UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2003

	¨
~~For the Quarterly Period Ended March 31, 2003~~

OR

¨		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number 000-24435

MICROSTRATEGY INCORPORATED

(Exact name of registrant as specified in its charter)

Delaware

(State of incorporation)

1861 International Drive, McLean, VA

(Address of Principal Executive Offices)

22102

(Zip Code)

51-0323571

(I.R.S. Employer

Identification Number)

~~For the transition period from __________ to __________~~

~~Commission File Number 000-24435~~

~~MICROSTRATEGY INCORPORATED~~
~~(Exact name of registrant as specified in its charter)~~

~~Delaware~~
~~(State of incorporation)~~

~~1861 International Drive, McLean, VA~~
~~(Address of Principal Executive Offices)~~

~~22102~~
~~(Zip Code)~~

~~51-0323571~~
~~(I.R.S. Employer Identification Number)~~

Registrant’s telephone number, including area code: (703) 848-8600

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No¨

~~Yes~~ x

No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No xo

No x

The number of shares of the registrant’s class A common stock and class B common stock outstanding on ~~May~~August 1, 2003 was ~~9,494,884~~12,151,532 and ~~4,616,252,~~3,702,780, respectively.

MICROSTRATEGY INCORPORATED

FORM 10-Q

TABLE OF CONTENTS

				Page

PART I.		FINANCIAL INFORMATION

Item 1.		Financial Statements

		Consolidated Balance Sheets as of ~~March 31,~~June 30, 2003 (unaudited) and December 31, ~~2002~~2002.		1

		Consolidated Statements of Operations ~~for~~For the Three Months Ended ~~March 31,~~June 30, 2003 (unaudited) and 2002 (unaudited)		2

		Consolidated Statements of Operations For the Six Months Ended June 30, 2003 (unaudited) and 2002 (unaudited)		3

		Consolidated Statements of Cash Flows ~~for~~For the ~~Three~~Six Months Ended ~~March 31,~~June 30, 2003 (unaudited) and 2002 (unaudited)	3	4

		Notes to Consolidated Financial Statements (unaudited)	4	6

Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations	14	19

Item 3.		Quantitative and Qualitative Disclosures About Market Risk	32	37

Item 4.		Controls and Procedures	32	38

PART II.		OTHER INFORMATION

Item 1.		Legal Proceedings	33	39

Item 2.		Changes in Securities and Use of Proceeds	33	39

Item 5.
~~Item 5.~~	Other Information	33	40

Item 6.		Exhibits and Reports on Form 8-K	34	40

PART I. FINANCIAL INFORMATION

ITEM 1.

~~ITEM 1.~~ FINANCIAL STATEMENTS

MICROSTRATEGY INCORPORATED

~~MICROSTRATEGY INCORPORATED~~
CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

March 31,
2003

December 31,
2002

(unaudited)

Assets

Current assets:

Cash and cash equivalents

$
21,929

$
15,036

Restricted cash

6,193

6,173

Short-term investments

41

44

Accounts receivable, net

24,038

28,195

Prepaid expenses and other current assets

4,911

5,032

Deferred tax assets, net

269

495

Total current assets

57,381

54,975

Property and equipment, net

17,313

18,471

Goodwill and intangible assets, net

659

789

Capitalized software development costs, net

3,952

4,414

Deposits and other assets

1,147

1,224

Total assets

$
80,452

$
79,873

Liabilities and Stockholders’ Equity (Deficit)

Current liabilities:

Accounts payable and accrued expenses

$
14,150

$
15,267

Accrued compensation and employee benefits

8,413

11,352

Accrued interest

1,304

244

Accrued restructuring costs

4,033

5,222

Deferred revenue and advance payments

26,433

23,961

Notes payable

4,824

4,698

Net liabilities of discontinued operations

1,080

1,151

Total current liabilities

60,237

61,895

Deferred revenue and advance payments

1,783

1,381

Other long-term liabilities

2,153

2,402

Accrued restructuring costs

3,547

3,663

Notes payable

44,612

45,041

Total liabilities

112,332

114,382

Stockholders’ Equity (Deficit):

Preferred stock undesignated, par value $0.001 per share, 4,971 shares authorized, no shares issued or outstanding

—

—

Class A common stock, par value $0.001 per share, 330,000 shares authorized, 9,233 and 9,157 shares issued and outstanding, respectively

9

9

Class B common stock, par value $0.001 per share, 165,000 shares authorized, 4,616 and 4,619 shares issued and outstanding, respectively

5

5

Additional paid-in capital

306,722

305,334

Deferred compensation

(4
)

(17
)
Accumulated other comprehensive income

2,733

2,170

Accumulated deficit

(341,345
)

(342,010
)

Total stockholders’ equity (deficit)

(31,880
)

(34,509
)

Total liabilities and stockholders’ equity (deficit)

$
80,452

$
79,873

	June 30, 2003			December 31, 2002
	(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	34,874		$	15,036
Restricted cash		679			6,173
Accounts receivable, net		28,956			28,195
Prepaid expenses and other current assets		4,258			5,076
Deferred tax assets, net		740			495

Total current assets		69,507			54,975

Property and equipment, net		16,884			18,471
Goodwill and intangible assets, net		639			789
Capitalized software development costs, net		3,490			4,414
Deposits and other assets		1,346			1,224
Deferred tax assets, net		76			—

Total assets	$	91,942		$	79,873

Liabilities and Stockholders’ Equity (Deficit)
Current liabilities:
Accounts payable and accrued expenses	$	15,235		$	15,267
Accrued compensation and employee benefits		12,536			11,352
Accrued interest		231			244
Accrued restructuring costs		4,215			5,222
Deferred revenue and advance payments		28,215			23,961
Deferred tax liabilities, net		10			—
Notes payable		4,955			4,698
Net liabilities of discontinued operations		1,011			1,151

Total current liabilities		66,408			61,895

Deferred revenue and advance payments		1,835			1,381
Other long-term liabilities		2,084			2,402
Accrued restructuring costs		3,708			3,663
Notes payable		39,183			45,041

Total liabilities		113,218			114,382

Stockholders’ Equity (Deficit):
Preferred stock undesignated, par value $0.001 per share, 4,971 shares authorized, no shares issued or outstanding		—			—
Class A common stock, par value $0.001 per share, 330,000 shares authorized, 10,455 and 9,157 shares issued and outstanding, respectively		10			9
Class B common stock, par value $0.001 per share, 165,000 shares authorized, 3,703 and 4,619 shares issued and outstanding, respectively		4			5
Additional paid-in capital		315,000			305,334
Deferred compensation		—			(17	)
Accumulated other comprehensive income		2,759			2,170
Accumulated deficit		(339,049	)		(342,010	)

Total stockholders’ equity (deficit)		(21,276	)		(34,509	)

Total liabilities and stockholders’ equity (deficit)	$	91,942		$	79,873

The accompanying notes are an integral part of these Consolidated Financial Statements.

MICROSTRATEGY INCORPORATED

~~MICROSTRATEGY INCORPORATED~~
CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

	Three Months Ended March 31,

	2003			2002			Three Months Ended June 30,
							2003			2002
Revenues:
Product licenses	$	16,529		$	14,498		$	19,637		$	15,032
Product support and other services		20,906			21,161			23,996			21,798

Total revenues		37,435			35,659			43,633			36,830

Cost of revenues:
Product licenses		790			521			739			572
Product support and other services		5,958			6,640			6,419			6,486

Total cost of revenues		6,748			7,161			7,158			7,058

Gross profit		30,687			28,498			36,475			29,772

Operating expenses:
Sales and marketing		12,683			12,470			14,279			11,411
Research and development		6,933			5,351			7,798			6,850
General and administrative		7,184			6,762			7,963			6,812
Restructuring and impairment charges		—			1,232			1,699			1,162
Amortization of intangible assets		130			965			18			862

Total operating expenses		26,930			26,780			31,757			27,097

Income from operations		3,757			1,718			4,718			2,675
Financing and other (expense) income:
Interest income		90			230			281			179
Interest expense, including discount amortization expense on notes payable of $973 and $0, respectively		(2,298	)		(1,619	)
Interest expense, including discount amortization expense on notes payable of $883 and $0, respectively								(2,049	)		(1,659	)
Loss on investments		—			(289	)		—			(205	)
Reduction in estimated cost of litigation settlement		—			3,460			—			7,936
Gain on early extinguishment of notes payable		18			—
Other expense, net		(38	)		(116	)
Loss on early extinguishment of notes payable								(858	)		—
Gain on contract termination								—			16,837
Other income, net								133			2,169

Total financing and other (expense) income		(2,228	)		1,666			(2,493	)		25,257

Income before income taxes		1,529			3,384			2,225			27,932
Provision for income taxes		864			399
(Benefit) provision for income taxes								(71	)		420

Net income		665			2,985			2,296			27,512

Dividends on and accretion of convertible preferred stock		—			(2,557	)		—			(2,566	)

Net income attributable to common stockholders	$	665		$	428		$	2,296		$	24,946

Basic earnings per share	$	0.05		$	0.05		$	0.16		$	2.43

Diluted earnings (loss) per share	$	0.05		$	(0.84	)
Diluted earnings per share							$	0.15		$	2.41

Basic weighted average shares outstanding		13,788			9,338			14,088			10,440

Diluted weighted average shares outstanding		14,056			11,882			14,940			10,498

The accompanying notes are an integral part of these Consolidated Financial Statements.

MICROSTRATEGY INCORPORATED

~~MICROSTRATEGY INCORPORATED~~
CONSOLIDATED STATEMENTS OF ~~CASH FLOWS~~
OPERATIONS

(in ~~thousands)~~
thousands, except per share data)

(unaudited)

Three Months Ended
March 31,

2003

2002

Operating activities:

Net income from continuing operations

$
665

$
2,985

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

Depreciation and amortization

2,477

3,493

Bad debt recovery

(144
)

(461
)
Net realized loss on sale and write-down of short-term investments

—

289

Decrease in estimated cost of litigation settlement

—

(3,460
)
Non-cash charges and fees on Credit Facility

—

172

Discount amortization expense on notes payable

973

—

Other, net

(30
)

411

Changes in operating assets and liabilities:

Accounts receivable

4,560

90

Prepaid expenses and other current assets

493

1,261

Deposits and other assets

2

(301
)
Accounts payable and accrued expenses, compensation and employee benefits, interest and preferred dividends

(2,895
)

(5,157
)
Accrued restructuring costs

(1,305
)

(341
)
Deferred revenue and advance payments

2,912

704

Other long-term liabilities

(250
)

(607
)

Net cash provided by (used in) operating activities

7,458

(922
)

Investing activities:

Purchases of property and equipment, net

(682
)

(582
)
Capitalized software development costs

—

(2,368
)
Decrease in restricted cash

(1
)

245

Net cash used in investing activities

(683
)

(2,705
)

Financing activities:

Proceeds from sale of class A common stock under employee stock purchase plan and exercise of employee stock options

97

565

Net cash payments under Credit Facility

—

(1,316
)

Net cash provided by (used in) financing activities

97

(751
)
Effect of foreign exchange rate changes on cash and cash equivalents

93

(234
)

Net increase (decrease) in cash and cash equivalents from continuing operations

6,965

(4,612
)
Net cash used in discontinued operations

(72
)

(1,170
)

Net increase (decrease) in cash and cash equivalents

6,893

(5,782
)
Cash and cash equivalents, beginning of period

15,036

38,409

Cash and cash equivalents, end of period

$
21,929

$
32,627

Supplemental disclosure of noncash investing and financing activities:

Stock received in exchange for products and services

$
—

$
93

Payment of series A redeemable convertible preferred stock dividends through the issuance of class A common stock

$
—

$
2,811

Early extinguishment of notes payable

$
(1,276
)
$
—

Issuance of class A common stock in connection with early extinguishment of notes payable

$
1,293

$
—

	Six Months Ended June 30,
	2003			2002
Revenues:
Product licenses	$	36,166		$	29,530
Product support and other services		44,902			42,959

Total revenues		81,068			72,489

Cost of revenues:
Product licenses		1,529			1,093
Product support and other services		12,377			13,126

Total cost of revenues		13,906			14,219

Gross profit		67,162			58,270

Operating expenses:
Sales and marketing		26,962			23,881
Research and development		14,731			12,201
General and administrative		15,147			13,574
Restructuring and impairment charges		1,699			2,394
Amortization of intangible assets		148			1,827

Total operating expenses		58,687			53,877

Income from operations		8,475			4,393
Financing and other (expense) income:
Interest income		371			409
Interest expense, including discount amortization expense on notes payable of $1,856 and $0, respectively		(4,347	)		(3,278	)
Loss on investments		—			(494	)
Reduction in estimated cost of litigation settlement		—			11,396
Loss on early extinguishment of notes payable		(840	)		—
Gain on contract termination		—			16,837
Other income, net		95			2,053

Total financing and other (expense) income		(4,721	)		26,923

Income before income taxes		3,754			31,316
Provision for income taxes		793			819

Net income		2,961			30,497

Dividends on and accretion of convertible preferred stock		—			(5,123	)

Net income attributable to common stockholders	$	2,961		$	25,374

Basic earnings per share	$	0.21		$	2.58

Diluted earnings per share	$	0.20		$	2.54

Basic weighted average shares outstanding		13,939			10,140

Diluted weighted average shares outstanding		14,500			10,303

The accompanying notes are an integral part of these Consolidated Financial Statements.

MICROSTRATEGY INCORPORATED

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

		Six Months Ended June 30,
		2003			2002
Operating activities:
Net income from continuing operations		$	2,961		$	30,497
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			4,742			6,914
Bad debt recovery			(26	)		(458	)
Net realized loss on sale and write-down of short-term investments			—			494
Non-cash portion of restructuring and impairment charges			—			(53	)
Decrease in estimated cost of litigation settlement			—			(11,396	)
Gain on contract termination			—			(16,837	)
Non-cash charges and fees on Credit Facility			—			211
Loss on early extinguishment of notes payable			840			—
Discount amortization expense on notes payable			1,856			—
Other, net			(24	)		293
Changes in operating assets and liabilities:
Accounts receivable			572			(34	)
Prepaid expenses and other current assets and deferred tax assets			(349	)		2,878
Deposits and other assets			(169	)		(260	)
Accounts payable and accrued expenses, compensation and employee benefits, interest and preferred dividends			1,071			(5,116	)
Accrued restructuring costs			(962	)		(618	)
Deferred revenue and advance payments, net of reclass on contingency from terminated contract			4,568			(1,762	)
Other long-term liabilities			(318	)		(748	)

Net cash provided by operating activities			14,762			4,005

Investing activities:
Purchases of property and equipment, net			(1,947	)		(786	)
Capitalized software development costs			—			(2,958	)
Proceeds from sales of short-term investments			—			271
Decrease in restricted cash	��		5,551			188

Net cash provided by (used in) investing activities			3,604			(3,285	)

Financing activities:
Proceeds from sale of class A common stock and exercise of stock options, net of offering costs			1,138			660
Net cash payments under Credit Facility			—			(1,405	)

Net cash provided by (used in) financing activities			1,138			(745	)
Effect of foreign exchange rate changes on cash and cash equivalents			474			543

Net increase in cash and cash equivalents from continuing operations			19,978			518
Net cash used in discontinued operations			(140	)		(1,976	)

Net increase (decrease) in cash and cash equivalents			19,838			(1,458	)
Cash and cash equivalents, beginning of period			15,036			38,409

Cash and cash equivalents, end of period		$	34,874		$	36,951

The accompanying notes are an integral part of these Consolidated Financial Statements.

MICROSTRATEGY INCORPORATED

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

(Continued)

	Six Months Ended June 30,
	2003			2002
Supplemental disclosure of noncash investing and financing activities:
Stock received in exchange for products and services	$	—		$	93

Issuance of class A common stock warrants	$	—		$	400

Payment of series A redeemable convertible preferred stock dividends through the issuance of class A common stock and series D convertible preferred stock	$	—		$	4,901

Issuance of class A common stock in connection with the conversion of series A preferred stock	$	—		$	6,500

Issuance of class A common stock in connection with the litigation settlement	$	—		$	1,785

Issuance of promissory notes in connection with the litigation settlement	$	—		$	550

Early extinguishment of notes payable	$	(7,456	)	$	—

Issuance of class A common stock in connection with early extinguishment of notes payable	$	8,533		$	—

The accompanying notes are an integral part of these Consolidated Financial Statements.

MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(1) Basis of Presentation

Except for the consolidated balance sheet of MicroStrategy Incorporated (“MicroStrategy” or the “Company”) as of December 31, 2002, which is derived from audited financial statements, the accompanying consolidated financial statements are unaudited. In the opinion of management, all adjustments (consisting of normal recurring items) necessary for a fair presentation of such financial statements have been included. Interim results are not necessarily indicative of results for a full year.

The consolidated financial statements and notes are presented as required by Form 10-Q and do not contain certain information included in the Company’s annual financial statements and notes. These financial statements should be read in conjunction with the Company’s audited financial statements and the notes thereto filed with the Securities and Exchange Commission (“SEC”) in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

As of ~~March 31,~~June 30, 2003, the Company had an accumulated deficit of ~~$341.3~~$339.0 million and ~~a working capital deficit~~negative stockholders’ equity of ~~$2.9 million, including net liabilities of discontinued operations of $1.1~~$21.3 million. During ~~the past two years,~~2001, the Company ~~has taken~~took several actions to realign its cost structure to better match its expected revenues, including reducing its workforce, consolidating its office space, reducing and limiting discretionary operating expenses, reducing capital expenditures, and discontinuing the operations of its subsidiary, Strategy.com. ~~Additionally, the~~The Company has also taken various actions to simplify its capital structure, including refinancing its preferred stock in 2002 and ~~repurchasing certain of~~converting its remaining 7 ½%¹/2% series A unsecured notes in July 2003 into shares of class A common stock (Note 8)9). The Company expects that its total stockholders’ equity will be positive after the effect of the conversion of the 7¹/2% series A unsecured notes. Additionally, during July 2003, the Company paid $5.2 million to repay in full the promissory notes issued to former preferred stockholders. As a result of these two transactions in July 2003, the Company has reduced its outstanding indebtedness by approximately $58 million. The Company continues to explore additional financing arrangements, which may include ~~credit facilities,~~ the sale of equity in MicroStrategy or other alternative financing sources for the Company. Any additional debt or equity financing may not be available on acceptable terms. If financing is not available on acceptable terms and/or the Company does not achieve revenues and generate cash flow at anticipated levels, it will need to take further actions to reduce costs in order to improve results from operations. Management believes that existing cash, ~~and~~ cash anticipated to be generated internally by operations, if any, and the credit facility entered into in May 2003 (Note 9) will be sufficient ~~to meet the Company’s obligations to repay the approximately $5.2 million in principal and accrued interest on the promissory notes issued to former preferred stockholders on July 31, 2003 and~~ to meet the Company’s working capital requirements and anticipated capital expenditures through ~~the end of 2003.~~at least June 30, 2004.

Certain prior year amounts in the consolidated financial statements have been reclassified to conform to the current year presentation.

