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SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549





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FORM 10-Q





[Mark One]





| | x |  | Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30,
2002. | 
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------ | 




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 No. 000-31003





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CORIO, INC.


(Exact name of the Registrant as specified in its charter)





Delaware (State or other
jurisdiction of Incorporation or organization

77-0492528 (I.R.S.
Employer Identification Number)959 Skyway Road, Suite 100 San
Carlos, California (Address of principal executive offices)

94070 (Zip
Code)





650-232-3000


(The Registrants telephone number, including area code)





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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  ̈





As of October 31, 2002, there were 56,508,451 shares of the Registrants common stock outstanding.





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CORIO, INC.





QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2002





Index





Page No.PART I.    FINANCIAL INFORMATIONItem 1.

Condensed Financial Statements (Unaudited):Condensed Balance SheetsSeptember 30, 2002 and December 31, 2001

3Condensed Statements of OperationsThree and Nine Months Ended September 30, 2002 and 2001

4Condensed Statements of Cash FlowsNine Months Ended September 30, 2002 and 2001

5Notes to Condensed Financial Statements

6Item 2.

Managements Discussion and Analysis of Financial Condition and Results of Operations

8Item 3.

Quantitative and Qualitative Disclosures about Market Risk

27Item 4.

Controls and Procedures

27PART II.    OTHER INFORMATIONItem 1.

Legal Proceedings

28Item 2.

Change in Securities and Use of Proceeds

28Item 3.

Defaults upon Senior Securities

28Item 4.

Submission of Matters to a Vote of Security Holders

28Item 5.

Other Information

28Item 6.

Exhibits and Reports on Form 8-K

28Signatures

29Certifications

30




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PART I.    
FINANCIAL INFORMATION





ITEM 1.    CONDENSED FINANCIAL STATEMENTS





CORIO, INC.





CONDENSED BALANCE SHEETS


(IN THOUSANDS, EXCEPT SHARE AMOUNTS)


(UNAUDITED)





SEPTEMBER 30, 2002


DECEMBER 31, 2001(1)ASSETSCurrent assets:Cash and cash equivalents

$
26,048


$
36,317Short-term investments


17,927



41,831Restricted cash


7,849



7,849Accounts receivable, net of allowance of $1,103 and $376 at September 30, 2002 and December 31, 2001,
respectively


7,216



2,819Unbilled receivables


1,968



999Prepaid expenses and other current assets


5,135



1,875Total current assets


66,143



91,690Property and equipment, net


19,392



20,618Other assets


3,316



982Total assets

$
88,851


$
113,290LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable

$
7,866


$
6,336Accrued liabilities


10,267



10,281Deferred revenue


2,443



1,969Current portion of notes payable


398



486Current portion of capital lease obligations


5,430



7,020Total current liabilities


26,404



26,092Notes payable less current portion






274Capital lease obligations less current portion


1,121



4,668Other liabilities


3,795



917Total liabilities


31,320



31,951CommitmentsStockholders equity:Preferred stock: $0.001 par value; 10,000,000 shares authorized, none issued and outstanding






Common stock: $0.001 par value; 200,000,000 shares authorized; 56,505,618 and 55,065,460 shares issued and outstanding
at September 30, 2002 and December 31, 2001, respectively


56



55Additional paid-in capital


296,705



298,272Unrealized gain on investments


95



372Deferred stock-based compensation


(1,457
)


(5,461
)Accumulated deficit


(237,868
)


(211,899
)Total stockholders equity


57,531



81,339Total liabilities and stockholders equity

$
88,851


$
113,290


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|(1) |  | Derived from audited financial statements.
|--- |  | ------------------------------------------




See accompanying notes to condensed financial statements.




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CORIO, INC.





CONDENSED STATEMENTS OF OPERATIONS


(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)


(UNAUDITED)





THREE MONTHS ENDED SEPTEMBER 30,


NINE MONTHS ENDED SEPTEMBER 30,2002


2001


2002


2001REVENUES:Application management services

$
9,399


$
9,959


$
28,417


$
27,381Professional services and other


3,982



2,720



9,959



11,167Total revenues


13,381



12,679



38,376



38,548COSTS AND EXPENSES:Application management services *


9,704



10,159



27,024



31,563Professional services and other *


3,708



2,938



10,583



12,929Research and development *


1,316



1,916



5,092



7,161Sales and marketing *


2,085



4,326



8,324



17,647General and administrative *


2,693



4,811



8,682



16,824Restructuring charges


4,036







4,036



1,413Amortization of stock based compensation


690



1,456



1,791



3,184Amortization of intangible assets


56



141



56



564Total operating expenses


24,288



25,747



65,588



91,285Loss from operations


(10,907
)


(13,068
)


(27,212
)


(52,737
)Interest and other income


482



1,179



1,596



4,810Interest and other expense


(203
)


(497
)


(753
)


(2,122
)Tax benefit


400







400



Net loss attributable to common stockholders

$
(10,228
)

$
(12,386
)

$
(25,969
)

$
(50,049
)Basic and diluted net loss per share

$
(0.19
)

$
(0.25
)

$
(0.49
)

$
(1.00
)Shares used in computationbasic and diluted


53,978



50,527



52,605



50,133* Amortization of stock-based compensation not included in expense line itemApplication management services

$
50


$
74


$
226


$
49Professional services and other


48



102



317



71Research and development


51



(37
)


116



(319
)Sales and marketing


160



279



718



9General and administrative


381



1,038



414



3,374Total amortization of stock-based compensation

$
690


$
1,456


$
1,791


$
3,184





See accompanying notes to condensed financial statements.




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CORIO, INC.





CONDENSED STATEMENTS OF CASH FLOWS


(IN THOUSANDS)


(UNAUDITED)





NINE MONTHS ENDED SEPTEMBER 30,2002


2001CASH FLOWS FROM OPERATING ACTIVITIES:Net loss

$
(25,969
)

$
(50,049
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


8,176



11,235Amortization of intangibles


56



564Amortization of deferred stock-based compensation


1,791



3,184Compensation for grants of stock options and warrants in exchange for services


(114
)


466Loss on retirement of assets


52



Changes in assets and liabilities (net of acquisition):Accounts receivable


(1,053
)


3,698Prepaid expenses and other current assets


301



(234
)Accounts payable and accrued liabilities


(253
)


(3,955
)Deferred revenue


(456
)


(147
)Other liabilities


2,878



143Net cash used in operating activities


(14,591
)


(35,095
)CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of marketable securities


(41,539
)


(42,274
)Sales of marketable securities


65,166



75,431Increase in restricted cash






(7,735
)Purchase of property and equipment


(498
)


(4,314
)Other assets


309



1,351Cash received from termination fee netted against acquisition


1,000



Cash paid for acquisition


(15,000
)


Net cash provided by investing activities


9,438



22,459CASH FLOWS FROM FINANCING ACTIVITIES:Proceeds from sale of common stock and exercise of stock options


791



1,723Payments on notes payable and capital lease obligations


(5,907
)


(7,534
)Net cash used in financing activities


(5,116
)


(5,811
)Net decrease in cash and cash equivalents


(10,269
)


(18,447
)Cash and cash equivalents, beginning of period


36,317



58,455Cash and cash equivalents, end of period

$
26,048


$
40,008SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Cash paid for interest

$
723


$
1,274SUPPLEMENTAL NON-CASH INVESTING AND FINANCING ACTIVITIES:Acquisition of property and equipment under capital leases

$
407


$
3,819Issuance of stock and options in exchange for services

$



$
4Deferred stock-based compensation/ forfeitures, net

$
2,213


$
5,034Unrealized (loss) gain on investments

$
(277
)

$
497





See accompanying notes to condensed financial statements.




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CORIO, INC.





NOTES TO CONDENSED FINANCIAL STATEMENTS





NOTE 1SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





BASIS OF PRESENTATION





The accompanying unaudited condensed financial statements have been
prepared by Corio, Inc. (Corio or the Company) and reflect all adjustments that are, in the opinion of management, necessary for a fair presentation of the interim periods presented. Such adjustments are of a normal recurring
nature. The results of operations for the interim periods presented are not necessarily indicative of the results for any future interim period or for the entire fiscal year. Certain information and footnote disclosures normally included in annual
financial statements prepared in accordance with generally accepted accounting principles have been omitted, although the Company believes that the disclosures included are adequate to make the information presented not misleading. The unaudited
condensed financial statements and notes included herein should be read in conjunction with the audited financial statements and accompanying notes included in the Companys Annual Report on Form 10-K for the year ended December 31, 2001.





NET LOSS PER SHARE





Basic net loss per share is computed by dividing the net loss for the period by the weighted average number of shares of common stock outstanding during the period (excluding shares subject to repurchase). Diluted net loss
per share is computed by dividing the net loss for the period by the weighted average number of shares of common stock and potentially dilutive common securities outstanding during the period. Potentially dilutive common shares are excluded from the
computation in loss periods, as their effect would be antidilutive.





The following table sets forth potential
shares of common stock that are not included in the diluted net loss per share calculation as their effect would have been antidilutive for the periods indicated (in thousands):





2002

2001WEIGHTED AVERAGE EXERCISE PRICE

SHARES

WEIGHTED AVERAGE EXERCISE PRICE

SHARESPreferred stock warrants

$
2.52

900

$
6.50

372Common stock subject to repurchase

$
0.01

2,310

$
0.01

3,936Common stock options and warrants

$
2.12

15,912

$
3.57

15,192





RESTRICTED CASH





In connection with two facility leases, the Company is required to provide letters of credit as security for the leases. The letters of credit are available for a period of
one year with automatic one year renewals. The letters of credit are collateralized by a $7.9 million cash deposit which is recorded as restricted cash on the accompanying condensed balance sheet.





RECENT ACCOUNTING PRONOUNCEMENTS





In November 2001, the Emerging Issues Task Force (EITF) reached a consensus on EITF No. 01-14 regarding the income statement characterization of reimbursements received for out-of-pocket expenses incurred. The EITF
requires that reimbursements received for out-of-pocket expenses should be characterized as revenue in the income statement, where the service provider is the primary obligor with respect to purchasing goods and services from third parties, has
supplier discretion and assumes credit risk for the transaction. The announcement was effective for financial reporting periods beginning after December 15, 2001. Upon application of the statement, comparative financial statements for the prior
period were reclassified. For the three and nine months ended September 30, 2001, $526,000 and $1,360,000, respectively, in reimbursed application and professional services expenses have been reclassified as revenues. For the three and nine
months ended September 30, 2002, the Company recorded $540,000 and $1,625,000, respectively, of reimbursed expenses as revenues.





SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, provides new guidance on the recognition of impairment losses on long-lived assets to be held and used, or to be disposed of. This statement
also broadens the definition of what constitutes a discontinued operation and how the results of a discontinued operation are to be measured and presented. The adoption of SFAS No. 144 did not have a material effect on the Companys financial
statements.





NOTE 2ACCOUNTS RECEIVABLE





The Company records accounts receivable when amounts are billed in accordance with the contract terms or as services are performed under non-cancelable contractual services
arrangements. Included in accounts receivable at September 30, 2002 and December 31, 2001 were $1,968,000 and $999,000, respectively, of unbilled receivables under various application management and professional services contracts.




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NOTE 3WARRANTS





On September 27, 2000, Cap Gemini Ernst & Young U.S., L.L.C exercised its right to convert a portion of its initial warrant representing 2,333,333 shares into 960,810
shares of common stock through a cashless exercise. As these shares outstanding are repurchaseable under certain circumstances, the fair value of these shares subject to repurchase will be remeasured each reporting period until May 2003, when the
repurchase rights lapse. Amortization expense (credit) of ($269,000) and ($314,000) was recorded in sales and marketing expense for the three months ended September 30, 2002 and 2001, respectively related to these shares. Amortization expense
(credit) of ($143,000) and ($463,000) was recorded as a sales and marketing expense for the nine months ended September 30, 2002 and 2001, respectively related to these shares.





NOTE 4STOCK-BASED COMPENSATION





In connection with
stock options granted to employees to purchase common stock and net of stock options forfeited, the Company recorded reductions in deferred charges for stock-based compensation of $60,000 and $238,000 for the three months ended September 30, 2002
and 2001, respectively, and $2.2 million and $5.0 million for the nine months ended September 30, 2002 and 2001, respectively. Such amounts represent unamortized deferred stock compensation for unvested options that are forfeited upon severance. The
deferred charges for employee options are being amortized to expenses using the graded vesting approach, prescribed by FASB Interpretation No. 28, through 2004. Amortization of deferred stock-based compensation expense was $690,000 and
$1.5 million for the three months ended September 30, 2002 and 2001, respectively, and $1.8 million and $3.2 million for the nine months ended September 30, 2002 and 2001, respectively, net of stock options forfeited.





NOTE 5SIGNIFICANT CUSTOMER INFORMATION AND SEGMENT REPORTING INFORMATION





The Companys operations have been classified into two operating segments (i) application management services and (ii) professional services. Corporate expenses,
including those for sales and marketing, general and administrative and research and development, are not allocated to operating segments.





Disaggregated information is as follows (in thousands):





APPLICATION MANAGEMENT SERVICES


PROFESSIONAL SERVICES


UNALLOCATED


TOTALFor the Three Months Ended September 30, 2002Revenues

$
9,399


$
3,982


$



$
13,381Depreciation and amortization

$
2,140


$
11


$
553


$
2,704Segment profit (loss)

$
(305
)

$
274


$
(10,197
)

$
(10,228
)For the Three Months Ended September 30, 2001Revenues

$
9,959


$
2,720


$



$
12,679Depreciation and amortization

$
2,458


$
59


$
1,307


$
3,824Segment loss

$
(200
)

$
(218
)

$
(11,968
)

$
(12,386
)For the Nine Months Ended September 30, 2002Revenues

$
28,417


$
9,959


$



$
38,376Depreciation and amortization

$
6,437


$
42


$
1,698


$
8,177Segment profit (loss)

$
1,393


$
(624
)

$
(26,738
)

$
(25,969
)For the Nine Months Ended September 30, 2001Revenues

$
27,381


$
11,167


$



$
38,548Depreciation and amortization

$
7,099


$
180


$
3,956


$
11,235Segment loss

$
(4,182
)

$
(1,762
)

$
(44,105
)

$
(50,049
)





The Company does not allocate assets to its operating segments, nor
does it allocate interest income or interest expense.





For the three and nine months ended September 30, 2002, one
customer accounted for 11% of total revenues. For the three months ended September 30, 2001, one customer accounted for 12% of total revenues. For the nine months ended September 30, 2001, no one single customer accounted for more than 10% of total
revenues.





At September 30, 2002, one customer accounted for 11% of total accounts receivable. At September 30,
2001, one customer represented 13% of total accounts receivable.




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NOTE 6RESTRUCTURING AND IMPAIRMENT ACCRUAL





The following table sets forth the charges added and taken against the restructuring and impairment accrual during the nine months ended
September 30, 2002 and the remaining restructuring and impairment accrual balance at September 30, 2002 (in thousands):





BALANCE DECEMBER 31, 2001

ADDITIONS

CASH PAID


BALANCE SEPTEMBER 30, 2002Employee severance

$
106

$
272

$
(378
)

$
Equipment lease obligations


480





(147
)


333Office lease obligation





3,764


(189
)


3,575Total

$
586

$
4,036

$
(714
)

$
3,908





The equipment lease obligations liability at September 30, 2002
relates to assets under equipment leases and financing agreements and will be paid over the remaining life of the lease and finance terms.





During the three months ended September 30, 2002, the Company reviewed its facilities requirements and vacated a portion of its headquarters in San Carlos, California. Related to this action, the Company took a third quarter
impairment charge of $3.8 million to record the estimated loss associated with a portion of the remaining lease stream of the unoccupied space. During the three months ended September 30, 2002, the Company also incurred $272,000 for severance
benefits.





NOTE 7BUSINESS COMBINATION





On September 20, 2002, the Company completed the purchase of the assets and the assumption of certain liabilities of the enterprise application service provider (ASP)
business of Qwest Cyber.Solutions LLC (QCS), a subsidiary of Qwest Communications International Inc. The Company paid $15 million in cash for the acquisition and accrued direct acquisition costs of approximately $1.3 million. The Company also
received $1 million in termination fees from a QCS customer that was acquired which the Company netted against the purchase price. $1.5 million of the purchase price was deposited into escrow, to be held as security for a limited period of time
for any losses incurred by the Company in the event, among other matters, of any breach by QCS of the agreements, covenants, representations and warranties it made under or in connection with the purchase agreement. All or a portion of the
$1.5 million in escrow will be paid to the Company if specified revenue levels are not met related to the customer contracts acquired from QCS.





The Company acquired certain assets of QCSs ASP business, including customer contracts related to the ASP business, internally used and developed software, certain tangible assets such as
computers, servers, routers, firewalls and related equipment, and accounts receivable. The Company is currently integrating the acquired business into its existing business and will support the QCS customer relationships acquired as part of the
acquisition.





The following table summarizes the Companys preliminary allocation of the total purchase price
of $16.3 million to the assets acquired and liabilities assumed from QCS at the date of acquisition. As the total purchase price exceeded the estimated fair values of the assets acquired and liabilities assumed, no goodwill was recorded as a result
of this transaction. The allocation of the total purchase price is preliminary and subject to final adjustment.





Accounts receivable

$
5,300,000Prepaid expenses and other current assets


3,600,000Property and equipment


6,100,000Other assets


2,700,000Accounts payable and accrued liabilities


(500,000
)Deferred revenue


(900,000
)Total

$
16,300,000





The Company recorded an intangible asset for acquired customer
contracts of $2.7 million, which is included in other assets in the accompanying balance sheet. This intangible asset is being amortized over an estimated life of 18 months.





NOTE 8INCOME TAXES





Since inception, we have incurred
net losses for federal and state tax purposes, and anticipate losses for the foreseeable future. We have therefore not recognized any material tax provision or benefit for income taxes for the three and nine months ended September 30, 2001. The
Company recognized a $400,000 tax benefit for the three and nine months ended September 30, 2002 after determining that a tax provision related to an exposure item recorded in connection with our acquisition of Data Systems Connectors, Inc. in 1998
was no longer needed due to the completion of a tax examination.





|ITEM 2. |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- |  | -------------------------------------------------------------------------------------




The following Managements Discussion and Analysis of our Financial Condition and Results of Operations should be read in conjunction
with the unaudited condensed financial statements and notes thereto included in Part I-Item 1 of this Quarterly Report and the audited financial statements and notes thereto and Managements Discussion and Analysis in the Companys 2001
Annual Financial Report to Stockholders.




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THIS REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE
MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AND THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995, INCLUDING, WITHOUT LIMITATION, STATEMENTS REGARDING THE COMPANYS
EXPECTATIONS, BELIEFS, INTENTIONS OR FUTURE STRATEGIES THAT ARE SIGNIFIED BY THE WORDS EXPECTS, ANTICIPATES, INTENDS, BELIEVES, OR SIMILAR LANGUAGE. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS
DOCUMENT ARE BASED ON INFORMATION AVAILABLE TO THE COMPANY ON THE DATE HEREOF, AND THE COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS AFTER THE DATE HEREOF. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE PROJECTED IN
THE FORWARD-LOOKING STATEMENTS AS A RESULT OF MANY FACTORS, INCLUDING BUT NOT LIMITED TO THOSE SET FORTH UNDER ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS HEREIN. IN EVALUATING THE COMPANYS BUSINESS, PROSPECTIVE INVESTORS
SHOULD CAREFULLY CONSIDER THE INFORMATION SET FORTH BELOW UNDER THE CAPTION ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS IN ADDITION TO THE OTHER INFORMATION SET FORTH HEREIN. THE COMPANY CAUTIONS INVESTORS THAT ITS BUSINESS AND
FINANCIAL PERFORMANCE ARE SUBJECT TO SUBSTANTIAL RISKS AND UNCERTAINTIES.





OVERVIEW





We are a leading enterprise application service provider, or ASP. We provide to our customers application implementation, integration,
management and various upgrade services and related hardware and network infrastructure. We implement, integrate and manage a suite of enterprise software applications from leading vendors. Following the rapid implementation of software
applications, performed for a fixed fee or on a time and material basis, our customers pay a monthly service fee based largely on the number of applications used and total users.





CRITICAL ACCOUNTING POLICIES





The preparation of financial
statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make judgments, assumptions and estimates that affect the amounts reported in the financial statements and
accompanying notes. Note 1 to the financial statements in the Annual Report on Form 10-K for the fiscal year ended December 31, 2001 describes the significant accounting policies and methods used in the preparation of the financial statements.
Estimates are used for, but not limited to, the accounting for revenue recognition, the allowance for doubtful accounts, contingencies and other special charges. Although we believe that our estimates and assumptions are reasonable, they are based
upon information presently available. Actual results could differ from these estimates.





