<PAGE>
 
================================================================================

                                 UNITED  STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                                   FORM 10-Q


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

For the quarterly period ended   June 30, 1998
                                 -------------
                                        
                                       OR
 
  [_]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 
        EXCHANGE ACT OF 1934
 
Commission file number     0-23795
                           ------- 
 

                          EXODUS COMMUNICATIONS, INC.
           ------------------------------------------------------
           (Exact name of registrant as specified in its charter)
 

             Delaware                                  77-0403076
   -------------------------------                 -------------------
   (State or other jurisdiction of                  (I.R.S. Employer 
    incorporation or organization)                 Identification No.)


               2650 San Tomas Expressway, Santa Clara, CA  95051
               -------------------------------------------------
                   (Address of principal executive offices)
                                  (Zip Code)


                                (408) 346-2200
              ---------------------------------------------------
             (Registrant's telephone number, including area code)

                                        
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

Yes  [X]          No  [_]

The number of shares outstanding of the issuer's common stock, par value $0.001,
as of August 7, 1998 was 19,544,057 shares.

================================================================================

                                       1
<PAGE>
 
                          EXODUS COMMUNICATIONS, INC.

                                     INDEX
                                     -----


PART I.   FINANCIAL INFORMATION                                        PAGE NO.
          ---------------------                                        --------

          Item 1.  Financial Statements
 
                   Condensed Balance Sheets June 30, 1998 and
                     December 31, 1997                                        3
 
                   Condensed Statements of Operations - Three and 
                     Six Month Periods ended June 30, 1998 and 1997           4
 
                   Condensed Statements of Cash Flows Six Month 
                     Period ended June 30, 1998 and 1997                      5
 
                   Notes to Condensed Financial Statements                    6
 
          Item 2.  Management's Discussion and Analysis of Financial 
                     Condition and Results of Operations                      8
 
          Item 3.  Quantitative and Qualitative Disclosures About 
                     Market Risk                                             26
 

PART II.  OTHER INFORMATION
          -----------------

          Item 1.  Legal Proceedings                                         26
 
          Item 2.  Changes in Securities and Use of Proceeds                 26 
 
          Item 3.  Defaults Upon Senior Securities                           27
 
          Item 4.  Submission of Matters to a Vote of Security Holders       27

          Item 5.  Other Information                                         27
 
          Item 6.  Exhibits and Reports on Form 8-K                          28
 
          Signatures                                                         29

                                       2
<PAGE>
 
I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

                         EXODUS COMMUNICATIONS, INC.
                          CONDENSED BALANCE SHEETS
                      (IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
                                                                                          JUNE 30,          DECEMBER 31,
                                                                                           1998                 1997
                                                                                       ------------         -----------
<S>                                                                                    <C>                  <C>
 ASSETS
 Current assets:
    Cash and cash equivalents....................................................      $     60,720          $     10,270
    Accounts receivable..........................................................             4,384                 1,837
    Prepaid expenses and other current assets....................................             2,082                 1,377
                                                                                       ------------          ------------
      Total current assets.......................................................            67,186                13,484
 Property and equipment, net.....................................................            43,105                25,170
 Restricted cash equivalents.....................................................             1,938                 1,753
 Other assets....................................................................               811                   566
                                                                                       ------------          ------------
                                                                                       $    113,040          $     40,973
                                                                                       ============          ============
 LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED
     STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)

 Current liabilities:
    Bank borrowings..............................................................      $          -          $      3,000
    Current portion of debt......................................................             7,301                 3,777
    Current portion of capital lease obligations.................................             3,294                 1,143
    Accounts payable.............................................................            11,144                 6,252
    Accrued expenses.............................................................             5,835                 2,808
    Deferred revenue.............................................................                41                   211
                                                                                       ------------          ------------
      Total current liabilities..................................................            27,615                17,191
 Debt, less current portion......................................................            21,453                12,693
 Capital lease obligations, less current portion.................................             8,461                 2,442
                                                                                       ------------          ------------
      Total liabilities..........................................................            57,529                32,326
                                                                                       ------------          ------------

 Redeemable convertible preferred stock and warrants.............................                 -                39,247
                                                                                       ------------          ------------
 Stockholders' equity (deficit):                                                                  

    Common stock, $0.001 par value:  50,000,000 and 53,281,579 authorized as
      of June 30, 1998 and December 31, 1997,  respectively;  19,477,098 and
      2,067,253 shares issued and outstanding as of June 30, 1998 and as of
      December 31, 1997, respectively............................................                19                     2
    Additional paid-in capital...................................................           115,160                 2,508
    Notes receivable from stockholders...........................................               (53)                 (140)
    Deferred stock compensation..................................................            (1,641)               (2,393)
    Accumulated deficit..........................................................           (57,974)              (30,577)
                                                                                       ------------          ------------
        Total stockholders' equity (deficit).....................................            55,511               (30,600)
                                                                                       ------------          ------------
                                                                                       $    113,040          $     40,973
                                                                                       ============          ============
</TABLE>


See accompanying notes to condensed financial statements.