(2) Recent Accounting Standards

In ~~April~~November 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” SFAS No. 145 changes guidance related to the reporting of gains and losses from extinguishment of debt as extraordinary items and resolves inconsistencies related to the required accounting treatment of certain lease modifications. SFAS No. 145 is effective for financial statements issued for fiscal years beginning after May 15, 2002. The Company elected early adoption of the provisions of this statement. The adoption of this standard had no impact on the Company’s net income (loss) for the periods presented.

In July 2002, the FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 supersedes the guidance in Emerging Issues Task Force (“EITF”) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” Under EITF No. 94-3, an entity recognized a liability for an exit cost on the date that the entity committed itself to an exit plan. In SFAS No. 146, the FASB acknowledges that an entity’s commitment to a plan does not, by itself, create a present obligation to the other parties that meets the definition of a liability and requires that a liability for a cost that is associated with an exit or disposal activity be recognized when the liability is incurred. It also establishes that fair value is the objective for the initial measurement of the liability. SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of this standard did not have a material effect on the financial position or results of operations of the Company.

~~MICROSTRATEGY INCORPORATED~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(unaudited)~~

~~In November 2002, the FASB~~ issued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires a company to recognize the fair value for certain guarantee obligations on the date of issuance of the guarantee. The initial recognition and ~~indemnification~~measurement provisions of FIN 45 are applicable on a prospective basis for guarantee arrangements issued or modified by the ~~company~~Company after December 31, ~~2002, if these arrangements are within~~2002. FIN 45 also requires a company to make certain additional disclosures even when the ~~scope~~likelihood of payment under the guarantee is remote. The adoption of FIN 45 had no impact on the results of operations of the ~~interpretation. In addition, a company must continue~~Company.

Pursuant to ~~monitor the conditions that~~FIN 45 and subsequent FASB staff positions, intellectual property infringement indemnifications are subject to the ~~guarantees~~disclosure requirements of FIN 45, but are exempt from its initial recognition and ~~indemnifications,~~measurement provisions. The Company typically includes its standard intellectual property indemnification clauses in its software license agreements. Pursuant to these clauses, the Company agrees to defend and hold harmless the indemnified party, typically the Company’s customers, business partners, and their directors, officers, employees and agents, in connection with certain intellectual property infringement claims by third parties relating to the Company’s products. The term of the indemnification clauses varies, typically ranging from five years to perpetuity, and generally applies at any time after the execution of the software license agreement. In addition, the Company generally warrants that its software products will perform in all material respects in accordance with its standard published software specifications in effect at the time of delivery of the licensed products to the customer for a specified period of time

MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

following delivery, typically 90 to 180 days. The Company has not experienced any material intellectual property indemnification or warranty claims historically and has no amounts accrued as ~~required under previously existing generally accepted accounting principles,~~of June 30, 2003 relating to such obligations.

The Company is also a party to a variety of other agreements with current and former customers, vendors, employees, and directors, pursuant to which it may be obligated to make payments to guaranteed parties. For example, such indemnification arrangements may obligate the Company to make payments to a property owner in ~~order to identify if~~the event of an adverse judgment in a loss has occurred. If a company determines it is probable that a loss has occurred then any such estimable loss would be recognized under those guarantees and indemnifications. Software licenses grantedlawsuit or the imposition of additional taxes in connection with real estate leased by the ~~Company contain standard indemnification provisions that indemnify licensees of~~Company. These obligations may require the other party to make an adverse claim pursuant to procedures specified in the specific agreement, and the Company’s ~~software from damages~~obligations may be limited in terms of time, and/or amount, or otherwise be qualified. It is not possible to predict the maximum potential amount of future payments under such agreements, due to the limited history of prior indemnification claims and ~~costs resulting from claims alleging that~~ the ~~Company’s software infringes the intellectual property rights of a third party. The Company does not have any historical experience of receiving requests for indemnification under these provisions~~unique facts and ~~has not been required to make any material payments pursuant to these provisions. Accordingly,~~circumstances involved in each particular agreement. To date, the Company has not ~~recorded a liability related~~incurred material expense under these agreements and has not accrued any amounts relating to ~~these indemnification provisions. The Company does not have any guarantees or indemnification arrangements other than the indemnification clause~~such provisions in its ~~software licenses. The adoption of this standard did not have a material effect on the Company’s~~ financial ~~position and results of operations.~~statements.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” SFAS No. 148 is effective for fiscal years ending after December 15, 2002 and amends SFAS No. 123 to provide for alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company has accounted for stock-based employee compensation using the intrinsic value method under APB No. 25 and has adopted the amendments to the disclosure provisions of SFAS No. 148. The table in Note 10 illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation.

In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. The Company does not have any controlling interest, contractual relationships or other business relationships with variable interest entities and therefore the adoption of this standard did not have any effect on the Company’s financial position and results of operations.

In April 2003, the FASB issued ~~SFAS~~Statement of Financial Accounting Standards (“SFAS”) No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. The statement requires that contracts with comparable characteristics be accounted for similarly and clarifies when a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, except in certain circumstances, and for hedging relationships designated after June 30, 2003. The Company does not expect that the adoption of this standard will have a material effect on its financial position or results of operations.

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” SFAS No. 150 requires that certain instruments with certain characteristics be classified as liabilities as opposed to equity. This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective July 1, 2003. The adoption of this standard did not have a material impact on the Company’s financial position and results of operations.

(3) Discontinued Operations

During 2001, the Company substantially curtailed, discontinued and ultimately shut down the operations of its subsidiary, ~~Strategy.com, and reduced its workforce to approximately 40 employees. On December 31, 2001, the Company discontinued the operations of Strategy.com and shut down its services.~~Strategy.com. The historical consolidated financial statements of the Company reflect

~~MICROSTRATEGY INCORPORATED~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(unaudited)~~

Strategy.com as a discontinued operation for all periods presented. The net liabilities of Strategy.com included within net liabilities of discontinued operations as of ~~March 31,~~June 30, 2003 and December 31, 2002, respectively, included accounts payable and accrued expenses of ~~$1.1~~$1.0 million and $1.2 ~~million, respectively.~~million. The Company continues to assess the valuation of these liabilities, and actual results and outcomes could differ from current estimates and assumptions. As these liabilities are satisfied in future periods, the expenditures will continue to be classified as cash used in discontinued operations in the accompanying consolidated statements of cash flows.

MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(4) Accounts Receivable

Accounts receivable, net of allowances, consist of the following, as of (in thousands):

March 31,
2003

December 31,
2002

Billed and billable

$
44,294

$
49,688

Less: billed and unpaid deferred revenue

(17,843
)

(17,841
)

26,451

31,847

Less: allowance for doubtful accounts

(2,413
)

(3,652
)

$
24,038

$
28,195

	June 30, 2003			December 31, 2002
Billed and billable	$	50,203		$	49,688
Less: billed and unpaid deferred revenue		(18,676	)		(17,841	)

		31,527			31,847
Less: allowance for doubtful accounts		(2,571	)		(3,652	)

	$	28,956		$	28,195

The Company offsets its accounts receivable and deferred revenue for any billed and unpaid items included in deferred revenue and advance payments.

(5) Deferred Revenue and Advance Payments

Deferred revenue and advance payments from customers consist of the following, as of (in thousands):

March 31,
2003

December 31,
2002

Current:

Deferred product revenue

$
1,713

$
1,790

Deferred product support and other services revenue

41,565

38,876

43,278

40,666

Less: billed and unpaid deferred revenue

(16,845
)

(16,705
)

$
26,433

$
23,961

Non-current:

Deferred product revenue

$
614

$
663

Deferred product support and other services revenue

2,167

1,854

2,781

2,517

Less: billed and unpaid deferred revenue

(998
)

(1,136
)

$
1,783

$
1,381

	June 30, 2003			December 31, 2002
Current:
Deferred product revenue	$	1,899		$	1,790
Deferred product support and other services revenue		42,951			38,876

		44,850			40,666
Less: billed and unpaid deferred revenue		(16,635	)		(16,705	)

	$	28,215		$	23,961

Non-current:
Deferred product revenue	$	323		$	663
Deferred product support and other services revenue		3,553			1,854

		3,876			2,517
Less: billed and unpaid deferred revenue		(2,041	)		(1,136	)

	$	1,835		$	1,381

The Company offsets its accounts receivable and deferred revenue for any billed and unpaid items included in deferred revenue and advance payments.

(6) Contingency from Terminated Contract

On June 28, 2002, the Company and Exchange Applications entered into an arrangement to terminate the software development and OEM agreement that the companies had entered into as of December 28, 1999. In connection with the arrangement, the Company paid $120,000 to Exchange Applications and granted Exchange Applications a limited license to support Exchange Applications’ customers that had purchased products prior to the effective date of the arrangement. As a result, the Company recognized $210,000 of product support and other services revenues in 2002 through the date of termination and recorded a $16.8 million gain on contract termination during the second quarter of 2002 relating to the remaining contingency from terminated contract that had previously been recorded.

MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(7) Litigation

(a) Securities Litigation

In 2000, the Company and certain of its officers and directors were named as defendants in a private securities class action lawsuit and a shareholder derivative lawsuit. The Company entered into agreements to settle these lawsuits in 2000 and subsequently completed its distribution of consideration under these lawsuits during 2002.

~~MICROSTRATEGY INCORPORATED~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(unaudited)~~

Based on the terms of the settlement agreements, the Company established an initial estimate for the cost of the litigation settlement during 2000. Subsequently, during each successive financial reporting period prior to distribution of the consideration, the Company updated the estimated value assigned to each individual component of the settlement based upon valuation assumptions stemming from the settlement. As a result of a change in the estimated market borrowing rate and discount on the promissory notes, a decline in the value of the Company’s class A common stock and a reduction in the estimated fair value of warrants ~~to be~~ issued in connection with the litigation settlement, the Company recorded an aggregate reduction in the provision for the litigation settlement of ~~$3.5~~$7.9 million and $11.4 million during the three and six months ended ~~March 31, 2002. No~~June 30, 2002, respectively. As distribution of the consideration was completed during the third quarter of 2002, no additional reductions were recorded during the three and six months ended ~~March 31,~~June 30, 2003. The reduction in estimated cost of litigation settlement was comprised of the following, (in thousands):

Three Months Ended
March 31,

2003

2002

Promissory notes

$
—

$
—

Class A common stock

—

(2,222
)
Warrants

—

(1,238
)

Reduction in estimated cost of litigation settlement

$
—

$
(3,460
)

	Three Months Ended June 30,				Six Months Ended June 30,
	2003	2002			2003	2002
Promissory notes	$ —	$	2,500		$ —	$	2,500
Class A common stock	—		(6,688	)	—		(8,910	)
Warrants	—		(3,614	)	—		(4,852	)
Pending loss on additional settlement	—		(134	)	—		(134	)

Reduction in estimated cost of litigation settlement	$ —	$	(7,936	)	$ —	$	(11,396	)

The Company substantially reduced its outstanding obligations relating to the accrued litigation settlement upon completing its distribution of the consideration under the private securities class action settlement during 2002. As of ~~March 31,~~June 30, 2003 and December 31, 2002, the Company’s remaining obligations relating to the litigation settlement were for accrued administration costs of ~~$194,000~~$179,000 and $208,000, respectively, which are included in accounts payable and accrued expenses in the accompanying consolidated balance sheets.

(b) Business Objects Litigation

On October 2, 2001, the Company filed a lawsuit in the Virginia Circuit Court for Fairfax County against two field employees of Business Objects, S.A. This lawsuit alleged that these employees, who previously worked for the Company, breached their fiduciary and contractual obligations to the Company by, among other things, misappropriating its trade secrets and confidential information and soliciting its employees and customers. The complaint sought injunctive relief and damages of at least $3 million. On October 17, 2001, Business Objects filed suit against the Company in the United States District Court for the Northern District of California, claiming that the Company’s software infringes a patent issued to Business Objects relating to relational database access. The suit seeks injunctive relief and ~~unspecified~~ monetary damages. The Company has filed an answer denying the allegations in the Complaint and has filed a declaratory judgment counterclaim seeking to have Business Objects’ patent declared invalid and unenforceable against the Company. ~~A trial date has not yet been set~~Trial is scheduled to commence on November 10, 2003 in the Northern District of California action. The Company intends to vigorously defend the case.

MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

using a web browser (the ‘033 patent) and a system and method of adapting automatic output of OLAP reports to disparate user output ~~devices.~~devices (the ‘050 patent). On March 13, 2002, the Company voluntarily dismissed without prejudice its lawsuit pending in the Virginia Circuit Court for Fairfax County against the two field employees of Business Objects. The complaint against Business Objects was amended to add claims for violations of the federal Computer Fraud and Abuse Act, misappropriation of trade secrets, tortious interference with contractual relations, and violations of the Virginia Conspiracy Act. As a result of pre-trial rulings, certain of these claims were dismissed. The Company’s claims for tortious interference and misappropriation of trade secrets are ~~expected~~currently scheduled to proceed to ~~trial. The~~ trial ~~is scheduled to commence~~ on October ~~15,~~20, 2003. In July 2003, the United States Patent & Trademark Office confirmed the validity of all the claims in the ‘033 and ‘050 patents and terminated reexamination proceedings that Business Objects had requested as to those patents. The Court is considering whether to try the Company’s ‘050 patent claims together with the tortious interference and misappropriation of trade secrets claims or whether to try the patent issues in a separate trial. Should the Court decide to try all the issues together, it is likely that the trial would be continued beyond October 2003, perhaps into 2004. The Company is seeking monetary damages and injunctive relief. ~~The patent claims have been stayed pending the conclusion of reexamination proceedings before the United States Patent & Trademark Office.~~ The outcome of this litigation is not presently determinable and as such the Company is currently

~~MICROSTRATEGY INCORPORATED~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(unaudited)~~

unable to estimate a potential range of gain or loss, if any, relating to these actions. Accordingly, no provision for these matters has been made in the accompanying consolidated financial statements.

(c) Other Matters

The Company is also involved in other legal proceedings through the normal course of business. Management believes that any unfavorable outcome related to these other proceedings will not have a material effect on the Company’s financial position, results of operations or cash flows.

~~(7)~~(8) Redeemable Convertible Preferred Stock

As a result of the refinancing of its series B, C and D preferred stock in August 2002 for cash, promissory notes, class A common stock and series F preferred stock, and the subsequent conversions of its series F preferred stock during the latter half of 2002 into shares of class A common stock, the Company did not have any outstanding shares of preferred stock during the first ~~quarter~~and second quarters of ~~2003. Accordingly, the Company did not accrue or pay any preferred stock dividends during the three months ended March 31,~~ 2003. Prior to the August 2002 refinancing transaction, the Company accrued dividends on its outstanding shares of preferred stock in accordance with terms stipulated in the preferred stock agreements. For the three and six months ended ~~March 31,~~June 30, 2002, the Company accrued aggregate dividends of $2.0 million and $4.0 million, respectively, on its preferred ~~stock and~~stock. During the six months ended June 30, 2002, the Company paid aggregate preferred stock dividends valued at ~~$2.8~~$4.9 million through the issuance of ~~75,672~~154,508 shares of class A common stock in lieu of cash. Additionally, for the three and six months ended ~~March 31,~~June 30, 2002, the Company recorded accretion on its preferred stock of ~~$566,000~~$567,000 and $1.1 million, respectively, to accrete the carrying value of its series B and C preferred stock to its stated value and to accrete the carrying value of the beneficial conversion feature on its series D preferred stock.

~~(8)~~(9) Notes Payable and Borrowings

The following summarizes the Company’s notes payable as of, (in thousands):

March 31,
2003

December 31,
2002

Principal
Amount

Discount

Carrying
Value

Principal
Amount

Discount

Carrying
Value

7 1/2% series A unsecured notes

$
61,534

$
(16,922
)
$
44,612

$
63,295

$
(18,254
)
$
45,041

Promissory notes issued to former preferred stockholders

5,000

(176
)

4,824

5,000

(302
)

4,698

$
66,534

$
(17,098
)
$
49,436

$
68,295

$
(18,556
)
$
49,739

Classified as:

Current notes payable

$
4,824

$
4,698

Long-term notes payable

44,612

45,041

$
49,436

$
49,739

MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

	June 30, 2003							December 31, 2002
	Principal Amount		Discount			Carrying Value		Principal Amount		Discount			Carrying Value
7¹/2% series A unsecured notes	$	53,035	$	(13,852	)	$	39,183	$	63,295	$	(18,254	)	$	45,041
Promissory notes issued to former preferred stockholders		5,000		(45	)		4,955		5,000		(302	)		4,698

	$	58,035	$	(13,897	)	$	44,138	$	68,295	$	(18,556	)	$	49,739

Classified as:
Current notes payable						$	4,955						$	4,698
Long-term notes payable							39,183							45,041

						$	44,138						$	49,739

(a) 7 ½%¹/2% Series A Unsecured Notes

Pursuant to settlement agreements relating to the Company’s securities class action litigation, the Company issued to class members, among other consideration, an aggregate principal amount of $80.3 million of its 7 ½% series A unsecured ~~notes.~~notes (“Series A Notes”). The ~~notes mature on June 24, 2007 and bear~~Series A Notes bore interest at a rate of 7.5% per annum, payable ~~semi-annually.~~semi-annually, and were to mature on June 24, 2007. Based upon market conditions and an estimated market borrowing rate of 18%, a discount of $25.3 million was computed on ~~these notes~~the Series A Notes at the time of issuance. The discount ~~is being~~was amortized to interest expense over the term of such notes, using the effective interest method.

~~MICROSTRATEGY INCORPORATED~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(unaudited)~~

Interest charges on the ~~7 ½% series~~Series A ~~unsecured notes~~Notes began accruing on ~~the settlement hearing date of~~ April 2, 2001. For the three months ended ~~March 31,~~June 30, 2003 and 2002, total interest expense on the ~~7 ½% series~~Series A ~~unsecured notes~~Notes was ~~$2.0~~$1.8 million and ~~$1.5~~$1.6 million, respectively, including stated interest expense of ~~$1.2~~$1.0 million and ~~$1.5~~$1.6 million, respectively, and discount amortization expense of ~~$847,000~~$753,000 and $0, respectively. For the six months ended June 30, 2003 and 2002, total interest expense on the Series A Notes was $3.8 million and $3.1 million, respectively, including stated interest expense of $2.2 million and $3.1 million, respectively, and discount amortization expense of $1.6 million and $0, respectively. During the six months ended June 30, 2003, the Company made interest payments on the Series A Notes of $2.0 million. The Company did not make any interest payments during the six months ended June 30, 2002.