We regularly monitor the
credit worthiness of our customers and designate certain customers, who we anticipate as credit risks, as cash basis customers. For these customers, revenue is generally recognized on or around the date when the payment for services is received by
us. Revenue could be affected based on the timing of payments by cash basis customers as well as the change in composition of the cash basis customers.





The allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts and the aging of the accounts receivable. If there is a deterioration of a major
customers credit worthiness or actual defaults are higher than our historical experience, our estimates of the recoverability of amounts due us could be adversely affected.





Our office lease obligation is based on our assessment of our estimated sublease income over the remaining lease term. If our actual sublease income is less than projected,
our estimated office lease obligation could be adversely affected.





We are subject to the possibility of various
loss contingencies arising in the ordinary course of business. We consider the likelihood of the loss or the incurrence of a liability as well as our ability to reasonably estimate the amount of loss in determining loss contingencies. An estimated
loss contingency is accrued when it is probable that a liability has been incurred or an asset has been impaired and the amount of loss can be reasonably estimated. We regularly evaluate current information available to us to determine whether such
accruals should be adjusted.





We evaluate long-lived assets, including goodwill and other intangibles, for
impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of any asset to future
undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the
assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.




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Since we implement some of our services on a fixed fee basis, if we incur more
costs than estimated, our profitability will suffer. Our process for tracking our progress to completion on such arrangements is through individual detailed project plans and the regular review of labor hours incurred compared to estimated hours to
complete the project. When estimates of costs to complete the project indicate that a loss will be incurred, these losses are recognized immediately.





We provided a valuation allowance against our entire net deferred tax asset, primarily consisting of net operating loss carryforwards as of December 31, 2001. The valuation allowance was recorded given
the losses we incurred through December 31, 2001, and our uncertainties regarding future operating profitability and taxable income. If we do not achieve profitability, we will not fully realize the deferred tax benefits.





RESULTS OF OPERATIONS





THREE AND NINE
MONTHS ENDED SEPTEMBER 30, 2002 and 2001





REVENUES





Total revenue was $13.4 and $12.7 million for the three months ended September 30, 2002 and September 30, 2001, respectively. For the
three months ended September 30, 2002, one customer accounted for 11% of total revenues. For the three months ended September 30, 2001, one customer accounted for 12% of total revenues. Total revenues decreased to $38.4 million for the nine months
ended September 30, 2002 from $38.6 million for the nine months ended September 30, 2001. For the nine months ended September 30, 2002, one customer accounted for 11% of total revenues. For the nine months ended September 30, 2001, no one single
customer accounted for 10% or more of total revenues.





We recorded no revenue for the three months ended September
30, 2002, arising from transactions with other companies with which we have directors in common. For the nine months ended September 30, 2002, we recorded $2.1 million of revenue arising from transactions with four companies with which we have
directors in common. Of this amount, $1.8 million related to services the Company provided to one customer. The Company did not purchase any products or services from this customer. At September 30, 2002, the Company had no accounts receivable
arising from such transactions. We recorded revenue of $1.7 million and $3.9 million for the three and nine months ended September 30, 2001, respectively, arising from transactions with seven companies with which we had directors in common. At
September 30, 2001, accounts receivable included $786,000 arising from such transactions.





In November 2001, the
Emerging Issues Task Force (EITF) reached a consensus on EITF No. 01-14 regarding the income statement characterization of reimbursements received for out-of-pocket expenses incurred. The EITF requires that reimbursements received for
out-of-pocket expenses should be characterized as revenue in the income statement, where the service provider is the primary obligor with respect to purchasing goods and services from third parties, has supplier discretion and assumes credit risk
for the transaction. The announcement was effective for financial reporting periods beginning after December 15, 2001. Upon application of the statement, comparative financial statements for the prior period were reclassified. For the three and nine
months ended September 30, 2001, $526,000 and $1,360,000, respectively, in reimbursed application and professional services expenses have been reclassified as revenues. For the three and nine months ended September 30, 2002, we recorded $540,000 and
$1,625,000, respectively, of reimbursed expenses as revenues. In future periods, we anticipate reimbursable revenue and expenses to be consistent with prior periods.





APPLICATION MANAGEMENT SERVICES REVENUES.For the three months ended September 30, 2002, revenues from our application management services
were $9.4 million, including approximately $2.0 million in non-recurring revenues from customer contract terminations, $3.9 million in payments from cash basis customers and $425,000 for 10 days of revenue from our newly acquired customers from QCS.
For the three months ended September 30, 2001, revenues were $10.0 million, including $971,000 in non-recurring revenues from customer contract terminations and $5.5 million in payments from cash basis customers. The decrease in application
management services revenues for the three months ended September 30, 2002, was primarily due to the decrease in payments from cash basis customers offset by an increase in termination fees and the additional revenue from the acquired QCS customers.
For the nine months ended September 30, 2002, revenues from our application management services were $28.4 million, including approximately $4.2 million in non-recurring revenues from customer contract terminations, approximately $500,000 from
customers for one-time fees, $11.6 million in payments from cash basis customers and $425,000 for 10 days of revenue from our newly acquired customers from QCS. For the nine months ended September 30, 2001, revenues were $27.4 million, including
$2.4 million in non-recurring revenues from customer contract terminations and $8.7 million in payments from cash basis customers. The increase in application management services revenues for the nine months ended September 30, 2002 was primarily
due to the increase in non-recurring revenues, one-time fees and payments from cash basis customers offset by a decrease in customers. We anticipate revenue to increase next quarter as we recognize an entire quarter of revenue for customers acquired
from QCS instead of the 10 days of revenue recognized in the three months ended September 30, 2002. We anticipate that non-recurring revenue from customer contract terminations will continue to vary over the next few periods. As we move away from
high-growth and middle market companies, revenue from termination fees may decrease.




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At September 30, 2002, the Company had a balance of $1.9 million for deferred
application management services revenues primarily from several customers who prepaid a portion of their contract. These deferred revenues are recognized as the related services are provided over the life of the contract.





PROFESSIONAL SERVICES AND OTHER REVENUES.Our professional services and other revenues were $4.0 million for
the three months ended September 30, 2002 and $2.7 million for the three months ended September 30, 2001. The increase in professional services revenues for the three months ended September 30, 2002 was primarily due to the increased size of the
customer implementations. Our professional services and other revenues were $10.0 million for the nine months ended September 30, 2002 and $11.1 million for the nine months ended September 30, 2001. The decrease in professional services revenues for
the nine months ended September 30, 2002 was primarily due to having 29 customer implementations during the nine months ended September 30, 2002 compared to 38 customer implementations during the nine months ended September 30, 2001.





COSTS AND EXPENSES





APPLICATION MANAGEMENT SERVICES EXPENSES.    Application management services expenses, excluding non-cash stock based compensation of $50,000 and $74,000 for the three months ended September 30, 2002 and
2001, respectively, were $9.7 million for the three months ended September 30, 2002 and $10.2 million for the three months ended September 30, 2001. Application management services expenses, excluding non-cash stock based compensation of
$226,000 and $49,000 for the nine months ended September 30, 2002 and 2001, respectively, were $27.0 million for the nine months ended September 30, 2002 and $31.6 million for the nine months ended September 30, 2001. The decrease in application
management services expenses for the three months ended September 30, 2002 was primarily attributable to a $805,000 reduction in personnel costs and a $620,000 reduction in application fees expenses offset by an increase of $654,000 in office
expenses and $120,000 in outside contractor expenses. The decrease in application management services expenses for the nine months ended September 30, 2002 was primarily attributable to a $3.6 million reduction in personnel costs and a $2.0 million
reduction in application fees offset by an increase of $1.4 million in office expenses. We anticipate expenses to increase next quarter as we recognize an entire quarter of expenses to support customers acquired from QCS instead of the 10 days of
expenses recognized in the three months ended September 30, 2002.





PROFESSIONAL SERVICES AND OTHER
EXPENSES.    Professional services and other expenses, excluding non-cash stock based compensation of $48,000 and $102,000 for the three months ended September 30, 2002 and 2001, respectively, were $3.7 million for the
three months ended September 30, 2002 and $2.9 million for the three months ended September 30, 2001. The increase in professional services expenses for the three months ended September 30, 2002 was primarily due to a $924,000 increase in outside
contractor expenses. Professional services expenses and other expenses, excluding non-cash stock based compensation of $317,000 and $71,000 for the nine months ended September 30, 2002 and 2001, respectively, were $10.6 million for the nine months
ended September 30, 2002 and $12.9 million for the nine months ended September 30, 2001. The decrease in professional services expenses for the nine months ended September 30, 2002 was primarily attributable to a $4.1 million reduction in personnel
costs, offset by a $902,000 increase in outside contractor expenses and a $249,000 increase in reimbursable expenses. The remaining difference was primarily attributable to an increase in our provision for contract losses related to our professional
services fixed-fee implementations.





RESEARCH AND DEVELOPMENT.    Research and
development expenses, excluding non-cash stock based compensation of $51,000 and ($37,000) for the three months ended September 30, 2002 and 2001, respectively, were $1.3 million for the three months ended September 30, 2002 and $1.9 million for the
three months ended September 30, 2001. Research and development expenses, excluding non-cash stock based compensation of $116,000 and ($319,000) for the nine months ended September 30, 2002 and 2001, respectively, were $5.1 million for the nine
months ended September 30, 2002 and $7.2 million for the nine months ended September 30, 2001. For the three months ended September 30, 2002, the decrease in research and development expenses was primarily attributable to a $523,000 reduction in
personnel costs and a $88,000 reduction in depreciation. Research and development expenses as a percentage of total revenues were 10% for the three months ended September 30, 2002 and 15% for the three months ended September 30, 2001. For the nine
months ended September 30, 2002, the decrease in research and development expenses was primarily attributable to a $1.7 million reduction in personnel costs and a $285,000 reduction in depreciation expenses. Research and development expenses as a
percentage of total revenues were 13% for the nine months ended September 30, 2002 and 19% for the nine months ended September 30, 2001.




