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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549



FORM 10-Q

(MARK ONE)

|    |  |                                                                   
|--- |  | ------------------------------------------------------------------
|[X] |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
|    |  | EXCHANGE ACT OF 1934                                              

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001

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 25737



USinternetworking, Inc.
(Exact name of registrant as specified in its charter)

|                                |  |                    
|------------------------------- |  | -------------------
|Delaware                        |  | 52-2078325         
|(State or other jurisdiction of |  | (I.R.S. Employer   
|incorporation or organization)  |  | Identification No.)

One USi Plaza, Annapolis, MD 21401-7478
(Address of principal executive offices)
(Zip Code)

(410) 897-4400
Registrants telephone number, including area code:

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 [   ]

Shares outstanding of the Registrants common stock

|                              |  |                                
|----------------------------- |  | -------------------------------
|Class                         |  | Outstanding at November 9, 2001
|                              |  |                                
|Common Stock, $.001 par value |  | 146,041,587                    
|                             

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INDEX

USinternetworking, Inc.

|           |  |                                                                  |  |      |    | 
|---------- |  | ---------------------------------------------------------------- |  | ---- | -- | 
|           |  |                                                                  |  | Page
|           |  |                                                                  |  |     
|PART I     |  | FINANCIAL INFORMATION                                            |  |      | 3  | 
|Item 1.    |  | Consolidated Financial Statements of USinternetworking, Inc.     |  |      |    | 
|           |  | Consolidated Balance Sheets as of September 30, 2001 (unaudited) |  |      |    | 
|           |  | and December 31, 2000                                            |  |      | 3  | 
|           |  | Consolidated Statements of Operations for the three months       |  |      |    | 
|           |  | ended September 30, 2001 and 2000 (unaudited) and for the        |  |      |    | 
|           |  | nine months ended September 30, 2001 and 2000 (unaudited)        |  |      | 4  | 
|           |  | Consolidated Statement of Stockholders Equity for the nine      |  |      |    | 
|           |  | months ended September 30, 2001 (unaudited)                      |  |      | 5  | 
|           |  | Consolidated Statements of Cash Flows for the nine months        |  |      |    | 
|           |  | ended September 30, 2001 and 2000 (unaudited)                    |  |      | 6  | 
|           |  | Notes to Consolidated Financial Statements                       |  |      | 7  | 
|Item 2.    |  | Managements Discussion and Analysis of Financial Condition      |  |      |    | 
|           |  | and Results of Operations                                        |  |      | 12 | 
|Item 3.    |  | Quantitative and Qualitative Disclosure of Market Risk           |  |      | 19 | 
|          
|PART II    |  | OTHER INFORMATION                                                |  |      | 20 | 
|Item 1.    |  | Legal Proceedings                                                |  |      | 20 | 
|Item 2.    |  | Changes in Securities and Use of Proceeds                        |  |      | 20 | 
|Item 3.    |  | Defaults Upon Senior Securities                                  |  |      | 20 | 
|Item 4.    |  | Submission of Matters to a Vote of Security Holders              |  |      | 20 | 
|Item 5.    |  | Other Information                                                |  |      | 20 | 
|Item 6.    |  | Exhibits and Reports on Form 8-K                                 |  |      | 20 | 
|SIGNATURES |  |                                                                  |  |      | 21 | 

2



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PART I. FINANCIAL INFORMATION

Item 1.Consolidated Financial Statements

USinternetworking, Inc.
Consolidated Balance Sheets

(Dollar amounts in thousands, except per share amounts)

|                                                                                                                |                                                                                                                                            |                                            |                                      |          |         |               |         |              |         |  |  | 
|--------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------ | ------------------------------------ | -------- | ------- | ------------- | ------- | ------------ | ------- |  |  | 
|                                                                                                                |                                                                                                                                            |                                            |                                      |          |         | September 30, |         | December 31,
|                                                                                                                |                                                                                                                                            |                                            |                                      |          |         | 2001          |         | 2000        
|                                                                                                                |                                                                                                                                            |                                            |                                      |          |         |               |         |             
|                                                                                                                |                                                                                                                                            |                                            |                                      |          |         | (unaudited)   |         |              |         | 
|                                                                                                                |                                                                                                                                            |                                            |                                      | ASSETS   |         |               |         |              |         |  |  | 
|Current assets:                                                                                                 |                                                                                                                                            |                                            |                                      |          |         |               |         |             
|                                                                                                                | Cash and cash equivalents                                                                                                                  |                                            | $                                    | 51,304   |         |               | $       | 56,962       |        
|                                                                                                                | Restricted cash                                                                                                                            |                                            |                                      | 4,739    |         |               |         | 3,102        |        
|                                                                                                                | Accounts receivable, less allowance of $1,449 in 2001 and
$1,785 in 2000                                                                   |                                            |                                      | 29,031   |         |               |         | 35,312       |        
|                                                                                                                | Due from director, less allowance of $1,307 in 2001                                                                                        |                                            |                                      | 1,307    |         |               |         | 2,158        |        
|                                                                                                                | Prepaid hardware and software maintenance costs                                                                                            |                                            |                                      | 6,312    |         |               |         | 9,115        |        
|                                                                                                                | Prepaid expenses and other current assets                                                                                                  |                                            |                                      | 4,646    |         |               |         | 4,232        |        
|                                                                                                                |                                                                                                                                            |                                            |                                      |          |         |               |         |             
|                                                                                                                |                                                                                                                                            | Total current assets                       |                                      |          | 97,339  |               |         |              | 110,881 | 
|Deferred iMAP costs, net of accumulated amortization of
$33,846 in 2001 and $18,820 in 2000                     |                                                                                                                                            |                                            | 24,659                               |          |         |               | 29,943  |             
|Software licenses, net of accumulated amortization of
$14,368 in 2001 and $9,727 in 2000                        |                                                                                                                                            |                                            | 14,390                               |          |         |               | 20,548  |             
|Property and equipment, net of accumulated depreciation of
$96,301 in 2001 and $52,336 in 2000                  |                                                                                                                                            |                                            | 209,624                              |          |         |               | 218,563 |             
|Goodwill, net of accumulated amortization of $23,349 in 2001
and $15,723 in 2000                                |                                                                                                                                            |                                            | 24,419                               |          |         |               | 27,560  |             
|Deferred financing costs and other assets, net of
accumulated amortization of $2,330 in 2001 and $1,232 in
2000 |                                                                                                                                            |                                            | 11,539                               |          |         |               | 11,288  |             
|                                                                                                                |                                                                                                                                            |                                            |                                      |          |         |               |         |             
|                                                                                                                |                                                                                                                                            | Total assets                               |                                      | $        | 381,970 |               |         | $            | 418,783 | 
|                                                                                                                |                                                                                                                                            |                                            |                                      |          |         |               |         |             
|                                                                                                                |                                                                                                                                            |                                            | LIABILITIES AND STOCKHOLDERS EQUITY |          |         |               |         |              |         |  | 
|Current liabilities:                                                                                            |                                                                                                                                            |                                            |                                      |          |         |               |         |             
|                                                                                                                | Accounts payable                                                                                                                           |                                            | $                                    | 11,956   |         |               | $       | 23,259       |        
|                                                                                                                | Accrued compensation and benefits                                                                                                          |                                            |                                      | 10,687   |         |               |         | 14,718       |        
|                                                                                                                | Other accrued expenses                                                                                                                     |                                            |                                      | 12,426   |         |               |         | 6,098        |        
|                                                                                                                | Deferred revenue                                                                                                                           |                                            |                                      | 22,831   |         |               |         | 20,478       |        
|                                                                                                                | Current portion of capital lease obligations                                                                                               |                                            |                                      | 32,549   |         |               |         | 21,802       |        
|                                                                                                                | Current portion of long-term debt                                                                                                          |                                            |                                      | 25,115   |         |               |         | 22,020       |        
|                                                                                                                | Convertible subordinated notes in default                                                                                                  |                                            |                                      | 125,000  |         |               |         |             |        
|                                                                                                                |                                                                                                                                            |                                            |                                      |          |         |               |         |             
|                                                                                                                |                                                                                                                                            | Total current liabilities                  |                                      |          | 240,564 |               |         |              | 108,375 | 
|Capital lease obligations, less current portion                                                                 |                                                                                                                                            |                                            | 34,069                               |          |         |               | 39,238  |             
|Long-term debt, less current portion                                                                            |                                                                                                                                            |                                            | 15,726                               |          |         |               | 29,187  |             
|Convertible subordinated notes                                                                                  |                                                                                                                                            |                                            |                                     |          |         |               | 125,000 |             
|Other long-term liabilities                                                                                     |                                                                                                                                            |                                            | 608                                  |          |         |               |        |             
|                                                                                                                |                                                                                                                                            |                                            |                                      |          |         |               |         |             
|                                                                                                                |                                                                                                                                            | Total liabilities                          |                                      |          | 290,967 |               |         |              | 301,800 | 
|Commitments and contingent liabilities                                                                          |                                                                                                                                            |                                            |                                     |          |         |               |        |             
|Stockholders equity:                                                                                           |                                                                                                                                            |                                            |                                      |          |         |               |         |             
|                                                                                                                | Preferred stock, $.001 par value, 1,000,000 shares
authorized, none issued and outstanding                                                 |                                            |                                      |         |         |               |         |             |        
|                                                                                                                | Common stock, $.001 par value, 450,000,000 shares
authorized; issued and outstanding shares of 145,668,405
in 2001 and 115,063,871 in 2000 |                                            |                                      | 146      |         |               |         | 115          |        
|                                                                                                                | Additional paid-in capital                                                                                                                 |                                            |                                      | 548,309  |         |               |         | 444,878      |        
|                                                                                                                | Note receivable from director for purchase of common
stock, less allowance of $1,125 in 2001                                               |                                            |                                      | (1,125   | )       |               |         | (2,250       | )      
|                                                                                                                | Unearned compensation                                                                                                                      |                                            |                                      | (11,057  | )       |               |         | (15,029      | )      
|                                                                                                                | Accumulated deficit                                                                                                                        |                                            |                                      | (445,270 | )       |               |         | (310,731     | )      
|                                                                                                                |                                                                                                                                            |                                            |                                      |          |         |               |         |             
|                                                                                                                |                                                                                                                                            | Total stockholders equity                 |                                      |          | 91,003  |               |         |              | 116,983 | 
|                                                                                                                |                                                                                                                                            |                                            |                                      |          |         |               |         |             
|                                                                                                                |                                                                                                                                            | Total liabilities and stockholders equity |                                      | $        | 381,970 |               |         | $            | 418,783 | 
|                                                                                                                |                                                                                                                                            |                                            |                                      |          |         |               |         |             

See accompanying notes.

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USinternetworking, Inc.