                                       3
<PAGE>
 
                          EXODUS COMMUNICATIONS, INC.
                       CONDENSED STATEMENT OF OPERATIONS
                     (IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE> 
<CAPTION> 
                                                                 THREE MONTHS ENDED          SIX MONTHS ENDED
                                                                JUNE 30,      JUNE 30,     JUNE 30,     JUNE 30,
                                                                  1998          1997         1998         1997
                                                             ------------------------------------------------------
<S>                                                           <C>            <C>           <C>         <C> 
Revenues                                                        $  10,071   $    2,393    $  17,176    $    4,062
                                                                ---------     --------    ---------      --------
Costs and expenses:
    Cost of revenues                                               12,983        2,999       22,864         4,898
    Marketing and sales                                             7,163        2,746       13,580         4,376
    General and administrative                                      3,000        1,163        5,657         2,079
    Product development                                               719          385        1,364           588
                                                                ---------     --------    ---------      --------
Total cost and expenses                                            23,865        7,293       43,465        11,941
                                                                ---------     --------    ---------      --------

Operating loss                                                    (13,794)      (4,900)     (26,289)       (7,879)

Net interest expense                                                  282           81        1,108           137
                                                                ---------     --------    ---------      --------
    Net loss                                                      (14,076)      (4,981)     (27,397)       (8,016)

Cumulative dividends and accretion on
    redeemable convertible preferred stock                              -            -       (2,014)            -
                                                                ---------     --------    ---------      --------
Net loss attributable to common stockholders                     ($14,076)     ($4,981)    ($29,411)      ($8,016)
                                                                =========     ========    =========      ========

Basic and diluted net loss per share                               ($0.73)      ($2.59)      ($2.57)       ($4.16)
                                                                =========     ========    =========      ========

Shares used in computing basic and diluted net
    loss per share                                                 19,412        1,921       11,460         1,927
                                                                =========     ========    =========      ========
</TABLE> 

See accompanying notes to condensed financial statements.

                                       4
<PAGE>
 
                         EXODUS COMMUNICATIONS, INC. 
                      CONDENSED STATEMENT OF CASH FLOWS 
                                (IN THOUSANDS)
<TABLE> 
<CAPTION> 
                                                                                      JUNE 30,           JUNE 30,
                                                                                       1998               1997
                                                                                     ---------           --------
<S>                                                                                 <C>                  <C> 
Cash flows from operating activities:
  Net loss                                                                           $ (27,397)          $ (8,016)
  Adjustments to reconcile net loss to net cash used for operating activities:
      Depreciation and amortization                                                      4,689                962
      Loss on disposal of property and equipment                                           248                  -
      Non-cash warrant expense                                                             786                  -
      Amortization of deferred stock compensation                                          752                  -
      Amortization of debt issuance costs                                                  198                  -
      Changes in operating assets and liabilities:
          Accounts receivable                                                           (2,547)              (419)
          Prepaid expenses and other assets                                             (1,148)              (394)
          Accounts payable                                                               4,892              2,478
          Accrued expenses                                                               3,027                (55)
          Deferred revenue                                                                (170)               (49)
                                                                                     ---------           --------
              Net cash used for operating activities                                   (16,670)            (5,493)
                                                                                     ---------           --------

Cash flows from investing activities:
  Purchases of property and equipment                                                  (17,842)            (5,765)
                                                                                     ---------           --------
             Net cash used for investing activities                                    (17,842)            (5,765)
                                                                                     ---------           --------

Cash flows from financing activities:
  Proceeds from issuance of redeemable convertible preferred stock and warrants          2,176             17,449
  Proceeds from issuance of common stock                                                70,460                 28
  Proceeds from issuance of bridge financing convertible notes                               -              3,975
  Notes receivable to stockholders, net                                                      -                (24)
  Repayment of notes receivable from stockholders                                           87                 17
  Repayment of bank borrowings                                                          (3,000)                 -
  Proceeds from sale-leaseback transactions                                              4,035                932
  Payment on capital lease obligations                                                    (895)              (570)
  Proceeds from debt                                                                    14,448              3,383
  Repayment of debt                                                                     (2,164)            (1,306)  
  Restricted cash                                                                         (185)                 -
                                                                                     ---------           --------
                  Net cash provided by financing activities                             84,962             23,884
                                                                                     ---------           --------