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SALES AND MARKETING EXPENSES.Sales and marketing
expenses, excluding non-cash stock based compensation of $160,000 and $279,000 for the three months ended September 30, 2002 and 2001, respectively, were $2.1 million for the three months ended September 30, 2002 and $4.3 million for the three
months ended September 30, 2001. Sales and marketing expenses, excluding non-cash stock based compensation of $718,000 and $9,000 for the nine months ended September 30, 2002 and 2001, respectively, were $8.4 million for the nine months ended
September 30, 2002 and $17.6 million for the nine months ended September 30, 2001. Sales and marketing expenses also include an amortization credit associated with repurchasable shares issued to Cap Gemini Ernst & Young (CGEY) of ($269,000)
and ($314,000) for the three months ended September 30, 2002 and 2001 respectively and ($143,000) and ($463,000) for the nine months ended September 30, 2002 and 2001 respectively. The amortization credit was due to a decrease in the price of our
common stock during the three and nine months ended September 30, 2002 and 2001. For the three months ended September 30, 2002, the decrease in sales and marketing expenses was primarily attributable to a $1.3 million reduction in personnel costs, a
$425,000 reduction in outside contractor expenses and a $317,000 reduction in marketing program expenses. Sales and marketing expenses as a percentage of total revenues were 16% for the three months ended September 30, 2002 and 34% for the three
months ended September 30, 2001. For the nine months ended September 30, 2002, the decrease in sales and marketing expenses was primarily attributable to a $5.8 million reduction in personnel costs, a $1.5 million reduction in outside contractor
expenses, a $1.0 million reduction in marketing program expenses and a $392,000 reduction in rent expense. Sales and marketing expenses as a percentage of total revenues were 22% for the nine months ended September 30, 2002 and 46% for the nine
months ended September 30, 2001.





GENERAL AND ADMINISTRATIVE EXPENSES.    General
and administrative expenses, excluding non-cash stock based compensation of $381,000 and $1.0 million for the three months ended September 30, 2002 and 2001, respectively, were $2.7 million for the three months ended September 30, 2002 and $4.8
million for the three months ended September 30, 2001, respectively. For the three months ended September 30, 2002, the decrease in general and administrative expenses was primarily attributable to a $1.2 million reduction in personnel costs,
$451,000 reduction in amortization expenses, $206,000 reduction in rent expense and a $166,000 reduction in depreciation expense. General and administrative expenses as a percentage of total revenues were 20% for the three months ended September 30,
2002 and 38% for the three months ended June 30, 2001.General and administrative expenses, excluding non-cash stock based compensation of $414,000 and $3.4 million for the nine months ended September 30, 2002 and 2001, respectively, were $8.7
million for the nine months ended September 30, 2002 and $16.8 million for the nine months ended September 30, 2001. For the nine months ended September 30, 2002, the decrease in general and administrative expenses was primarily attributable to a
$4.9 million reduction in personnel costs, $1.3 million reduction in amortization expenses, $395,000 reduction in rent expense, $473,000 reduction in outside contractor expenses and a $588,000 reduction in depreciation expense. General and
administrative expenses as a percentage of total revenues were 23% for the nine months ended September 30, 2002 and 44% for the nine months ended September 30, 2001.





RESTRUCTURING AND IMPAIRMENT CHARGE.During the three months ended September 30, 2002, we reviewed our facilities requirements and vacated a
portion of our headquarters in San Carlos, California. Related to this action, we took a third quarter impairment charge of $3.8 million to record the estimated loss associated with a portion of the remaining lease stream of the unoccupied space.
During the three months ended September 30, 2002, we also incurred $272,000 for severance benefits.





AMORTIZATION OF STOCK-BASED COMPENSATION.    Amortization of deferred stock-based compensation was $690,000 for the three months ended September 30, 2002 and $1.5 million for the three months ended
September 30, 2001. Amortization of deferred stock-based compensation was $1.8 million for the nine months ended September 30, 2002 and $3.2 million for the nine months ended September 30, 2001. For the three and nine months ended September 30,
2002, the decrease was primarily attributable to significant forfeitures of stock options during the nine months ended September 30, 2002 and the accelerated vesting of these deferred charges. When employees, who have been granted options below fair
market value, terminate, the accounting effects of the forfeiture of their unvested stock options lower the amortization expense and deferred stock based compensation.





INTEREST AND OTHER INCOME AND EXPENSE.Net interest and other income and (expense) was $279,000 for the three months ended September 30, 2002
and $682,000 for the three months ended September 30, 2001. Net interest and other income and (expense) was $843,000 million for the nine months ended September 30, 2002 and $2.7 million for the nine months ended September 30, 2001. For the three
and nine month periods, the decrease in net interest income was due primarily to lower average cash and investment balances at September 30, 2002 as well as lower interest rates and was offset, in part, by a decrease in interest expense due to lower
average debt balances. Included in interest expense in the nine months ended September 30, 2001 is a charge of $740,000 reflecting the unamortized fair value of the warrants that were issued in connection with a loan and security agreement that was
paid in full in January 2001.





INCOME TAXES.    Since inception, we have incurred net
losses for federal and state tax purposes, and anticipate losses for the foreseeable future. We have therefore not recognized any material tax provision or benefit for income taxes for the three and nine months ended September 30, 2001. The Company
recognized a $400,000 tax benefit for the three and nine months ended September 30, 2002 after determining that a tax provision related to an exposure item recorded in connection with our acquisition of Data Systems Connectors, Inc. in 1998 was
no longer needed due to the completion of a tax examination.




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LIQUIDITY AND CAPITAL RESOURCES





As of September 30, 2002, we had cash and cash equivalents, short-term investments, and restricted cash of $51.8 million, a decrease of $34.2 million from December 31,
2001. The decrease was primarily the result of $14.6 million cash used by operating activities, $5.9 million repayment of debt and $15.0 million for the purchase of substantially all of the assets of Qwest Cyber.Solutions LLC (QCS).





Net cash used in operating activities was $14.6 million for the nine months ended September 30, 2002, and $35.1 million used in
the nine months ended September 30, 2001. The net decrease was primarily due to a decrease in our net loss.





Net
cash provided by investing activities was $9.4 for the nine months ended September 30, 2002 compared to $22.5 million provided by investing activities in the nine months ended September 30, 2001. Investing activities consisted primarily of the
purchase and sale of short-term investments. The net decrease was mainly due to the $15.0 million used for the purchase of substantially all of the assets of QCS.





Net cash used by financing activities was $5.1 million and $5.8 million for the nine months ended September 30, 2002 and 2001, respectively. Financing activities consisted
primarily of the proceeds from the issuance of common stock and exercise of stock options, offset by repayments of notes and capital leases.





Except for equipment operating leases, the Company has no off balance sheet financing arrangements.





Effective August 2002, senior management of the Company agreed to reduce their base compensation by percentages ranging from 10% to 33% which will result in an approximate aggregate reduction of
$700,000 per year. Affected employees received stock option grants equivalent to two options for every dollar reduced from their annual base salary which resulted in the Company granting approximately an additional 1.4 million stock options. These
grants were priced at fair market value on the date of grant and vest over a two year period. The salary reductions were implemented as part of the Companys cost and cash management initiatives, with the intent of further enabling the Company
to improve its operating margins.





On September 20, 2002, the Company completed the purchase of the assets and the
assumption of certain liabilities of the enterprise application service provider (ASP) business of Qwest Cyber.Solutions LLC (QCS), a subsidiary of Qwest Communications International Inc. The Company paid $15 million in cash for the acquisition and
accrued direct acquisition costs of approximately $1.3 million. The Company also received $1 million in termination fees from a QCS customer that was acquired which the Company netted against the purchase price. $1.5 million of the purchase
price was deposited into escrow, to be held as security for a limited period of time for any losses incurred by the Company in the event, among other matters, of any breach by QCS of the agreements, covenants, representations and warranties it made
under or in connection with the purchase agreement. All or a portion of the $1.5 million in escrow will be paid to the Company if specified revenue levels are not met related to the customer contracts acquired from QCS.





The Company acquired certain assets of QCSs ASP business, including customer contracts related to the ASP business, internally used
and developed software, certain tangible assets such as computers, servers, routers, firewalls and related equipment, and accounts receivable. The Company is currently integrating the acquired business into its existing business and will support the
QCS customer relationships acquired as part of the acquisition.





The following table summarizes the Companys
preliminary allocation of the total purchase price of $16.3 million to the assets acquired and liabilities assumed from QCS at the date of acquisition. As the total purchase price exceeded the estimated fair values of the assets acquired and
liabilities assumed, no goodwill was recorded as a result of this transaction. The allocation of the total purchase price is preliminary and subject to final adjustment.





Accounts receivable

$
5,300,000Prepaid expenses and other current assets


3,600,000Property and equipment


6,100,000Other assets


2,700,000Accounts payable and accrued liabilities


(500,000
)Deferred revenue


(900,000
)Total

$
16,300,000





The Company recorded an intangible asset for acquired customer
contracts of $2.7 million, which is included in other assets in the accompanying balance sheet. This intangible asset is being amortized over an estimated life of 18 months.





We expect that our current cash balances will be sufficient to meet our cash requirements for at least the next 12 months. However, any major change in the nature of the
Companys business, or a significant reduction in demand for its services, the acquisition of products, the need for significant new capital expenditures, or acquisition of other businesses, could further utilize the Companys cash
reserves. To the extent the Company requires additional cash, there can be no assurances that we will be able to obtain such financing on terms favorable to the Company, or at all.




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OTHER MATTERS





In connection with the engagement of our independent auditors, our audit committee has reviewed both the audit and non-audit services provided pursuant to this engagement
to ensure that our auditors satisfy the independence requirements mandated by generally accepted accounting principles and the SEC. However, our audit committee has not had the opportunity to formally approve the non-audit services provided by our
auditors, as required under new federal law that was enacted July 30, 2002. We intend to seek the approval of these services by our audit committee at its next scheduled meeting.





RECENT ACCOUNTING PRONOUNCEMENTS





SFAS No. 145,
Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections, which was issued in April 2002. The statement rescinds FASB No. 4, Reporting Gains and Losses from Extinguishment of
Debt, and an amendment of that statement, FASB No. 64, Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements. As a result, gains and losses from extinguishment of debt will no longer be aggregated and classified as an
extraordinary item, net of related income tax effect, on the statement of earnings. Instead, such gains and losses will be classified as extraordinary items only if they meet the criteria of unusual or infrequently occurring items. SFAS No. 145 also
requires that the gains and losses from debt extinguishments, which were classified as extraordinary items in prior periods, be reclassified to continuing operations if they do not meet the criteria for extraordinary items. The provisions related to
this portion of the statement are required to be applied in fiscal years beginning after May 15, 2002, with earlier application encouraged. The adoption of SFAS No. 145 is not expected to have a material effect on the Companys financial
statements.





SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, was
issued in June 2002. The statement requires that costs associated with exit or disposal activities must be recognized when they are incurred rather than at the date of a commitment to an exit or disposal plan. Such costs include lease termination
costs and certain employee severance costs associated with a restructuring, discontinued operations or other exit or disposal activity. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002.




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ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS





RISK FACTORS





Risks Related to Our Business





We have a history of losses and expect that we will continue to incur operating
losses and negative cash flow and may never be profitable.