Consolidated Statements of Operations

(Dollar amounts in thousands, except per share amounts)

|                                                                            |                                      |                                  |         |                    |         |                   |         |        |         |      |          |         |          |   |          |         |          |  
|--------------------------------------------------------------------------- | ------------------------------------ | -------------------------------- | ------- | ------------------ | ------- | ----------------- | ------- | ------ | ------- | ---- | -------- | ------- | -------- | - | -------- | ------- | -------- | -
|                                                                            |                                      |                                  |         | Three months ended |         | Nine months ended
|                                                                            |                                      |                                  |         | September 30,      |         | September 30,    
|                                                                            |                                      |                                  |         |                    |         |                  
|                                                                            |                                      |                                  |         | 2001               |         | 2000              |         | 2001   |         | 2000
|                                                                            |                                      |                                  |         |                    |         |                   |         |        |         |     
|                                                                            |                                      |                                  |         | (unaudited)        |         | (unaudited)      
|Revenue                                                                     |                                      | $                                | 31,718  |                    |         | $                 | 28,268  |        |         | $    | 100,557  |         |          | $ | 72,281   |        
|                                                                            |                                      |                                  |         |                    |         |                   |         |        |         |      |          |         |          |   |          |        
|Costs and expenses:                                                         |                                      |                                  |         |                    |         |                   |         |        |         |      |          |         |          |   |          |        
|                                                                            | Direct cost of services              |                                  |         | 14,723             |         |                   |         | 18,222 |         |      |          | 51,186  |          |   |          | 46,758  |         
|                                                                            | Network and infrastructure costs     |                                  |         | 5,271              |         |                   |         | 7,038  |         |      |          | 20,395  |          |   |          | 19,350  |         
|                                                                            | General and administrative           |                                  |         | 6,526              |         |                   |         | 6,844  |         |      |          | 20,865  |          |   |          | 19,856  |         
|                                                                            | Sales and marketing                  |                                  |         | 9,005              |         |                   |         | 17,740 |         |      |          | 36,704  |          |   |          | 52,676  |         
|                                                                            | Product research and development     |                                  |         | 483                |         |                   |         | 945    |         |      |          | 1,854   |          |   |          | 2,286   |         
|                                                                            | Restructuring charge                 |                                  |         | 2,643              |         |                   |         |       |         |      |          | 11,496  |          |   |          |        |         
|                                                                            | Impairment loss                      |                                  |         | 2,432              |         |                   |         |       |         |      |          | 3,780   |          |   |          |        |         
|                                                                            | Non-cash stock compensation expense: |                                  |         |                    |         |                   |         |        |         |      |          |         |          |   |          |         |         
|                                                                            |                                      | Direct cost of services          |         |                    | 858     |                   |         |        | 1,059   |      |          |         | 3,348    |   |          |         | 2,534    |  
|                                                                            |                                      | Network and infrastructure costs |         |                    | 1,059   |                   |         |        | 1,396   |      |          |         | 3,431    |   |          |         | 3,845    |  
|                                                                            |                                      | General and administrative       |         |                    | 825     |                   |         |        | 1,965   |      |          |         | 4,997    |   |          |         | 5,046    |  
|                                                                            |                                      | Sales and marketing              |         |                    | 1,242   |                   |         |        | 1,588   |      |          |         | 4,520    |   |          |         | 4,437    |  
|                                                                            |                                      | Product research and development |         |                    | 1       |                   |         |        | 11      |      |          |         | 6        |   |          |         | 33       |  
|                                                                            |                                      |                                  |         |                    |         |                   |         |        |         |      |          |         |          |   |          |        
|                                                                            |                                      |                                  | 3,985   |                    |         |                   | 6,019   |        |         |      | 16,302   |         |          |   | 15,895   |        
|                                                                            | Depreciation and amortization        |                                  |         | 19,721             |         |                   |         | 15,447 |         |      |          | 57,513  |          |   |          | 36,377  |         
|                                                                            |                                      |                                  |         |                    |         |                   |         |        |         |      |          |         |          |   |          |        
|                                                                            |                                      | Total costs and expenses         |         |                    | 64,789  |                   |         |        | 72,255  |      |          |         | 220,095  |   |          |         | 193,198  |  
|                                                                            |                                      |                                  |         |                    |         |                   |         |        |         |      |          |         |          |   |          |        
|Operating loss                                                              |                                      |                                  | (33,071 | )                  |         |                   | (43,987 | )      |         |      | (119,538 | )       |          |   | (120,917 | )      
|Other income (expense):                                                     |                                      |                                  |         |                    |         |                   |         |        |         |      |          |         |          |   |          |        
|                                                                            | Interest income                      |                                  |         | 802                |         |                   |         | 2,385  |         |      |          | 4,111   |          |   |          | 6,883   |         
|                                                                            | Interest expense                     |                                  |         | (5,352             | )       |                   |         | (6,149 | )       |      |          | (19,112 | )        |   |          | (15,337 | )       
|                                                                            |                                      |                                  |         |                    |         |                   |         |        |         |      |          |         |          |   |          |        
|                                                                            |                                      |                                  | (4,550  | )                  |         |                   | (3,764  | )      |         |      | (15,001  | )       |          |   | (8,454   | )      
|                                                                            |                                      |                                  |         |                    |         |                   |         |        |         |      |          |         |          |   |          |        
|                                                                            |                                      | Net loss                         |         | $                  | (37,621 | )                 |         | $      | (47,751 | )    |          | $       | (134,539 | ) |          | $       | (129,371 | )
|                                                                            |                                      |                                  |         |                    |         |                   |         |        |         |      |          |         |          |   |          |        
|Basic and diluted loss per common share attributable to
common stockholders |                                      | $                                | (0.27   | )                  |         | $                 | (0.49   | )      |         | $    | (0.96    | )       |          | $ | (1.36    | )      
|                                                                            |                                      |                                  |         |                    |         |                   |         |        |         |      |          |         |          |   |          |        

See accompanying notes.

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USinternetworking, Inc.

Consolidated Statement of Stockholders Equity

Nine months ended September 30, 2001

(Dollar amounts in thousands, except share amounts)

|                                          |                                                                                            |  |              |            |            |   |            |    |               |   |              |        |               |   |        |       |       |   |         |       |   |   |          |          |   |   |         |          |  
|----------------------------------------- | ------------------------------------------------------------------------------------------ |  | ------------ | ---------- | ---------- | - | ---------- | -- | ------------- | - | ------------ | ------ | ------------- | - | ------ | ----- | ----- | - | ------- | ----- | - | - | -------- | -------- | - | - | ------- | -------- | -
|                                          |                                                                                            |  | Common Stock |            | Additional |   | Note       |    |               |   |              |        |               |   |        |       | Total
|                                          |                                                                                            |  |              |            | Paid-in    |   | Receivable |    | Unearned      |   | Accumulated  |        | Stockholders'
|                                          |                                                                                            |  | Shares       |            | Par value  |   | Capital    |    | From Director |   | Compensation |        | Deficit       |   | Equity
|                                          |                                                                                            |  |              |            |            |   |            |    |               |   |              |        |               |   |       
|Balance at January 1, 2001                |                                                                                            |  | 115,063,871  |            |            | $ | 115        |    |               | $ | 444,878      |        |               | $ | (2,250 | )     |       | $ | (15,029 | )     |   | $ | (310,731 | )        |   | $ | 116,983 |         
|                                          | Issuance of common stock for cash, net of offering costs
of $6,664                         |  |              | 28,634,815 |            |   |            | 29 |               |   |              | 90,093 |               |   |        |      |       |   |         |      |   |   |          |         |   |   |         | 90,122   |  
|                                          | Issuance of restricted stock in connection with employee
bonus plan                        |  |              | 240,193    |            |   |            |   |               |   |              | 636    |               |   |        |      |       |   |         | (428  | ) |   |          |         |   |   |         | 208      |  
|                                          | Common stock issued upon exercise of stock options                                         |  |              | 205,241    |            |   |            |   |               |   |              | 386    |               |   |        |      |       |   |         |      |   |   |          |         |   |   |         | 386      |  
|                                          | Common stock issued for employee stock purchase plan                                       |  |              | 454,904    |            |   |            | 1  |               |   |              | 821    |               |   |        |      |       |   |         |      |   |   |          |         |   |   |         | 822      |  
|                                          | Allowance on note receivable from director                                                 |  |              |           |            |   |            |   |               |   |              |       |               |   |        | 1,125 |       |   |         |      |   |   |          |         |   |   |         | 1,125    |  
|                                          | Contribution of common stock to employee benefit plan                                      |  |              | 455,328    |            |   |            | 1  |               |   |              | 1,546  |               |   |        |      |       |   |         |      |   |   |          |         |   |   |         | 1,547    |  
|                                          | Stock compensation expense for issuance of common stock
options at below fair market value |  |              |           |            |   |            |   |               |   |              | 9,949  |               |   |        |      |       |   |         |      |   |   |          |         |   |   |         | 9,949    |  
|                                          | Amortization of unearned compensation                                                      |  |              |           |            |   |            |   |               |   |              |       |               |   |        |      |       |   |         | 4,400 |   |   |          |         |   |   |         | 4,400    |  
|                                          | Net loss for the period January 1, 2001 through September
30, 2001                         |  |              |           |            |   |            |   |               |   |              |       |               |   |        |      |       |   |         |      |   |   |          | (134,539 | ) |   |         | (134,539 | )
|                                          |                                                                                            |  |              |            |            |   |            |    |               |   |              |        |               |   |        |       |       |   |         |       |   |   |          |          |   |   |         |         
|Balance at September 30, 2001 (unaudited) |                                                                                            |  | 145,668,405  |            |            | $ | 146        |    |               | $ | 548,309      |        |               | $ | (1,125 | )     |       | $ | (11,057 | )     |   | $ | (445,270 | )        |   | $ | 91,003  |         
|                                          |                                                                                            |  |              |            |            |   |            |    |               |   |              |        |               |   |        |       |       |   |         |       |   |   |          |          |   |   |         |         

See accompanying notes

5



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USinternetworking, Inc.
Consolidated Statements of Cash Flows