The Company ~~has~~had the right, at any time prior to the June 24, 2007 maturity date, to prepay its ~~7 ½% series~~Series A ~~unsecured notes~~Notes in full, or to mandatorily convert these notes into shares of the Company’s class A common stock at a conversion price equal to 80% of the dollar-volume weighted average trading price per share for all round lot transactions in the Company’s class A common stock on the Nasdaq National Market for the ten trading days ending two days prior to the date ~~that~~on which written notice of conversion ~~has been~~is given. The Company ~~may~~could also repurchase, convert or redeem a portion of the outstanding notes so long as the combination of redemptions, conversions and repurchases ~~does~~did not reduce the total outstanding principal amount of the notes below 60% of the original $80.3 million principal amount of the notes, or approximately $48.2 million, unless all of the remaining outstanding notes ~~are~~were redeemed or converted by the Company. ~~Upon maturity, the outstanding principal balance of the promissory notes will become due.~~ During the first ~~quarter~~and second quarters of 2003, the Company repurchased ~~promissory notes~~Series A Notes with an aggregate principal amount of ~~$1.8~~$10.3 million in exchange for ~~56,053~~317,810 shares of class A common stock. ~~The carrying value~~As a result of the ~~extinguished promissory~~repurchases, the Company recorded an aggregate net loss during 2003 on the early extinguishment of notes ~~plus accrued and unpaid interest~~payable in the amount of ~~$1.3 million in aggregate was substantially~~$840,000 equal to the excess of the aggregate fair value of the consideration transferred to the holders of the Series A Notes of $8.5 million over the carrying value of such ~~promissory notes.~~extinguished notes plus accrued and unpaid interest of $7.7 million in aggregate. Because the Company repurchased Series A Notes on several occasions during 2002 and 2003, management concluded that the extinguishments would not be presented as extraordinary items in the accompanying consolidated statements of operations.

~~During April~~

On June 23, 2003, the Company ~~repurchased additional promissory notes with an aggregate~~announced that it had elected to convert the remaining $53.0 million in principal amount outstanding of ~~$8.5 million~~its Series A Notes plus accrued and unpaid interest into shares of the Company’s class A

MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

common stock in ~~exchange for 261,757~~accordance with the terms of the indenture pursuant to which the Series A Notes were issued. On July 30, 2003, the Company completed the conversion and issued 1,654,839 shares of class A common ~~stock. As a result~~stock and approximately $47,000 in cash in lieu of fractional shares. In connection with this ~~repurchase,~~transaction, the Company will record a loss during the ~~second~~third quarter of 2003 on the early extinguishment of notes payable in the amount of ~~$858,000~~approximately $30.2 million equal to the excess of the fair value of the consideration transferred to the holders of the ~~promissory notes~~Series A Notes of ~~$7.3~~$70.0 million over the carrying value of such extinguished ~~promissory~~ notes plus accrued and unpaid interest of ~~$6.4 million in aggregate. Because~~$39.8 million. Upon completion of this transaction, the ~~Company repurchased promissory notes on several occasions during 2002 and 2003 and may continue~~Company’s remaining obligations relating to ~~seek arrangements to repurchase promissory notes in the future, management determined that the extinguishments~~its Series A Notes were not infrequent in occurrence and, therefore, concluded that the extinguishments would not be presented as extraordinary items in the accompanying consolidated statement of operations. Through April 2003, the Company has repurchased approximately 34% of the original principal amount of the notes.eliminated.

(b) Promissory Notes Issued to Former Preferred Stockholders

In connection with the refinancing of its series B, C and D preferred stock in August 2002, the Company issued to preferred stockholders, among other consideration, $5.0 million in promissory notes which ~~mature on July 31, 2003 and bear~~bore interest at a rate of 7.5% per annum, payable ~~semi-annually.~~semi-annually, and matured on July 31, 2003. Based upon market conditions and an estimated market borrowing rate of 18%, a discount of $500,000 was computed on these promissory notes at the time of issuance. The discount ~~is being~~was amortized to interest expense over the term of such promissory notes, using the effective interest method.

For the three months ended ~~March 31,~~June 30, 2003, total interest expense on the promissory notes issued to former preferred stockholders was ~~$217,000,~~$224,000, including stated interest expense of ~~$91,000~~$93,000 and discount amortization expense of ~~$126,000.~~$131,000. For the six months ended June 30, 2003, total interest expense on the promissory notes issued to former preferred stockholders was $441,000, including stated interest expense of $184,000 and discount amortization expense of $257,000. During the six months ended June 30, 2003, the Company made total interest payments on the promissory notes issued to preferred stockholders of $183,000.

Upon maturity of the promissory notes on July 31, 2003, the Company paid in full $5.2 million in principal and interest due under the promissory notes issued to former preferred stockholders.

(c) ~~Borrowings~~Credit Facility

~~In July 2002,~~

On May 19, 2003, the Company entered into a ~~letter of~~$10 million secured credit ~~security agreement~~facility (the ~~“Security Agreement”~~“Credit Facility”) with Bank of ~~America. Under~~America, N.A. The Credit Facility consists of a $10 million revolving line of credit subject to borrowing base limitations based on accounts receivable, as defined in the ~~Security Agreement,~~agreement. The Credit Facility, which matures in April 2004, includes a letter of credit sub-limit of $10 million and is secured by substantially all of the assets of the Company. Bank of America has ~~issued letters~~an option to extend the maturity date by one additional year. As of ~~credit for the benefit of~~June 30, 2003, the Company ~~which are currently secured by restricted cash equal to~~had no amounts outstanding under the ~~balance~~Credit Facility. After consideration of outstanding letters of credit of $5.6 ~~million. Prior~~million and borrowing base limitations applicable to ~~entering into~~ the ~~Security Agreement,~~Credit Facility, the Company had $4.4 million of borrowing capacity as of June 30, 2003.

At the Company’s option, borrowings under the Credit Facility bear interest at a ~~loan and~~variable rate equal to LIBOR plus 2.5% to 3.0%, depending on the outstanding balance, or the prime rate plus 1.0%. The Credit Facility also includes a 2.0% letter of credit fee.

In connection with obtaining the Credit Facility, the Company’s previous letter of credit security agreement ~~(the “Credit Facility”)~~ with ~~Foothill Capital, a subsidiary~~Bank of ~~Wells Fargo Bank,~~America, under which ~~provided for aggregate borrowing capacity~~outstanding letters of upcredit of $5.6 million were secured by an equal amount of restricted cash, was terminated.

Under the terms of the Credit Facility, the Company is required to ~~$30 million, including a $5 million maintenance receivables backed sub-facility, subject~~maintain certain financial covenants, the most restrictive of which include achieving certain minimum earnings amounts and maximum debt to ~~specified borrowing base~~earnings ratios, maintaining minimum liquidity amounts, and minimizing the ability to invest further in subsidiaries. As of June 30, 2003, the Company was in compliance with all covenants contained in the Credit Facility.

MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
~~(unaudited)~~

limitations based on eligible maintenance receivables. During the three months ended March 31, 2002, the Company made payments under the Credit Facility of $2.3 million which were offset by cash advances of $1.0 million.

~~(9)~~(unaudited)

(10) Comprehensive Income

Comprehensive income includes foreign currency translation adjustments and unrealized gains and losses on short-term investments, net of related tax effects, that have been excluded from net income and reflected in stockholders’ equity (deficit) as accumulated other comprehensive income.

Comprehensive income for the three and six months ended ~~March 31,~~June 30, 2003 and 2002, respectively, is calculated as follows (in thousands):

Three Months Ended
March 31,

2003

2002

Net income

$
665

$
2,985

Foreign currency translation adjustment

565

115

Unrealized loss on short-term investments, net of applicable taxes

—

(117
)

Comprehensive income

$
1,230

$
2,983

	Three Months Ended June 30,						Six Months Ended June 30,
	2003			2002			2003			2002
Net income	$	2,296		$	27,512		$	2,961		$	30,497
Foreign currency translation adjustment		38			(239	)		603			(124	)
Unrealized loss on short-term investments, net of applicable taxes		(11	)		(25	)		(11	)		(142	)

Comprehensive income	$	2,323		$	27,248		$	3,553		$	30,231

~~(10)~~(11) Earnings ~~(Loss) Per~~per Share and Pro Forma ~~Loss~~(Loss) Earnings per Share

(a) Basic and diluted earnings ~~(loss)~~ per share

The following table sets forth the computation of basic and diluted earnings ~~(loss)~~ per share for the three months ended ~~March 31,~~June 30, 2003 and 2002, respectively (in thousands, except per share data):

MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Three months ended
March 31, 2003

Three months ended
March 31, 2002

Income
(Numerator)

Shares
(Denominator)

Per Share
Amount

Income
(Numerator)

Shares
(Denominator)

Per Share
Amount

Net income

$
665

$
2,985

Dividends on and accretion of convertible preferred stock

—

(2,557
)

Net income attributable to common stockholders

665

428

Effect of common stock:

Weighted average shares of class A common stock

—

9,172

—

4,685

Weighted average shares of class B common stock

—

4,616

—

4,653

Basic earnings per share

665

13,788

$
0.05

428

9,338

$
0.05

Effect of dilutive securities:

Series C preferred stock

—

—

(4,957
)

1,050

Series B preferred stock

—

—

(4,585
)

1,250

Series A preferred stock

—

—

(894
)

244

Employee stock options

—

268

—

—

Diluted earnings (loss) per share

$
665

14,056

$
0.05

$
(10,008
)

11,882

$
(0.84
)

	Three months ended June 30, 2003					Three months ended June 30, 2002
	Income (Numerator)		Shares (Denominator)	Per Share Amount		Income (Numerator)			Shares (Denominator)	Per Share Amount
Net income	$	2,296				$	27,512
Dividends on and accretion of convertible preferred stock		—					(2,566	)

Net income attributable to common stockholders		2,296					24,946
Effect of common stock:
Weighted average shares of class A common stock		—	10,385				—		5,079
Weighted average shares of class B common stock		—	3,703				—		4,643
Series A preferred stock		—	—				151		428
Series D preferred stock		—	—				244		290

Basic earnings per share		2,296	14,088	$	0.16		25,341		10,440	$	2.43

Effect of dilutive securities:
Employee stock options		—	852				—		58

Diluted earnings per share	$	2,296	14,940	$	0.15	$	25,341		10,498	$	2.41

The numerator in the basic and diluted ~~loss~~earnings per share calculation for the three months ended ~~March 31,~~June 30, 2002 has been adjusted to add ~~a $10.4 million loss on conversion~~back $395,000 of dividends and accretion on the series ~~C, series B~~A and ~~series A~~D preferred stock that would have ~~resulted~~been excluded from net income attributable to common stockholders assuming ~~settlement~~conversion at the ~~end~~beginning of the period ~~as required by~~under the ~~share settlement~~if-converted method.

The diluted ~~loss~~earnings per share calculation for the three months ended ~~March 31,~~June 30, 2002 ~~excludes~~excluded series DB and series C preferred stock, which ~~was~~were convertible into ~~290,220~~265,000 and 159,000 weighted average shares of class A common stock, ~~because its effect would have been anti-dilutive. Employee stock options of 267,503 for the three months ended March 31, 2002 have also been excluded from the diluted loss per share calculation~~respectively, because their effect would have been anti-dilutive.

The following table sets forth the computation of basic and diluted earnings per share for the six months ended June 30, 2003 and 2002, respectively (in thousands, except per share data):

MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

	Six months ended June 30, 2003					Six months ended June 30, 2002
	Income (Numerator)		Shares (Denominator)	Per Share Amount		Income (Numerator)			Shares (Denominator)	Per Share Amount
Net income	$	2,961				$	30,497
Dividends on and accretion of convertible preferred stock		—					(5,123	)

Net income attributable to common stockholders		2,961					25,374
Effect of common stock:
Weighted average shares of class A common stock		—	10,236				—		4,887
Weighted average shares of class B common stock		—	3,703				—		4,643
Series A preferred stock		—	—				327		320
Series D preferred stock		—	—				474		290

Basic earnings per share		2,961	13,939	$	0.21		26,175		10,140	$	2.58

Effect of dilutive securities:
Employee stock options		—	561				—		163

Diluted earnings per share	$	2,961	14,500	$	0.20	$	26,175		10,303	$	2.54

The numerator in the basic and diluted earnings per share calculation for the six months ended June 30, 2002 has been adjusted to add back $801,000 of dividends and accretion on the series A and D preferred stock that would have been excluded from net income attributable to common stockholders assuming conversion at the beginning of the period under the if-converted method.

The diluted earnings per share calculation for the six months ended June 30, 2002 excluded series B and series C preferred stock, which were convertible into 265,000 and 159,000 weighted average shares of class A common stock, respectively, because their effect would have been anti-dilutive.

(b) Pro forma basic and diluted ~~loss~~(loss) earnings per share

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” SFAS No. 148 provides for alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. The Company ~~accounts~~continues to account for its stock-based employee compensation plans under the recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. APB No. 25 provides that compensation expense relative to a company’s employee stock options is measured based on the intrinsic value of the stock options at the measurement date. ~~No stock-based employee compensation cost is reflected in net income,~~Effective for interim periods beginning after December 15, 2002, SFAS No. 148 also requires disclosure of pro-forma results on a quarterly basis as if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation.”

As all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date of ~~grant.~~

grant, no stock-based employee compensation cost is reflected in net income. If compensation expense had been recorded based on the fair value at the grant dates for awards under the stock option and purchase

MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

plans as set forth in SFAS No. 123, ~~‘‘Accounting for Stock-based Compensation,’’~~as amended, the Company’s net income attributable to common stockholders would have been adjusted to the pro forma amounts presented below, for the three and six months ended ~~March 31,~~June 30, 2003 and 2002, respectively (in thousands, except per share data):

	Three Months Ended June 30,						Six Months Ended June 30,
	2003			2002			2003			2002
Net income attributable to common stockholders, as reported	$	2,296		$	24,946		$	2,961		$	25,374
Stock-based employee compensation expense under fair value based method		(3,583	)		(2,263	)		(7,079	)		(4,706	)

Pro forma net (loss) income	$	(1,287	)	$	22,683		$	(4,118	)	$	20,668

Basic earnings per share, as reported	$	0.16		$	2.43		$	0.21		$	2.58

Diluted earnings per share, as reported	$	0.15		$	2.41		$	0.20		$	2.54

Basic (loss) earnings per share, pro forma	$	(0.09	)	$	2.21		$	(0.30	)	$	2.12

Diluted (loss) earnings per share, pro forma	$	(0.09	)	$	2.20		$	(0.30	)	$	2.08

~~MICROSTRATEGY INCORPORATED~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(unaudited)~~

Three Months Ended
March 31,

2003

2002

Net income attributable to common stockholders, as reported

$
665

$
428

Stock-based employee compensation expense under fair value based method

(3,496
)

(2,443
)

Pro forma net loss

$
(2,831
)
$
(2,015
)

Basic net income per share, as reported

$
0.05

$
0.05

Diluted net income (loss) per share, as reported

$
0.05

$
(0.84
)

Basic net loss per share, pro forma

$
(0.21
)
$
(0.22
)

Diluted net loss per share, pro forma

$
(0.21
)
$
(0.22
)

The fair value of each option is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for option grants under MicroStrategy’s stock option plans issued during the three and six months ended ~~March 31,~~June 30, 2003 and 2002, respectively: volatility factors of 97%, 97%, 127% and 127%, risk-free interest rates of 2%, 3%, 4% and 4%, weighted-average expected life of 5 years, and no dividend yields.

The following assumptions were used for shares issued during the ~~three~~six months ended ~~March 31,~~June 30, 2003 and 2002, respectively, under MicroStrategy’s employee stock purchase plan: volatility factors of 97% and 127%, risk free interest rates of 3% and 4%, weighted-average expected life of 6 months, and no dividend yields.

The weighted average fair value of grants made under MicroStrategy’s stock option plans during the three and six months ended ~~March 31,~~June 30, 2003 and 2002 are $28.53, $18.18, $22.71 and $22.71, respectively.

~~(11)~~(12) Segment Information

On December 31, 2001, the Company discontinued the operations of Strategy.com and shut down its services. Accordingly, the historical consolidated financial statements of the Company reflect Strategy.com as a discontinued operation for all periods presented (Note 3). Prior to this, the Company had two operating segments and had begun operating its business as such in the latter part of 1999. As a result of the shutting down of Strategy.com operations, the

The Company operates in one significant business segment – business intelligence.

The following summary discloses total revenues and long-lived assets relating to the Company’s geographic regions (in thousands):

Domestic

International

Consolidated

Three Months Ended March 31, 2003

Total license and service revenues

$
24,051

$
13,384

$
37,435

Long-lived assets

21,028

2,043

23,071

Three Months Ended March 31, 2002

Total license and service revenues

$
23,367

$
12,292

$
35,659

Long-lived assets

32,315

2,338

34,653

MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

	Domestic		International		Consolidated
Three Months Ended June 30, 2003
Total license and service revenues	$	29,731	$	13,902	$	43,633
Long-lived assets		20,200		2,159		22,359

Three Months Ended June 30, 2002
Total license and service revenues	$	23,322	$	13,508	$	36,830
Long-lived assets		29,628		2,329		31,957

Six Months Ended June 30, 2003
Total license and service revenues	$	53,782	$	27,286	$	81,068
Long-lived assets		20,200		2,159		22,359

Six Months Ended June 30, 2002
Total license and service revenues	$	46,689	$	25,800	$	72,489
Long-lived assets		29,628		2,329		31,957

Transfers relating to intercompany software fees and certain other allocations from international to domestic operations of ~~$5.0~~$5.1 million and ~~$2.4~~$10.1 million, respectively, for the three and six months ended ~~March 31,~~June 30, 2003, and transfers relating to intercompany software fees and certain other allocations from international to domestic operations of $7.3 million and $9.7 million, respectively, for the three and six months ended June 30, 2002, ~~respectively,~~ have been excluded from the above tables and eliminated in the consolidated financial statements.

~~MICROSTRATEGY INCORPORATED~~

~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(unaudited)~~

For the three and six months ended ~~March 31,~~June 30, 2003 and 2002, no individual customer accounted for 10% or more of consolidated total revenue.

~~(12)~~(13) Restructuring and Impairment Charges

During 2001, the Company adopted restructuring plans which included a strategic decision to focus operations on the business intelligence market, the elimination or reduction of speculative technology initiatives, a greater emphasis on indirect sales, a reduction of the Company’s workforce, and a consolidation of its multiple Northern Virginia facilities into a single location in McLean, Virginia.