We have spent significant funds to date to develop
and refine our current services, to create and run our operations organization, to build and run a professional services organization and to develop and run our sales and marketing resources. We have incurred significant operating and net losses and
negative cash flow and have not achieved profitability. As of September 30, 2002, we had an accumulated deficit of $237.9 million.





We expect to continue to invest significantly in our organization to provide services, enhance current services and expand our service offerings. We also may grow our sales force and spend significant funds to promote our
company and our services. We may hire additional people in other areas of our company in order to support our business. In addition, we expect to continue to incur significant fixed and other costs associated with customer acquisitions and with the
implementation and configuration of software applications for customers. As a result of all of these factors, to achieve operating profitability, excluding non-cash charges, we will need to increase our customer base, to decrease our overall costs
of providing services, including the costs of our licensed technology, our operations and the costs of customer acquisitions, and to increase our number of customers. We cannot assure you that we will be able to increase our revenues or increase our
operating efficiencies in this manner. Also, because we may continue to invest in our business faster than we anticipate growth in our revenues, we expect that we will continue to incur significant operating losses and negative cash flow for the
foreseeable future and we may never be profitable.





The emerging high-growth and middle-market companies that currently comprise a
significant portion of our revenue base may be volatile, which could continue to result in greater than expected customer loss and continued difficulty in collecting fees from some customers, and uncertainty regarding the stability of the economy in
general could continue to adversely affect demand for our services.





A significant portion of our current
revenue consists of revenue from middle-market companies, e-commerce trading exchanges and other technology companies. These companies will be more likely to be acquired, experience financial difficulties or cease operations than other companies
that are larger and better established or are in more stable industries. In particular, these companies may experience difficulties in raising capital needed to fund their operations when required or at all. In the past we have terminated our
agreements with a substantial number of customers who were unable or unwilling to continue their financial obligations to us and we expect to terminate additional customers in the future. As a result, our client base will likely be more volatile
than those companies whose customers consist of more mature and established entities. If we continue to experience greater than expected customer loss or an inability to collect fees from our customers in a timely manner because of this volatility,
our operating results could be seriously harmed. In addition, uncertainty regarding the stability of the economy in general could continue to diminish and delay demand for our services. Also, as we move up market and away from high-growth and middle
market companies, revenue from termination fees resulting from high-growth and middle market companies may diminish.




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Our limited history of offering ASP services to customers and the fact that we operate in a new
industry for application services expose us to risks that affect our ability to execute our business model.





We have offered our services for a relatively short period of time, and our industry is relatively new. Prior to September 1998, our predecessor company, DSCI, carried on a different business. Accordingly, we have a limited operating
history as a provider of ASP services. We have a limited number of customers and have implemented our services a limited number of times. Because our business model is new, it continues to evolve. In the future, we may revise our pricing model for
different services, and our model for our customers to gain access to third-party software applications and other third-party services is evolving. Changes in our anticipated business and financial model could materially impact our ability to become
profitable in the future. Additionally, especially as we move up-market to larger, more established customers, the demand for our services is uncertain and the sales process will take longer than with smaller potential customers. An investor in our
common stock must consider these facts as well as the risks, uncertainties, expenses and difficulties frequently encountered by companies in their early stages of development, particularly companies in new and rapidly evolving markets such as the
market for Internet-based software application services. Some of the risks and difficulties relate to our potential inability to:





| |  |  | acquire and retain new customers, particularly larger, more established companies required to create a stable revenue and customer base;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------




| |  |  | reduce costs associated with the delivery of services to our customers;
| | - |  | -----------------------------------------------------------------------




| |  |  | expand and maintain our pipeline of sales prospects in order to promote greater predictability in our period-to-period sales levels;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------




| |  |  | acquire or license third-party software applications at a reasonable cost or at a structure beneficial to us;
| | - |  | -------------------------------------------------------------------------------------------------------------




| |  |  | complete successful implementations of our software applications in a manner that is repeatable and scalable;
| | - |  | -------------------------------------------------------------------------------------------------------------




| |  |  | integrate successfully software applications we manage with each other and with our customers existing systems;
| | - |  | ----------------------------------------------------------------------------------------------------------------




| |  |  | continue to offer new services that complement our existing offerings;
| | - |  | ----------------------------------------------------------------------




| |  |  | increase awareness of our brand; and
| | - |  | ------------------------------------




| |  |  | maintain our current, and develop new, strategic relationships.
| | - |  | ---------------------------------------------------------------




We cannot assure you that we will successfully address these risks or difficulties. If we fail to address any of these risks or difficulties adequately, we will likely be
unable to execute our business model.





Because we may spend significant sums to run our business and to try to grow our business, we
may be unable to adjust spending to offset any future revenue shortfall, which could cause our quarterly operating results to fluctuate and our stock price to fall.





Although we are monitoring our spending, in order to promote future growth, we expect we may continue to expend significant sums in our business, in our operations,
professional services, research and development, and sales and marketing organizations. Because the expenses associated with these activities are relatively fixed in the short-term, we may be unable to adjust spending quickly enough to offset any
unexpected shortfall in revenue growth or any decrease in revenue levels. As our quarterly results fluctuate, they may fall short of the expectations of public market analysts or investors. If this occurs, the price of our common stock may fall.





Our quarterly operating results may fluctuate due to the nature of our ASP business and other factors affecting our revenues and
costs, which could cause our stock price to fall.





Our financial results will vary over time as our ASP
business matures. For individual customers, we may recognize professional services revenues associated with the implementation of our applications during the early months of our engagement. We then recognize monthly fees from the customer,
consisting primarily of application management services revenues, over the balance of the contractual relationship. As a result, for some customers we have a high proportion of up-front professional services revenues associated with implementation.
We expect that our financial results may continue to vary over time as monthly fees increase as a portion of total revenue. Third parties also provide professional services for some of our application management services customers, and whether
professional services will be provided by us or by third parties may be difficult to predict. Changes in our revenue mix from professional services revenues to application management services revenues could be difficult to predict and could cause
our quarterly results and stock price to fluctuate.




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Other important factors that could cause our quarterly results and stock price to
fluctuate materially include:





| |  |  | the timing of obtaining, implementing and establishing connectivity with individual customers;
| | - |  | ----------------------------------------------------------------------------------------------




| |  |  | the loss of or change in our relationship with important customers and our ability or inability to collect termination fees from terminating customers;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | any decrease in termination fees paid in a quarter versus other quarters;
| | - |  | -------------------------------------------------------------------------




| |  |  | the timing and magnitude of expanding our operations and of other capital expenditures;
| | - |  | ---------------------------------------------------------------------------------------




| |  |  | costs, including license fees, relating to the software applications we use;
| | - |  | ----------------------------------------------------------------------------




| |  |  | changes in our pricing policies or those of our competitors;
| | - |  | ------------------------------------------------------------




| |  |  | potential changes in the accounting standards associated with accounting for stock or warrant issuances and for revenue recognition; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------




| |  |  | accounting charges associated with the warrants currently held by third parties, as well as potential accounting charges we may incur in the future relating to
stock or warrant issuances to future parties.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




Our financial results could vary over time as our business model
evolves, which could cause our stock price to fall.





Our financial results could vary over time as our
business and financial model evolves. For example, we historically included a broad range of customer support in our fixed monthly fees but now bill certain customers for support services in excess of specified limits in certain circumstances. As
another example, we are increasingly unbundling from our fixed monthly fee the cost of software licenses and have started to require our customers to obtain licenses to enterprise software applications directly from third-party software providers.
Any such changes to our business or financial model would likely cause financial results to vary, which could cause our stock price to fall.





In this regard, from time to time we negotiate with some of our major third-party software vendors to modify the pricing and other terms currently in place with these vendors. We may agree to
restructure our current arrangements with some of our third-party software providers. For example for future customers of our PeopleSoft and Siebel services, our customers must obtain licenses for software directly from the independent software
vendor. We currently plan to eventually migrate all customers from a model whereby some rent enterprise application licenses from us to a model whereby they all purchase the licenses directly from independent software vendors. Such new pricing
structures or business models may not in fact be more beneficial to us and may ultimately hinder our ability to become profitable.





We
depend on software vendors to supply us with the software necessary to provide our services, and the loss of access to this software or any decline or obsolescence in its functionality could cause our customers businesses to suffer, which, in
turn, could harm our revenues and increase our costs.





We offer our customers software application services
for applications from third parties such as PeopleSoft, Oracle, SAP and Siebel Systems. We have agreements in place with certain of our third-party software vendors, and our agreements with third-party software vendors are non-exclusive, are for
limited terms ranging from two to five years and typically permit termination in the event of our breach of the agreements. Additionally, as we move more to host-only relationships, whereby our customers must obtain licenses directly
from independent software vendors such as PeopleSoft and Siebel, we rely on the independent software vendors to consent to allow us to access the software to provide our services. If we lose the right to use the software that we license from
third-parties, if the cost of licensing the software applications becomes prohibitive, or if we change the vendors from whom we currently license software, our customers businesses could be significantly disrupted, which could harm our
revenues and increase our costs. Our financial results may also be harmed if the cost structure we negotiate with the third-party software vendors changes in a manner that is less beneficial to us compared to our current cost structure with software
vendors. We cannot assure you that our services will continue to support the software of our third-party vendors, or that we will be able to adapt our own offerings to changes in third-party software. In addition, if our vendors were to experience
financial or other difficulties, it could adversely affect the availability of their software. It is also possible that improvements in software by third-parties with whom we have no relationship could render the software we offer to our customers
less compelling or obsolete.




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Our licenses for the third-party software we use to deliver our services contain limits on our
ability to use them that could impair our growth and operating results.





The licenses we have for the
third-party software we use to deliver our services typically restrict our ability to sell our services in specified countries and to customers with revenue above or below specified revenue levels. For example, some of our licenses restrict us from
selling our services to customers with annual revenues greater than various levels such as $1 billion, and some restrict our ability to sell to customers outside of North America. In addition, some of these licenses contain limits on our ability to
sell our services to certain types of customers. Our operating results and ability to grow could be harmed to the extent these licenses prohibit us from selling our services to customers to which we would otherwise sell our services, or in countries
in which we would otherwise sell our services.





Poor performance of the software we deliver to our customers or disruptions in our
business-critical services could harm our reputation, delay market acceptance of our services and subject us to liabilities.