(Dollar amounts in thousands)

|                                                                            |                                                       |                                              |                                           |        |                   |         |          |        |        |         |  
|--------------------------------------------------------------------------- | ----------------------------------------------------- | -------------------------------------------- | ----------------------------------------- | ------ | ----------------- | ------- | -------- | ------ | ------ | ------- | -
|                                                                            |                                                       |                                              |                                           |        | Nine months ended
|                                                                            |                                                       |                                              |                                           |        | September 30,    
|                                                                            |                                                       |                                              |                                           |        |                  
|                                                                            |                                                       |                                              |                                           |        | 2001              |         | 2000    
|                                                                            |                                                       |                                              |                                           |        |                   |         |         
|                                                                            |                                                       |                                              |                                           |        | (unaudited)      
|Operating Activities                                                        |                                                       |                                              |                                           |        |                   |         |          |       
|Net loss                                                                    |                                                       | $                                            | (134,539                                  | )      |                   | $       | (129,371 | )     
|Adjustments to reconcile net loss to net cash used in
operating activities: |                                                       |                                              |                                           |        |                   |         |          |       
|                                                                            |                                                       | Depreciation                                 |                                           |        | 49,887            |         |          |        | 30,661 |        
|                                                                            |                                                       | Amortization                                 |                                           |        | 7,626             |         |          |        | 5,716  |        
|                                                                            |                                                       | Non-cash stock compensation expense          |                                           |        | 16,302            |         |          |        | 15,593 |        
|                                                                            |                                                       | Non-cash interest expense                    |                                           |        |                  |         |          |        | 199    |        
|                                                                            |                                                       | Changes in operating assets and liabilities: |                                           |        |                   |         |          |        |        |        
|                                                                            |                                                       |                                              | Accounts receivable                       |        |                   | 6,281   |          |        |        | (12,514 | )
|                                                                            |                                                       |                                              | Prepaid expenses and other current assets |        |                   | 2,729   |          |        |        | (17,763 | )
|                                                                            |                                                       |                                              | Deferred iMAP costs                       |        |                   | 5,284   |          |        |        | (19,922 | )
|                                                                            |                                                       |                                              | Accounts payable                          |        |                   | (11,303 | )        |        |        | 10,659  |  
|                                                                            |                                                       |                                              | Accrued compensation and benefits         |        |                   | (4,031  | )        |        |        | 9,822   |  
|                                                                            |                                                       |                                              | Other accrued expenses                    |        |                   | 6,936   |          |        |        | 3,047   |  
|                                                                            |                                                       |                                              | Deferred revenue                          |        |                   | 2,353   |          |        |        | 10,557  |  
|                                                                            |                                                       |                                              |                                           |        |                   |         |          |       
|Net cash used in operating activities                                       |                                                       |                                              | (52,475                                   | )      |                   |         | (93,316  | )     
|Investing Activities                                                        |                                                       |                                              |                                           |        |                   |         |          |       
|Purchases of property and equipment                                         |                                                       |                                              | (23,537                                   | )      |                   |         | (92,417  | )     
|Proceeds from sale-leaseback transaction                                    |                                                       |                                              | 17,900                                    |        |                   |         |         |       
|Purchases of available-for-sale securities                                  |                                                       |                                              |                                          |        |                   |         | (17,546  | )     
|Proceeds from sale of available-for-sale securities                         |                                                       |                                              |                                          |        |                   |         | 48,941   |       
|Payments to shareholders of acquired businesses                             |                                                       |                                              | (4,485                                    | )      |                   |         | (2,000   | )     
|Changes in other assets                                                     |                                                       |                                              | (251                                      | )      |                   |         |         |       
|                                                                            |                                                       |                                              |                                           |        |                   |         |          |       
|Net cash used in investing activities                                       |                                                       |                                              | (10,373                                   | )      |                   |         | (63,022  | )     
|Financing Activities                                                        |                                                       |                                              |                                           |        |                   |         |          |       
|Proceeds from exercise of employee stock options                            |                                                       |                                              | 386                                       |        |                   |         | 2,434    |       
|Proceeds from issuance of common stock to employee stock
purchase plan      |                                                       |                                              | 822                                       |        |                   |         |         |       
|Proceeds from issuance of common stock, net of offering
costs               |                                                       |                                              | 90,122                                    |        |                   |         | 119,238  |       
|Proceeds from issuance of long-term debt                                    |                                                       |                                              | 18,323                                    |        |                   |         | 26,296   |       
|Payments on long-term debt                                                  |                                                       |                                              | (26,496                                   | )      |                   |         | (13,650  | )     
|Payments on capital lease obligations                                       |                                                       |                                              | (25,967                                   | )      |                   |         | (9,211   | )     
|                                                                            |                                                       |                                              |                                           |        |                   |         |          |       
|Net cash provided by financing activities                                   |                                                       |                                              | 57,190                                    |        |                   |         | 125,107  |       
|                                                                            |                                                       |                                              |                                           |        |                   |         |          |       
|Net decrease in cash and cash equivalents                                   |                                                       |                                              | (5,658                                    | )      |                   |         | (31,231  | )     
|Cash and cash equivalents at beginning of period                            |                                                       |                                              | 56,962                                    |        |                   |         | 112,302  |       
|                                                                            |                                                       |                                              |                                           |        |                   |         |          |       
|Cash and cash equivalents at end of period                                  |                                                       | $                                            | 51,304                                    |        |                   | $       | 81,071   |       
|                                                                            |                                                       |                                              |                                           |        |                   |         |          |       
|Supplemental cash flow information:                                         |                                                       |                                              |                                           |        |                   |         |          |       
|                                                                            | Additional capital assets acquired via capital
leases |                                              | $                                         | 11,252 |                   |         | $        | 32,341 |       
|                                                                            |                                                       |                                              |                                           |        |                   |         |          |       

See accompanying notes.

6



---



##### 



USinternetworking, Inc.

Notes to Consolidated Financial Statements
September 30, 2001
(unaudited)

1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and disclosures required by generally accepted accounting
principles for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for
a fair presentation have been included. For further information, refer to the
consolidated financial statements and notes thereto included in the Companys
annual report on Form 10-K for the year ended December 31, 2000. Operating
results for the nine months ended September 30, 2001 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2001.

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Currently, the Company is performing an
assessment as to the recoverability of certain long-lived assets including
software licenses and decommissioned hardware inventory. Pending the outcome
of this assessment, the Company may determine that these assets are impaired,
which could result in a material charge being recorded in the near term.
Management expects to complete this assessment by December 31, 2001.

In the first half of fiscal year 2001, the Company estimated that its
annual bonus program would be paid in full in accordance with employment
contracts and anticipated 2001 operating results, and established an accrual
based on this estimate. During the third quarter, management lowered the
estimate on the bonus payout due to the Companys financial performance and
reductions in workforce, which resulted in a $3,600 decrease to the estimated
accrual. The effect of this change in estimate was to decrease general and
administrative expense and the net loss by $3,600 for the three and nine-month
periods ended September 30, 2001. Basic and diluted loss per share for the
three and nine-month periods ended September 30, 2001 was lowered by $0.10 and
$0.03, respectively, as a result of the change.

2. Recent Accounting Pronouncements

As of January 1, 2001, the Company adopted Financial Accounting Standards
Board Statement No. 133, Accounting for Derivative Instruments and Hedging
Activities.The Statement requires the Company to recognize all derivatives on
the balance sheet at fair value. Derivatives that are not hedges must be
adjusted to fair value through income. If the derivative is a hedge, depending
on the nature of the hedge, changes in the fair value of derivatives are either
offset against the change in fair value of assets, liabilities, or firm
commitments through earnings or recognized in comprehensive income until the
hedged item is recognized in earnings. The ineffective portion of a
derivatives change in fair value is immediately recognized in earnings.

Upon adoption of the Statement on January 1, 2001, the Company maintained
an interest rate swap agreement in the notional amount of $4,750 related to
outstanding notes payable. The interest rate swap effectively fixes the rate of
interest on a portion of the Companys floating rate note, and is settled as
the related term note matures. The adoption of the Statement was immaterial to
the Companys financial condition and results of operations.

In June 2001, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets,
effective for fiscal years beginning after December 15, 2001. Under the new
rules, goodwill and other intangible assets deemed to have indefinite lives
will no longer be amortized but will be subject to annual impairment tests in
accordance with the Statement. Other intangible assets will continue to be
amortized over their useful lives.

The Company will apply the new rules on accounting for goodwill and other
intangible assets beginning in the first quarter of 2002. The Company recorded
goodwill amortization of $7,626 for the nine months ended September 30, 2001,
and expects that goodwill amortization will approximate $10,350 for the full
year. During 2002, the Company will perform the first of the required
impairment tests of goodwill and indefinite lived intangible assets. Currently,
management has not yet determined the effect of these
7

tests; however, a transitional adjustment is expected to be required as of
January 1, 2002.

3. Loss Per Share

The following table sets forth the computation of basic and diluted loss
per common share:

|                                        |                                                                                                               |   |                    |             |                   |   |       |            |      |   |       |             |   |   |       |            |  
|--------------------------------------- | ------------------------------------------------------------------------------------------------------------- | - | ------------------ | ----------- | ----------------- | - | ----- | ---------- | ---- | - | ----- | ----------- | - | - | ----- | ---------- | -
|                                        |                                                                                                               |   | Three months ended |             | Nine months ended
|                                        |                                                                                                               |   | September 30,      |             | September 30,    
|                                        |                                                                                                               |   |                    |             |                  
|                                        |                                                                                                               |   | 2001               |             | 2000              |   | 2001  |            | 2000
|                                        |                                                                                                               |   |                    |             |                   |   |       |            |     
|Numerator:                              |                                                                                                               |   |                    |             |                   |   |       |            |      |   |       |             |   |   |       |           
|                                        | Net loss                                                                                                      |   | $                  | (37,621     | )                 |   | $     | (47,751    | )    |   | $     | (134,539    | ) |   | $     | (129,371   | )
|                                        |                                                                                                               |   |                    |             |                   |   |       |            |      |   |       |             |   |   |       |           
|Denominator:                            |                                                                                                               |   |                    |             |                   |   |       |            |      |   |       |             |   |   |       |           
|                                        | Weighted-average number of shares of common stock
outstanding and not subject to repurchase during the
period |   |                    | 140,624,292 |                   |   |       | 97,146,353 |      |   |       | 139,607,253 |   |   |       | 95,342,494 |  
|                                        |                                                                                                               |   |                    |             |                   |   |       |            |      |   |       |             |   |   |       |           
|Basic and diluted loss per common share |                                                                                                               | $ | (0.27              | )           |                   | $ | (0.49 | )          |      | $ | (0.96 | )           |   | $ | (1.36 | )         
|                                        |                                                                                                               |   |                    |             |                   |   |       |            |      |   |       |             |   |   |       |           

Basic loss per share is based upon the average number of shares of common
stock outstanding during the periods.

Diluted loss per common share is equal to basic loss per common share
because if potentially dilutive securities were included in the computation,
the result would be anti-dilutive. These potentially dilutive securities
consist of unvested restricted common stock, stock options and warrants.

4. Capital Lease Obligations

The Company has entered into capital lease agreements to acquire certain
equipment. Property and equipment includes the following amounts for leases
that have been capitalized.

|                         |       |   |               |        |              |   |         |        | 
|------------------------ | ----- | - | ------------- | ------ | ------------ | - | ------- | ------ | 
|                         |       |   | September 30, |        | December 31,
|                         |       |   | 2001          |        | 2000        
|                         |       |   |               |        |             
|Computers and software   |       | $ | 108,176       |        |              | $ | 79,356  |       
|Accumulated amortization |       |   | (36,951       | )      |              |   | (20,688 | )     
|                         |       |   |               |        |              |   |         |       
|                         | Total |   | $             | 71,225 |              |   | $       | 58,668 | 
|                         |       |   |               |        |              |   |         |       

Amortization of leased property is included in depreciation and amortization expense.

