conferences. The following table sets forth sales and marketing expenses (in thousands) and related percentage changes for the periods indicated: Three Months Ended Nine Months Ended September 30, % September 30, % 2014 2013 Change 2014 2013 Change Sales and marketing expenses $ 58,195 $ 50,798 14.6 % $ 178,028 $ 154,198 15.5 % 32 -------------------------------------------------------------------------------- Table of Contents Sales and marketing expenses increased $7.4 million for the three months ended September 30, 2014, as compared to the same period in 2013, due to a $3.6 million increase in compensation and related costs, a $1.3 million increase in marketing and advertising costs, a $1.1 million increase in recruiting costs, a $0.7 million increase in facility and other related support costs, a $0.3 million increase in consulting and advisory costs, a $0.2 million increase in travel and entertainment expenditures, and a $0.2 million increase in share-based compensation expense related to the grant of stock options under the 2013 Plan. Sales and marketing headcount increased 0.4% to 827 at September 30, 2014 from 824 at September 30, 2013. We expect sales and marketing headcount to decrease in the near term as a result of our restructuring activities. As a result of stock options granted under the 2013 Plan, we expect that share-based compensation expense, a portion of which is recognized as sales and marketing expense, will continue to be a recurring expense. As of September 30, 2014, we estimate that approximately $2.8 million of additional share-based compensation expense will be recognized as sales and marketing expense over a remaining weighted average period of 3.6 years. See "Overview" and Note 11, Share-based Compensation, to the Consolidated Financial Statements for further information regarding the 2013 Plan and related share-based compensation expense. Sales and marketing expenses increased $23.8 million for the nine months ended September 30, 2014, as compared to the same period in 2013, due to a $12.4 million increase in compensation, variable compensation, and related costs, a $4.2 million increase in marketing and advertising costs, a $1.6 million increase in travel and entertainment expenditures, a $1.6 million increase in recruiting costs, a $1.5 million increase in facility and other related support costs, a $1.3 million increase due to previously disputed variable compensation, a $0.9 million increase in consulting and advisory costs, and a $0.3 million increase in share-based compensation expense related to the grant of stock options under the 2013 Plan. General and administrative expenses. General and administrative expenses consists of personnel and related overhead costs, and other costs of our executive, finance, human resources, information systems, and administrative departments, as well as third-party consulting, legal, and other professional fees. The following table sets forth general and administrative expenses (in thousands) and related percentage changes for the periods indicated: Three Months Ended Nine Months Ended September 30, % September 30, % 2014 2013 Change 2014 2013 Change General and administrative expenses $ 24,811 $ 24,265 2.3 % $ 76,376 $ 77,271 -1.2 % General and administrative expenses increased $0.5 million for the three months ended September 30, 2014, as compared to the same period in the prior year, primarily due to a $2.9 million increase in share-based compensation expense related to the grant of stock options under the 2013 Plan and a $0.3 million increase in compensation and related costs due to a change in staffing composition, partially offset by a $2.3 million decrease in variable compensation primarily due to a reduction in accrued executive bonuses and a $0.3 million decrease in other aircraft-related operating costs. General and administrative headcount decreased 10.3% to 417 at September 30, 2014 from 465 at September 30, 2013. We expect general and administrative headcount to decrease in the near term as a result of our restructuring activities. As a result of stock options granted under the 2013 Plan, we expect that share-based compensation expense, a portion of which is recognized as general and administrative expense, will continue to be a significant recurring expense. As of September 30, 2014, we estimate that approximately $42.4 million of additional share-based compensation expense will be recognized as general and administrative expense over a remaining weighted average period of 3.3 years. See "Overview" and Note 11, Share-based Compensation, to the Consolidated Financial Statements for further information regarding the 2013 Plan and related share-based compensation expense. 