On a quarterly basis, the Company assesses the adequacy of its restructuring reserve based upon changes in current market conditions. Due to a ~~decline~~sustained increase in vacancy rates in the commercial real estate market since the fourth quarter of 2002 and difficulties experienced in subleasing idle space, the Company updated its estimated sublease ~~rates and~~losses to take into consideration these market conditions. As a result, the Company recorded an increase in ~~the expected length of time~~its restructuring reserve relating to sublease ~~vacant space~~losses of $1.7 million during the second quarter of 2003. During the first ~~quarter~~and second quarters of 2002, the Company updated its accrued restructuring costs by recording additional aggregate sublease losses of ~~$1.2 million for the three months ended March 31, 2002. No additional restructuring charges were recorded for the three months ended March 31, 2003.~~

~~The following table sets forth a summary of the accrued restructuring costs as of March 31, 2003 (in thousands):~~

Accrued
Restructuring
Costs at
December 31, 2002

Q1 2003
Cash
Payments

Adjustments for
Q1 2003

Accrued
Restructuring
Costs at
March 31, 2003

Estimated sublease losses and other facility closing costs

$
8,589

$
(1,289
)
$
135

$
7,435

Terminations of computer and equipment leases

152

(16
)

(17
)

119

Accrual for professional fees

144

—

(118
)

26

Total accrued restructuring costs

$
8,885

$
(1,305
)
$
—

$
7,580

As of March 31, 2003, unpaid amounts of $4.0 million and $3.6 million were classified as current and long-term accrued restructuring costs, respectively, in the accompanying consolidated balance sheet. Remaining cash expenditures relating to fees incurred for professional services will be substantially paid during the second quarter of 2003.$2.4 million. Amounts related to the estimated sublease losses associated with exiting facilities and terminations of computer and equipment leases will be paid over the respective lease terms through February 2009. As a result of the restructuring, the Company has approximately ~~204,000~~126,000 square feet of vacant office space with the following lease expiration dates: ~~78,000 square feet expire in June 2003;~~ 49,000 square feet expire in September 2003; 46,000 square feet expire in August ~~2006;~~2006, and 31,000 square feet expire in February 2009. Prior to ~~the first quarter of~~ 2003, 101,000 square feet had been subleased. During March and June 2003, ~~a sublease~~subleases for approximately 23,000 square feet ~~expired. As a result, as of March 31, 2003, the Company had~~and 78,000 square feet, respectively, expired. As of June 30, 2003, none of the Company’s 126,000 square feet of vacant office space ~~which had been~~was subleased. ~~All of the subleased space relates to leases that will expire in June 2003 and September 2003.~~ The remaining vacant office space is currently being marketed for sublease. The ~~accrual for estimated computer, equipment and~~accrued restructuring costs as of June 30, 2003 of $7.9 million primarily represented losses associated with idle real ~~estate losses of $7.6 million at March 31,~~estate. At June 30, 2003, ~~represents $12.8~~the Company had $11.1 million in gross lease obligations ~~plus $1.7~~and $2.1 million of estimated commissions, concessions, and other costs, offset by ~~$6.9~~$5.3 million in estimated gross sublease income recoveries during the remaining lease terms. The Company estimated its sublease losses based upon current information available relating to ~~estimated~~ sublease commission costs, sub-tenant concession costs, sublease rental income, and the ~~estimated~~ length of time expected to sublease excess space. Final amounts could differ from current estimates if the Company is unable to sublet the remaining vacant office space on the estimated terms. The Company is also considering terminating certain leases

MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

early. Except for estimated sublease losses and ~~the payment of~~ other ~~accrued~~ facility closing costs and computer and equipment leases, the 2001 restructuring plans have been substantially completed.

The following table sets forth a summary of the accrued restructuring costs as of June 30, 2003 (in thousands):

~~ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS~~

	Accrued Restructuring Costs at December 31, 2002		2003 Cash Payments			Adjustments for Q1 2003			Adjustments for Q2 2003		Accrued Restructuring Costs at June 30, 2003
Estimated sublease losses and other facility closing costs	$	8,589	$	(2,608	)	$	135		$	1,699	$	7,815
Terminations of computer and equipment leases		152		(27	)		(17	)		—		108
Accrual for professional fees		144		(26	)		(118	)		—		—

Total accrued restructuring costs	$	8,885	$	(2,661	)	$	—		$	1,699	$	7,923

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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. 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 below under the caption “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

We are a leading worldwide provider of business intelligence software that enables companies to analyze the raw data stored across their enterprise to reveal the trends and insights needed to develop solutions to manage their business effectively. Our software delivers this critical information to workgroups, the enterprise and extranet communities via e-mail, web, fax, wireless and voice communication channels. Businesses can use our software platform to develop user-friendly solutions, proactively optimize revenue-generating strategies, enhance cost-efficiency and productivity and improve customer relationships.

Our software platform, MicroStrategy 7i, enables users to query and analyze the most detailed, transaction-level databases, turning data into business intelligence and delivering reports and alerts about the users’ business processes. Our web-based architecture provides reporting, security, performance and standards that are critical for web deployment. With intranet deployments, our products provide employees with information to enable them to make better, more cost-effective business decisions. With extranet deployments, enterprises can use MicroStrategy 7i to build stronger relationships by linking customers and suppliers via the Internet. We also offer a comprehensive set of consulting, education, technical support and technical advisory services for our customers and partners.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our condensed 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, restructuring and impairment charges and litigation and contingencies, have a material impact on our financial statements and are discussed in detail throughout our analysis of the results of operations below.

In addition to evaluating estimates relating to the items discussed above, we also consider other estimates, including, but not limited to, those related to allowance for doubtful accounts, software development costs, intangible assets, income taxes, and financing operations. We base our estimates on historical experience and on 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. For a more detailed explanation of the judgments made in these areas and a discussion of our accounting policies, refer to “Critical Accounting Policies” included in Item 7 and “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, 2002. Since December 31, 2002, there have been no significant changes to our critical accounting policies.

Results of Operations

The following table sets forth for the periods indicated the percentage of total revenues represented by certain items reflected in our consolidated statements of operations:

Three Months Ended
March 31,

2003

2002

Statements of Operations Data

Revenues:

Product licenses

44.2
%

40.7
%
Product support and other services

55.8

59.3

Total revenues

100.0

100.0

Cost of revenues:

Product licenses

2.1

1.5

Product support and other services

15.9

18.6

Total cost of revenues

18.0

20.1

Gross profit

82.0

79.9

Operating expenses:

Sales and marketing

33.9

35.0

Research and development

18.5

15.0

General and administrative

19.2

19.0

Restructuring and impairment charges

—

3.4

Amortization of intangible assets

0.3

2.7

Total operating expenses

71.9

75.1

Income from operations

10.1

4.8

Financing and other (expense) income:

Interest income

0.2

0.6

Interest expense

(6.1
)

(4.5
)
Loss on investments

—

(0.8
)
Reduction in estimated cost of litigation settlement

—

9.7

Gain on early extinguishment of notes payable

0.0

—

Other expense, net

(0.1
)

(0.3
)

Total financing and other (expense) income

(6.0
)

4.7

Income before income taxes

4.1

9.5

Provision for income taxes

2.3

1.1

Net income

1.8

8.4

Dividends on and accretion of convertible preferred stock

—

(7.2
)

Net income attributable to common stockholders

1.8
%

1.2
%

	Three Months Ended June 30,				Six Months Ended June 30,
	2003		2002		2003		2002
Statements of Operations Data
Revenues:
Product licenses	45.0	%	40.8	%	44.6	%	40.7	%
Product support and other services	55.0		59.2		55.4		59.3

Total revenues	100.0		100.0		100.0		100.0

Cost of revenues:
Product licenses	1.7		1.6		1.9		1.5
Product support and other services	14.7		17.6		15.3		18.1

Total cost of revenues	16.4		19.2		17.2		19.6

Gross profit	83.6		80.8		82.8		80.4

Operating expenses:
Sales and marketing	32.7		31.0		33.3		32.9
Research and development	17.9		18.6		18.2		16.8
General and administrative	18.2		18.5		18.7		18.7
Restructuring and impairment charges	3.9		3.2		2.1		3.3
Amortization of intangible assets	—		2.3		0.2		2.5

Total operating expenses	72.7		73.6		72.5		74.2

Income from operations	10.9		7.2		10.3		6.2
Financing and other (expense) income:
Interest income	0.6		0.5		0.5		0.5
Interest expense	(4.7	)	(4.5	)	(5.3	)	(4.5	)
Loss on investments	—		(0.5	)	—		(0.7	)
Reduction in estimated cost of litigation settlement	—		21.5		—		15.7
Loss on early extinguishment of notes payable	(2.0	)	—		(1.0	)	—
Gain on contract termination	—		45.7		—		23.2
Other income, net	0.3		5.9		0.1		2.8

Total financing and other (expense) income	(5.8	)	68.6		(5.7	)	37.0

Income before income taxes	5.1		75.8		4.7		43.2
(Benefit) provision for income taxes	(0.2	)	1.1		1.0		1.1

Net income	5.3		74.7		3.7		42.0

Dividends on and accretion of convertible preferred stock	—		(7.0	)	—		(7.1	)

Net income attributable to common stockholders	5.3	%	67.7	%	3.7	%	35.0	%

Comparison of the Three and Six Months Ended ~~March 31,~~June 30, 2003 and 2002

Revenues

Total revenues consist of revenues derived from sales of product licenses and product support and other services, including technical support, education and consulting services. Total revenues increased from ~~$35.7~~$36.8 million to ~~$37.4~~$43.6 million for the three months ended ~~March 31,~~June 30, 2002 and 2003, respectively, representing an increase of ~~5.0%~~18.5%, and from $72.5 million to $81.1 million for the six months ended June 30, 2002 and 2003, respectively, representing an increase of 11.8%.

Product Licenses Revenues. Product licenses revenues increased from ~~$14.5~~$15.0 million to ~~$16.5~~$19.6 million for the three months ended ~~March 31,~~June 30, 2002 and 2003, respectively, representing an increase of ~~14.0%~~30.6%, and from $29.5 million to $36.2 million for the six months ended June 30, 2002 and 2003, respectively, representing an increase of 22.5%. ~~The~~Our domestic operations accounted for the increase in product licenses revenues, iswhich was partially offset by a decline in our international operations, as discussed further below. The overall increase in product licenses revenues was attributable to our continued focus on licensing core business intelligence software, an increase in the size of our sales force to further our presence in the business intelligence market, and an increase in the average size of

our product license transactions from ~~$69,000~~$74,000 in the ~~first~~second quarter of 2002 to ~~$90,000~~$80,000 in the second quarter of 2003 and from $71,000 in the first ~~quarter~~half of 2002 to $84,000 in the first half of 2003. ~~During~~In the first ~~quarter~~half of 2003, we had ~~four~~nine product license transactions in excess of ~~$1.0 million. During~~$500,000, including one transaction that generated product licenses revenues of $4.0 million during the second quarter of 2003. In the comparable period in 2002, we had ~~one~~five product license ~~transaction~~transactions in excess of ~~$1.0 million.~~$500,000. The average size of our product license transactions and the number of high-dollar transactions may fluctuate on a period-to-period basis. Additionally, product licenses revenues as a percentage of total revenues may fluctuate on a period-to-period basis and may vary significantly from the percentage of total revenues achieved in prior years.

Product Support and Other Services Revenues. Product support and other services revenues ~~decreased~~increased from ~~$21.2~~$21.8 million to ~~$20.9~~$24.0 million for the three months ended ~~March 31,~~June 30, 2002 and 2003, respectively, representing ~~a decrease~~an increase of ~~1.2%~~10.1%, and from $43.0 million to $44.9 million for the six months ended June 30, 2002 and 2003, respectively, representing an increase of 4.5%. The overall ~~decrease~~increase in product support and other services revenues for the three months ended June 30, 2003, as compared to the comparable period in 2002, was primarily attributable to a ~~27.1%~~23.2% increase in revenues from technical support services, offset by an 8.1% decrease in revenues from consulting and education ~~services, offset by a 19.7% increase~~services. For the six months ended June 30, 2003, as compared to the comparable period in ~~revenues from~~2002, technical support services. Although there continues to be a global economic slowdown in information technology spending, our customers are continuing to invest in our product offerings; however, customers are decreasing their spending on ourrevenues increased by 21.5%, while education and consulting ~~and education offerings.~~revenues decreased by 17.7%. Revenues from technical support services have increased as a result of an ongoing increase in our installed base of software licenses under technical support contracts, an increase in ~~addition to~~the average rate charged for technical support and our high renewal rates offor such contracts. In addition, fluctuations in foreign currencies used by our international subsidiaries positively influenced product support and other services revenues levels, as discussed below. However, in connection with the continued global economic slowdown in information technology spending, we believe customers are decreasing their spending on our education and consulting offerings. As a result of possible fluctuations in product licenses revenues discussed above, product support and other services revenues as a percentage of total revenues may fluctuate on a period-to-period basis and vary significantly from the percentage of total revenues achieved in prior years.

International Revenues. International revenues are included in the amounts discussed above and are discussed separately within this paragraph. Total international revenues increased from ~~$12.3~~$13.5 million to ~~$13.4~~$13.9 million for the three months ended ~~March 31,~~June 30, 2002 and 2003, respectively, representing an increase of ~~8.9%. International product licenses revenues increased~~2.9%, and from ~~$5.2~~$25.8 million to ~~$5.4~~$27.3 million for the ~~three~~six months ended ~~March 31,~~June 30, 2002 and 2003, respectively, representing an increase of ~~4.5%~~5.8%. International product licenses revenues decreased from $5.8 million to $5.3 million for the three months ended June 30, 2002 and 2003, respectively, representing a decrease of 9.2%, and from $11.0 million to $10.7 million for the six months ended June 30, 2002 and 2003, respectively, representing a decrease of 2.7%. The ~~increase~~decrease in international product licenses revenues was primarily attributable to ~~an 11.3%~~the continued global economic slowdown in information technology spending, offset by positive foreign currency ~~impact, offset by a decline,~~impacts. For the three months ended June 30, 2003, as compared to the same period in 2002, international product licenses revenues decreased 22.6%, after adjusting for foreign currency fluctuations, and were offset in ~~product licenses revenues~~part by positive foreign currency impacts of ~~6.8%, which was primarily attributable to the global economic slowdown in information technology spending.~~13.4%. International product support and other services revenues increased from ~~$7.1~~$7.7 million to ~~$8.0~~$8.6 million for the three months ended ~~March 31,~~June 30, 2002 and 2003, respectively, representing an increase of 12.0%, and from $14.8 million to $16.6 million for the six months ended June 30, 2002 and 2003, respectively, representing an increase of 12.0%. The increase in the second quarter of 2003 was the result of a ~~10.9%~~15.1% positive foreign currency impact, ~~and~~offset by a ~~1.1% increase~~3.1% decrease in product support and other ~~service~~services revenues, after adjusting for foreign currency fluctuations. ~~International~~For the three months ended June 30, 2003, international product support and other services revenues, after adjusting for foreign currency fluctuations, included ~~a 26.8%~~an 18.7% increase in revenues from technical support services, offset by a ~~22.4%~~24.3% decrease in revenues from ~~consulting~~education and ~~education~~consulting services. As a percentage of total revenues, international revenues were ~~34.5%~~31.9% and ~~35.8%~~36.7% for the three months ended ~~March 31,~~June 30, 2003 and 2002, respectively, and 33.7% and 35.6% for the six months ended June 30, 2003 and 2002, respectively. As positive foreign currency impacts may not occur in future

periods, the same volume of license transactions and support services in a future period may result in lower reported earnings if future foreign currency impacts are less favorable than those experienced in the first ~~quarter~~and second quarters of 2003. We anticipate that international revenues will continue to account for a significant amount of total revenues, and management expects to continue to commit significant time and financial resources to the maintenance and ongoing development of direct and indirect international sales and support channels.

Costs and Expenses

Cost of Product Licenses Revenues. Cost of product licenses revenues consists primarily of the costs of product manuals, media, amortization of capitalized software ~~development costs~~expenses and royalties paid to ~~third-party~~third party software vendors. Cost of product licenses revenues increased from ~~$521,000~~$572,000 to ~~$790,000~~$739,000, or 29.2%, for the three months ended ~~March 31,~~June 30, 2002 and 2003, respectively, and from $1.1 million to $1.5 million, or 39.9% for the six months ended June 30, 2002 and 2003, respectively. As a percentage of product licenses revenues, cost of product licenses revenues ~~increased from 3.6% to 4.8%~~remained flat at 3.8% for the three months ended ~~March 31,~~June 30, 2002 and 2003, and increased from 3.7% to 4.2% for the six months ended June 30, 2002 and 2003, respectively. The increase in cost of product licenses revenues was primarily ~~due~~related to the increase in product licenses revenues and an increase in the amortization of capitalized software development costs associated with the release of MicroStrategy 7i and Narrowcast Server 7.2 in April 2002 and MicroStrategy Web Universal in November 2002.

Cost of Product Support and Other Services Revenues. Cost of product support and other services revenues consists of the costs of providing consulting services to customers and partners, technical advisory services, technical support and education. Cost of product support and other services revenues decreased from ~~$6.6~~$6.5 million to ~~$6.0~~$6.4 million, or ~~10.3%~~1.0%, for the three months ended ~~March 31,~~June 30, 2002 and 2003, respectively, and from $13.1 million to $12.4 million, or 5.7%, for the six months ended June 30, 2002 and 2003, respectively. The decrease in the second quarter of 2003 was comprised of a ~~14.9%~~7.0% decrease in costs, discussed further below, ~~offset by~~and a ~~4.6%~~6.0% unfavorable impact ~~on fluctuations in~~from foreign currency ~~exchange rates.~~fluctuations. As a percentage of product support and other services revenues, cost of product support and other services revenues decreased from ~~31.4%~~29.8% to ~~28.5%~~26.8% for the three months ended ~~March 31,~~June 30, 2003 and 2003, respectively, and decreased from 30.6% to 27.6% for the six months ended June 30, 2002 and 2003,

respectively. The decrease in total cost of product support and other services revenues as a percentage of product support and other services revenues (“services cost ratio”) was primarily due to a decrease in our ~~consulting~~education and ~~education~~consulting staffing levels by approximately ~~12%~~6% in the first ~~quarter~~half of 2003, as compared to the first ~~quarter~~half of 2002, as we continue to align our resources with our current revenue and expense streams. The decrease in services cost ratio was also attributable to improved utilization of consulting personnel and an increase in technical support revenues as a percentage of total product support and other services revenues, which result in higher profit margins than our consulting and education services.

Sales and Marketing Expenses. Sales and marketing expenses include personnel costs, commissions, office facilities, travel, advertising, public relations programs and promotional events, such as trade shows, seminars and technical conferences. Sales and marketing expenses increased from ~~$12.5~~$11.4 million to ~~$12.7~~$14.3 million, or ~~1.7%~~25.1%, for the three months ended ~~March 31,~~June 30, 2002 and 2003, respectively, and from $23.9 million to $27.0 million, or 12.9%, for the six months ended June 30, 2002 and 2003, respectively. The increase during the second quarter of 2003 was comprised of a ~~4.4%~~19.8% increase in costs and a 5.3% unfavorable impact on fluctuations in foreign currency exchange ~~rates, offset by~~rates. As a ~~2.7% decrease in costs.~~percentage of total revenues, sales and marketing expenses increased from 31.0% to 32.7% for the three months ended June 30, 2002 and 2003, respectively, and from 32.9% to 33.3% for the six months ended June 30, 2002 and 2003, respectively. Staffing levels for sales and marketing personnel increased by approximately ~~16%~~19% in the first ~~quarter~~half of 2003 as compared to the first ~~quarter~~half of ~~2002; however,~~2002, which in conjunction with the increase in ~~staffing levels did not~~product licenses revenues, as noted above, have ~~a significant impact on our overall cost structure. The decline in sales~~caused salary and ~~marketing expense as a percentage of total revenues was primarily attributable~~commission costs to ~~the increase in revenues, discussed above.~~increase. We expect that sales and marketing expenses may increase in future periods if our planned expansion of our sales force continues.