Future minimum payments under capital lease obligations consist of the following at September 30, 2001:

|                                           |                              |   |         |        | 
|------------------------------------------ | ---------------------------- | - | ------- | ------ | 
|2001                                       |                              | $ | 10,493  |       
|2002                                       |                              |   | 38,400  |       
|2003                                       |                              |   | 20,632  |       
|2004                                       |                              |   | 1,236   |       
|                                           |                              |   |         |       
|                                           | Total minimum lease payments |   |         | 70,761 | 
|Amounts representing interest              |                              |   | (4,143  | )     
|                                           |                              |   |         |       
|Present value of capital lease obligations |                              |   | 66,618  |       
|Current portion                            |                              |   | (32,549 | )     
|                                           |                              |   |         |       
|Capital lease obligations, non-current     |                              | $ | 34,069  |       
|                                           |                              |   |         |       

5. Long-Term Debt and Convertible Subordinated Notes in Default

Long-term debt consists of the following:

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |  |   |   |               |  |              |  |  |  |   |     |  |  | 
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | - | - | ------------- |  | ------------ |  |  |  | - | --- |  |  | 
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |  |   |   | September 30, |  | December 31,
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |  |   |   | 2001          |  | 2000        
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |  |   |   |               |  |             
|Note payable to bank due in June 2002 and bearing interest
at 9% per annum. This note is payable in aggregate monthly
installments of principal and interest of $7 with all
unpaid principal and interest due at maturity. This note
is secured by a mortgage on the real property purchased
with the proceeds and with restricted cash equal to the
principal balance pledged as additional security. This
property was sold in September 2001 and the note was paid
in full |  | $ |  |               |  |              |  |  |  | $ | 795 | 
|Notes payable due September 1, 2002 through May 1, 2003 and                                                                                                                                                                                                                                                                                                                                                                                                                   |  |   |   |               |  |              |  |  |  |   |     | 

8



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##### 



|                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                           |       |  |  |  |   |        |       |        |   |        |        |        | 
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ----- |  |  |  | - | ------ | ----- | ------ | - | ------ | ------ | ------ | 
|                                                                                                                                                                                                                                                                                                                                                                       | bearing interest at 11.3% to 13.61% per annum. These notes
are payable in aggregate monthly installments of principal
and interest of $303 and are collateralized by certain furniture, fixtures, equipment, and software |       |  |  |  |   |        | 4,360 |        |   |        | 13,568 |       
|Notes payable due January 2002 through March 2002 and
bearing interest at 10.0% to 11.9% per annum. These notes
are payable in quarterly installments of $1,071 with all
unpaid principal and interest due at maturity. These notes
are collateralized by certain software licenses                                                                                    |                                                                                                                                                                                                                           |       |  |  |  |   | 2,167  |       |        |   | 9,030  |       
|Notes payable due in May 2002 and bearing interest at 12.4%
and 13.1% per annum. The notes are payable in aggregate
monthly installments of principal and interest of $446 and
are collateralized by certain equipment                                                                                                                                                 |                                                                                                                                                                                                                           |       |  |  |  |   | 4,163  |       |        |   | 7,235  |       
|Notes payable due on February 2005 through May 2006 and
bearing interest at 7.5% per annum. The notes are payable
in aggregate monthly installments of principal and
interest of $79 with all unpaid principal and interest due
at maturity. The notes are secured by a mortgage on the
real property purchased with the proceeds                                      |                                                                                                                                                                                                                           |       |  |  |  |   | 7,974  |       |        |   | 8,232  |       
|Notes payable due on March 1, 2001 and bearing interest at
6.6% per annum. These notes were payable in aggregate
monthly installments of principal and interest of $39 and
were collateralized by the general assets of the
Company                                                                                                                                    |                                                                                                                                                                                                                           |       |  |  |  |   |       |       |        |   | 154    |       
|Notes payable due between March 2003 and September 2004
and bearing interest at rates from 8.25% to 10.25% per
annum. The notes are payable in aggregate monthly
installments of principal and interest of $2 and are
secured by
automobiles purchased with the proceeds                                                                                               |                                                                                                                                                                                                                           |       |  |  |  |   | 85     |       |        |   | 99     |       
|Note payable due on December 29, 2003 bearing interest at
9.8% per annum. The note is payable in monthly principal
installments of $99 plus interest and is collateralized by
restricted cash equal to the principal balance and certain
building improvements                                                                                                         |                                                                                                                                                                                                                           |       |  |  |  |   | 2,771  |       |        |   | 3,563  |       
|Note payable due on January 9, 2002 and bearing interest at
6.85% per annum. The note is payable in aggregate monthly
installments of principal and interest of $96 and is
collateralized by the general assets of the Company                                                                                                                                         |                                                                                                                                                                                                                           |       |  |  |  |   | 377    |       |        |   |       |       
|Note payable due June 1, 2010 and bearing interest at 8.80%
per annum. The note is payable in aggregate monthly
installments of principal and interest of $55 with all
unpaid principal and interest due at maturity. This note
is secured by a mortgage on the real property purchased
with the proceeds and restricted cash for a portion of the
outstanding balance |                                                                                                                                                                                                                           |       |  |  |  |   | 6,664  |       |        |   | 6,719  |       
|Amount outstanding under revolving credit line. Credit line
expires on January 2, 2004 and bears interest based on a
floating rate. Current rate is LIBOR plus 4.75%. Note is
interest only with principal due upon facility expiration
The note is secured by the general assets of the
Company                                                                       |                                                                                                                                                                                                                           |       |  |  |  |   | 10,300 |       |        |   |       |       
|Note payable to former shareholders of Conklin, bearing
interest at 10% per annum and due with accrued interest on
October 8, 2001                                                                                                                                                                                                                                     |                                                                                                                                                                                                                           |       |  |  |  |   | 2,000  |       |        |   | 2,000  |       
|                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                           |       |  |  |  |   |        |       |        |   |        |       
|                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                           | Total |  |  |  |   |        |       | 40,861 |   |        |        | 51,395 | 
|Less: current portion                                                                                                                                                                                                                                                                                                                                                  |                                                                                                                                                                                                                           |       |  |  |  |   | 25,115 |       |        |   | 22,020 |       
|Less: discounts                                                                                                                                                                                                                                                                                                                                                        |                                                                                                                                                                                                                           |       |  |  |  |   | 20     |       |        |   | 188    |       
|                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                           |       |  |  |  |   |        |       |        |   |        |       
|                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                           |       |  |  |  | $ | 15,726 |       |        | $ | 29,187 |       
|                                                                                                                                                                                                                                                                                                                                                                       |                                                                                                                                                                                                                           |       |  |  |  |   |        |       |        |   |        |       

Aggregate maturities of long-term debt at September 30, 2001 are as follows:

|                                          |       |   |        |        | 
|----------------------------------------- | ----- | - | ------ | ------ | 
|October 1, 2001 through December 31, 2001 |       | $ | 20,062 |       
|2002                                      |       |   | 5,376  |       
|2003                                      |       |   | 1,794  |       
|2004                                      |       |   | 567    |       
|2005                                      |       |   | 261    |       
|2006 and thereafter                       |       |   | 12,801 |       
|                                          |       |   |        |       
|                                          | Total |   | $      | 40,861 | 
|                                          |       |   |        |       

The Company is subject to a number of restrictive covenants under the
various debt agreements. On September 30, 2001, the Company was not in
compliance with certain financial covenants under the $50,000 revolving line of
credit with GE Capital Corporation and a $5,000 loan with Charter Financial
Corporation. These debt obligations have been classified as current
debt at

9



---



##### 



September 30, 2001. On October 5, 2001, the Company retired the debt of
$10,300 owed to GE Capital Corporation and has subsequently terminated the
revolving line of credit. Additionally, the Company continues to make the
scheduled payments on the loan with Charter Financial Corporation and is in
negotiations regarding the default provisions.

The Company has a secured note in the amount of $2,000 due to the former
shareholders of Conklin & Conklin on October 8, 2001, that bears interest at
10%, with interest payable monthly until the maturity date. The Company did
not make the scheduled payment on October 8, 2001 and is in discussions with
the former shareholders regarding the payment terms.

In 1999, the Company issued $125,000 of convertible subordinated notes,
due November 1, 2004, with interest accruing at 7% per annum, payable
semi-annually on May 1 and November 1 each year. The subordinated notes have
been classified as current debt as a result of the Companys election not to
make the interest payment due on November 1, 2001. The Company is in
discussions with holders of the subordinated notes regarding the restructuring
of these obligations. During the three months ended
September 30, 2001, minimal trading has occured with our notes
and, therefore, their fair market value is difficult to ascertain.

On November 2, 2001, the Company entered into a $25,000 revolving credit
facility with Foothill Capital Corporation for general corporate purposes. The
revolving credit facility bears interest ranging between 0.25% to 2.0% over
prime based on various covenants and is due on the maturity date of April 30,
2003 or earlier upon the occurrence and during continuation of an event of
default. The note has no principle amortization requirements and is secured by
the Companys cash and accounts receivable. The Company has not drawn funds from this
facility as of November 14, 2001.

6. Segment Information

The following tables set forth the Companys operating segments:

|                         |                                    |  |                    |        |                   |  |      |        |      |  |   |         |  |  |   |        | 
|------------------------ | ---------------------------------- |  | ------------------ | ------ | ----------------- |  | ---- | ------ | ---- |  | - | ------- |  |  | - | ------ | 
|                         |                                    |  | Three months ended |        | Nine months ended
|                         |                                    |  | September 30,      |        | September 30,    
|                         |                                    |  |                    |        |                  
|                         |                                    |  | 2001               |        | 2000              |  | 2001 |        | 2000
|                         |                                    |  |                    |        |                   |  |      |        |     
|Revenues:                |                                    |  |                    |        |                   |  |      |        |      |  |   |         |  |  |   |       
|                         | Enterprise Wide Solutions          |  | $                  | 15,633 |                   |  | $    | 11,599 |      |  | $ | 47,723  |  |  | $ | 29,810 | 
|                         | E-Commerce and Web Based Solutions |  |                    | 16,085 |                   |  |      | 16,669 |      |  |   | 52,834  |  |  |   | 42,471 | 
|                         |                                    |  |                    |        |                   |  |      |        |      |  |   |         |  |  |   |       
|                         | Consolidated                       |  | $                  | 31,718 |                   |  | $    | 28,268 |      |  | $ | 100,557 |  |  | $ | 72,281 | 
|                         |                                    |  |                    |        |                   |  |      |        |      |  |   |         |  |  |   |       
|Segment operating profit |                                    |  |                    |        |                   |  |      |        |      |  |   |         |  |  |   |       
|                         | Enterprise Wide Solutions          |  | $                  | 5,533  |                   |  | $    | 4,282  |      |  | $ | 16,863  |  |  | $ | 9,918  | 
|                         | E-Commerce and Web Based Solutions |  |                    | 11,462 |                   |  |      | 5,764  |      |  |   | 32,508  |  |  |   | 15,605 | 
|                         |                                    |  |                    |        |                   |  |      |        |      |  |   |         |  |  |   |       
|                         | Consolidated                       |  | $                  | 16,995 |                   |  | $    | 10,046 |      |  | $ | 49,371  |  |  | $ | 25,523 | 
|                         |                                    |  |                    |        |                   |  |      |        |      |  |   |         |  |  |   |       