Our customers depend on our hosted software applications for their critical systems and business functions, including enterprise resource planning, customer relationship management and e-commerce. Our customers businesses could
be seriously harmed if the applications we provide to them work improperly or fail, even if only temporarily. Accordingly, if the software that we license from our vendors or our implementation of such software performs poorly, experiences errors or
defects or is otherwise unreliable, our customers would likely be extremely dissatisfied, which could cause our reputation to suffer, force us to divert research and development and management resources, cause a loss of revenues or hinder market
acceptance of our services. It is also possible that any customer disruptions resulting from failures in our applications could force us to refund all or a portion of the fees customers have paid for our services or result in other significant
liabilities to our customers.





We may fail to implement, host or manage enterprise software applications successfully due to the
complicated nature of the services we provide and our limited experience in providing these services, which would harm our reputation and sales.





Implementations of integrated enterprise software applications can be complicated and we have limited experience to date completing implementations of integrated software applications for our
customers. We cannot assure you that we will develop the requisite expertise or that we can convince customers that we have the expertise required to implement, host or manage these applications. In addition, our customers to date have primarily
implemented PeopleSoft applications and we have limited experience installing some of the other applications we offer. Our reputation will be harmed and sales of our services would decline significantly if we are not able to complete successfully
repeated implementations of our enterprise software applications, including those applications with which we have limited or no implementation, hosting or management experience to date.





Any inability to expand sufficiently our enterprise software implementation and systems consulting capabilities could harm our ability to service our customers effectively and could
hinder our growth.





A failure to maintain and expand relationships with third-party systems integrators that
we use to implement our services could harm our ability to service our customers effectively. As we seek to provide applications management services for larger, more established customers, they may frequently utilize the systems integration and
consulting services of independent, third-party systems integrators rather than Corio. In such cases, we may receive only modest revenue for implementation and integration services if any. In addition, we frequently contract with our customers for
implementation on a fixed price basis. As a result, unexpected complexities in implementing software applications for our customers could result in unexpected losses for us or increases in losses. Our business and reputation could also be seriously
harmed if third party systems integrators were unable to perform their services for our customers in a manner that meets customer expectations.





Increased demand for customization of our services beyond what we currently provide or anticipate could reduce the scalability and profitability of our business.





Companies may prefer more customized applications and services than our business model contemplates. Most of our customers have required some level of customization of our
services, and our customers may continue to require customization in the future, perhaps to a greater extent than we currently provide or anticipate. If we do not offer the desired customization, there may be less demand for our services.
Conversely, providing customization of our services increases our costs and reduces our flexibility to provide similar services to many customers. Accordingly, increased demand for customization of our services could reduce the scalability and
profitability of our business and increase risks associated with completing software upgrades.




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Growth could strain our operations and require us to incur costs to upgrade our infrastructure and
expand our personnel.





If our customer base grows significantly, we cannot be sure that we will successfully
manage our growth. In order to manage our growth successfully, we must:





| |  |  | expand our management team, financial and information systems and controls and operations team;
| | - |  | -----------------------------------------------------------------------------------------------




| |  |  | maintain a high level of customer service and support;
| | - |  | ------------------------------------------------------




| |  |  | expand our implementation and consulting resources internally and with third-parties; and
| | - |  | -----------------------------------------------------------------------------------------




| |  |  | expand, train, manage and retain our employee base effectively.
| | - |  | ---------------------------------------------------------------




If our customer base grows significantly, there will be additional demands on our customer service support, research and development, sales and marketing and administrative
resources as we try to increase our service offerings and expand our target markets. Any delay in the implementation of, or disruption in the transition to, new or enhanced systems and controls could harm our ability to accurately forecast demand
for our services, manage our billing of customers, manage our sales cycle and implementation services and record and report management and financial information on a timely and accurate basis. Moreover, any inability to expand our service offerings
and employee base commensurate with any increase in the demand for our services could cause our revenues to decline.





We will need to
perform software upgrades for our customers, and any inability to successfully perform these upgrades could cause interruptions or errors in our customers software applications, which could increase our costs and delay market acceptance of our
services.





Our software vendors from time to time will upgrade their software applications, and at such time
we will be required to implement these software upgrades for certain of our customers. Implementing software upgrades can be a complicated and costly process, particularly implementation of an upgrade simultaneously across multiple customers, and we
have not performed many software upgrades to date. Accordingly, we cannot assure you that we will be able to perform these upgrades successfully or at a reasonable cost. We may also experience difficulty implementing software upgrades to a large
number of customers, particularly if different software vendors release upgrades simultaneously. If we are unable to perform software upgrades successfully and to a large customer base, our customers could be subject to increased risk of
interruptions or errors in their business-critical software, our reputation and business would likely suffer and the market would likely delay the acceptance of our services. It will also be difficult for us to predict the timing of these upgrades,
the cost to us of these upgrades and the additional resources that we may need to implement these upgrades. Additionally, as we continue to evolve our business model to charge customers for the cost of software upgrades, we may lose prospective
customers who choose not to pay for these upgrades. Therefore, any such upgrades could strain our development and engineering resources, require significant unexpected expenses and cause us to miss our financial forecasts or those of securities
analysts. Any of these problems could impair our customer relations and our reputation and subject us to litigation.





Security risks
and concerns may decrease the demand for our services, and security breaches with respect to our systems may disrupt our services or make them inaccessible to our customers.





Our services involve the storage and transmission of business-critical, proprietary information, and security breaches could expose us to a risk of loss of this
information, litigation and possible liability. Anyone who circumvents our security measures could misappropriate business-critical proprietary information or cause interruptions in our services or operations. In addition, computer
hackers could introduce computer viruses into our systems or those of our customers, which could disrupt our services or make them inaccessible to customers. We may be required to expend significant capital and other resources to protect
against the threat of security breaches or to alleviate problems caused by breaches. Our security measures may be inadequate to prevent security breaches, and our business and reputation would be harmed if we do not prevent them.




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If we are unable to adapt our services to rapidly changing technology, our reputation and our ability
to grow our revenues could be harmed.





The markets we serve are characterized by rapidly changing technology,
evolving industry standards, emerging competition and the frequent introduction of new services, software and other products. We cannot assure you that we will be able to enhance existing or develop new services that meet changing customer needs in
a timely and cost-effective manner. For example, as software application architecture changes, the software for which we provide services could become out of date or obsolete and we may be forced to upgrade or replace our technology. For example,
this is of particular concern with regard to our enterprise resource planning, or ERP, software, including PeopleSoft, Oracle and SAP. The architecture of the software we currently use for ERP applications is not designed to be hosted. We believe
that future software may be written to be hosted. Our existing software application providers may face competition from new vendors who have written hostable software. It may be difficult for us to acquire hostable ERP software from these new
vendors and for our software application providers to develop this software quickly or successfully. In either event, the services we offer would likely become less attractive to our customers, which could cause us to lose revenue and market share.
Performing upgrades may also require substantial time and expense and even then we cannot be sure that we will succeed in adapting our business to these technological developments. Prolonged delays resulting from our efforts to adapt to rapid
technological change, even if ultimately successful, could harm our reputation within our industry and our ability to grow our revenues.





We may incur substantial accounting charges as a result of repurchasable common stock held by Cap Gemini Ernst & Young which may result in significant operating losses over the next several years.





On September 27, 2000, Cap Gemini Ernst & Young U.S., L.L.C (CGEY), exercised its right to convert a portion of its initial warrant
representing 2,333,333 shares into 960,810 shares of common stock through a cashless exercise. Even if we are able to generate revenues that exceed our operating costs, we may incur substantial accounting charges through May 2003 associated with
these shares held by CGEY. These shares and other expenses related to our strategic alliance with CGEY may result in expenses and operating losses for us over the term of our agreement with them. Because of the accounting policies applicable to
these shares, any charges associated with these shares will be measured and recorded each fiscal quarter in part using the trading price of our common stock. Significant increases in our stock price could result in significant non-cash accounting
charges.





Our application management agreements are typically long-term, fixed-price contracts, which may hinder our ability to become
profitable.





We enter into agreements with our customers to provide application management services for long
periods, typically three to five years. Most of these agreements are in the form of fixed-price contracts that do not provide for price adjustments to reflect any cost overruns associated with providing our services, such as potential increases in
the costs of software applications we license from third parties, the costs of upgrades or inflation. As a result, unless we are able to provide our services in a more cost-effective manner than we do today and unless the number of users at
individual customers increases to provide us higher revenue levels per customer, we may never achieve profitability for a particular customer. In addition, customers may not be able to pay us or may cancel our services before becoming profitable for
us.





Our long-term, fixed-price application management contracts may hinder our ability to evolve our business and to ultimately
become profitable.





Our business is new and, accordingly, our business and financial models may evolve as the
understanding of our business evolves. We may be unable to adjust our pricing or cost structure with respect to our current customers in response to changes we make in our business or financial model due to the long-term, fixed price nature of the
application management agreements we have with our customers. This potential inflexibility may result in our inability to become profitable as rapidly as we would like or at all.





If we do not meet the service levels provided for in our contracts with customers, we may be required to give our customers credit for free service, and our customers may be entitled to cancel their
service contracts, which could adversely affect our reputation and hinder our ability to grow our revenues.





Our application management services contracts contain service level guarantees that obligate us to provide our applications at a guaranteed level of performance. If we fail to meet those service levels, we may be contractually
obligated to provide our customers credit for free service. If we were to continue to fail to meet these service levels, our customers would then have the right to cancel their contracts with us. These credits or cancellations could harm our
reputation and hinder our ability to grow our revenues.




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If we cannot obtain additional software applications that meet the evolving business needs of our
customers, the market for our services will not grow and may decline, and sales of our services will suffer.





Part of our strategy may be to expand our services by offering our customers additional software applications that address their evolving business needs. We cannot be sure, however, that we will be able to license these applications
at a commercially viable cost or at all or that we will be able to cost-effectively develop the applications in-house. If we cannot obtain these applications on a cost-effective basis and, as a result, cannot expand the range of our service
offerings, the market for our services will not grow and may decline, and sales of our services will suffer.





We have many competitors
and expect new competitors to enter our market, which could adversely affect our ability to increase revenues, maintain our margins or grow our market share.





The market for our services is extremely competitive and the barriers to entry in our market are relatively low. We currently have no patented technology that would bar competitors from our market.