33-------------------------------------------------------------------------------- Table of Contents General and administrative expenses decreased $0.9 million for the nine months ended September 30, 2014, as compared to the same period in the prior year, primarily due to a $5.1 million decrease in variable compensation primarily due to a reduction in accrued executive bonuses and due to the fact that variable compensation in the prior year included additional amounts incurred as a result of the sale of Angel.com, a $2.7 million decrease in legal, consulting, and other advisory costs, a $0.6 million decrease in other aircraft-related operating costs, a $0.3 million decrease in facility and other related support costs, and a $0.2 million decrease in travel and entertainment expenditures, partially offset by a $6.8 million increase in share-based compensation expense related to the grant of stock options under the 2013 Plan and a $1.4 million increase in compensation and related costs due to a change in staffing composition. Research and development expenses. Research and development expenses consists of the personnel costs for our software engineering personnel, depreciation of equipment, and other related costs. The following table summarizes research and development expenses and amortization of capitalized software development costs (in thousands) and related percentage changes for the periods indicated: Three Months Ended Nine Months Ended September 30, % September 30, % 2014 2013 Change 2014 2013 Change Gross research and development expenses before capitalized software development costs $ 30,913 $ 25,655 20.5 % $ 91,723 $ 77,435 18.5 % Capitalized software development costs (2,254 ) (3,678 ) -38.7 % (2,254 ) (5,414 ) -58.4 % Total research and development expenses $ 28,659 $ 21,977 30.4 % $ 89,469 $ 72,021 24.2 % Amortization of capitalized software development costs included in cost of product licenses revenues $ 1,171 $ 1,172 -0.1 % $ 4,090 $ 3,878 5.5 % Research and development expenses, before capitalization of software development costs, increased $5.3 million for the three months ended September 30, 2014, as compared to the same period in the prior year, primarily due to a $3.9 million increase in compensation and related costs due to an increase in average staffing levels, a $0.4 million increase in facility and other related support costs, a $0.3 million increase in share-based compensation expense related to the grant of stock options under the 2013 Plan, a $0.2 million increase in consulting and advisory costs, and a $0.2 million increase in recruiting costs. Research and development headcount increased 1.9% to 965 at September 30, 2014 from 947 at September 30, 2013. We expect research and development headcount to decrease in the near term as a result of our restructuring activities. As a result of stock options granted under the 2013 Plan, we expect that share-based compensation expense, a portion of which is recognized as research and development expense, will continue to be a recurring expense. As of September 30, 2014, we estimate that approximately $5.0 million of additional share-based compensation expense will be recognized as research and development expense over a remaining weighted average period of 3.1 years. See "Overview" and Note 11, Share-based Compensation, to the Consolidated Financial Statements for further information regarding the 2013 Plan and related share-based compensation expense. Research and development expenses, before capitalization of software development costs, increased $14.3 million for the nine months ended September 30, 2014, as compared to the same period in the prior year, primarily due to a $12.1 million increase in compensation and related costs due to an increase in average staffing levels, a $1.4 million increase in recruiting costs, a $1.0 million increase in share-based compensation expense related to the grant of stock options under the 2013 Plan, and a $0.4 million increase in facility and other related support costs, partially offset by a $1.0 million decrease in consulting and advisory costs. 34 -------------------------------------------------------------------------------- Table of Contents For the nine months ended September 30, 2014, our research and development effort was focused on the following: 67.8% on the MicroStrategy Analytics Platform, MicroStrategy Mobile, MicroStrategy Cloud, and internal information technology initiatives and 32.2% on other research and development, including the MicroStrategy Identity Platform. Restructuring costs. In the third quarter of 2014, we adopted the 2014 Restructuring Plan, which includes a planned reduction in our workforce by approximately 800 employees. Restructuring costs consist primarily of employee severance and related benefit costs, contract termination costs, and other related costs associated with our restructuring activities. The following table summarizes restructuring costs (in thousands) and related percentage changes for the periods indicated: Three Months Ended Nine Months Ended September 30, % September 30, % 2014 2013 Change 2014 2013 Change Restructuring costs $ 11,578 $ 0 n/a $ 11,578 $ 0 n/a Restructuring costs increased $11.6 million for each of the three and nine months ended September 30, 2014, as compared to the same periods in the prior year, due to the implementation of the 2014 Restructuring Plan in the third quarter of 2014. We expect to incur an additional pre-tax restructuring charge of $6.8 