Research and Development Expenses. Research and development expenses consist primarily of salaries and benefits of software engineering personnel, depreciation of equipment and other costs. Research and development expenses increased from ~~$5.4~~$6.9 million to ~~$6.9~~$7.8 million for the three months ended ~~March 31,~~June 30, 2002 and 2003, ~~respectively. As a percentage of total revenues, research~~respectively, and ~~development expenses increased~~ from ~~15.0%~~$12.2 million to ~~18.5%~~$14.7 million for the ~~three~~six months ended ~~March 31,~~June 30, 2002 and 2003, respectively. The increase in research and development expenses was primarily attributable to the reduction of capitalized software development costs in the first ~~quarter~~half of 2003 as compared to the first ~~quarter~~half of 2002, as discussed further below. ~~The increase in research and development expenses was offset by a decrease in costs resulting from a reduction in~~Additionally,

although staffing ~~levels of our research and development personnel during the first quarter of 2003. Staffing~~ levels of our research and development personnel were lower by approximately 7%6% in the first ~~quarter~~half of 2003 as compared to the first ~~quarter~~half of ~~2002.~~2002, costs increased as a result of higher compensation costs.

During the three and six months ended ~~March 31,~~June 30, 2003, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86, “Accounting for the Costs of Computer Equipment to be Sold, Leased, or Otherwise Marketed,” we did not capitalize any software development costs associated with the development of our new business intelligence products. During the three and six months ended ~~March 31,~~June 30, 2002, we capitalized ~~$2.4~~$590,000 and $3.0 million, respectively, of software development costs associated with the ~~release~~development of MicroStrategy 7i and Narrowcast Server ~~7.2.~~7.2 software. Software development costs ~~of a product~~ are capitalized from the time that technological feasibility is reached until the general release of ~~that product.~~the respective software products. We consider technological feasibility to be achieved when a product design and working model of the software product ~~has~~have been completed. These capitalized software costs are amortized over ~~the estimated product life~~their respective useful lives of approximately three years. Amortization expense related to software development costs was $462,000 and ~~$179,000~~$338,000 for the three months ended ~~March 31,~~June 30, 2003 and 2002, respectively, and $924,000 and $517,000 for the six months ended June 30, 2003 and 2002, respectively.

As of ~~March 31,~~June 30, 2003, our research and development engineering resources were allocated to the following major projects: ~~24%~~37% to our MicroStrategy 7i product, ~~8% to our Narrowcast Server 7.2 product, 32%~~19% to our Unix products, ~~11%~~10% to our non-core ~~business intelligence~~ projects, Angel.com and Alarm.com, and ~~25%~~34% to on-going support of existing products and other research and development efforts. The allocation of our research and development resources is expected to change as project development efforts require, as current projects are completed, and as new projects commence.

General and Administrative Expenses. General and administrative expenses include personnel and other costs of our finance, human resources, information systems, administrative and executive departments as well as third-party consulting, legal and other professional fees. General and administrative expenses increased ~~6.2%~~16.9% from $6.8 million to ~~$7.2~~$8.0 million for the three months ended ~~March 31,~~June 30, 2002 and 2003, respectively, and 11.6% from $13.6 million to $15.1 million for the six months ended June 30, 2002 and 2003, respectively. As a percentage of total revenues, general and administrative expenses ~~increased~~decreased from ~~19.0%~~18.5% to ~~19.2%~~18.3% for the three months ended ~~March 31,~~June 30, 2002 and 2003, respectively, and remained unchanged at 18.7% for the six months ended June 30, 2002 and 2003, respectively. General and administrative expenses increased primarily due to normal annual increases in salaries and benefits, variable compensation costs and other costs, while the staffing levels of our general and administrative personnel

remained relatively flat during the comparable periods. ~~The overall increase in general and administrative expenses was partially offset by a decrease in external legal and consulting fees.~~

Restructuring and Impairment Charges.During 2001, we adopted restructuring plans which included a strategic decision to focus operations on the business intelligence market, the elimination or reduction of speculative technology initiatives, a reduction of our workforce, and a consolidation of our multiple Northern Virginia facilities into a single location in McLean, Virginia.

On a quarterly basis, we assess the adequacy of our restructuring reserve based upon changes in current market conditions. Due to a ~~decline~~sustained increase in vacancy rates in the commercial real estate market since the fourth quarter of 2002 and difficulties experienced in subleasing idle space, we updated our estimated sublease ~~rates and~~losses to take into consideration these market conditions. As a result, we recorded an increase in ~~the expected length of time~~our restructuring reserve relating to sublease ~~vacant space~~losses of $1.7 million during the second quarter of 2003. During the first ~~quarter~~and second quarters of 2002, we updated our accrued restructuring costs by recording additional aggregate sublease losses of ~~$1.2 million for the three months ended March 31, 2002. No additional restructuring charges were recorded for the three months ended March 31, 2003.~~

~~The following table sets forth a summary of the accrued restructuring costs as of March 31, 2003 (in thousands):~~

Accrued
Restructuring
Costs at
December 31, 2002

Q1 2003
Cash
Payments

Adjustments for
Q1 2003

Accrued
Restructuring
Costs at
March 31, 2003

Estimated sublease losses and other facility closing costs

$
8,589

$
(1,289
)
$
135

$
7,435

Terminations of computer and equipment leases

152

(16
)

(17
)

119

Accrual for professional fees

144

—

(118
)

26

Total accrued restructuring costs

$
8,885

$
(1,305
)
$
—

$
7,580

$2.4 million. Amounts related to the estimated sublease losses associated with exiting facilities and terminations of computer and equipment leases will be paid over the respective lease terms through February 2009. As a result of the restructuring, we have approximately ~~204,000~~126,000 square feet of vacant office space with the following lease expiration dates: ~~78,000 square feet expire in June 2003;~~ 49,000 square feet expire in September 2003; 46,000 square feet expire in August ~~2006;~~2006, and 31,000 square feet expire in February 2009. Prior to ~~the first quarter of~~ 2003, 101,000 square feet had been subleased. During March and June 2003, ~~a sublease~~subleases for approximately 23,000 square feet ~~expired. As a result, as of March 31, 2003, we had~~and 78,000 square feet, respectively, expired. As of June 30, 2003, none of the Company’s 126,000 square feet of vacant office space ~~which had been~~was subleased. ~~All of the subleased space relates to the leases that will expire in June 2003 and September 2003.~~ The remaining vacant office space is currently being marketed for sublease. The ~~accrual for estimated computer, equipment and~~accrued restructuring costs as of June 30, 2003 of $7.9 million primarily represented losses associated with idle real ~~estate losses of $7.6 million at March 31,~~estate. At June 30, 2003, ~~represents $12.8~~we had $11.1 million in gross lease obligations ~~plus $1.7~~and $2.1 million of estimated commissions, concessions, and other costs, offset by ~~$6.9~~$5.3 million in estimated gross sublease income recoveries during the remaining lease terms. We estimated our sublease losses based upon current

information available relating to ~~estimated~~ sublease commission costs, sub-tenant concession costs, sublease rental income, and the ~~estimated~~ length of time expected to sublease excess space. Final amounts could differ from current estimates if we are unable to sublet the remaining vacant office space on the estimated terms. For example if our estimates relating to sublease income and costs to sublease differ from current estimates by 10%, our final restructuring costs could be approximately ~~$860,000 higher or lower.~~$740,000 higher. We are also considering terminating certain leases early. Except for estimated sublease losses and ~~the payment of~~ other ~~accrued~~ facility closing costs and computer and equipment leases, the 2001 restructuring plans have been substantially completed.

The following table sets forth a summary of the accrued restructuring costs as of June 30, 2003 (in thousands):

	Accrued Restructuring Costs at December 31, 2002		2003 Cash Payments			Adjustments for Q1 2003			Adjustments for Q2 2003		Accrued Restructuring Costs at June 30, 2003
Estimated sublease losses and other facility closing costs	$	8,589	$	(2,608	)	$	135		$	1,699	$	7,815
Terminations of computer and equipment leases		152		(27	)		(17	)		—		108
Accrual for professional fees		144		(26	)		(118	)		—		—

Total accrued restructuring costs	$	8,885	$	(2,661	)	$	—		$	1,699	$	7,923

Amortization of Intangible Assets.Amortization of intangible assets decreased from ~~$965,000~~$862,000 to ~~$130,000~~$18,000 for the three months ended ~~March 31,~~June 30, 2002 and 2003, respectively, and from $1.8 million to $148,000 for the six months ended June 30, 2002 and 2003, respectively. The decrease in amortization expense was primarily attributable to the impairment charge of $1.4 million recorded in the fourth quarter of 2002 to write-off our Teracube intangible asset which had been acquired in connection with the purchase of intellectual property and other tangible and intangible assets relating to NCR Corporation’s Teracube project. Additionally, certain intangible assets that had been amortized during the first ~~quarter~~half of 2002 were fully amortized by the end of 2002.

~~Interest Income.~~ ~~Interest income decreased from $230,000 to $90,000 for the three months ended March 31, 2002~~

~~and 2003, respectively. The decline in interest income was primarily attributable to lower average cash balances during the first quarter of 2003 compared to the first quarter of 2002.~~

Interest Expense.Interest expense increased from ~~$1.6~~$1.7 million to ~~$2.3~~$2.0 million for the three months ended ~~March 31,~~June 30, 2002 and 2003, respectively, and from $3.3 million to $4.3 million for the six months ended June 30, 2002 and 2003, respectively. The increase in interest expense was primarily attributable to discount amortization expense on notes payable of ~~$973,000~~$883,000 and $1.9 million during the three and six months ended June 30, 2003, respectively, related to the 7 ½% series A unsecured notes (“Series A Notes”) and the promissory notes issued to former preferred ~~stockholders during the third quarter of 2002.~~stockholders. The increase in interest expense was partially offset by a decline in stated interest charges on the ~~7 ½% series~~Series A ~~unsecured notes~~Notes resulting from aggregate repurchases of ~~$18.8~~$27.2 million of principal on such notes between July 2002 and ~~March~~April 2003.

~~Loss on Investments.~~ Loss on investments decreased from $289,000 to $0 for the three months ended March 31, 2002 and 2003, respectively. This decline was primarily attributable to the decline in our average short-term investment holdings during the first quarter of 2003 compared to the first quarter of 2002.

Reduction in Estimated Cost of Litigation Settlement. In 2000, we entered into agreements to settle a private securities class action lawsuit and ~~the~~a shareholder derivative lawsuit. During 2002, we completed our distribution of consideration under these lawsuits.

Based on the terms of the settlement agreements, we established an initial estimate for the cost of the litigation settlement during 2000. Subsequently, during each successive financial reporting period prior to distribution of the consideration, we updated the estimated value assigned to each individual component of the settlement based upon valuation assumptions stemming from the settlement. As a result of a change in the estimated market borrowing rate and discount on the Series A Notes, a decline in the value of our class A common stock and a reduction in the estimated fair value of warrants ~~to be~~ issued in connection with the litigation settlement, we recorded an aggregate reduction in the provision for the litigation settlement of ~~$3.5~~$7.9 million and $11.4 million during the three and six months ended ~~March 31, 2002. No~~June 30, 2002, respectively. As distribution of the consideration was completed during the third quarter of 2002, no additional reductions were recorded during the three and six months ended ~~March 31,~~June 30, 2003. The reduction in estimated cost of litigation settlement was comprised of the following, (in thousands):

Three Months Ended
June 30,
   Six Months Ended
June 30,

2003
   2002
   2003
   2002

Series A Notes
$ —      $ 2,500    $ —      $ 2,500
Class A common stock
—      (6,688 )    —      (8,910 )
Warrants
—      (3,614 )    —      (4,852 )
Pending loss on additional settlement
—      (134 )    —      (134 )




Reduction in estimated cost of litigation settlement
$ —      $ (7,936 )    $ —      $ (11,396 )

We are involved in lawsuits with Business Objects, S.A. relating to claims involving patent infringement and other intellectual property claims. We are currently unable to estimate the potential range of gain or loss, if any, and as such, the outcome of this litigation is not presently determinable. Accordingly, no provision for these matters has been made in the accompanying consolidated financial statements. Additional information regarding these matters is included below under “Risk Factors.”

We are also involved in other legal proceedings through the normal course of business. Management believes that any unfavorable outcome related to these other proceedings will not have a material effect on our financial position, results of operations or cash flows.

~~Gain~~Loss on Early Extinguishment of Notes Payable. We have the right, at any time prior to the June 24, 2007 maturity date, to prepay our 7 ½% series A unsecured notes in full or to mandatorily convert these notes into shares of class A common stock at a conversion price equal to 80% of the dollar-volume weighted average trading price per share for all round lot transactions in the stock on the Nasdaq National Market for the ten trading days ending two days prior to the date that written notice of conversion has been given. The Company may also repurchase, convert or redeem a portion of the outstanding notes so long as the combination of redemptions, conversions and repurchases does not reduce the total outstanding principal amount of the notes below 60% of the original $80.3 million principal amount of the notes, or approximately $48.2 million, unless all of the remaining outstanding notes are redeemed or converted by us. Upon maturity, the outstanding principal balance of the promissory notes will become due. During the first

~~quarter~~ and second quarters of 2003, we repurchased ~~promissory notes~~certain of our Series A Notes with an aggregate principal amount of ~~$1.8~~$10.3 million in exchange for ~~56,053~~317,810 shares of class A common stock. ~~The carrying value~~As a result of the ~~extinguished promissory~~repurchases, we recorded an aggregate net loss during 2003 on the early extinguishment of notes ~~plus accrued and unpaid interest~~payable in the amount of ~~$1.3 million in aggregate was substantially~~$840,000 equal to the excess of the aggregate fair value of the consideration transferred to the holders of ~~such promissory notes.~~

~~During April 2003, we repurchased additional promissory notes with an aggregate principal amount~~the Series A Notes of $8.5 million over the carrying value of such extinguished notes plus accrued and unpaid interest of $7.7 million in ~~exchange for 261,757~~aggregate.

On June 23, 2003, we announced that we had elected to convert the remaining $53.0 million in principal amount outstanding of our Series A Notes plus accrued and unpaid interest into shares of class A common ~~stock. As a result~~stock in accordance with the terms of the indenture pursuant to which the Series A Notes were issued. On July 30, 2003, we completed the conversion and issued 1,654,839 shares of class A common stock and approximately $47,000 in cash in lieu of fractional shares. In connection with this ~~repurchase,~~transaction, we will record a loss during the ~~second~~third quarter of 2003 on the early extinguishment of notes payable in the ~~aggregate~~ amount of ~~$858,000~~approximately $30.2 million equal to the excess of the fair value of the consideration transferred to the holders of the ~~promissory notes~~Series A Notes of ~~$7.3~~$70.0 million over the carrying value of such ~~extinguished~~ promissory notes plus accrued and unpaid interest of ~~$6.4 million in aggregate. Through April 2003,~~$39.8 million.

Gain on Contract Termination. On June 28, 2002, MicroStrategy and Exchange Applications entered into an arrangement to terminate the software development and OEM agreement that the companies had entered into as of December 28, 1999. In connection with the arrangement, we ~~have repurchased approximately 34%~~paid $120,000 to Exchange Applications and granted Exchange Applications a limited license to support their customers that had purchased products prior to the effective date of the ~~original principal amount~~arrangement. As a result, we recognized $210,000 of product support and other services revenues in 2002 through the ~~notes.~~date of termination and recorded a $16.8 million gain on contract termination during the second quarter of 2002 relating to the remaining contingency from terminated contract that had previously been recorded.

Other ~~Expense,~~Income, net.Other ~~expense,~~income, net includes gains and losses on foreign currency transactions, gains on the reduction in the carrying value of outstanding warrants, ~~issued in connection with the litigation settlement,~~ and losses from disposals of property and equipment and certain other assets held for sale. Other ~~expense,~~income, net decreased from ~~$116,000~~$2.2 million to ~~$38,000~~$133,000 for the three months ended ~~March 31,~~June 30, 2002 and 2003, respectively, and from $2.1 million to $95,000 for the six months ended June 30, 2002 and 2003, respectively. The change is primarily attributable to a decline in gains on the revaluation of warrants and a decline in gains on foreign currency transactions.

(Benefit) Provision for Income Taxes. During the three and six months ended ~~March 31,~~June 30, 2003, we recorded an income tax benefit of $71,000 and income tax expense of $793,000, respectively. During the three and six months ended June 30, 2002, ~~and 2003,~~ we recorded income tax expense of ~~$399,000~~$420,000 and ~~$864,000,~~$819,000, respectively. The provision for income taxes is primarily related to foreign jurisdictions where we are profitable, withholding taxes on intercompany

software fees and other intercompany transactions with our foreign subsidiaries. During the three and six months ended ~~March 31,~~June 30, 2002 and 2003, we utilized net operating loss carryforwards (“NOL’s”) in the United States and in certain foreign subsidiaries, which had the effect of reducing our effective tax rate and related tax expense. ~~During~~Additionally, during the ~~first quarter~~three months ended June 30, 2003, our tax expense was reduced by a decrease in profitability of ~~2003, the~~certain foreign subsidiaries and an increase in net deferred tax assets of certain foreign subsidiaries. The use of NOL’s during 2003 was partially offset by an increase in withholding taxes paid in foreign jurisdictions that could not be offset against current ~~taxes and a decrease in our net deferred tax assets since December 31, 2002.~~taxes. We expect that our domestic NOL’s will offset the majority of any domestic taxable income we may generate for the foreseeable future. The provision for income taxes may increase as we become more profitable in certain foreign jurisdictions where we have limited or no ~~net operating losses~~NOL’s to offset taxable income.

Dividends on and Accretion of Convertible Preferred Stock. During the three and six months ended ~~March 31,~~June 30, 2002, we recorded aggregate preferred stock dividends and accretion of $2.6 ~~million.~~million and $5.1 million, respectively. Additionally, during the ~~three~~six months ended ~~March 31,~~June 30, 2002, we paid aggregate preferred stock dividends valued at ~~$2.8~~$4.9 million through the issuance of ~~75,672~~154,508 shares of class A common stock in lieu of cash. During the first ~~quarter~~and second quarters of 2003, we did not have any outstanding shares of preferred stock. Accordingly, we did not accrue or pay any preferred stock dividends or record any accretion during the three and six months ended ~~March 31,~~June 30, 2003.

Deferred Revenue and Advance Payments

Deferred revenue and advance payments primarily represent product support and other services fees that are collected in advance and recognized over the contract service period and product license and product support and other services fees relating to multiple element software arrangements that include future deliverables. Aggregate deferred revenue and advance payments were ~~$28.2~~$30.1 million as of ~~March 31,~~June 30, 2003 compared to $25.3 million as of December 31, 2002. The increase in deferred revenue and advance payments was primarily attributable to an ongoing increase in our installed base of software licenses under technical support contracts, an increase in ~~addition to~~the average rate charged for technical support during the first six months of 2003 and our high renewal rates of such contracts during the first ~~quarter~~and second quarters of 2003. The increase was partially offset by a reduction of deferred revenue and advance payment balances due to the recognition of revenues on existing license and maintenance contracts. We expect to recognize approximately ~~$26.4~~$28.2 million of this 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.

