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 June 30, 2003, the Company had an accumulated deficit of $339.0 million and negative stockholders’ equity of $21.3 million. During 2001, the Company 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. The Company has also taken various actions to simplify its capital structure, including refinancing its preferred stock in 2002 and converting its remaining 7  ¹ / 2 % series A unsecured notes in July 2003 into shares of class A common stock (Note 9). The Company expects that its total stockholders’ equity will be positive after the effect of the conversion of the 7  ¹ / 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 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. Management believes that existing cash, 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 working capital requirements and anticipated capital expenditures through 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 November 2002, the Financial Accounting Standards Board (“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 measurement provisions of FIN 45 are applicable on a prospective basis for guarantee arrangements issued or modified by the Company after December 31, 2002. FIN 45 also requires a company to make certain additional disclosures even when the likelihood of payment under the guarantee is remote. The adoption of FIN 45 had no impact on the results of operations of the Company.

Pursuant to FIN 45 and subsequent FASB staff positions, intellectual property infringement indemnifications are subject to the disclosure requirements of FIN 45, but are exempt from its initial recognition and 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

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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 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 the event of an adverse judgment in a lawsuit or the imposition of additional taxes in connection with real estate leased by the 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 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, the Company has not incurred material expense under these agreements and has not accrued any amounts relating to such provisions in its financial statements.

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 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. The historical consolidated financial statements of the Company reflect 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 June 30, 2003 and December 31, 2002, respectively, included accounts payable and accrued expenses of $1.0 million and $1.2 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.

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MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

(4)    Accounts Receivable

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

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):

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.

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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.

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 issued in connection with the litigation settlement, the Company recorded an aggregate reduction in the provision for the litigation settlement of $7.9 million and $11.4 million during the three and six months ended 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 June 30, 2003. The reduction in estimated cost of litigation settlement was comprised of the following, (in thousands):

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 June 30, 2003 and December 31, 2002, the Company’s remaining obligations relating to the litigation settlement were for accrued administration costs of $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 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. Trial is scheduled to commence on November 10, 2003 in the Northern District of California action. The Company intends to vigorously defend the case.

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

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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 (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 currently scheduled to proceed to trial on October 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 outcome of this litigation is not presently determinable and as such the Company is currently 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.

(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 and second quarters of 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 June 30, 2002, the Company accrued aggregate dividends of $2.0 million and $4.0 million, respectively, on its preferred stock. During the six months ended June 30, 2002, the Company paid aggregate preferred stock dividends valued at $4.9 million through the issuance of 154,508 shares of class A common stock in lieu of cash. Additionally, for the three and six months ended June 30, 2002, the Company recorded accretion on its preferred stock of $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.

(9)    Notes Payable and Borrowings

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

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(a)  7  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 (“Series A Notes”). The Series A Notes bore interest at a rate of 7.5% per annum, payable 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 the Series A Notes at the time of issuance. The discount was amortized to interest expense over the term of such notes, using the effective interest method.

Interest charges on the Series A Notes began accruing on April 2, 2001. For the three months ended June 30, 2003 and 2002, total interest expense on the Series A Notes was $1.8 million and $1.6 million, respectively, including stated interest expense of $1.0 million and $1.6 million, respectively, and discount amortization expense of $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 had the right, at any time prior to the June 24, 2007 maturity date, to prepay its Series A 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 on which written notice of conversion is given. The Company could also repurchase, convert or redeem a portion of the outstanding notes so long as the combination of redemptions, conversions and repurchases 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 were redeemed or converted by the Company. During the first and second quarters of 2003, the Company repurchased Series A Notes with an aggregate principal amount of $10.3 million in exchange for 317,810 shares of class A common stock. As a result of the repurchases, the Company recorded an aggregate net loss during 2003 on the early extinguishment of notes payable in the amount of $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 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.

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

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MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

common stock in 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 and approximately $47,000 in cash in lieu of fractional shares. In connection with this transaction, the Company will record a loss during the third quarter of 2003 on the early extinguishment of notes payable in the amount of approximately $30.2 million equal to the excess of the fair value of the consideration transferred to the holders of the Series A Notes of $70.0 million over the carrying value of such extinguished notes plus accrued and unpaid interest of $39.8 million. Upon completion of this transaction, the Company’s remaining obligations relating to its Series A Notes were 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 bore interest at a rate of 7.5% per annum, payable 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 was amortized to interest expense over the term of such promissory notes, using the effective interest method.

For the three months ended June 30, 2003, total interest expense on the promissory notes issued to former preferred stockholders was $224,000, including stated interest expense of $93,000 and discount amortization expense of $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)  Credit Facility

On May 19, 2003, the Company entered into a $10 million secured credit facility (the “Credit Facility”) with Bank of 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 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 an option to extend the maturity date by one additional year. As of June 30, 2003, the Company had no amounts outstanding under the Credit Facility. After consideration of outstanding letters of credit of $5.6 million and borrowing base limitations applicable to the 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 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 with Bank of America, under which outstanding letters of credit 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 maintain certain financial covenants, the most restrictive of which include achieving certain minimum earnings amounts and maximum debt to 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.

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MICROSTRATEGY INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(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 June 30, 2003 and 2002, respectively, is calculated as follows (in thousands):

(11)    Earnings per Share and Pro Forma (Loss) Earnings per Share

(a)  Basic and diluted earnings per share

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

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The numerator in the basic and diluted earnings per share calculation for the three months ended June 30, 2002 has been adjusted to add back $395,000 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 three 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.

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):

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