million in the fourth quarter of 2014. See "Overview", "Liquidity and Capital Resources", and Note 6, Restructuring, to the Consolidated Financial Statements for further information regarding the 2014 Restructuring Plan and related restructuring costs by major cost category. Other Income (Expense), Net Other income (expense), net is comprised primarily of realized and unrealized gains and losses on our foreign currency forward contracts and foreign currency transaction gains and losses. For the three months ended September 30, 2014, other income, net, of $4.9 million was comprised of $3.9 million in foreign currency transaction net gains, arising mainly from the revaluation of U.S. dollar denominated cash balances held at international locations, and $1.0 million in net unrealized gains from foreign currency forward contracts. For the nine months ended September 30, 2014, other income, net, of $3.3 million was comprised of $3.2 million in foreign currency transaction net gains, arising mainly from the revaluation of U.S. dollar denominated cash balances held at international locations, and $0.9 million in net unrealized gains from foreign currency forward contracts, offset by $0.6 million in net realized losses from the settlement of certain foreign currency forward contracts and $0.3 million in impairment losses related to software developed for internal use. Benefit from Income Taxes We have estimated an annual effective tax rate for the full fiscal year 2014 and applied that rate to the loss from continuing operations before income taxes in determining the benefit from income taxes for the nine months ended September 30, 2014. We also record discrete items in each respective period as appropriate. The estimated effective tax rate is subject to fluctuation based upon the level and mix of earnings and losses by tax jurisdiction, foreign tax rate differentials, and the relative impact of permanent book to tax differences (e.g., non-deductible expenses). Each quarter, a cumulative adjustment is recorded for any fluctuations in the estimated annual effective tax rate as compared to the prior quarter. As a result of these factors, and due to potential changes in our period to period results, fluctuations in our effective tax rate and respective tax provisions or benefits may occur. The effective tax rate for the nine months ended September 30, 2013 was calculated based on the actual benefit from income taxes for the nine months ended September 30, 2013 (i.e. the "cut-off" method) because we determined that we were unable to make a reliable estimate of the annual effective tax rate as relatively small changes in the projected income or loss produced significant variances in the annual effective tax rate. 35 -------------------------------------------------------------------------------- Table of Contents For the nine months ended September 30, 2014, we recorded a benefit from income taxes from continuing operations of $6.9 million that resulted in an effective tax rate of 28.2%, as compared to a benefit from income taxes from continuing operations of $10.9 million that resulted in an effective tax rate of 2,012.1% for the nine months ended September 30, 2013. The change in the effective tax rate is mainly due to the changes in the year-to-date loss or income amounts and the release of liability for certain unrecognized tax benefits in the second and third quarter of 2013. As of September 30, 2014, we estimated that we had U.S. federal net operating loss carryforwards of $24.1 million and foreign net operating loss carryforwards of $7.0 million. As of September 30, 2014, we estimated that we had U.S. and foreign net operating loss carryforwards, other temporary differences and carryforwards, and credits that resulted in deferred tax assets, net of valuation allowances and deferred tax liabilities, of $28.1 million. As of September 30, 2014, we had a valuation allowance of $1.7 million primarily related to certain foreign tax credit carryforwards and foreign net operating loss carryforwards that, in our present estimation, more likely than not will not be realized. Although we are implementing the 2014 Restructuring Plan, if we are unable to achieve profitability after we have fully implemented the restructuring plan, we may not be able to realize these tax assets. If we are unable to achieve profitability in the near future, particularly relating to our U.S. operations, we may be required to increase the valuation allowance against our deferred tax assets. We will continue to regularly assess the realizability of deferred tax assets. Discontinued Operations On March 15, 2013, we completed the sale of our equity interest in our Angel.com business and received consideration of approximately $111.2 million, resulting in a net cash inflow of $100.7 million after $10.5 million in transaction costs. The sale resulted in a gain of $57.4 million, net of tax. On our Consolidated Statement of Operations, we classified operations of the Angel.com business as Loss from Discontinued Operations, net of tax, because we have no continuing involvement with or cash flows from this business following its divestiture. 