Our current and potential competitors primarily include:





| |  |  | application service providers and business process outsourcers, such as Bluestar Solutions, CSC, Electronic Data Systems, Hewlett-Packard, Oracle, PeopleSoft,
IBM Global Services, Surebridge and USinternetworking;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | systems integrators, such as Accenture;
| | - |  | ---------------------------------------




| |  |  | internet service providers and web hosting companies, such as Cable & Wireless, DIGEX and Genuity;
| | - |  | --------------------------------------------------------------------------------------------------




| |  |  | software vendors, such as Commerce One, SAP and Siebel Systems; and
| | - |  | -------------------------------------------------------------------




| |  |  | major technology providers, such as Microsoft.
| | - |  | ----------------------------------------------




Many of our competitors and potential competitors have substantially greater financial, customer support, technical and marketing resources, larger customer bases, longer operating histories, greater
name recognition and more established relationships in the industry than we do. We cannot be sure that we will have the resources or expertise to compete successfully in the future. Our competitors may be able to:





| |  |  | develop and expand their network infrastructures and service offerings more quickly;
| | - |  | ------------------------------------------------------------------------------------




| |  |  | adapt to new or emerging technologies and changing customer needs faster;
| | - |  | -------------------------------------------------------------------------




| |  |  | take advantage of acquisitions and other opportunities more readily;
| | - |  | --------------------------------------------------------------------




| |  |  | negotiate more favorable agreements with software application vendors;
| | - |  | ----------------------------------------------------------------------




| |  |  | devote greater resources to the marketing and sale of their products; and
| | - |  | -------------------------------------------------------------------------




| |  |  | address customers service-related issues more effectively.
| | - |  | -----------------------------------------------------------




Some of our competitors may also be able to provide customers with additional benefits at lower overall costs or to reduce their application service charges aggressively in
an effort to increase market share. We cannot be sure that we will be able to match cost reductions by our competitors.





Our competitors and other companies may form strategic relationships with each other to compete with us. These relationships may take the form of strategic investments, joint-marketing agreements, licenses or other contractual
arrangements, which arrangements may increase our competitors ability to address customer needs with their product and service offerings. We believe that there is likely to be consolidation in our markets, which could lead to increased price
competition and other forms of competition that could cause our business to suffer.




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We may be unable to deliver effectively our services if our data center management services
providers, computer hardware suppliers or software providers do not provide us with key components of our technology infrastructure in a timely, consistent and cost-effective manner.





We depend on third-parties, such as XO Communications, Qwest and (i)Structure, for our data center management services and for key components of our network infrastructure.
Our contracts with these data center and network infrastructure providers are for a fixed term and for a specified amount of services, which may be insufficient to meet our needs. Additionally, as has been reported in the press, XO Communications
recently filed for bankruptcy and has been negotiating a restructuring of its debt. The services we provide could be materially disrupted by any disruption in the services provided by XO Communications to us. We depend on suppliers such as Sun
Microsystems for our computer hardware and WebMethods and Netegrity and others for our software technology platform. If any of these relationships fail to provide needed products or services in a timely and consistent manner or at an acceptable
cost, we may be unable to deliver effectively our services to customers. Some of the key components of our infrastructure are available only from sole or limited sources in the quantity and quality we demand. We do not carry significant inventories
of those components that we obtain from third-parties and have no guaranteed supply arrangements for some of these components. Additionally, some of our service and product providers have recently experienced financial difficulty, and financial
problems they experience may cause disruptions in our service, loss of customers and expose us to additional costs.





System failures
caused by us or factors outside of our control could cause us to lose our customers and subject us to liability and increased expenses.





Our operations depend upon our ability and the ability of our third-party data center and network services providers to maintain and protect the computer systems on which we host our customers
applications. Any loss of customer data or an inability to provide service for a period of time could cause us to lose our customers and subject us to significant potential liabilities. We currently use two data centers to house our hardware and to
provide network services, but each of our customers is serviced at a single site. While our data center and network providers maintain back-up systems and we have disaster recovery processes, a natural disaster or similar disruption at their site
could impair our ability to provide our services to our customers until the site is repaired or back-up systems become operable. Some of our data center providers, as well as our corporate headquarters, are located in Northern California, near known
earthquake fault zones. Our systems and the data centers are also vulnerable to damage from fire, flood, power loss, telecommunications failures and similar events.





If we are unable to retain our executive officers and key personnel, or to integrate new members of our senior management that are critical to our business, we may not be able to successfully manage
our business or achieve our objectives.





Our future success depends upon the continued service of our
executive officers and other key personnel. None of our executive officers or key employees is bound by an employment agreement for any specific term. If we lose the services of one or more of our executive officers or key employees, or if one or
more of them decides to join a competitor or otherwise compete directly or indirectly with us, we may not be able to successfully manage our business or achieve our business objectives.





If we are unable to hire and retain sufficient sales, marketing, technical and operations personnel, we may be unable to grow our business or to service our customers effectively.





In the future, we may expand our sales operations and marketing efforts, both domestically and
internationally, in order to try to increase market awareness and sales of our services. We may also need to increase our technical staff in order to service customers and perform research and development. There is competition for qualified sales,
marketing, technical and operations personnel as these personnel are in limited supply and in high demand and we might not be able to hire and retain sufficient numbers of these personnel to grow our business or to service our customers effectively.
Also, recent reductions in our workforce, although designed to not affect service levels and demand generation, may adversely affect these areas of our business.




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Any acquisitions of businesses, technologies or services may result in distraction of our management
and disruptions to our business and additional costs.





We recently acquired the ASP assets of Qwest
Cyber.Solutions LLC, or QCS, and we expect that further consolidation in our industry may occur. We may acquire or make investments in additional complementary businesses, technologies or services if appropriate opportunities arise. From time to
time we may engage in discussions and negotiations with companies regarding acquiring or investing in their businesses, technologies or services. We cannot make assurances that we will be able to identify suitable acquisition or investment
candidates, or that if we do identify suitable candidates, we will be able to make the acquisitions or investments on commercially acceptable terms or at all. If we acquire or invest in another company, we could have difficulty assimilating that
companys personnel, operations, technology or products and service offerings. In addition, the key personnel of the acquired company may decide not to work for us. These difficulties could disrupt our ongoing business, distract our management
and employees, increase our expenses and adversely affect our results of operations. Furthermore, we may incur indebtedness or issue equity securities to pay for any future acquisitions. The issuance of equity or convertible debt securities could be
dilutive to our existing stockholders. The integration of the ASP assets of QCS into our business is ongoing, and we may experience disruption and distraction related thereto and unexpected costs associated therewith.





Any inability to protect our intellectual property rights could reduce our competitive advantage, divert management attention, require additional intellectual
property to be developed or cause us to incur expenses to enforce our rights.





We cannot assure you that we
will be able to protect or maintain our intellectual property from infringement or misappropriation from others. In particular, our business would be harmed if we were unable to protect our technology platform and processes, our trademarks or our
other software and confidential and proprietary information. Agreements on which we rely to protect our intellectual property rights and the trade secret, copyright and other laws on which we rely may only afford limited protection to these rights.
In addition, we currently have no patents issued, which limits significantly our ability to protect our proprietary rights in the event they are infringed. Any infringement or misappropriation of our intellectual property could reduce our
competitive advantage, divert management attention, require us to develop technology and cause us to incur expenses to enforce our rights.





Any infringement claims involving our technology or the applications we offer or other lawsuits could cost a significant amount of money and could divert managements attention away from our business.





If the number of software applications used by us and our customers increases and the functionality of these products further
overlaps and integrates, software industry participants may become increasingly subject to infringement claims. In addition, we have agreed, and may agree in the future, to indemnify some of our customers against claims that our services infringe
upon the intellectual property rights of others. Someone may claim that our technology or the applications or services we offer infringes their proprietary rights. Someone may also claim that we do not have adequate licenses to perform the services
we offer. Any infringement claims, even if without merit, can be time consuming and expensive to defend, may divert managements attention and resources and could cause service delays. Such claims could require us to enter into costly royalty
or licensing agreements. If successful, a claim of infringement against us and our inability to modify or license the infringed or similar technology could adversely affect our business. In addition, if our software vendors cease to offer their
software applications to us because of infringement claims against us or them, we would be forced to license different software applications to our customers that may not meet our customers needs. This could result in a loss of customers and a
decline in our revenues. Also, a securities class action lawsuit against Corio is currently pending in the U.S. District Court for the Southern District of New York. This lawsuit may be time consuming and expensive to defend and may divert
managements attention.




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We may not be able to continue to meet the continued listing criteria for The Nasdaq National Market,
which would materially adversely affect our business and financial condition.





Continued listing on The Nasdaq
National Market requires that the minimum bid price of our common stock not fall below $1.00 for a period of time prescribed by Nasdaq rules. If the closing bid price of our stock fails to increase to $1.00 or more and sustain at that level for
10 trading days by mid-November of this year, our stock could be subject to delisting from the Nasdaq National Market by the end of the year. We may not be able to effect measures to come into compliance with this minimum bid price requirement
within this period of time, in which case our stock may no longer be eligible to trade on The Nasdaq National Market.





If we are unable to continue to list our common stock for trading on The Nasdaq National Market, this would materially adversely affect business, including, among other things:





| |  |  | Our ability to raise additional financing to fund our operations;
| | - |  | -----------------------------------------------------------------




| |  |  | Our ability to attract and retain customers and distributors; and
| | - |  | -----------------------------------------------------------------




| |  |  | Our ability to attract and retain personnel, including management personnel.
| | - |  | ----------------------------------------------------------------------------




In addition, if we were unable to list our common stock for trading on The Nasdaq National Market, many institutional investors would no longer be able to retain their
interests in and/or make further investments in our common stock because of their internal rules and protocols. If institutional shareholders liquidated their holdings in our common stock and/or did not continue to make investments in our common
stock, this would decrease the trading volume of our shares and would likely result in a lower price for our common stock.




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Risks Related to our Industry





We cannot assure you that the ASP market will become viable or grow at a rate that will allow us to achieve profitability.





Growth in demand for and acceptance of ASPs and their hosted business software applications is highly uncertain. This is especially true
given the current uncertain macroeconomic environment. Companies in the ASP industry, such as Pandesic and Red Gorilla, have ceased operations. Other companies in the ASP industry, such as USinternetworking, have filed for bankruptcy. We cannot
assure you that this market will become viable or, if it becomes viable, that it will grow at a rate that will allow us to achieve profitability. The market for Internet services, private network management solutions and widely distributed
Internet-enabled application software has only recently begun to develop and is now evolving rapidly. We believe that many of our potential customers are not fully aware of the benefits of hosted and managed solutions. It is possible that these
solutions will never achieve market acceptance. It is also possible that potential customers will decide that the risks associated with hiring ASPs in general (or smaller ASPs in particular) to implement and manage their critical systems and
business functions outweigh the efficiencies associated with the products and services we provide. Concerns over transaction security and user privacy, inadequate network infrastructure for the entire Internet and inconsistent performance of the
Internet and the financial viability of ASPs could also limit the growth of Internet-based business software solutions.