A reconciliation of segment operating profit to net loss during the
periods presented is as follows:

|                                          |  |                    |         |                   |  |      |         |      |  |   |          |   |  |   |          |  
|----------------------------------------- |  | ------------------ | ------- | ----------------- |  | ---- | ------- | ---- |  | - | -------- | - |  | - | -------- | -
|                                          |  | Three months ended |         | Nine months ended
|                                          |  | September 30,      |         | September 30,    
|                                          |  |                    |         |                  
|                                          |  | 2001               |         | 2000              |  | 2001 |         | 2000
|                                          |  |                    |         |                   |  |      |         |     
|Segment operating profit for all segments |  | $                  | 16,995  |                   |  | $    | 10,046  |      |  | $ | 49,371   |   |  | $ | 25,523   |  
|Network and infrastructure costs          |  |                    | (5,271  | )                 |  |      | (7,038  | )    |  |   | (20,395  | ) |  |   | (19,350  | )
|General and administrative                |  |                    | (6,526  | )                 |  |      | (6,844  | )    |  |   | (20,865  | ) |  |   | (19,856  | )
|Sales and marketing                       |  |                    | (9,005  | )                 |  |      | (17,740 | )    |  |   | (36,704  | ) |  |   | (52,676  | )
|Product research and development          |  |                    | (483    | )                 |  |      | (945    | )    |  |   | (1,854   | ) |  |   | (2,286   | )
|Non-cash stock compensation expense       |  |                    | (3,985  | )                 |  |      | (6,019  | )    |  |   | (16,302  | ) |  |   | (15,895  | )
|Restructuring charge                      |  |                    | (2,643  | )                 |  |      |        |      |  |   | (11,496  | ) |  |   |         |  
|Impairment loss                           |  |                    | (2,432  | )                 |  |      |        |      |  |   | (3,780   | ) |  |   |         |  
|Depreciation and amortization             |  |                    | (19,721 | )                 |  |      | (15,447 | )    |  |   | (57,513  | ) |  |   | (36,377  | )
|Interest income                           |  |                    | 802     |                   |  |      | 2,385   |      |  |   | 4,111    |   |  |   | 6,883    |  
|Interest expense                          |  |                    | (5,352  | )                 |  |      | (6,149  | )    |  |   | (19,112  | ) |  |   | (15,337  | )
|                                          |  |                    |         |                   |  |      |         |      |  |   |          |   |  |   |          |  
|Net loss                                  |  | $                  | (37,621 | )                 |  | $    | (47,751 | )    |  | $ | (134,539 | ) |  | $ | (129,371 | )
|                                          |  |                    |         |                   |  |      |         |      |  |   |          |   |  |   |          |  

7. Restructuring Charge

In December 2000, the Company accrued a restructuring charge of $2,110.
The restructuring charge consisted of accrued severance costs of $727 related
to the involuntary termination of three employees and non-cancelable lease
obligations of $1,383

10



---



##### 



related to the closing of three sales offices. During the first nine
months of 2001, the Company accrued $11,496 related to additional restructuring
efforts. During this period, the Company accrued restructuring charges of
$7,965 related to severance costs for the involuntary termination of 481
employees. Additionally, the Company recognized restructuring charges of $3,531
for non-cancelable lease obligations resulting from the closing of an
additional seven offices. The Company is in the process of negotiating lease
termination settlements on these properties. A $556 reduction to the 2000
estimated accrual for the termination of various non-cancelable leases was
recorded in January 2001. The following table summarizes the activity related
to the accrued restructuring charges for the nine-month period ended September
30, 2001.

|                              |                                               |   |               |        |                |   |       |        |   |   |       |        |  
|----------------------------- | --------------------------------------------- | - | ------------- | ------ | -------------- | - | ----- | ------ | - | - | ----- | ------ | -
|                              |                                               |   | Severance and |        | Non-cancelable |   |       |        |  
|                              |                                               |   | related costs |        | lease costs    |   | Total
|                              |                                               |   |               |        |                |   |      
|Balance at December 31, 2000  |                                               | $ | 727           |        |                | $ | 1,383 |        |   | $ | 2,110 |       
|                              | Restructuring charge in 2001                  |   |               | 7,965  |                |   |       | 3,531  |   |   |       | 11,496 |  
|                              | Payments in 2001                              |   |               | (7,214 | )              |   |       | (1,038 | ) |   |       | (8,252 | )
|                              | Changes in estimate for restructuring accrual |   |               |       |                |   |       | (556   | ) |   |       | (556   | )
|                              |                                               |   |               |        |                |   |       |        |   |   |       |       
|Balance at September 30, 2001 |                                               | $ | 1,478         |        |                | $ | 3,320 |        |   | $ | 4,798 |       
|                              |                                               |   |               |        |                |   |       |        |   |   |       |       

Of the remaining $4,798 accrued restructuring charge at September 30,
2001, $4,190 is included in other accrued expenses and $608 in other long-term
liabilities.

8. Related Party Transactions and Impairment Loss

The Company holds a full recourse note totaling $4,249 due from a director
that bears interest at 9% per annum, and payable within 90 days on demand. The
loan was used to purchase shares of common stock pursuant to a stock option
agreement and to pay the tax liability resulting from the exercise of options.
At the time the loan was executed in July 2000, the Company reduced
stockholders equity by $2,250. In September 2001, the Company exercised the
demand provision of the note and requested full payment within the 90 days.
Subsequent to this demand, the Company became aware that the
collectibility of the full amount of the note was uncertain. Given
the current uncertainty regarding the collectibility of the note, the
Company presently estimates that it will likely recover an amount
approximating one-half of the total amount due, and has therefore
recorded an allowance of $2,432 classified as an impairment loss. The
Company continues to assess the collectibility of the note. The
Companys estimates as to the ultimate amount collected on the note
are subject to revision in the near term.

In November 2001, the Company collected from a former employee and
officer the prepayment of the principal amount of his loan, totaling $300, in
consideration of the Company waiving the 9% per annum interest on the loan
(approximately $35 at the time of pre-payment). The loan was due to be paid on
July 5, 2002.

9. Stock Warrants

In connection with shares of common stock issued for cash on January 2,
2001, the Company granted warrants to purchase 9,457,721 shares of common stock
at an exercise price of $4.08 per share, which expire in January 2006. All of
the warrants remained outstanding at September 30, 2001. For further
information, refer to notes to the consolidated financial statements included
in the Companys annual report on Form 10-K for the year ended December 31,
2000.

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Item 2.Managements Discussion and Analysis of Financial Condition and
Results of Operations

You should read the following discussion of our results of operations and
financial condition in conjunction with our consolidated financial statements
and related notes included elsewhere in this Form 10-Q. This discussion
contains forward-looking statements based on current expectations that involve
risks and uncertainties. Actual results and the timing of certain events may
differ significantly from those projected in such forward-looking statements
due to a number of factors. Dollar amounts stated herein are in thousands
except per share amounts.

Overview

We have developed an advanced, integrated service offering that provides
our clients the ability to use leading business software applications through
our state-of-the-art GSP environment. During 1998, we devoted substantially all
of our efforts to developing our network infrastructure, recruiting and
training personnel, establishing strategic business partnerships with
application software providers, completing two strategic acquisitions and
raising capital. During our first full year of operations in 1999, we continued
the development activities started in 1998 and began to market and sell our new
iMAP offerings. In 2000, we completed our development activities, increased our
client base, and expanded our iMAP offerings. We have incurred a cumulative net
loss since inception and expect to incur additional losses for the foreseeable
future. As of September 30, 2001, we had an accumulated deficit of $445,270.

As of September 30, 2001, we had 194 signed contracts with 133 clients
accounting for total revenue, assuming payment over the full contract terms, of
over $370,000, assuming payment of the full contract terms. While we continued
to obtain new contracts in the quarter, our total revenue under contract has
been reduced approximately $10,000 since the second quarter of 2001. This
reduction mainly results from terminations of clients in financial distress.

In August 2000, we purchased the assets of EnableVision, LLC, a
comprehensive provider of Lawson financial and human resources system
implementation services. The purchase price consisted of cash of $2,000 and
290,640 shares of restricted stock valued at $4,000 on the purchase date.

In October 1999, we purchased the assets of Conklin & Conklin, Inc., a
comprehensive provider of Lawson financial and human resources system
implementation services and a certified reseller of Lawson software licenses.
The purchase price consisted of cash of $7,700, assumed liabilities of $1,500,
and a $2,000 secured note. The secured note, which became due on October 8,
2001, bears interest at 10%, with interest payable monthly. In addition, the
purchase price consists of contingent payments of up to $4,600 in cash. The
Company already made payment of $2,185 to the Conklin shareholders in 2000. The
balance of $2,300 is payable on January 7, 2002, and has been accrued in the
other accrued expenses at September 30, 2001. We did not make the scheduled
payment of the Conklin note on October 8, 2001, and we are in discussions with
the Conklin shareholders regarding payment terms of the note and the balance of
the contingent payment as part of the proposed balance sheet restructuring
discussed in the Liquidity and Capital Resources section.

Revenue.We generate revenue from iMAP services and information
technology services. Revenues from professional IT services are recognized as
services are provided. iMAP revenues consist of fees for the Companys iMAP
services. iMAP service fees are consideration for access to our network of
Enterprise Data Centers or EDCs, hosting application software, and the
implementation and management of that software. iMAP contracts generally have a
three to five year term and revenues are recognized ratably over the contract
term. Payments received in advance of revenue recognition, even if
non-refundable, are recorded as deferred revenue and recognized ratably over
the term of the iMAP service contract. Some contracts permit termination
without cause by the clients. Contracts permitting termination without cause
generally provide for termination payments to us that will be recognized as
revenue when collectibility is assured.

Costs and expenses.We incur operating costs and expenses related to the
delivery of iMAP and professional IT services. They include direct cost of
services, network and infrastructure costs, general and administrative, sales
and marketing, product research and development, non-cash stock compensation,
and depreciation and amortization expenses.