Liquidity and Capital Resources

Our principal source of liquidity is our cash, cash equivalents, short-term investments, ~~and~~ on-going collection of our accounts receivable and a revolving line of credit subject to borrowing base limitations based on accounts receivable. ~~On March 31,~~As of June 30, 2003, ~~and December 31, 2002,~~ we had ~~$28.2 million and $21.3~~$35.6 million of cash, cash equivalents, and short-term investments, ~~respectively,~~ of which ~~$6.2 million~~$679,000 was restricted ~~cash as~~cash. As of ~~March 31,~~June 30, 2003, ~~and December 31, 2002.~~we had $4.4 million of borrowing capacity under our revolving line of credit based on the borrowing base limitation applicable to the facility.

The following are our contractual obligations associated with our restructuring plans, interest and certain principal obligations and lease commitments (in thousands):

Twelve months ending March 31,

2004

2005

2006

2007

2008

Thereafter

Total

Restructuring-related obligations:

Leases (1)

$
4,007

$
1,187

$
1,035

$
628

$
364

$
333

$
7,554

Other

26

—

—

—

—

—

26

Restructuring-related obligations, net

4,033

1,187

1,035

628

364

333

7,580

Other obligations:

Principal and interest on 7 1/2% series A unsecured promissory notes (2)

4,705

4,615

4,615

4,615

63,764

—

82,314

Principal and interest due on promissory notes issued to former preferred stockholders

5,186

—

—

—

—

—

5,186

Operating leases

9,367

8,509

7,605

6,249

5,782

12,211

49,723

Other obligations

19,258

13,124

12,220

10,864

69,546

12,211

137,223

Total contractual cash obligations

$
23,291

$
14,311

$
13,255

$
11,492

$
69,910

$
12,544

$
144,803

	Twelve months ending June 30,										Thereafter		Total
	2004		2005		2006		2007		2008		Thereafter		Total
Restructuring-related obligations, net (1)	$	4,215	$	1,203	$	1,195	$	566	$	446	$	298	$	7,923
Other obligations:
Series A Notes (2)		4,056		3,978		3,978		56,945		—		—		68,957
Principal and interest due on promissory notes issued to former preferred stockholders (3)		5,186		—		—		—		—		—		5,186
Operating leases		10,006		8,462		7,445		6,094		5,909		10,730		48,646

Other obligations		19,248		12,440		11,423		63,039		5,909		10,730		122,789

Total contractual cash obligations	$	23,463	$	13,643	$	12,618	$	63,605	$	6,355	$	11,028	$	130,712

(1)		Restructuring-related lease obligations include estimated concessions, commission payments, and other costs associated with marketing our idle space for sublease of ~~$1.7~~$2.1 million and are reflected net of estimated sublease income recoveries of ~~$6.9~~$5.3 million. Total gross restructuring-related lease obligations are ~~$12.8~~$11.1 million. We may incur additional charges and expend more cash than currently expected if we are unable to sublet our idle space on the estimated terms.

(2)

~~(2)~~

The principal and interest obligation on the 7 ½% series A unsecured notes may be reduced if we exercise our right to repurchase or prepay the promissory notes or convert the promissory notes into shares of class A common stock prior to their June 24, 2007 maturity date. This table reflects our contractual obligations as of ~~March 31,~~June 30, 2003. ~~During April~~On July 30, 2003, we ~~repurchased an additional aggregate~~completed the conversion of the remaining $53.0 million in principal amount ~~of $8.5 million~~outstanding of our ~~7 ½% series~~Series A ~~unsecured notes in exchange for an aggregate of 261,757~~Notes plus accrued and unpaid interest and issued 1,654,839 shares of ~~our~~ class A common stock. ~~As a result~~Upon completion of this ~~repurchase,~~transaction, our remaining obligation for principal and interest ~~under these notes has been reduced by $11.4~~relating to our Series A Notes was entirely eliminated.

(3)

Upon maturity on July 31, 2003, we paid in full the $5.2 million ~~consisting of $8.5 million of~~in principal and ~~$2.9 million of cumulative~~ interest ~~over~~due under the ~~remaining term on such notes. In addition, we may elect~~promissory notes issued to settle the 7 ½% series A unsecured notes in cash or common stock. If we elect to settle these securities in common stock, we would no longer be obligated to pay the remaining $61.5 million principal amount of the 7 ½% series A unsecured notes in June 2007. The 7 ½% series A unsecured notes are discussed more fully below.

former preferred stockholders.

Operating Activities

Net cash provided by operating activities was ~~$7.5~~$14.8 million and $4.0 million for the ~~three~~six months ended ~~March 31,~~June 30, 2003 ~~as compared to net cash used in operating activities of $922,000 for the three months ended March 31, 2002.~~and 2002, respectively. The change was primarily attributable to ~~a reduction in accounts receivable resulting from improved cash collections from customers and~~ a decrease in cash used for payment of accounts payable, accrued expenses, and accrued ~~compensation.~~compensation and an increase in deferred revenue balances. The cash flow improvements in operating results also reflect the effect of the restructuring actions undertaken in 2001 and 2000.

Investing Activities

Net cash ~~used in~~provided by investing activities was ~~$683,000 and $2.7~~$3.6 million for the ~~three~~six months ended ~~March 31,~~June 30 2003, ~~and 2002, respectively. The decrease in~~as compared to net cash used in investing activities of $3.3 million for the six months ended June 30, 2002. The change was primarily attributable to the $5.6 million in restricted cash that was released during 2003 in connection with the termination of our previous letter of credit security agreement. The change was also due to the decrease in capitalized software development costs, as discussed above.

Financing Activities

Net cash provided by financing activities was ~~$97,000~~$1.1 million for the ~~three~~six months ended ~~March 31,~~June 30, 2003 as compared to net cash used in financing activities of ~~$751,000~~$745,000 for the ~~three~~six months ended ~~March 31,~~June 30, 2002. ~~This~~The change was primarily due to an increase in proceeds from the sale of our class A common stock under our employee stock purchase plan and the exercise of employee stock options. The change was also attributable to net cash payments of ~~$1.3~~$1.4 million under our previous credit facility with Foothill Capital Corporation in the 2002 period.

In connection with the refinancing of our series B, C and D preferred stock in August 2002, we issued to preferred stockholders, among other consideration, $5.0 million in promissory notes with a carrying value of $4.5 million at the time of issuance. The promissory notes ~~mature on July 31, 2003 and bear~~bore interest at a rate of 7.5% per annum, payable ~~semi-annually. Dividends that would have otherwise accrued at a rate of 12.5% per annum~~semi-annually, and matured on ~~the series B preferred stock and the series C preferred stock were eliminated as a result~~July 31, 2003. Upon maturity of the ~~refinancing transaction~~promissory notes on July 31, 2003, we paid in ~~August 2002. As a result, we expect to save $7.6~~full the $5.2 million in ~~dividends per year that would have otherwise been paid in cash or in shares of class A common stock.~~principal and interest due under the promissory notes issued to former preferred stockholders.

Pursuant to settlement agreements relating to our securities class action litigation, we issued to class members, among other consideration, an aggregate principal amount of $80.3 million of our ~~7 ½% series~~Series A ~~unsecured notes~~Notes with a carrying value of $55.0 million at the time of issuance. The notes ~~mature on June 24, 2007 and bear~~bore interest at a rate of 7.5% per annum, payable ~~semi-annually.~~semi-annually, and were to mature on June 24, 2007. During 2002, we repurchased $17.0 million ~~face value worth~~principal amount of our ~~7 ½% series~~Series A ~~unsecured notes.~~Notes. During the first ~~quarter~~and second quarters of 2003, we repurchased an additional ~~$1.8~~$10.3 million ~~face value worth~~principal amount of these notes. ~~During April~~On July 30, 2003, we ~~repurchased an additional $8.5~~completed the conversion of the remaining $53.0 million ~~face value worth~~in principal amount outstanding of ~~these notes.~~our Series A Notes plus accrued and unpaid interest and issued 1,654,839 shares of class A common stock. As a result of ~~these repurchases,~~this transaction, we ~~expect~~have eliminated our remaining principal and interest obligations relating to make semi-annual interest payments of approximately $2.0 million in 2003 and through maturity, under the terms of the promissory notes, based on the outstanding principal amount of $53.0 million as of April 30, 2003. The next semi-annual interest payment is due on June 24, 2003.our Series A Notes.

As discussed above, we ~~have taken~~took various actions in 2001 to realign our cost structure to better match our expected revenues, including reducing our workforce, consolidating our office space, reducing and limiting discretionary operating expenses, reducing capital expenditures, and discontinuing the operations of ~~Strategy.com. Additionally, we~~our Strategy.com subsidiary. We have also taken various actions to simplify our capital structure, including refinancing our preferred stock in 2002 and ~~repurchasing certain~~converting our remaining Series A Notes in July 2003 into shares of class A common stock (Note 9). We expect that our total stockholders’ equity will be positive after the effect of the conversion of our ~~7 ½% series~~Series A ~~unsecured~~Notes. Additionally, during July 2003, we paid $5.2 million to repay in full the promissory notes ~~(Note 8).~~issued to former preferred stockholders. As a result of these two transactions in July 2003, we have reduced our outstanding indebtedness by approximately $58 million. We continue to explore additional financing arrangements, which may include ~~credit facilities,~~ the sale of equity in MicroStrategy or other financing sources. Any additional debt or equity financing may not be available on acceptable terms. If financing is not available on acceptable terms and/or we do not achieve revenues and generate cash flow at anticipated levels, we will need to take further actions to reduce costs in order to improve results from operations. Management believes that existing cash, ~~and~~ cash anticipated to be generated internally by operations, if any, and the credit facility entered into in May 2003 (Note 9) will be sufficient ~~to meet our obligations to repay the approximately $5.2 million in principal and accrued interest on the promissory notes issued to former preferred stockholders on July 31, 2003 and~~ to meet our working capital requirements and anticipated capital expenditures through ~~the end of 2003.~~at least June 30, 2004. Our liquidity and capital resources and ability to generate revenues are subject to various business and economic risks discussed below under “Risk Factors.”

Recent Accounting Standards

In ~~April~~November 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” SFAS No. 145 changes guidance related to the reporting of gains and losses from extinguishment of debt as extraordinary items and resolves inconsistencies related to the required accounting treatment of certain lease modifications. SFAS No. 145 is effective for financial statements issued for fiscal years beginning after May 15, 2002. We elected early adoption of the provisions of this statement. The adoption of this standard had no impact on our net income (loss) for the periods presented.

~~In November 2002, the FASB~~ issued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires a company to recognize the fair value for certain guarantee obligations on the date of issuance of the guarantee. The initial recognition and ~~indemnification~~measurement provisions of FIN 45 are applicable on a prospective basis for guarantee arrangements issued or modified by ~~the company~~us after December 31, ~~2002, if these arrangements are within the scope of the interpretation. In addition,~~2002. FIN 45 also requires a company ~~must continue~~ to ~~monitor~~make certain additional disclosures even when the ~~conditions that~~likelihood of payment under the guarantee is remote. The adoption of FIN 45 had no impact on our results of operations.

Pursuant to FIN 45 and subsequent FASB staff positions, intellectual property infringement indemnifications are subject to the ~~guarantees~~disclosure requirements of FIN 45, but are exempt from its initial recognition and ~~indemnifications, as required under previously existing generally accepted accounting principles,~~measurement provisions. We typically include our standard intellectual property indemnification clauses in order to identify if a loss has occurred. If a company determines it is probable that a loss has occurred then any such estimable loss would be recognized under those guarantees and indemnifications. Our software licenses contain standard indemnification provisions that indemnify licensees of our software license agreements. Pursuant to these clauses, we agree to defend and hold harmless the indemnified party, typically our customers, business partners, and their directors, officers, employees and agents, in connection with certain intellectual property infringement claims by third parties relating to our products. The term of the indemnification clauses varies, typically ranging from ~~damages~~five years to perpetuity, and ~~costs resulting from claims alleging~~generally applies at any time after the execution of the software license agreement. In addition, we generally warrant that our software ~~infringes~~products will perform in all material respects in accordance with our standard published software specifications in effect at the time of delivery of the licensed products to the customer for a specified period of time following delivery, typically 90 to 180 days. We have not experienced any material intellectual property ~~rights~~indemnification or warranty claims historically and have no amounts accrued as of June 30, 2003 relating to such obligations.

We are also a ~~third party. We do~~party to a variety of other agreements with current and former customers, vendors, employees, and directors, pursuant to which we may be obligated to make payments to guaranteed parties. For example, such indemnification arrangements may obligate us to make payments to a property owner in the event of an adverse judgment in a lawsuit or the imposition of additional taxes in connection with real estate leased by us. These obligations may require the other party to make an adverse claim pursuant to procedures specified in the specific agreement, and our obligations may be limited in terms of time, and/or amount, or otherwise be qualified. It is not possible to predict the maximum potential amount of future payments under such agreements, due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. To date, we have ~~any historical experience of receiving requests for indemnification~~not incurred material expense under these ~~provisions~~agreements and have not ~~been required~~accrued any amounts relating to make any material payments pursuant to these provisions. Accordingly, we have not recorded a liability related to these indemnification provisions. We do not have any guarantees or indemnification arrangements other than the indemnification clausesuch provisions in our ~~software licenses. The adoption of this standard did not have a material effect on our~~ financial ~~position and results of operations.~~statements.

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” SFAS No. 148 is effective for fiscal years ending after December 15, 2002 and amends SFAS No. 123 to provide for alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require prominent disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We have accounted for stock-based employee compensation using the intrinsic value method under APB No. 25 and have adopted the amendments to the disclosure provisions of SFAS No. 148.

In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. We do not have any controlling interest, contractual relationships or other business relationships with variable interest entities and therefore the adoption of this standard did not have any effect on our financial position and results of operations.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. The statement requires that contracts with comparable characteristics be accounted for similarly and clarifies when a derivative contains a financing component that warrants special reporting in the statement of cash flows. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, except in certain circumstances, and for hedging relationships designated after June 30, 2003. We do not expect that the adoption of this standard will have a material effect on our financial position or results of operations.

Risk Factors

You should carefully consider the risks described below before making an investment decision. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations.

If any of the following risks actually occur, our business, financial condition or results of operations could be materially adversely affected. In such case, the trading price of our class A common stock could decline and you may lose all or part of your investment.

We may not be able to sustain or increase profitability in the future

We generated net income for the three and six months ended ~~March 31,~~June 30, 2003 and for the year ended December 31, 2002; however, we may not be able to sustain or increase profitability on a quarterly or annual basis in the future. Due to an approximately $30.2 million charge attributable to the conversion of our Series A Notes into shares of class A common stock on July 30, 2003, we will incur substantial net losses for the three months ending September 30, 2003 and for the year ending December 31, 2003. For the years ended December 31, 2001 and 2000, we incurred net losses of $80.9 million and $261.3 million, respectively. As of ~~March 31,~~June 30, 2003, our accumulated deficit

was ~~$341.3~~$339.0 million. If operating expenses exceed our expectations or cannot be adjusted accordingly, our business, results of operations and financial condition will be materially and adversely affected.

We may need additional financing which could be difficult to obtain

We may require additional external financing through ~~credit facilities,~~ sale of additional debt or equity securities in MicroStrategy or by obtaining other financing facilities to support our operations. Obtaining additional financing will be subject to a number of factors, including:

•	~~market conditions;~~
market conditions; our operating performance; and investor sentiment.
•	~~our operating performance; and~~

•	~~investor sentiment.~~

These factors may make the timing, amount, terms and conditions of additional financing unattractive to us. If we are unable to raise capital needed to fund our operations, ~~and repay our outstanding indebtedness as it becomes due,~~ our business, operating results and financial condition may be materially and adversely affected.

Our quarterly operating results, revenues and expenses may fluctuate significantly, which could have an adverse effect on the market price of our stock

For a number of reasons, including those described below, our operating results, revenues and expenses may vary significantly from quarter to quarter. These fluctuations could have an adverse effect on the market price of our class A common stock.

Fluctuations in Quarterly Operating Results. Our quarterly operating results may fluctuate as a result of:

the size, timing, volume and execution of significant orders and shipments;

the mix of products and services of customer orders, which can affect whether we recognize revenue upon the signing and delivery of our software products or whether revenue must be recognized as work progresses or over the entire contract period;

the timing of new product announcements;

changes in our pricing policies or those of our competitors;

market acceptance of business intelligence software generally and of new and enhanced versions of our products in particular;

the length of our sales cycles;

changes in our operating expenses;

personnel changes;

our success in adding to our indirect distribution channels;

utilization of our consulting personnel, which can be affected by delays or deferrals of customer implementation of our software products and consulting, education and support services;

•	~~the size, timing, volume and execution of significant orders and shipments;~~
changes in the value of the warrants to purchase 189,698 shares of class A common stock, increases in which will have the effect of reducing our reported operating results and decreases in which will have the effect of increasing our quarterly operating results; changes in foreign currency exchange rates, which have had a positive impact on our results in the first half of 2003; and seasonal factors, such as our traditionally lower pace of new sales in the summer.
•	the mix of products and services of customer orders, which can affect whether we recognize revenue upon the signing and delivery of our software products or whether revenue must be recognized as work progresses or over the entire contract period;

•	~~the timing of new product announcements;~~

•	~~changes in our pricing policies or those of our competitors;~~

•	~~market acceptance of business intelligence software generally and of new and enhanced versions of our products in particular;~~

•	~~the length of our sales cycles;~~

•	~~changes in our operating expenses;~~

•	~~personnel changes;~~

•	~~our success in adding to our indirect distribution channels;~~

•	~~utilization of our consulting personnel, which can be affected by delays or deferrals of customer implementation of our software products and consulting, education and support services;~~

•	~~changes in non-cash discount amortization expense and non-cash gains or losses on the early extinguishment of notes payable;~~

•	changes in the value of the warrants to purchase 189,698 shares of class A common stock, increases in which will have the effect of reducing our reported operating results and decreases in which will have the effect of increasing our quarterly operating results;

•	~~changes in foreign currency exchange rates; and~~

•	~~seasonal factors, such as our traditionally lower pace of new sales in the summer.~~

Limited Ability to Adjust Expenses. We base our operating expense budgets on expected revenue trends. Many of our expenses, such as office and equipment leases and personnel costs, are relatively fixed. We may be unable to adjust spending quickly enough to offset any unexpected revenue shortfall. Accordingly, any shortfall in revenue may cause significant variation in operating results in any quarter.

Based on the above factors, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. It is possible that in one or more future quarters, our operating results may be below the expectations of public market analysts and investors. In that event, the trading price of our class A common stock may fall.

We may lose sales, or sales may be delayed, due to the long sales and implementation cycles for our products, which would reduce our revenues

To date, our customers have typically invested substantial time, money and other resources and involved many people in the decision to license our software products and purchase our consulting and other services. As a result, we may wait nine months or more after the first contact with a customer for that customer to place an order while they seek internal approval for the purchase of our products and/or services. During this long sales cycle, events may occur that affect the size or timing of the order or even cause it to be canceled. For example, our competitors may introduce new products, or the customer’s own budget and purchasing priorities may change.

Even after an order is placed, the time it takes to deploy our products and complete consulting engagements varies widely from one customer to the next. Implementing our product can sometimes last several months, depending on the customer’s needs and may begin only with a pilot program. It may be difficult to deploy our products if the customer has complicated deployment requirements, which typically involve integrating databases, hardware and software from different vendors. If a customer hires a third party to deploy our products, we cannot be sure that our products will be deployed successfully.