Increasing
government regulation could limit the market for, or impose sales and other taxes on the sale of, our services, which could cause our revenues to decline or increase our expenses.





We offer our suite of software applications over networks, which subject us to government regulation concerning Internet usage and electronic commerce. We expect that
state, federal and foreign agencies will adopt and modify regulations covering issues such as user and data privacy, pricing, taxation of goods and services provided over the Internet, the use and export of cryptographic technology and content and
quality of products and services. It is possible that legislation could expose us and other companies involved in electronic commerce to liability or require permits or other authorizations, which could limit the growth of electronic commerce
generally. Legislation could dampen the growth in Internet usage and decrease its acceptance as a communications and commercial medium. If enacted, these laws, rules or regulations could limit the market for or make it more difficult to offer our
services.





The taxation of commerce activities in connection with the Internet has not been established, may
change in the future and may vary from jurisdiction to jurisdiction. One or more states or countries may seek to impose sales or other taxes on companies that engage in or facilitate electronic commerce. A number of proposals have been made at the
local, state, national and international levels that would impose additional taxes on the sale of products and services over the Internet. These proposals, if adopted, could substantially impair the growth of electronic commerce and could subject us
to taxation relating to our use of the Internet as a means of delivering our services. Moreover, if any state or country were to assert successfully that we should collect sales or other taxes on the exchange of products and services over the
Internet, our customers may refuse to continue using our services, which could cause our revenues to decline significantly.





As we
expand our business outside the United States we will be subject to unfavorable international conditions and regulations that could cause our international business to fail.





We have customers with international operations and may expand our business outside of the United States in the future. Conducting our business in international markets is
subject to complexities associated with foreign operations and to additional risks related to our business, including the possibility that the scarcity of cost-effective, high-speed Internet access and the slow pace of future improvements in access
to the Internet will limit the market for hosting software applications over the Internet or adversely affect the delivery of our services to customers. Additionally, some countries outside of the United States do not permit hosting applications on
behalf of companies. The European Union has adopted a privacy directive that regulates the collection and use of information. This directive may inhibit or prohibit the collection and sharing of personal information in ways that could harm us. The
globalization of Internet commerce may be harmed by these and similar regulations since the European Union privacy directive prohibits transmission of personal information outside the European Union unless the receiving country has enacted
individual privacy protection laws at least as strong as those enacted by the European Union privacy directive.




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General political and economic conditions may reduce our revenues and harm our business.





Because of the economic downturn and political environment, many industries have delayed or reduced
technology expenditures. If this trend continues, we may fall short of our revenue expectations, and ultimately may fail to achieve profitability. Moreover, weakness in the technology sector as a whole could negatively affect the cash flow of some
of our customers, which in turn could impact their ability to meet their obligations to us as they come due. This could increase our credit risk exposure and harm our overall financial position.





In addition, global and domestic political conditions, terrorist acts, or acts of war (wherever located in the world) may damage or disrupt global and domestic markets
and negatively affect our business, employees, customers, and suppliers, which in turn could have an adverse effect on our operations and our overall profitability.





Market prices of Internet and technology companies have been highly volatile, and the market for our stock may be volatile as well.





The stock market has experienced significant price and trading volume fluctuations, and the market prices of technology companies generally, and Internet-related software
companies particularly, have been extremely volatile. The market prices of technology companies generally, and technology service companies in particular have been subject to significant downward pressure. In the past, following periods of
volatility in the market price of a public companys securities, securities class action litigation has often been instituted against that company. Such litigation could result in substantial costs to us and a diversion of our managements
attention and resources.





Many significant corporate actions are controlled by our officers, directors and affiliated entities
regardless of the opposition of other investors or the desire of other investors to pursue an alternative cause of action.





Our executive officers, directors and entities affiliated with them, in the aggregate, beneficially own approximately 42% of our common stock. If they were to act together, these stockholders would be able to exercise control over
most matters requiring approval by our stockholders, including the election of directors and approval of significant corporate transactions. This concentration of ownership may also have the effect of delaying or preventing a change in control of
our company, which could cause our stock price to drop. These actions may be taken even if they are opposed by the other investors, including those who purchased shares in the initial public offering.





Delaware law and our charter, bylaws and contracts provide anti-takeover defenses that could delay or prevent an acquisition of us, even if an acquisition
would be beneficial to our stockholders.





Provisions of Delaware law, our certificate of incorporation, bylaws
and contracts could delay, defer or prevent an acquisition or change of control of us, even if an acquisition would be beneficial to our stockholders, and this could adversely affect the price of our common stock.





| |  |  | Our bylaws limit the ability of our stockholders to call a special meeting and do not permit stockholders to act by written consent.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------




| |  |  | We are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which prohibits us from engaging in a business
combination with an interested stockholder for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Several members of our senior management have contracts with us that provide for the acceleration of the vesting of their stock options upon termination
following a change of control.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Our certificate of incorporation permits our board to issue shares of preferred stock without stockholder approval. In addition to delaying or preventing an
acquisition, the issuance of a substantial number of shares of preferred stock could adversely affect the price of the common stock.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




| |  |  | Additional provisions of our certificate of incorporation that may serve to delay or prevent an acquisition include a staggered board, advance notice procedures
for stockholders to nominate candidates for election as directors, authorization of our board to alter the number of directors without stockholder approval and lack of cumulative voting.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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ITEM 3.    
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT FINANCIAL MARKET RISK





We develop and
market our services primarily in the United States. As we expand our operations outside of the United States, our financial results could be affected by factors such as changes in foreign currency rates or weak economic conditions in foreign
markets. Because all of our revenues are currently denominated in U.S. dollars, a strengthening of the dollar could make our services less competitive in international markets.





Interest Rate Risk





Our exposure to market rate risk for
changes in interest rates relates primarily to our investment portfolio. We do not use derivative financial instruments in our investment portfolio. We manage our interest rate risk by maintaining an investment portfolio primarily consisting of debt
instruments with high credit quality and average maturities less than nine months in accordance with the our investment policy. The policy also limits the amount of credit exposure to any one issuer. Notwithstanding our efforts to manage interest
rate risks, there can be no assurances that we will be adequately protected against the risks associated with interest rate fluctuations.





ITEM 4.    
CONTROLS AND PROCEDURES





Within 90 days prior to the date of this report, we carried out
an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation,
our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC reports. It should be
noted that the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future
conditions, regardless of how remote.





In addition, we reviewed our internal controls, and there have been no
significant changes in our internal controls or in other factors that could significantly affect those controls subsequent to the date of their last evaluation.




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PART II.    
OTHER INFORMATION





ITEM 1.    LEGAL PROCEEDINGS





In November 2001, a securities class action lawsuit was filed in the U.S. District Court for the Southern District of New York against the
Company, certain of its officers and certain of the underwriters involved in the Companys initial public offering. This is one of approximately 300 similar lawsuits in a coordinated proceeding sometimes referred to as IPO allocation
lawsuits or laddering lawsuits. The plaintiffs generally allege that the underwriters engaged in undisclosed improper practices by giving favorable allocations of IPO shares to certain investors in exchange for excessive brokerage
commissions and/or agreements for those investors to purchase additional shares in the aftermarket at predetermined higher prices. The plaintiffs seek an unspecified amount of damages.





ITEM 2.    
CHANGE IN SECURITIES AND USE OF PROCEEDS





On July 20, 2000, the Company effected an
initial public offering (the IPO), of 10,000,000 shares of its common stock at $14.00 per share, pursuant to a registration statement (No. 333-35402) declared effective by the Securities and Exchange Commission on July 20, 2000. The IPO
has been terminated, and all shares have been sold. The managing underwriters for the IPO were Goldman, Sachs & Co., Merrill Lynch & Co., Robertson Stephens and Epoch Partners. Aggregate proceeds from the IPO were $140,000,000.





The Company incurred the following expenses in connection with the IPO: underwriters discounts and commissions of
$9,800,000 and approximately $2,000,000 in other expenses, for a total expense of $11,800,000. No payments constituted direct or indirect payments to directors, officers or general partners of the Company or their associates, to persons owning 10%
or more of any class of equity securities of the Company, or to any affiliates of the Company.





After deducting
expenses of the IPO, the net offering proceeds to the Company were approximately $128,200,000. From July 20, 2000, the effective date of the Registration Statement, to September 30, 2002, the ending date of the reporting period, the approximate
amount of net offering proceeds used were $17.0 million to repay outstanding debt, approximately $71.6 million to fund operations and $15 million to purchase substantially all of the assets of QCS. The remaining net proceeds are invested in
short-term financial instruments.





ITEM 3.    
DEFAULTS UPON SENIOR SECURITIES





None





ITEM 4.    
SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS





No matter was submitted to a vote
of the stockholders, through the solicitation of proxies or otherwise, during the quarter ended September 30, 2002.





On July 31, 2002, Roger Siboni tendered his resignation as a member of the board of directors.





ITEM
5.    
OTHER INFORMATION





None





ITEM 6.    
EXHIBITS AND REPORTS ON FORM 8-K





| | (a) |  | Exhibits
| | --- |  | --------




99.1         Certification of Chief Executive Officer and Chief Financial Officer





| | (b) |  | Reports on Form 8-K
| | --- |  | -------------------




On August 6, 2002, the Company filed a Current Report on Form 8-K in connection with the agreement to acquire substantially all of the assets related to Qwest Cyber.Solutions LLC.





On September 27, 2002, the Company filed a Current Report on 8-K in connection with the completion of the asset purchase of Qwest Cyber.Solutions LLC.




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SIGNATURES





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





Dated:    November 14, 2002





CORIO, INC.By:

/s/    GEORGE
KADIFAGeorge Kadifa Chairman and
Chief Executive OfficerBy:

/s/    BRETT
WHITEBrett White Executive Vice President,
Finance and Chief Financial Officer




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##### Table of Contents




CERTIFICATIONS





I, George Kadifa, certify that:





|1. |  | I have reviewed this quarterly report on Form 10-Q of Corio, Inc.
|-- |  | -----------------------------------------------------------------




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




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




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




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




| | b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly
report (the Evaluation Date); and
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




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




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




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




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




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




Date:    November 14, 2002





/s/    GEORGE
KADIFAGeorge Kadifa President and Chief Executive
Officer




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I, Brett White, certify that:





|1. |  | I have reviewed this quarterly report on Form 10-Q of Corio, Inc.
|-- |  | -----------------------------------------------------------------




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




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




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




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




| | b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly
report (the Evaluation Date); and
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------




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




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




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




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




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




Date:    November 14, 2002





/s/    BRETT WHITEBrett White Executive Vice President and
Chief Financial Officer




31