We incur up-front costs related to the delivery of iMAP services. Product
research and development costs and the cost to operate our network and data
centers are recognized as period costs. Costs related to the acquisition of
hardware are capitalized and depreciated over the estimated useful life of the
hardware of five years. Costs related to the acquisition of software licenses
are capitalized and amortized over the lesser of either three years or the term
of the individual client contract, depending on the terms of the software
license agreement. Amortization is recorded on a straight-line basis over the
remaining useful life. Direct costs related to the integration of software
applications for a client on our network are
capitalized and amortized over the related contract period.

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Historical Results of Operations

Revenue

|                                   |               |   |                    |        |                    |   |                    |        |                    |   |        |         |  |   |        |        | 
|---------------------------------- | ------------- | - | ------------------ | ------ | ------------------ | - | ------------------ | ------ | ------------------ | - | ------ | ------- |  | - | ------ | ------ | 
|                                   |               |   | Three months       |        | Three months       |   | Nine months        |        | Nine months       
|                                   |               |   | ended              |        | ended              |   | ended              |        | ended             
|                                   |               |   | September 30, 2001 |        | September 30, 2000 |   | September 30, 2001 |        | September 31, 2000
|                                   |               |   |                    |        |                    |   |                    |        |                   
|iMAP                               |               | $ | 29,179             |        |                    | $ | 24,811             |        |                    | $ | 92,465 |         |  | $ | 60,354 |       
|Professional IT services           |               |   | 2,539              |        |                    |   | 3,457              |        |                    |   | 8,092  |         |  |   | 11,927 |       
|                                   |               |   |                    |        |                    |   |                    |        |                    |   |        |         |  |   |        |       
|                                   | Total revenue |   | $                  | 31,718 |                    |   | $                  | 28,268 |                    |   | $      | 100,557 |  |   | $      | 72,281 | 
|                                   |               |   |                    |        |                    |   |                    |        |                    |   |        |         |  |   |        |       
|Enterprise Wide Solutions          |               | $ | 15,633             |        |                    | $ | 11,599             |        |                    | $ | 47,723 |         |  | $ | 29,810 |       
|E-Commerce and Web Based Solutions |               |   | 16,085             |        |                    |   | 16,669             |        |                    |   | 52,834 |         |  |   | 42,471 |       
|                                   |               |   |                    |        |                    |   |                    |        |                    |   |        |         |  |   |        |       
|                                   | Total revenue |   | $                  | 31,718 |                    |   | $                  | 28,268 |                    |   | $      | 100,557 |  |   | $      | 72,281 | 
|                                   |               |   |                    |        |                    |   |                    |        |                    |   |        |         |  |   |        |       

Direct cost of services

|                                   |                                                                    |   |                    |        |                    |   |                    |        |                    |   |        |        |  |   |        |        | 
|---------------------------------- | ------------------------------------------------------------------ | - | ------------------ | ------ | ------------------ | - | ------------------ | ------ | ------------------ | - | ------ | ------ |  | - | ------ | ------ | 
|                                   |                                                                    |   | Three months       |        | Three months       |   | Nine months        |        | Nine months       
|                                   |                                                                    |   | ended              |        | ended              |   | ended              |        | ended             
|                                   |                                                                    |   | September 30, 2001 |        | September 30, 2000 |   | September 30, 2001 |        | September 30, 2000
|                                   |                                                                    |   |                    |        |                    |   |                    |        |                   
|iMAP                               |                                                                    | $ | 13,279             |        |                    | $ | 15,928             |        |                    | $ | 46,153 |        |  | $ | 39,016 |       
|Professional IT services           |                                                                    |   | 1,444              |        |                    |   | 2,294              |        |                    |   | 5,033  |        |  |   | 7,742  |       
|Network and infrastructure         |                                                                    |   | 5,271              |        |                    |   | 7,038              |        |                    |   | 20,395 |        |  |   | 19,350 |       
|                                   |                                                                    |   |                    |        |                    |   |                    |        |                    |   |        |        |  |   |        |       
|                                   | Total direct cost of services and Network and
infrastructure costs |   | $                  | 19,994 |                    |   | $                  | 25,260 |                    |   | $      | 71,581 |  |   | $      | 66,108 | 
|                                   |                                                                    |   |                    |        |                    |   |                    |        |                    |   |        |        |  |   |        |       
|Enterprise Wide Solutions          |                                                                    | $ | 10,100             |        |                    | $ | 7,317              |        |                    | $ | 30,860 |        |  | $ | 19,892 |       
|E-Commerce and Web Based Solutions |                                                                    |   | 4,623              |        |                    |   | 10,905             |        |                    |   | 20,326 |        |  |   | 26,866 |       
|Network and infrastructure         |                                                                    |   | 5,271              |        |                    |   | 7,038              |        |                    |   | 20,395 |        |  |   | 19,350 |       
|                                   |                                                                    |   |                    |        |                    |   |                    |        |                    |   |        |        |  |   |        |       
|                                   | Total direct cost of services and Network and
infrastructure costs |   | $                  | 19,994 |                    |   | $                  | 25,260 |                    |   | $      | 71,581 |  |   | $      | 66,108 | 
|                                   |                                                                    |   |                    |        |                    |   |                    |        |                    |   |        |        |  |   |        |       

Comparison of the three-month period ended September 30, 2001 to the
three-month period ended September 30, 2000

Revenue.Revenue generated was $31,718 for the three-month period ended
September 30, 2001 as compared to $28,268 for the three months ended September
30, 2000 and represents an increase of $3,450, or 12.2%.

The increase of $4,368 in iMAP revenue is attributable to increased
contract upgrades and cross sales with existing clients and one-time
termination fees. iMAP revenue for the third quarter includes one-time fees of
$2,323 related to the early terminations of an E-Commerce client and the early
termination of a portion of our business with another E-Commerce client.
Professional IT services revenue of $2,539 decreased $918, primarily due to
shifting resources from traditional IT clients to iMAP clients.

Enterprise Wide Solutions revenue increased $4,034 for the three-month
period ended September 30, 2001 as compared to the three-month period ended
September 30, 2000. The increase in Enterprise Wide Solutions revenue is
mainly attributable to additional iMAP contracts for our financial management,
human resource and customer relationship management products. E-Commerce and
Web Based Solutions revenue decreased $584 as a result of the difficult market
conditions within the e-commerce market place. Despite deterioration of the
e-commerce market, the Company continues to see demand for mature e-commerce
capability from traditional businesses.

Gross margins, direct costs of services, network and infrastructure costs.
For the three months ended September 30, 2001, we incurred $19,994 for direct
costs of services and network and infrastructure costs as compared to $25,260
for the three months ended September 30, 2000. The decrease of $5,266 is mainly
attributable to cost efficiencies gained as the company continues to improve
processes and the restructuring efforts made in the first six months of fiscal
year 2001.

For the three month period ended September 2001, we incurred $13,279 and
$1,444 of direct costs related to the delivery of our iMAP and professional IT
services, respectively, as compared to $15,928 and $2,294, respectively, for
the three month period ended September 30, 2000. The decrease of $2,649 in iMAP
services is directly attributable to gains in operational efficiency and the
restructuring efforts that occurred in early 2001. In addition, we wrote off
$287 of deferred iMAP costs related to the early

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terminations of contracts for which we received termination fees. The $850
decrease in professional IT services costs is directly related to the decrease
in professional services revenue.

In addition, we incurred $5,271 of costs related to the maintenance of our
network and infrastructure costs for the three months ended September 30, 2001
as compared to $7,038 in related costs during the three months ended September
30, 2000. The decrease of $1,767 is attributable to reduced labor costs from
the Companys restructuring efforts in the first six months of fiscal year
2001, partially offset by increased client related telecom and hardware
maintenance costs.

Gross margins, including iMAP network and infrastructure costs, for the
three months ended September 30, 2001 were 36.4%and 43.1% for iMAP and
professional IT services, respectively. These margins for the three months
ended September 30, 2000 were 7.4% and 33.6%, respectively. Our margins for
iMAP services are expected to continue to improve because our business model
contemplates a much smaller increase in network and infrastructure costs as
revenues increase. Professional IT services margins are expected to remain
constant for the foreseeable future.

For the three months ended September 30, 2001, we incurred $10,100 and
$4,623 of direct costs related to the delivery of our Enterprise Wide Solutions
and E-Commerce and Web Based Solutions, respectively. For the three months
ended September 30, 2000, we incurred $7,317 of direct costs related to
Enterprise Wide Solutions and $10,905 of direct costs related to E-Commerce and
Web Based Solutions. The increase in the Enterprise Wide Solution costs is
directly attributable to incremental client costs associated with our increase
in iMAP client contracts. The decrease in the E-Commerce and Web Based
Solutions costs results from the changing product mix within the company and
the restructuring efforts as described in note 7 to the financial statements.

Segment operating profit margin, which excludes iMAP networking and
infrastructure costs, for Enterprise Wide Solutions was 35.4% for the three
months ended September 30, 2001 as compared to 36.9% for the three months ended
September 30, 2000. Excluding the early termination fees of $3,529 received in
the quarter, segment operating profit margins for E-Commerce and Web Based
Solutions improved to 54.0% for the three months ended September 30, 2001 as
compared to 34.6% for the three months ended September 30, 2000. Enterprise
Wide Solutions operating profit margin decreased slightly as a result of
competitive pricing. The operating profit margins for both segments continue to
benefit from the utilization of the investment made in 2000 to support the
increase in iMAP contracts.

General and administrative expenses.We incurred $6,526 of general and
administrative expenses compared to $6,844 for the three-month periods ended
September 2001 and 2000, respectively. The decrease of $318 results from the
Companys restructuring efforts in the first six months of fiscal year 2001.
We anticipate general and administrative expenses to decrease in future periods
due to the additional restructuring efforts initiated in September 2001.

Sales and marketing expenses.For the three months ended September 30,
2001, we incurred $9,005 of sales and marketing expenses compared to $17,740
for the three months ended September 30, 2000. The decrease of $8,735 results
from a reduction in the product management and sales force in 2001 due to the
restructuring efforts and the consolidation of business units in early 2001.
Additionally, the Company has incurred lower marketing and advertising costs
for the three months ended September 30, 2001.

Product research and development expenses.For the three months ended
September 30, 2001, we incurred $483 of product research and development
expenses compared to $945 for the three months ended September 30, 2000. This
decrease results from the companys focus on core product offerings and the
consolidation of business units in 2001. We expect our product research and
development costs to remain constant for the foreseeable future.

Non-cash stock compensation expense.For the three-month period ended
September 30, 2001, we incurred a total of $3,985 in non-cash stock
compensation expenses compared to $6,019 for the three-month period ended
September 30, 2000. During fiscal year 2000, the company offered employee stock
options granted for nominal exercise prices in lieu of cash bonuses. Non-cash
stock compensation decreased period over period as the stock options related to
2000 bonuses vested earlier in 2001. This program was discontinued in December
2000. Additionally, contributions to employee retirement plans decreased as a
result of the reduction in work force during the first six months of fiscal
year 2001. We expect to incur up to $10,044 of non-cash stock compensation
expense over the next three to four years as a result of a stock option swap
program implemented in November 2000. This program allowed employees to
exchange stock options granted since January 2000 at a rate of two options for
one share of restricted stock. We also expect to incur up to $5,793 in non-cash
stock compensation expense through 2002 related to the intrinsic value of 1999
and 2000 stock option grants.