Our recognition of deferred revenue and advance payments is subject to future performance obligations and may not be representative of revenues for succeeding periods

Our deferred revenue and advance payments were ~~$28.2~~$30.1 million as of ~~March 31,~~June 30, 2003. The timing and ultimate recognition of our deferred revenue and advance payments depend on our performance of various service obligations. Because of the possibility of customer changes in development schedules, delays in implementation and development efforts and the need to satisfactorily perform product support services, deferred revenue and advance payments at any particular date may not be representative of actual revenue for any succeeding period.

~~The issuance of class A common stock upon a conversion of our 7 ½% series A unsecured notes could result in a substantial number of additional shares of class A common stock being issued~~

As of May 1, 2003, we had outstanding $53.0 million principal amount of our 7 ½% series A unsecured notes as part of a class action litigation settlement. We have the option at any time prior to the June 24, 2007 maturity date of the notes, subject to certain limitations, to convert the notes into a number of shares of class A common stock equal to the principal amount of the notes being converted divided by 80% of the dollar-volume weighted average trading price of the class A common stock over a ten-day period preceding our delivery of a notice of conversion, which could result in a substantial number of shares of class A common stock being issued. For example, if the conversion price of the notes were based on the dollar-volume weighted average trading price of the class A common stock during the 10 trading days ending May 1, 2003, we would be obligated to issue 2,221,374 shares of class A common stock if we elected to convert the remaining notes. In addition, if we elect to convert the notes at prices that would result in the issuance of shares with a market value in excess of the value of the notes reflected on our balance sheet, we would incur a non-cash charge to earnings at the time of conversion equal to the amount of such excess, and this charge could be substantial. The issuance of a substantial number of shares of class A common stock upon future conversions of the notes may result in substantial dilution to the interests of holders of class A common stock and may result in downward pressure on the price of our class A common stock.

We have substantial real estate lease commitments for unoccupied space and if we are unable to sublet this space on acceptable terms our operating results and financial condition could be adversely affected

We are party to real estate leases for approximately 126,000 square feet of space that is unoccupied. We have established a restructuring reserve of ~~$7.6~~$7.8 million related to the costs of disposition of this space as of ~~March 31,~~June 30, 2003. In establishing this reserve, we have assumed that we will be able to sublet the available space and receive approximately ~~$6.9~~$5.3 million of sublease income relating to this space. We may not be able to sublet this space on the assumed terms. If we are unable to do so, we would incur additional restructuring costs relating to these leases and would expend more cash than currently expected, which could have an adverse effect on our operating results and financial condition.

We face intense competition, which may lead to lower prices for our products, reduced gross margins, loss of market share and reduced revenue

The markets for business intelligence software, analytical applications and narrowcast messaging technologies are intensely competitive and subject to rapidly changing technology. In addition, many companies in these markets are offering, or may soon offer, products and services that may compete with MicroStrategy products.

MicroStrategy’s most direct competitors include providers of:

business intelligence software;

OLAP tools; query and reporting tools; web-based static reporting tools; and report delivery and proactive alerting.	•	~~business intelligence software;~~

	•	~~OLAP tools;~~

	•	~~query and reporting tools;~~

	•	~~web-based static reporting tools; and~~

	•	~~report delivery and proactive alerting.~~

Each of these markets is discussed more fully below.

Business Intelligence Software.Makers of business intelligence software provide business intelligence capabilities designed for integration, customization and application development. Companies such as Microsoft, Oracle, Hyperion Solutions, SAP AG, Computer Associates and SAS provide business intelligence software.

OLAP Tools.Companies that build software to perform online analytical processing (OLAP) provide offerings competitive with the core MicroStrategy7i platform. Whether web-based or client-server, these tools give end users the ability to query underlying data sources without having to hand code structured query language queries. Most OLAP tools allow users to build their own calculations and specify report layouts and other options. Additionally, OLAP tools provide users the ability to navigate throughout the underlying data in an easy, graphical mode, often referred to as drilling. Providers of OLAP tools include Cognos, Hyperion Solutions, Brio Software, IBM, Crystal Decisions and Microsoft.

Query and Reporting Tools.Query and reporting tools allow large numbers of end users to gain access to pre-defined reports for simple analysis. Often the end users are able to specify some sort of run-time criteria that customizes the result set for that particular person. Some limited drilling is also provided. Companies that produce query and reporting tools include Business Objects, Cognos, Oracle, Crystal Decisions, Information Builders and Brio Software.

Web-based Static Reporting Tools.Companies that offer software to deliver pre-built reports for end user viewing and consumption can also compete with MicroStrategy. These applications often lack the sophistication, robustness and scalability of MicroStrategy’s platform, but can be attractive for small, departmental applications. Vendors in this category include Actuate, Business Objects, Crystal Decisions, Microsoft and SAS.

Report Delivery and Proactive Alerting.Companies that focus on the proactive delivery of information, via e-mail, website, or other medium can compete with MicroStrategy’s offerings. Typically, these tools serve to push out compiled reports on a scheduled basis to sets of users based on job type. MicroStrategy software has integrated this technology into the MicroStrategy7i platform. Vendors of such technology include Actuate and Business Objects.

Many of our competitors have longer operating histories, significantly greater financial, technical, marketing or other resources, and greater name recognition than we do. In addition, many of our competitors have strong relationships with current and potential customers and extensive knowledge of the business intelligence industry. As a result, they

may be able to respond more quickly to new or emerging technologies and changes in customer requirements or devote greater resources to the development, promotion and sale of their products than we can. Increased competition may lead to price cuts, reduced gross margins and loss of market share. We may not be able to compete successfully against current and future competitors and the failure to meet the competitive pressures we face may have a material adverse effect on our business, operating results and financial condition.

Current and future competitors have made and may also continue to make strategic acquisitions or establish cooperative relationships among themselves or with others. By doing so, they may increase their ability to meet the needs of our potential customers. Our current or prospective indirect channel partners may establish cooperative relationships with our current or future competitors. These relationships may limit our ability to sell our products through specific distribution channels. Accordingly, new competitors or alliances among current and future competitors may emerge and rapidly

gain significant market share. These developments could limit our ability to obtain revenues from new customers and to maintain maintenance revenues from our installed customer base.

If we are unable to recruit or retain skilled personnel, or if we lose the services of any of our key management personnel, our business, operating results and financial condition would be materially adversely affected

Our future success depends on our continuing ability to attract, train, assimilate and retain highly skilled personnel. Competition for these employees is intense. We may not be able to retain our current key employees or attract, train, assimilate or retain other highly skilled personnel in the future. Our future success also depends in large part on the continued service of key management personnel, particularly Michael J. Saylor, our Chairman and Chief Executive Officer, and Sanju K. Bansal, our Vice Chairman, Executive Vice President and Chief Operating Officer. If we lose the services of one or both of these individuals or other key personnel, or if we are unable to attract, train, assimilate and retain the highly skilled personnel we need, our business, operating results and financial condition could be materially adversely affected.

Our inability to develop and release product enhancements and new products to respond to rapid technological change in a timely and cost-effective manner would have a material adverse effect on our business, operating results and financial condition

The market for our products is characterized by rapid technological change, frequent new product introductions and enhancements, changing customer demands and evolving industry standards. The introduction of products embodying new technologies can quickly make existing products obsolete and unmarketable. We believe that our future success depends largely on three factors:

•	~~our ability to continue to support a number of popular operating systems and databases;~~
our ability to continue to support a number of popular operating systems and databases; our ability to maintain and improve our current product line; and our ability to rapidly develop new products that achieve market acceptance, maintain technological competitiveness and meet an expanding range of customer requirements.
•	~~our ability to maintain and improve our current product line; and~~

•	~~our ability to rapidly develop new products that achieve market acceptance, maintain technological competitiveness and meet an expanding range of customer requirements.~~

Business intelligence applications are inherently complex, and it can take a long time to develop and test major new products and product enhancements. In addition, customers may delay their purchasing decisions because they anticipate that new or enhanced versions of our products will soon become available. We cannot be sure that we will succeed in developing and marketing, on a timely and cost-effective basis, product enhancements or new products that respond to technological change or new customer requirements, nor can we be sure that any new products and product enhancements will achieve market acceptance.

The emergence of new industry standards may adversely affect our ability to market our existing products

The emergence of new industry standards in related fields may adversely affect the demand for our existing products. This could happen, for example, if new web standards and technologies emerged that were incompatible with customer deployments of our products. Although the core database component of our business intelligence solutions is compatible with nearly all enterprise server hardware and operating system combinations, such as OS/390,

AS/400, Unix, Linux and Windows, certain of our application server components run only on the Windows NT and Windows 2000 operating systems. Therefore, our ability to increase sales currently depends in part on the continued acceptance of the Windows NT and Windows 2000 operating systems.

If the market for business intelligence software fails to grow as we expect, or if businesses fail to adopt our products, our business, operating results and financial condition would be materially adversely affected

Nearly all of our revenues to date have come from sales of business intelligence software and related technical support, consulting and education services. We expect these sales to account for a large portion of our revenues for the foreseeable future. Although demand for business intelligence software has grown in recent years, the market for business intelligence software applications is still emerging. Resistance from consumer and privacy groups to

increased commercial collection and use of data on spending patterns and other personal behavior and recent European Union restrictions on the collection and use of personal data may impair the further growth of this market, as may other developments. We cannot be sure that this market will continue to grow or, even if it does grow, that businesses will adopt our solutions. We have spent, and intend to keep spending, considerable resources to educate potential customers about business intelligence software in general and our solutions in particular. However, we cannot be sure that these expenditures will help our products achieve any additional market acceptance. If the market fails to grow or grows more slowly than we currently expect, our business, operating results and financial condition would be materially adversely affected.

Because of the rights of our two classes of common stock, and because we are controlled by our existing holders of class B common stock, these stockholders could transfer control of MicroStrategy to a third party without anyone else’s approval or prevent a third party from acquiring MicroStrategy

We have two classes of common stock: class A common stock and class B common stock. Holders of our class A common stock generally have the same rights as holders of our class B common stock, except that holders of class A common stock have one vote per share while holders of class B common stock have ten votes per share. As of ~~May~~August 1, 2003, holders of our class B common stock owned or controlled ~~4,616,252~~3,702,780 shares of class B common stock, or ~~82.9%~~75.3% of the total voting power. Michael J. Saylor, our Chairman and Chief Executive Officer, controlled ~~44,142~~882 shares of class A common stock and ~~3,709,022~~2,849,700 shares of class B common stock, or ~~66.7%~~57.9% of the total voting power, as of ~~May~~August 1, 2003. Accordingly, Mr. Saylor is able to control MicroStrategy through his ability to determine the outcome of elections of our directors, amend our certificate of incorporation and by-laws and take other actions requiring the vote or consent of stockholders, including mergers, going-private transactions and other extraordinary transactions and their terms.

Our certificate of incorporation allows holders of class B common stock, almost all of whom are current employees or former employees of our company or related parties, to transfer shares of class B common stock, subject to the approval of stockholders possessing a majority of the outstanding class B common stock. Mr. Saylor or a group of stockholders possessing a majority of the outstanding class B common stock could, without seeking anyone else’s approval, transfer voting control of MicroStrategy to a third party. Such a transfer of control could have a material adverse effect on our business, operating results and financial condition. Mr. Saylor will also be able to prevent a change of control of MicroStrategy, regardless of whether holders of class A common stock might otherwise receive a premium for their shares over the then current market price.

We rely on our strategic channel partners and if we are unable to develop or maintain successful relationships with them, our business, operating results and financial condition will suffer

In addition to our direct sales force, we rely on strategic channel partners such as value-added resellers, system integrators and original equipment manufacturers to license and support our products in the United States and internationally. In particular, for the ~~three~~six months ended ~~March 31,~~June 30, 2003 and the years ended December 31, 2002, 2001 and 2000, channel partners accounted for, directly or indirectly, approximately ~~23.2%~~22.9%, 27.3%, 35.4% and 45.0% of our total product licenses revenues, respectively. Our channel partners generally offer customers the products of several different companies, including some products that compete with ours. Although we believe that direct sales will continue to account for a majority of product license revenues, we are seeking to increase the level of indirect sales activities through our strategic channel partners; however, we may not be successful in our efforts to expand

indirect sales in this manner. We may not be able to attract strategic partners who will market our products effectively and who will be qualified to provide timely and cost-effective customer support and service. Our ability to achieve revenue growth in the future will depend in part on our success in developing and maintaining successful relationships with those strategic partners. If we are unable to develop or maintain our relationships with these strategic partners, our business, operating results and financial condition will suffer.

We have only limited protection for our proprietary rights in our software, which makes it difficult to prevent third parties from infringing upon our rights

We rely primarily on a combination of copyright, patent, trademark and trade secret laws, customer licensing agreements, employee and third-party nondisclosure agreements and other methods to protect our proprietary rights.

However, these laws and contractual provisions provide only limited protection. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Policing such unauthorized use is difficult, and we cannot be certain that we can prevent it, particularly in countries where the laws may not protect our proprietary rights as fully as in the United States.

Our products may be susceptible to claims by other companies that our products infringe upon their proprietary rights, which could adversely affect our business, operating results and financial condition

As the number of software products in our target markets increases and the functionality of these products further overlaps, we may become increasingly subject to claims by a third party that our technology infringes such party’s proprietary rights. Regardless of their merit, any such claims could be time consuming and expensive to defend, may divert management’s attention and resources, could cause product shipment delays and could require us to enter into costly royalty or licensing agreements. If successful, a claim of infringement against us and our inability to license the infringed or similar technology could have a material adverse effect on our business, operating results and financial condition.

On October 17, 2001, Business Objects filed suit against us in the United States District Court for the Northern District of California, claiming that our software infringes a patent issued to Business Objects relating to relational database access. The suit seeks injunctive relief and ~~unspecified~~ monetary damages. We have filed an answer denying the allegations in the Complaint and have filed a declaratory judgment counterclaim seeking to have Business Objects’ patent declared invalid and unenforceable against us. ~~A trial date has not yet been set~~Trial is scheduled to commence on November 10, 2003 in the Northern District of California action. We intend to vigorously defend the case.

On October 31, 2001, we filed suit against Business Objects, S.A. and its subsidiary, Business Objects Americas, Inc., in the United States District Court for the Eastern District of Virginia, claiming that Business Objects’ software infringes two patents held by us relating to asynchronous control of report generation using a web browser (the ‘033 patent) and a system and method of adapting automatic output of OLAP reports to disparate user output ~~devices.~~devices (the ‘050 patent). The complaint against Business Objects was amended to add claims for violations of the federal Computer Fraud and Abuse Act, misappropriation of trade secrets, tortious interference with contractual relations, and violations of the Virginia Conspiracy Act. As a result of pre-trial rulings, certain of these claims were dismissed. Our claims for tortious interference and misappropriation of trade secrets are ~~expected~~currently scheduled to proceed to ~~trial. The~~ trial ~~is scheduled to commence~~ on October ~~15,~~20, 2003. In July 2003, the United States Patent & Trademark Office confirmed the validity of all the claims in the ‘033 and ‘050 patents and terminated reexamination proceedings that Business Objects had requested as to those patents. The Court is considering whether to try our ‘050 patent claims together with the tortious interference and misappropriation of trade secrets claims or whether to try the patent issues in a separate trial. Should the Court decide to try all the issues together, it is likely that the trial would be continued beyond October 2003, perhaps into 2004. We are seeking monetary damages and injunctive relief. ~~The patent claims have been stayed pending the conclusion of reexamination proceedings before the United States Patent & Trademark Office.~~

Managing our international operations is complex and our failure to do so successfully or in a cost-effective manner would have a material adverse effect on our business, operating results and financial condition

International sales accounted for ~~35.8%~~33.7%, 36.0%, 33.8% and 25.6% of our total revenues for the ~~three~~six months ended ~~March 31,~~June 30, 2003 and for the years ended December 31, 2002, 2001 and 2000, respectively. Our international operations require significant management attention and financial resources.

There are certain risks inherent in our international business activities including:

•	~~changes in foreign currency exchange rates;~~
changes in foreign currency exchange rates; unexpected changes in regulatory requirements; tariffs and other trade barriers; costs of localizing products for foreign countries; lack of acceptance of localized products in foreign countries; longer accounts receivable payment cycles; difficulties in managing international operations; tax issues, including restrictions on repatriating earnings; weaker intellectual property protection in other countries; economic weakness or currency related crises that may arise in different countries or geographic regions; and the burden of complying with a wide variety of foreign laws.
•	~~unexpected changes in regulatory requirements;~~

•	~~tariffs and other trade barriers;~~

•	~~costs of localizing products for foreign countries;~~

•	~~lack of acceptance of localized products in foreign countries;~~

•	~~longer accounts receivable payment cycles;~~

•	~~difficulties in managing international operations;~~

•	~~tax issues, including restrictions on repatriating earnings;~~

•	~~weaker intellectual property protection in other countries;~~

•	~~economic weakness or currency related crises that may arise in different countries or geographic regions; and~~

•	~~the burden of complying with a wide variety of foreign laws.~~

These factors may have a material adverse effect on our future international sales and, consequently, on our business, operating results and financial condition.

The nature of our products makes them particularly vulnerable to undetected errors, or bugs, which could cause problems with how the products perform and which could in turn reduce demand for our products, reduce our revenue and lead to product liability claims against us

Software products as complex as ours may contain errors or defects. Although we test our products extensively, we have in the past discovered software errors in new products after their introduction. Despite testing by us and by our current and potential customers, errors may be found in new products or releases after commercial shipments begin. This could result in lost revenue or delays in market acceptance, which could have a material adverse effect upon our business, operating results and financial condition.

Our license agreements with customers typically contain provisions designed to limit our exposure to product liability claims. It is possible, however, that these provisions may not be effective under the laws of certain domestic or international jurisdictions. Although there have been no product liability claims against us to date, our license and support of products may involve the risk of these claims. A successful product liability claim against us could have a material adverse effect on our business, operating results and financial condition.

The price of our stock may be extremely volatile

The market price for our class A common stock has historically been volatile and could fluctuate significantly for any of the following reasons:

•	~~quarter-to-quarter variations in our operating results;~~
quarter-to-quarter variations in our operating results; developments or disputes concerning proprietary rights; technological innovations or new products; governmental regulatory action; general conditions in the software industry; increased price competition; changes in revenue or earnings estimates by analysts; or other events or factors.
•	~~developments or disputes concerning proprietary rights;~~

•	~~technological innovations or new products;~~

•	~~governmental regulatory action;~~

•	~~general conditions in the software industry;~~

•	~~increased price competition;~~

•	~~changes in revenue or earnings estimates by analysts;~~

•	~~any change in the actual or expected amount of dilution attributable to issuances of additional shares of class A common stock as a result of conversions of our 7 ½% series A unsecured notes; or~~

•	~~other events or factors.~~

Many of the above factors are beyond our control.

The stock market has recently experienced extreme price and volume fluctuations. These fluctuations have particularly affected the market price of many software companies, often without regard to their operating performance.

ITEM 3.