36 -------------------------------------------------------------------------------- Table of Contents Deferred Revenue and Advance Payments Deferred revenue and advance payments represent product support, subscription services, and other services fees that are collected in advance and recognized over the contract service period and product licenses revenues relating to multiple-element software arrangements that include future deliverables. The following table summarizes deferred revenue and advance payments (in thousands), as of: September 30, December 31, September 30, 2014 2013 2013 Current: Deferred product licenses revenue $ 10,010 $ 14,538 $ 9,419 Deferred subscription services revenue 10,382 10,923 8,370 Deferred product support revenue 145,917 167,771 146,633 Deferred other services revenue 10,216 17,056 13,595 Gross current deferred revenue and advance payments 176,525 210,288 178,017 Less: unpaid deferred revenue (55,818 ) (96,632 ) (60,232 ) Net current deferred revenue and advance payments $ 120,707 $ 113,656 $ 117,785 Non-current: Deferred product licenses revenue $ 7,700 $ 4,401 $ 2,978 Deferred subscription services revenue 669 1,161 1,031 Deferred product support revenue 7,062 5,877 6,655 Deferred other services revenue 951 1,175 1,484 Gross non-current deferred revenue and advance payments 16,382 12,614 12,148 Less: unpaid deferred revenue (4,903 ) (3,644 ) (3,017 ) Net non-current deferred revenue and advance payments $ 11,479 $ 8,970 $ 9,131 We offset our accounts receivable and deferred revenue for any unpaid items included in deferred revenue and advance payments. Total gross deferred revenue and advance payments decreased $30.0 million as of September 30, 2014, as compared to December 31, 2013, due to the recognition of previously deferred product licenses, subscription services, product support, and other services revenues. Total gross deferred revenue and advance payments increased $2.7 million as of September 30, 2014, as compared to September 30, 2013, primarily due to an increase in deferred revenue from new product licenses and subscription services contracts, partially offset by the recognition of previously deferred product support and other services revenues. We expect to recognize approximately $176.5 million of deferred revenue and advance payments over the next 12 months. However, the timing and ultimate recognition of our deferred revenue and advance payments depend on our performance of various service obligations, and the amount of deferred revenue and advance payments at any date should not be considered indicative of revenues for any succeeding period. As of September 30, 2014, we had entered into certain additional agreements that include future minimum commitments by our customers to purchase products, subscription services, product support, or other services through 2019 totaling approximately $132.8 million. Revenue relating to such future commitments by our customers is not included in our deferred revenue balances. Revenue relating to such agreements will be recognized during the period in which all revenue recognition criteria are met. The timing and ultimate recognition of any revenue from such customer purchase commitments depend on our customers' meeting their future purchase commitments and our meeting our associated performance obligations related to those purchase commitments. 37-------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Liquidity. Our principal sources of liquidity are cash and cash equivalents and on-going collection of our accounts receivable. Cash and cash equivalents include holdings in bank demand deposits and U.S. Treasury securities. We also periodically invest a portion of our excess cash in short-term investments with stated maturity dates between three months and one year from the purchase date. As of September 30, 2014, total accrued restructuring costs were $8.1 million, all of which are expected to be paid in the fourth quarter of 2014. Further, we expect approximately $6.8 million of additional future cash expenditures related to our restructuring activities to be paid in the fourth quarter of 2014. The 2014 Restructuring Plan is expected to deliver annualized pre-tax savings of approximately $73.4 million, primarily as a result of reduced employee compensation and rent expense across the following line items within the Consolidated Statements of Operations (in thousands): Estimated Annual Pre-Tax Savings Cost of other services $ 6,900 Sales and marketing 30,200 Research and development 27,900 General and administrative 8,400 Total estimated annual pre-tax savings from restructuring $ 73,400 In addition to the 2014 Restructuring Plan, we plan to implement other internal cost-saving initiatives that we expect will deliver additional annualized pre-tax savings. As of September 30, 2014 and December 31, 2013, the amount of cash and cash equivalents and short-term investments held by U.S. entities were $120.7 million and $160.5 million, respectively, and by non-U.S. entities were $233.9 million and $196.9 