Depreciation and amortization.For the three months ended September 30,
2001, we incurred $19,721 in depreciation and
14amortization expenses, compared to $15,447 for the three months ended
September 30, 2000. Of the $4,274 million increase, $3,774 represents
depreciation of our increasing investment in property and equipment and the
amortization of our prepaid software licenses. The remaining amount of $500
represents the amortization of the goodwill recorded upon our acquisitions of
Conklin, ACR, IIT and EnableVision.Interest income and expense.For the three months ended September 30,
2001, we incurred $5,352 in interest expense and generated $802 of interest
income. For three months ended September 30, 2000, we incurred $6,149 of
interest expense and generated $2,385 of interest income. Our interest expense
decreased as our long-term debt and capital lease obligations mature and also
result from reduced interest payments on software licenses purchased early in
fiscal year 2000. See Notes 4 and 5 to our September 30, 2001 consolidated
financial statements for a summary of our capital lease and long-term debt
obligations at September 30, 2001.We generated interest income in the third quarter of 2001 from the
temporary investments of our proceeds from our November 2000 and January 2001
debt and equity transactions. During the three-month period ended September 30,
2000, we generated interest income from the temporary investment of the
proceeds of our February 2000 common stock offering and our November 1999 debt
offering.Comparison of the nine-month period ended September 30, 2001 to the nine-month
period ended September 30, 2000Revenue.For the nine-month period ended September 30, 2001, revenue
generated was $100,557 as compared to $72,281 for the nine-month period ended
September 30, 2000 and represents a $28,276, or 39.1%, increase.The increase of $32,111 in iMAP revenue is attributable to the increased
contract units, increased contract upgrades and cross sales with existing iMAP
clients as well as a full nine months of revenue from contracts signed in
fiscal year 2000. Included in our 2001 iMAP revenues were one-time fees of
$6,237 related to the early termination of several E-Commerce contracts.
Professional IT services revenue decreased $3,835, primarily due to shifting
resources from traditional IT clients to iMAP.The increase of $17,913 in Enterprise Wide Solutions revenue is mainly
attributable to additional iMAP contracts for our financial management, human
resource and customer relationship management products. The increase of $10,363
in E-Commerce and Web Based Solutions is attributable to additional client iMAP
contracts for our E-Commerce and E-business products. In addition, three early
terminations of E-Commerce contracts contributed $6,237 to revenue in the
nine-month period ended September 30, 2001.Gross margins, direct costs of services, network and infrastructure costs.
For the nine months ended September 30, 2001, we incurred $71,581 for direct
costs of services and network and infrastructure costs as compared to $66,108
for the three months ended September 30, 2000. The increase of $5,473 is mainly
attributable to increased volume and increases in hardware and software
maintenance and client network connectivity.For the nine months September 30, 2001, we incurred $46,153 and $5,033 of
direct costs related to the delivery of our iMAP and professional IT services,
respectively. For the nine months ended September 30, 2000, we incurred $39,016
of direct costs related to iMAP services and $7,742 of direct costs related to
professional IT services. The $7,137 increase in iMAP services costs is
directly attributable to our increase in the volume of iMAP services. In
addition, we wrote off $1,101 of deferred iMAP costs related to the early
termination of three contracts for which we received termination fees. The
$2,709 decrease in professional IT services costs is directly related to the
decrease in professional services revenue.In addition, we incurred $20,395 of costs related to the maintenance of
our network and infrastructure costs for the nine months ended September 30,
2001 as compared to $19,350 in related costs for the nine months ended
September 30, 2000. The increase of $1,045 is attributable to costs required to
support our business growth.Gross margins, including iMAP network and infrastructure costs, for the
nine months ended September 30, 2001 were 28.0% and 37.8% for iMAP and
professional IT services, respectively. These margins for the nine months ended
September 30, 2000 were 3.3% and 35.1%, respectively. Our margins for iMAP
services are expected to continue to improve because our business model
contemplates a much smaller increase in network and infrastructure costs as
revenues increase. Professional IT services margins are expected to remain
constant for the foreseeable future.For the nine months ended September 30, 2001, we incurred $30,860 and
$20,326 of direct costs related to the delivery of our Enterprise Wide
Solutions and E-Commerce and Web Based Solutions, respectively. For the nine
months ended September 30 2000, we incurred $19,892 of direct costs related to
Enterprise Wide Solutions and $26,866 of direct costs related to E-Commerce and
Web15Based Solutions. The increase in the Enterprise Wide Solution costs is
directly attributable to incremental client costs associated with our increase
in iMAP client contracts. E-Commerce and Web Based Solutions costs decreased
as a result of a change in product mix and the restructuring efforts made early
in fiscal year 2001.Segment operating profit margins, which exclude iMAP networking and
infrastructure costs, for Enterprise Wide Solutions improved to 35.3% for the
nine months ended September 30, 2001 as compared to 33.3% for the nine months
ended September 30, 2000. Excluding termination fees of $7,549 received during
the fiscal year 2001, segment operating profit margins for E-Commerce and Web
Based Solutions improved to 49.2% for the nine months ended September 30, 2001
as compared to 36.7% for the nine months ended September 30, 2000. Both of
these improvements reflect the utilization of the investment made in 2000 to
support the increase in iMAP contracts.General and administrative expenses.For the nine months ended September
30, 2001, we incurred $20,865 of general and administrative expenses compared
to $19,856 for the nine months ended September 30, 2000. The increase of $1,009
principally reflects the costs associated with a sign-on bonus for a new
executive and additional leased office space. We anticipate general and
administrative expenses to decrease in future periods due to the restructuring
efforts initiated in May and September of fiscal year 2001.Sales and marketing expenses.For the nine months ended September 30,
2001, we incurred $36,704 of sales and marketing expenses compared to $52,676
for the nine month period ended September 30, 2000. The decrease of $15,972
reflects lower marketing and advertising costs incurred for the nine-months
ended September 30, 2001. Additionally, the number of product management and
sales personnel has decreased due to the consolidation of business units from
eight in 2000 to two in 2001 and the restructuring efforts in the first and
second quarters of 2001 as further described in note 7 to the financial
statements.Product research and development expenses.For the nine months ended
September 30, 2001, we incurred $1,854 of product research and development
expenses compared to $2,286 for the nine months ended September 30, 2000. The
decrease results from our focus on core products and the consolidation of
business units from eight in 2000 to two in 2001. We expect our product
research and development costs to remain constant for the foreseeable future.Non-cash stock compensation expense.For the nine months ended September
30, 2001, we incurred a total of $16,302 in non-cash stock compensation
expenses compared to $15,895 for the nine months ended September 30, 2000. The
increase reflects the amortization of unearned compensation for awards prior to
the period offset by reductions in the period expense in connection with
employee retirement plans and the discontinuation of the employee stock
purchase plan. We expect to incur up to $10,044 of non-cash stock compensation
expense over the next three to four years as a result of a stock option swap
program implemented in November 2000. This program allowed employees to
exchange stock options granted since January 2000 at a rate of two options for
one share of restricted stock. We also expect to incur up to $5,793 in non-cash
stock compensation expense through 2002 related to the intrinsic value of 1999
and 2000 stock option grants.Depreciation and amortization.For the nine months ended September 30,
2001, we incurred $57,513 in depreciation and amortization expenses, compared
to $36,377 for the nine months ended September 30, 2000. Of the $21,136
increase, $19,636 represents depreciation of our increasing investment in
property and equipment and the amortization of our prepaid software licenses.
The remaining amount of $1,500 represents the amortization of the goodwill
recorded upon our acquisitions of Conklin, ACR, IIT and EnableVision.Interest income and expense.For the nine months ended September 30,
2001, we incurred $19,112 in interest expense and generated $4,111 of interest
income. For nine months ended September 30, 2000, we incurred $15,337 of
interest expense and generated $6,883 of interest income. Our interest expense
has increased as we continue to finance through long-term debt and capital
lease obligations investments in our client solutions and in our network and
infrastructure. See Notes 4 and 5 to our September 30, 2001 consolidated
financial statements for a summary of our capital lease and long-term debt
obligations.We generated interest income in the first nine months of fiscal year 2001
from the temporary investments of our proceeds from our November 2000 and
January 2001 debt and equity transactions. During the same prior year period,
we generated interest income from the temporary investment of the proceeds of
our February 2000 common stock offering and our November 1999 debt offering.16Future Assessment of Recoverability and Impairment of GoodwillIn connection with our acquisition of the stock of IIT and ACR, and the
assets of Conklin and EnableVision, we recorded goodwill that is being
amortized on a straight-line basis over its estimated useful life. At September
30, 2001 the unamortized portion of these intangibles was $24,419, which
represented 6% of total assets and 27% of stockholders equity. Goodwill
represents the amount that we paid for these acquired businesses in excess of
the fair value of the acquired tangible and separately measurable intangible
net assets. We have estimated the useful life of our goodwill to be between
three to five years based upon several factors, the most significant of which
is the susceptibility of acquired businesses to change as a result of
technological advances and the rapidly changing needs of their customers.We periodically review the carrying value and recoverability of our
unamortized goodwill and other intangible assets for impairment. If the facts
and circumstances suggest that the goodwill or other intangible assets may be
impaired, the carrying value of this goodwill will be adjusted by an immediate
charge against income during the period of the adjustment. The length of the
remaining amortization period may also be shortened, which will result in an
increase in the amount of goodwill amortization during the period of adjustment
and each period thereafter until fully amortized. Once adjusted, there can be
no assurance that there will not be further adjustments for impairment and
recoverability in future periods. We have integrated the acquired businesses
into our primary iMAP service offerings. Therefore, in evaluating impairment a
principal factor we consider is the failure to achieve expected cash flows from
operations. (See the Recent Accounting Pronouncements section below.)Liquidity and Capital ResourcesAt September 30, 2001, we had cash and cash equivalents of $51,304. Cash
in excess of operating requirements is invested in high-grade liquid financial
instruments with maturities less than 90 days.For the nine months ended September 30, 2001, we used $52,475 of cash for
operating activities, $10,373 of cash in investing activities and generated
$57,190 of cash (net of debt repayments) through financing activities. Cash
used in operating activities was primarily used to fund operating losses. Our
accounts receivable balance was $29,031 at September 30, 2001, including
unbilled accounts receivable of $12,341. During the first nine months of 2001,
we wrote off $5,167 and reserved an additional $4,830 of accounts receivable
related to several early-stage companies that were experiencing financial
difficulty. At September 30, 2001 our accounts receivable balance has no
specific industry or customer concentration. We do not believe that delinquent
payments on our accounts receivable will materially affect our liquidity.We used cash in investing activities in the first nine months of 2001 and
2000, primarily to purchase computer hardware and software required to support
our shared infrastructure and new iMAP clients. During the first nine months of
2001, we acquired $34,789 of property and equipment, including equipment
financed with capital leases, compared to $124,758 purchased in the first nine
months of 2000. During 2001, we also received $17,900 of cash in a
sale-leaseback transaction of equipment we purchased in a prior period. The
majority of the base infrastructure required to provide our iMAP offerings has
been purchased. As a result, we expect that our capital expenditures for the
next several years will now largely be success-based, consisting of software
licenses, hardware and the expansion of existing data center facilities
required to implement iMAP offerings for our new customers. We expect to
expend between $30,000 and $35,000 on capital expenditures for fiscal year 2001
depending on our success in signing new contracts, including $180 committed to
improve our facilities. As financing of our capital expenditures may be
difficult, we plan to use cash for our capital expenditure requirements.During the first nine months of 2001, we paid contingent consideration of
$2,185 to the former shareholders of Conklin and Conklin, Inc., a company whose
assets we acquired in 1999. The purchase price of the acquisition consisted of
cash and a $2,000 secured note which became due in October 2001. On June 30,
2001, we accrued an additional $2,300 of contingent payments due to three
shareholders. We did not make payment on the note and such payment, along with
payment of the additional $2,300 contingent payment, are being negotiated as
part of out balance sheet restructuring.During the first nine months of 2001, we continued to obtain needed
capital through the sale of common stock, borrowings on our $50,000 line of
credit, and equipment financing arrangements. In January 2001, we received net
proceeds of $90,174 from the sale of 26,634,815 shares of our common stock.
During the nine months ended September 30, 2001, we also received cash of
$18,323 from our long-term borrowing arrangements, including $10,300 from our
line of credit. We made principal payments during the nine months ended
September 30, 2001 of $52,463 for our long-term debt and capital lease
obligations, compared to $22,861 for the nine months ended September 30, 2000.
Our debt and capital lease arrangements for the remainder of 2001 require
principal payments of17$28,050. We have retained a restructuring advisor,
Conway, Del Genio, Gries
& Co., LLC, who along with management, have begun discussions with our debt
holders and other creditors regarding the restructuring of our obligations. In
conjunction with these restructuring efforts, we elected not to pay the $4,375
semi-annual interest payment due on November 1, 2001 on our $125,000
convertible subordinated notes due November 1, 2004. Due to our election, we
are technically in default of the note indenture, with the default cure period
expiring as of December 1, 2001. We are also exploring alternatives
to reduce our capital needs. The timing and amount of our capital needs will
vary depending on a number of factors, including the level and pace of our
operations, the availability of our existing financing sources, unexpected
increases in our working capital needs, and the rate of our expansion and
growth.We worked throughout the quarter with our investment bank to identify more
permanent funding and evaluate strategic alternatives. On October 8, 2001 and
November 8, 2001, we executed letters of intent with Bain Capital Partners,
LLC (Bain) providing for an equity investment of up to $100,000, of which
affiliates of Bain would initially invest $75,000 in our business, with an
additional $25,000 available upon achievement of certain business milestones.
The investment is contingent upon a number of conditions, including, among
others, a mutually agreeable restructuring of our obligations, execution of
definitive documentation, and any necessary regulatory approvals. We continue
to work closely with Bain to structure the form of the transaction and to
execute a definitive agreement. If we consummate this agreement, we expect
that Bain will own substantially all of our equity, materially diluting our
current stockholders equity. We do not know whether we will reach a
definitive agreement with Bain or, if we do so, whether we will consummate the
transaction with Bain.If we do not reach a definitive agreement with Bain, we cannot be sure
that we will be able to obtain the additional financing to satisfy our cash
requirements or to implement our growth strategy on acceptable terms, if at
all. Based on our current plans and expectations, we will need additional
sources of capital beginning in 2002. If we cannot obtain such financing on
terms acceptable to us, we may be unable to fund our ongoing operations at their current
levels. Additionally, if we cannot come to consensual agreement with
our creditors, we may seek an in-court reorganization of the Company.As of September 30, 2001, we have arrangements with lenders and investors
that provide us with additional financing if certain conditions are met. These
arrangements are as follows:
        