~~ITEM 3.~~ QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The following discussion about our market ~~risk disclosures~~risks involves forward-looking statements. Actual results could differ materially from those projected in the forward-looking statements.

We are exposed to the impact of interest rate changes and foreign currency fluctuations.

Interest Rate Risk

Our exposure to market risk for changes in interest rates relates primarily to our cash equivalents and short-term investments. We invest our excess cash in short-term, fixed income financial instruments. These fixed rate investments are subject to interest rate risk and may fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10% from the levels at ~~March 31,~~June 30, 2003, the fair market value of ~~the~~our investment portfolio would decline by an immaterial amount. We have the ability to hold our fixed income investments until maturity and, therefore, we do not expect our operating results or cash flows to be materially affected by a sudden change in market interest rates on our investment portfolio.

Foreign Currency Risk

We face exposure to adverse movements in foreign currency exchange rates. Our international revenues and expenses are denominated in foreign currencies, principally the Euro and the British pound sterling. The functional currency of each of our foreign subsidiaries is the local currency. Our international business is subject to risks typical of an international business, including, but not limited to differing tax structures, other regulations and restrictions, and foreign exchange rate volatility. Based on our overall currency rate exposure at ~~March 31,~~June 30, 2003, a 10% change in foreign exchange rates would have had an immaterial effect on our financial position, results of operations and cash flows. As a percentage of total revenues, international revenues ~~grew~~decreased from ~~34.5%~~36.7% for the three months ended ~~March 31,~~June 30, 2002 to ~~35.8%~~31.9% for the three months ended ~~March 31,~~June 30, 2003, and from 35.6% for the six months ended June 30, 2002 to 33.7% for the six months ended June 30, 2003, primarily as a result of ~~positive exchange rate fluctuations.~~increases in domestic revenues during 2003. We anticipate that international revenues will continue to account for a significant amount of total revenues. To date, we have not hedged the risks associated with foreign exchange exposure. Although we may do so in the future, we cannot be sure that any hedging techniques we may implement will be successful or that our business, results of operations, financial condition and cash flows will not be materially adversely affected by exchange rate fluctuations.

ITEM 4. ~~ITEM 4.~~ CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. ~~Based on their evaluation~~Our management, with the participation of our chief executive officer and chief financial officer, evaluated the ~~Company’s~~effectiveness of our disclosure controls and procedures (as defined in Rules ~~13a-14(c)~~13a-15(e) and ~~15d-14(c)~~15d-15(e) under the ~~Securities~~ Exchange ~~Act of 1934)~~Act) as of ~~a date within 90 days of the filing date of~~June 30, 2003. Based on this ~~Quarterly Report on Form 10-Q, the Company’s~~evaluation, our chief executive officer and chief financial officer ~~have~~ concluded that, ~~the Company’s~~as of June 30, 2003, our disclosure controls and procedures ~~are~~were (1) designed to ensure that material information relating to our company, including our consolidated subsidiaries, is made known to our chief executive officer and chief financial officer by others within those entities, particularly during the period in which this report was being prepared and (2) effective, in that they provide reasonable assurance that information required to be disclosed by ~~the Company~~us in the reports that ~~it files~~we file or ~~submits~~submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and ~~forms and are operating in an effective manner.~~forms.

(b) Changes in internal controls. ~~There were no significant changes~~No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the ~~Company’s~~Exchange Act) occurred during the fiscal quarter ended June 30, 2003 that has materially affected, or is reasonably likely to materially affect, our internal ~~controls or in other factors that could significantly affect these controls subsequent to the date of their most recent evaluation.~~control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1.

~~ITEM 1.~~ LEGAL PROCEEDINGS

Business Objects Litigation

On October 31, 2001, the Company filed suit against Business Objects, S.A. and its subsidiary, Business Objects Americas, Inc., in the United States District Court for the Eastern District of Virginia, claiming that Business Objects’ software infringes two patents held by the Company relating to asynchronous control of report generation using a web browser (the ‘033 patent) and a system and method of adapting automatic output of OLAP reports to disparate user output ~~devices.~~devices (the ‘050 patent). On March 13, 2002, the Company voluntarily dismissed without prejudice its lawsuit pending in the Virginia Circuit Court for Fairfax County against the two field employees of Business Objects. The complaint against Business Objects was amended to add claims for violations of the federal Computer Fraud and Abuse Act, misappropriation of trade secrets, tortious interference with contractual relations, and violations of the Virginia Conspiracy Act. As a result of pre-trial rulings, certain of these claims were dismissed. The Company’s claims for tortious interference and misappropriation of trade secrets are ~~expected~~currently scheduled to proceed to ~~trial. The~~ trial ~~is scheduled to commence~~ on October ~~15,~~20, 2003. In July 2003, the United States Patent & Trademark Office confirmed the validity of all the claims in the ‘033 and ‘050 patents and terminated reexamination proceedings that Business Objects had requested as to those patents. The Court is considering whether to try the Company’s ‘050 patent claims together with the tortious interference and misappropriation of trade secrets claims or whether to try the patent issues in a separate trial. Should the Court decide to try all the issues together, it is likely that the trial would be continued beyond October 2003, perhaps into 2004. The Company is seeking monetary damages and injunctive relief. ~~The patent claims have been stayed pending the conclusion of reexamination proceedings before the United States Patent & Trademark Office.~~

Other Proceedings

ITEM 2.

~~ITEM 2.~~ CHANGES IN SECURITIES AND USE OF PROCEEDS

Exchange of 7 ½%¹/2% Series A Unsecured Notes

During the ~~first~~second quarter of 2003, the Company repurchased an aggregate principal amount of approximately ~~$1.8~~$8.5 million of its 7½7¹/2% series A unsecured notes in exchange for an aggregate of ~~56,053~~261,757 shares of class A common stock. Since January 1 2003, the Company has repurchased an aggregate principal amount of approximately $10.3 million of its 7½7¹/2% series A unsecured notes in exchange for an aggregate of 317,810 shares of class A common stock. The class A common stock issued in these repurchase transactions was issued in reliance on the exemption from registration under the Securities Act of 1933, as amended (the “Securities Act”) provided by Section 3(a)(9) thereunder. No underwriters were involved in the foregoing issuance of securities.

ITEM 5. ~~ITEM 5.~~ OTHER INFORMATION

~~On May 5, 2003, MicroStrategy Chairman and Chief Executive Officer, Michael~~The Company’s Annual Meeting of Stockholders was held on July 10, 2003. The following proposals were adopted by the votes specified below.

	For	Withheld/ Against	Abstain	Broker Non-votes
1. To elect seven (7) directors for the next year:
Michael J. Saylor	50,219,817	1,791,379	—	—
Sanju K. Bansal	50,219,931	1,791,265	—	—
David B. Blundin	51,858,877	152,319	—	—
F. David Fowler	51,779,132	232,064	—	—
Carl J. Rickertsen	51,847,754	163,442	—	—
Stuart B. Ross	51,767,691	243,505	—	—
Ralph S. Terkowitz	51,767,473	243,723	—	—

2. To approve the Second Amended and Restated 1999 Stock Option Plan which will (i) increase the number of shares of class A common stock reserved for issuance under the plan from 2,350,000 to 3,850,000 shares and (ii) increase the maximum number of shares of class A common stock with respect to which options may be granted to any participant under the plan from 100,000 to 1,000,000 shares per calendar year.	46,606,922	1,180,786	13,832	5,109,656

3. To ratify the selection of PricewaterhouseCoopers LLP as the Company’s independent auditors for the fiscal year ending December 31, 2003.	51,787,128	211,242	12,826	-0-

Jonathan J. ~~Saylor, caused to be filed a Form 144 (Notice~~Ledecky retired from the Company’s Board of Proposed Sale of Securities) indicating the intent to sell up to 300,000 shares of class A common stock beneficially owned by him. On May 9, 2003, MicroStrategy Vice Chairman, Executive Vice President and Chief Operating Officer, Sanju K. Bansal, caused to be filed a Form 144 indicating the intent to sell up to 70,000 shares of class A common stock beneficially owned by him. Messrs. Saylor and Bansal have each informed the Company that the proposed sales are part of their routine asset diversification plans.Directors effective July 10, 2003.

ITEM 6. ~~ITEM 6.~~ EXHIBITS AND REPORTS ON FORM 8-K

A. Exhibits

Exhibit Number		Description

3.1		Second Restated Certificate of Incorporation of the ~~registrant.~~ registrant (filed as Exhibit 3.1 to the registrant’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2003 (File No. 000-24435) and incorporated by reference herein).

3.2		Restated By-Laws of the registrant (filed as Exhibit 3.2 to the registrant’s Registration Statement on Form S-1 (Registration No. 333-49899) and incorporated by reference herein).

4.1		Form of Certificate of Class A Common Stock of the ~~registrant (filed as Exhibit 4.1 to the registrant’s Registration Statement on Form S-1 (Registration No. 333-49899) and incorporated by reference herein).~~ registrant.

Exhibit
Number
Description
4.2
Indenture, dated as of January 11, 2001, by and between the ~~Company~~registrant and American Stock Transfer & Trust Company relating to 7 ½% Series A Unsecured Notes (filed as Exhibit T3C to the registrant’s Form T-3 (File No. 022-22591) filed on October 25, 2001 and incorporated by reference herein).
4.3
First Amendment to Indenture, dated as of June 18, 2002, by and between the ~~Company~~registrant and American Stock Transfer & Trust Company (filed as Exhibit T3C.2 to the registrant’s Amendment No. 1 to Form T-3 (File No. 022-22591) filed on June 20, 2002 and incorporated by reference herein).
4.4
Warrant Agreement, dated as of January 11, 2001, by and between the registrant and American Stock Transfer & Trust Company, included as Exhibit E to the Stipulation of Settlement regarding the settlement of the class action lawsuit, dated as of January 11, 2001 (filed as Exhibit 10.29 to the registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000 (File No. 000-24435) and incorporated by reference herein).
31.1
Certification pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Chairman of the Board of Directors
and Chief Executive Officer.
~~99.1~~31.2
Certification pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the President and Chief Financial Officer.
32
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(This certification is furnished in accordance with Item 601(b)(32)(ii) of Regulation S-K.)

B. Reports on Form 8-K

On ~~January 31,~~April 18, 2003, the registrant filed a Current Report on Form 8-K dated April 16, 2003 to report that it had issued a press release announcing that, on April 16, 2003, the registrant had repurchased approximately $8.5 million in principal of its 7¹/2% series A unsecured notes (the “Notes”) in exchange for 261,757 shares of the registrant’s class A common stock and that, since January 1, 2003, the registrant had repurchased approximately $10.3 million in principal amount of the Notes in exchange for 317,810 shares of class A common stock.

On April 30, 2003, the registrant furnished a Current Report on Form 8-K dated April 29, 2003 to report that it had issued a press release announcing its financial results for the quarter ended ~~December~~March 31, ~~2002~~2003 and providing additional outlook and financial guidance information.

On May 20, 2003, the registrant filed a Current Report on Form 8-K dated May 19, 2003 to report that the registrant and its wholly-owned domestic subsidiaries had entered into a secured revolving credit facility with Bank of America, N.A.

On June 24, 2003, the registrant filed a Current Report on Form 8-K dated June 23, 2003 to report that it had issued a press release announcing its election to convert on July 30, 2003 all of its outstanding 7¹/2% series A unsecured notes (the “Notes”) into shares of its class A common stock, in accordance with the terms of the indenture pursuant to which the Notes were issued.

All other items included in a Quarterly Report of Form 10-Q are omitted because they are not applicable or the answers are ~~none.~~“none.”

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

			M~~ICROSTRATEGY~~ I~~NCORPORATED~~MICROSTRATEGY INCORPORATED

By:	~~By:~~	/s/S/ MICHAEL J. SAYLOR

		Michael J. Saylor
		Chairman of the Board of Directors and Chief Executive Officer


By:
	~~By:~~	/s/S/ ERIC F. BROWN

		Eric F. Brown
		President and Chief Financial Officer

~~Date: May 13, 2003~~

~~CERTIFICATIONS~~

~~I, Michael J. Saylor, certify that:~~

	1.	~~I have reviewed this quarterly report on Form 10-Q of MicroStrategy Incorporated;~~

	2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

	3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

	4.	The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

			a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

			b)	~~evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and~~

			c)	~~presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;~~

	5.	The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

			a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

			b)	~~any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and~~

	6.	The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

~~Dated: May 13,~~

Date: August 12, 2003

~~/s/ MICHAEL~~ ~~J. SAYLOR~~

~~Michael J. Saylor~~
~~Chairman of the Board of Directors~~
~~and Chief Executive Officer~~

~~CERTIFICATIONS~~

~~I, Eric F. Brown, certify that:~~

	1.	~~I have reviewed this quarterly report on Form 10-Q of MicroStrategy Incorporated;~~

	2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

	3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

	4.	The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

			a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

			b)	~~evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and~~

			c)	~~presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;~~

	5.	The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

			a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

			b)	~~any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and~~

	6.	The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

~~Dated: May 13, 2003~~

~~/s/ ERIC~~ ~~F. BROWN~~

~~Eric F. Brown~~
~~President and Chief Financial Officer~~

	March 31, 2003			December 31, 2002

	(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	21,929		$	15,036
Restricted cash		6,193			6,173
Short-term investments		41			44
Accounts receivable, net		24,038			28,195
Prepaid expenses and other current assets		4,911			5,032
Deferred tax assets, net		269			495

Total current assets		57,381			54,975

Property and equipment, net		17,313			18,471
Goodwill and intangible assets, net		659			789
Capitalized software development costs, net		3,952			4,414
Deposits and other assets		1,147			1,224

Total assets	$	80,452		$	79,873

Liabilities and Stockholders’ Equity (Deficit)
Current liabilities:
Accounts payable and accrued expenses	$	14,150		$	15,267
Accrued compensation and employee benefits		8,413			11,352
Accrued interest		1,304			244
Accrued restructuring costs		4,033			5,222
Deferred revenue and advance payments		26,433			23,961
Notes payable		4,824			4,698
Net liabilities of discontinued operations		1,080			1,151

Total current liabilities		60,237			61,895

Deferred revenue and advance payments		1,783			1,381
Other long-term liabilities		2,153			2,402
Accrued restructuring costs		3,547			3,663
Notes payable		44,612			45,041

Total liabilities		112,332			114,382

Stockholders’ Equity (Deficit):
Preferred stock undesignated, par value $0.001 per share, 4,971 shares authorized, no shares issued or outstanding		—			—
Class A common stock, par value $0.001 per share, 330,000 shares authorized, 9,233 and 9,157 shares issued and outstanding, respectively		9			9
Class B common stock, par value $0.001 per share, 165,000 shares authorized, 4,616 and 4,619 shares issued and outstanding, respectively		5			5
Additional paid-in capital		306,722			305,334
Deferred compensation		(4	)		(17	)
Accumulated other comprehensive income		2,733			2,170
Accumulated deficit		(341,345	)		(342,010	)

Total stockholders’ equity (deficit)		(31,880	)		(34,509	)

Total liabilities and stockholders’ equity (deficit)	$	80,452		$	79,873

	March 31, 2003			December 31, 2002

Billed and billable	$	44,294		$	49,688
Less: billed and unpaid deferred revenue		(17,843	)		(17,841	)

		26,451			31,847
Less: allowance for doubtful accounts		(2,413	)		(3,652	)

	$	24,038		$	28,195

	Three Months Ended March 31,

	2003		2002

Promissory notes	$	—	$	—
Class A common stock		—		(2,222	)
Warrants		—		(1,238	)

Reduction in estimated cost of litigation settlement	$	—	$	(3,460	)

	Three months ended March 31, 2003						Three months ended March 31, 2002

	Income (Numerator)		Shares (Denominator)		Per Share Amount		Income (Numerator)			Shares (Denominator)		Per Share Amount

Net income	$	665					$	2,985
Dividends on and accretion of convertible preferred stock		—						(2,557	)

Net income attributable to common stockholders		665						428
Effect of common stock:
Weighted average shares of class A common stock		—		9,172				—			4,685
Weighted average shares of class B common stock		—		4,616				—			4,653

Basic earnings per share		665		13,788	$	0.05		428			9,338	$	0.05

Effect of dilutive securities:
Series C preferred stock		—		—				(4,957	)		1,050
Series B preferred stock		—		—				(4,585	)		1,250
Series A preferred stock		—		—				(894	)		244
Employee stock options		—		268				—			—

Diluted earnings (loss) per share	$	665		14,056	$	0.05	$	(10,008	)		11,882	$	(0.84	)

	Accrued Restructuring Costs at December 31, 2002		Q1 2003 Cash Payments			Adjustments for Q1 2003			Accrued Restructuring Costs at March 31, 2003

Estimated sublease losses and other facility closing costs	$	8,589	$	(1,289	)	$	135		$	7,435
Terminations of computer and equipment leases		152		(16	)		(17	)		119
Accrual for professional fees		144		—			(118	)		26

Total accrued restructuring costs	$	8,885	$	(1,305	)	$	—		$	7,580

	Twelve months ending March 31,

	2004		2005		2006		2007		2008		Thereafter		Total

Restructuring-related obligations:
Leases (1)	$	4,007	$	1,187	$	1,035	$	628	$	364	$	333	$	7,554
Other		26		—		—		—		—		—		26

Restructuring-related obligations, net		4,033		1,187		1,035		628		364		333		7,580

Other obligations:
Principal and interest on 7 1/2% series A unsecured promissory notes (2)		4,705		4,615		4,615		4,615		63,764		—		82,314
Principal and interest due on promissory notes issued to former preferred stockholders		5,186		—		—		—		—		—		5,186
Operating leases		9,367		8,509		7,605		6,249		5,782		12,211		49,723

Other obligations		19,258		13,124		12,220		10,864		69,546		12,211		137,223

Total contractual cash obligations	$	23,291	$	14,311	$	13,255	$	11,492	$	69,910	$	12,544	$	144,803

Exhibit Number		Description
4.2		Indenture, dated as of January 11, 2001, by and between the ~~Company~~registrant and American Stock Transfer & Trust Company relating to 7 ½% Series A Unsecured Notes (filed as Exhibit T3C to the registrant’s Form T-3 (File No. 022-22591) filed on October 25, 2001 and incorporated by reference herein).

4.3		First Amendment to Indenture, dated as of June 18, 2002, by and between the ~~Company~~registrant and American Stock Transfer & Trust Company (filed as Exhibit T3C.2 to the registrant’s Amendment No. 1 to Form T-3 (File No. 022-22591) filed on June 20, 2002 and incorporated by reference herein).

4.4		Warrant Agreement, dated as of January 11, 2001, by and between the registrant and American Stock Transfer & Trust Company, included as Exhibit E to the Stipulation of Settlement regarding the settlement of the class action lawsuit, dated as of January 11, 2001 (filed as Exhibit 10.29 to the registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000 (File No. 000-24435) and incorporated by reference herein).

31.1		Certification pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the Chairman of the Board of Directors and Chief Executive Officer.

~~99.1~~31.2		Certification pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the President and Chief Financial Officer.

32		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (This certification is furnished in accordance with Item 601(b)(32)(ii) of Regulation S-K.)