million, respectively. We earn a significant amount of our revenues outside the U.S. and, except for Subpart F deemed dividends, we intend to indefinitely reinvest undistributed earnings of certain non-U.S. entities. We do not anticipate needing to repatriate the cash or cash equivalents held by non-U.S. entities to the U.S. to finance our U.S. operations. However, if we were to elect to repatriate these amounts, we would generate U.S. taxable income to the extent of our undistributed foreign earnings, which amounted to $192.7 million at December 31, 2013. Although the tax impact of repatriating these earnings is difficult to determine and our effective tax rate could increase as a result of any such repatriation, we would not expect the maximum effective tax rate that would be applicable to such repatriation to exceed the U.S. statutory rate of 35.0%, after considering applicable foreign tax credits. We believe that existing cash and cash equivalents and short-term investments held by us and cash and cash equivalents anticipated to be generated by us are sufficient to meet working capital requirements, anticipated capital expenditures, restructuring activities, and contractual obligations for at least the next 12 months. The following table sets forth a summary of our cash flows from continuing operations (in thousands) and related percentage changes for the periods indicated: Nine Months Ended September 30, % 2014 2013 Change Net cash provided by operating activities from continuing operations $ 16,321 $ 15,253 7.0 % Net cash used in investing activities from continuing operations $ (96,388 ) $ (195,645 ) -50.7 % Net cash (used in) provided by financing activities from continuing operations $ (2,035 ) $ 21,884 -109.3 % Net Cash Provided by Operating Activities from Continuing Operations. The primary source of our cash provided by operating activities from continuing operations is cash collections of our accounts receivable from customers following the sales and renewals 38-------------------------------------------------------------------------------- Table of Contents of our software licenses, technical software support, software updates and upgrades, as well as consulting, education, and subscription services. Our primary uses of cash in operating activities from continuing operations are for personnel related expenditures for software development, personnel related expenditures for providing consulting, education, and subscription services, and for sales and marketing costs, general and administrative costs, and income taxes. Net cash provided by operating activities from continuing operations was $16.3 million and $15.3 million for the nine months ended September 30, 2014 and 2013, respectively. The increase in net cash provided by operating activities from continuing operations during the nine months ended September 30, 2014, as compared to the same period in the prior year, was primarily due to a $38.3 million increase from changes in non-cash items, partially offset by a $28.1 million decrease in income from continuing operations and a $9.1 million change in operating assets and liabilities. Non-cash items primarily consist of depreciation and amortization, bad debt expense, the non-cash portion of restructuring costs, deferred taxes, release of liabilities for unrecognized tax benefits, share-based compensation expense, and excess tax benefits from share-based compensation arrangements. Net Cash Used in Investing Activities from Continuing Operations. The changes in net cash used in investing activities from continuing operations primarily relate to purchases and redemptions of short-term investments, expenditures on property and equipment, and capitalized software development costs. Net cash used in investing activities from continuing operations was $96.4 million and $195.6 million for the nine months ended September 30, 2014 and 2013, respectively. The decrease in net cash used in investing activities from continuing operations for the nine months ended September 30, 2014, as compared to the same period in the prior year, was primarily due to a $193.3 million increase in proceeds from the redemption of U.S. Treasury securities and a $3.2 million decrease in capitalized software development costs, partially offset by a $94.5 million increase in purchases of short-term investments, a $1.8 million increase in purchases of property and equipment, and a $0.9 million increase in restricted cash. Net Cash (Used in) Provided by Financing Activities from Continuing Operations. The changes in net cash (used in) provided by financing activities from continuing operations primarily relate to the exercise of employee stock options. Net cash used in financing activities from continuing operations was $2.0 million for the nine months ended September 30, 2014. Net cash provided by financing activities from continuing operations was $21.9 million for the nine months ended September 30, 2013. The increase in net cash used in financing activities from continuing operations for the nine months ended September 30, 2014, as compared to the same period in the