        On November 1, 2001, we entered into a $25,000 revolving credit
facility with Foothill Capital for general corporate purposes. We have
not drawn funds from this facility as of November 14, 2001.
        
        We have entered into an equity draw-down agreement with Acqua
Wellington North American Equities Fund Ltd., which permits us to sell
shares of our common stock to Acqua Wellington at our sole discretion,
depending upon our needs. To date, Acqua Wellington has purchased
$5,000 of our common stock under this agreement. The agreement provides
that Acqua Wellington is committed to purchase up to $60,800 of our
common stock over the 28-month term of the purchase agreement. When our
common stock trades below $1 per share, Acqua Wellington is not
obligated to purchase our common stock. Our stock price has been below
$1 since August 2001, and there can be no assurance that Aqua Wellington
will agree to purchase our stock in future periods if our stock price is
not above $1. During the three months ended September 30, 2001, we made
no draw-downs under this line, and no future draw-downs are expected.On January 2, 2001, we entered into a $50,000 revolving line of credit with a
group of lenders led by GE Capital. On September 30, 2001, we were not in
compliance with certain covenant requirements under the revolving line of
credit. Therefore, these debt agreements were reclassified as current debt in
the September 30, 2001 financials. On October 5, 2001, we retired the
outstanding balance of $10,300 and subsequently terminated the revolving line
of credit.RestructuringIn December 2000, we accrued a restructuring charge of $2,110 related to
severance costs associated with the involuntary termination of certain
employees of USi and non-cancelable lease costs associated with the closing of
three sales offices. In January 2001, we accrued a restructuring charge of
$1,020 related to severance costs associated with the involuntary termination
of certain employees of USi. In May 2001, we accrued a restructuring charge of
$7,833 related to severance costs associated with the involuntary termination
of certain employees and an estimated accrual for the termination of various
non-cancelable lease costs. In September 2001, we accrued an additional
restructuring charge of $2,643 related to severance costs associated with the
involuntary termination of certain employees and an estimated accrual for the
termination of non-cancelable lease costs. We anticipate that substantially all
of the restructuring accrual will be paid in the next twelve months.18Recent Accounting PronouncementsIn June 2001, the Financial Accounting Standards Board approved the
issuance of Statement No. 141, Business Combinations, and Statement No. 142,
Goodwill and Other Intangible Assets. Statement No. 141 on business
combinations changes current practice by requiring the use of the purchase
method for all business combinations initiated after June 30, 2001, thereby
eliminating the use of the pooling-of-interest method of accounting.
Additionally, Statement No. 141 provides new criteria for determining whether
acquired intangible assets should be recognized separately from goodwill and
continues to ensure that the presentation of pro forma information required
under Accounting Principles Board Opinion No. 16, Business Combinations,be
included in the financial statements.Statement No. 142, Goodwill and Other Intangibles, eliminates the
requirement to amortize goodwill over finite lives. Rather, the asset will be
tested for impairment at least annually at the reporting unit level using an
approach defined by the Statement. Upon adoption, goodwill amortization will
cease. Any impairment loss recognized as a result of a transitional impairment
test of goodwill is recognized as the effect of a change in accounting
principle in the period of adoption. Statement No. 142 will be effective for
fiscal years beginning January 1, 2002. Currently, management has not yet
determined the effect of the pronouncement.Item 3.Quantitative and Qualitative Disclosures About Market RiskWe are exposed to market risk from changes in interest rates. Market risk
is the risk of loss to future earnings, to fair value or to future cash flows
that may result from the changes in the price of financial instruments. At
September 30, 2001, we had cash and cash equivalents of $51,304, which
consisted of demand deposit and money market accounts. The accounts are
interest rate sensitive; however, these investments have short maturities
mitigating this sensitivity. A hypothetical 100 basis point change in interest
rates would result in an immaterial change in our net loss for the nine months
ended September 30, 2001. At September 30, 2001, the fair value of long-term
debt and capital leases approximates its carrying value. A hypothetical 100
basis point change in interest rates would result in an immaterial change in
the fair value of the long-term debt and capital leases. Changes in the quoted
market price of our common stock affects the fair value of our convertible
subordinated notes. At September 30, 2001, we had $125,000 in principal amount
of convertible subordinated notes outstanding, bearing interest at 7%, which
mature November 1, 2004. During the three month period ended
September 30, 2001, minimal trading has occurred with our notes
and, therefore, their fair market value is difficult to ascertain. We continue to manage our
exposure to this risk through our regular operating and financing activities.
There have been no other significant changes in our interest rate risk and
other market risks.19PART II. OTHER INFORMATIONItem 1.Legal ProceedingsWe are not a party to any material legal proceedings. On or about October
24, 2001, a class action complaint was filed in the United States District
Court, Southern District of New York, naming the Company, its underwriters and
three of its officers. The bulk of the complaint alleges a laddering scheme
by the underwriters in which the initial public offering price of the Companys
common stock in April 1999 was artificially inflated. As of November 14, 2001,
the complaint had not been formally served upon the Company.Item 2.Changes in Securities and Use of ProceedsOn January 2, 2001, we issued 27,022,059 shares of common stock with
certain registration rights for an aggregate purchase price of $91,875,000 to
Microsoft, Inc., CFE, Inc., (a wholly owned subsidiary of GE Capital) and
Aether Systems, certain venture investors, our Chairman Christopher R.
McCleary, and Chief Executive Officer Andrew A. Stern. We also issued to these
shareholders warrants to purchase 9,457,721 shares of common stock for $4.08
per shares.The offer and sale of the securities above were made in reliance on the
exemption from registration under the Securities Act, provided by Section 4(2)
thereunder. The purchasers of these securities represented that they had
adequate access to information about the Company and were experienced in making
such investments.Item 3.Defaults Upon Senior SecuritiesNoneItem 4.Submission of Matters to a Vote of Security HoldersThere were no matters submitted to a vote of security holders.Item 5.Other InformationOn October 1, 2001, R. Dean Meiszer resigned from the Board of Directors.
We do not currently intend to fill the vacancy created by Mr. Meiszers
resignation.Item 6.Exhibits and Reports on Form 8-KNone20SIGNATURESPursuant to the requirements of the Securities Act of 1934, as amended,
USinternetworking, Inc. has duly caused this registration statement to be
signed on its behalf by the undersigned, thereunto duly authorized, in
Annapolis, Maryland on November 14, 2001.USINTERNETWORKING, INCBy:
        /s/ ANDREW A. STERNAndrew A. SternChief Executive OfficerBy:
        /s/ WILLIAM H. WASHECKAWilliam H. WasheckaExecutive Vice President and Chief Financial OfficerBy:
        /s/ MARK J. MCENEANEYMark J. McEneaneySenior Vice President and Chief Accounting Officer21