prior year, was due to a $23.6 million decrease in excess tax benefits, generated primarily from stock option exercises in previous years, that were recognized in 2013 due to the taxable gain arising from the sale of Angel.com, and a $0.3 million decrease in proceeds from the exercise of employee stock options. Contractual Obligations. As disclosed in Note 8, Commitments and Contingencies, to the Consolidated Financial Statements, we lease office space and computer and other equipment under operating lease agreements. We also lease certain computer and other equipment under capital lease agreements and license certain software under other financing arrangements. Under the lease agreements, in addition to base rent, we are generally responsible for certain taxes, utilities and maintenance costs, and other fees; and several leases include options for renewal or purchase. The following table shows future minimum rent payments under noncancellable operating and capital leases and agreements with initial terms of greater than one year, net of total future minimum rent payments to be received under noncancellable sublease agreements (in thousands), based on the expected due dates of the various installments as of September 30, 2014: Payments due by period ended September 30, Total 2015 2016-2017 2018-2019 Thereafter Contractual Obligations: Operating leases $ 125,683 $ 26,119 $ 41,357 $ 34,232 $ 23,975 Capital leases and other financing arrangements 1,898 1,739 159 0 0 Total $ 127,581 $ 27,858 $ 41,516 $ 34,232 $ 23,975 39 -------------------------------------------------------------------------------- Table of Contents Unrecognized Tax Benefits. As of September 30, 2014, we had $2.1 million of total gross unrecognized tax benefits, including interest accrued. The unrecognized tax benefits have been netted against deferred tax assets upon adoption of Accounting Standards Update No. 2013-11, Income Taxes (Topic 740), and are recorded in other long-term liabilities. The timing of any payments that could result from these unrecognized tax benefits will depend on a number of factors, and accordingly the amount and period of any future payments cannot be estimated. We do not expect a significant tax payment related to these obligations during 2014. Off-Balance Sheet Arrangements. As of September 30, 2014, we did not have any off-balance sheet arrangements that had or were reasonably likely to have a current or future material impact on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources. Recent Accounting Standards In July 2013, the FASB issued Accounting Standards Update No. 2013-11, Income Taxes (Topic 740) ("ASU 2013-11"), which requires the financial statement presentation of an unrecognized tax benefit in a particular jurisdiction, or a portion thereof, as a reduction to a deferred tax asset for a net operating loss ("NOL") carryforward, a similar tax loss, or a tax credit carryforward, unless the uncertain tax position is not available to reduce, or would not be used to reduce, the NOL or carryforward under the tax law in the same jurisdiction; otherwise, the unrecognized tax benefit should be presented as a gross liability and should not be combined with a deferred tax asset. The Company adopted ASU 2013-11 on January 1, 2014. As a result, liabilities for unrecognized tax benefits of $1.0 million were netted against deferred tax assets, as of September 30, 2014. The adoption of this guidance did not have a material effect on the Company's consolidated results of operations or cash flows. In May 2014, the FASB issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) ("ASU 2014-09"), which supersedes nearly all existing revenue recognition guidance. The standard's core principle is that an entity should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard creates a five-step model to achieve its core principle: (1) identify the contract(s) with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the separate performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation. In addition, entities must disclose sufficient information to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Qualitative and quantitative disclosures are required about: (1) the entity's contracts with customers, (2) the significant judgments, and changes in judgments, made in applying the guidance to those contracts, and (3) any assets recognized from the costs to obtain or fulfill a contract with a customer. ASU 2014-09 is effective for interim and annual periods beginning January 1, 2017. Early adoption is not permitted. The standard allows entities to apply the standard retrospectively to each prior reporting period presented ("full retrospective adoption") or retrospectively with the cumulative effect of initially applying the standard recognized at the date of initial application ("modified retrospective adoption"). The Company is currently evaluating the impact of this guidance on its consolidated financial position, results of operations, and cash flows. 40-------------------------------------------------------------------------------- Table of Contents |