Net increase in cash and cash equivalents                                               50,450             12,626
Cash and cash equivalents at beginning of year                                          10,270              3,715
                                                                                     ---------           --------
Cash and cash equivalents at end of period                                           $  60,720           $ 16,341
                                                                                     =========           ========

Supplemental disclosure of cash flow information:
  Cash paid-interest                                                                 $   1,016           $    175
                                                                                     =========           ========
  Noncash investing and financing activities:
      Assets recorded under capital lease                                            $   6,007           $  1,532
                                                                                     =========           ========
      Cumulative dividends and accretion on Series C and D
          redeemable convertible preferred stock and warrants                        $   2,014           $      -
                                                                                     =========           ========
      Conversion of redeemable convertible preferred stock to
           common stock                                                              $  43,576           $      -
                                                                                     =========           ========
      Conversion of bridge financing convertible notes to
           redeemable convertible preferred stock                                    $      -            $  3,975
                                                                                     =========           ========
</TABLE> 
See accompanying notes to condensed financial statements.

                                       5
<PAGE>
 
                          EXODUS COMMUNICATIONS, INC.
                          ---------------------------
                    Notes to Condensed Financial Statements
                    ---------------------------------------

NOTE 1 - BASIS OF PRESENTATION

    The accompanying unaudited condensed financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information, the instructions to Form 10Q and Article 10 of
Regulation S-X. Accordingly, they do not contain all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, the accompanying unaudited
condensed financial statements have been prepared on the same basis as the
audited financial statements and include all adjustments, consisting only of
normal recurring adjustments, necessary for the fair presentation of the
Company's financial position as of June 30, 1998 and the results of its
operations for the three and six month periods ended June 30, 1998 and 1997
and its cash flows for the six months ended June 30, 1998 and 1997. These
financial statements should be read in conjunction with the Company's audited
financial statements as of December 31, 1997 and 1996 and for each of the
three years in the period ended December 31, 1997, including notes thereto,
included in the Company's final prospectus filed pursuant to Rule 424(b) under
the Securities Act of 1933, as amended, in connection with the Company's
Registration Statement on Form S-1 (File No. 333-44469). Operating results for
the six month period ended June 30, 1998 are not necessarily indicative of the
results that may be expected for the year ending December 31, 1998.


NOTE 2 - NET LOSS PER SHARE

    Basic and diluted net loss per share has been computed by dividing the net
loss attributable to common stockholders by the weighted average number of
shares of common stock outstanding.  Diluted net loss per share for the six
month periods ended June 30, 1998 and 1997 does not include the effect of (i)
3,259,000 and 832,000 stock options outstanding as of June 30, 1998 and June 30,
1997, respectively, (ii) 247,000 warrants to purchase common stock and 870,000
warrants to purchase common and redeemable convertible preferred stock, as of
June 30, 1998 and June 30, 1997, respectively and, (iii) 11,987,000 shares (up
to the date of the initial public offering) and 10,444,000 shares of redeemable
convertible preferred stock on an "as if converted" basis for the six month
periods ended June 30, 1998 and 1997, respectively as the effect of their
inclusion is antidilutive during each period.


NOTE 3 - INITIAL PUBLIC OFFERING

    On March 24, 1998, the Company completed its initial public offering of
5,125,000 shares of its Common Stock (the "IPO").  Net proceeds to the Company,
after deducting underwriting discounts and commissions and offering expenses,
aggregated approximately $69,700,000.  At the closing of the IPO, all redeemable
convertible preferred stock was converted to Common Stock on a one-for-three
basis.  In connection with the IPO, certain warrant holders exercised their
warrants to purchase preferred stock (which converted into Common Stock), which
resulted in additional proceeds of $1,842,000.


NOTE 4 - REVENUE RECOGNITION

    Revenues consist of monthly fees for server hosting, Internet connectivity,
collaborative systems management and Internet technology services, equipment
sales to customers and one-time fees for installation. Revenues (other than
installation fees and equipment sales to customers) are generally billed 

                                       6
<PAGE>
 
and recognized ratably over the term of the contract, generally one year.
Installation fees are typically recognized at the time the installation occurs,
and equipment sales are typically recognized when the equipment is delivered to
the customer.


NOTE 5 - PROPERTY AND EQUIPMENT

     Property and equipment consisted of the following (in thousands):

<TABLE>
<CAPTION>
                                                                   June 30,         December 31,
                                                                     1998               1997
                                                               -----------------  -----------------
<S>                                                            <C>                <C>
Data centers and related equipment...........................            $33,332            $16,316
Furniture, fixtures, computer equipment and other............             14,504             12,815
Construction in progress.....................................              3,729                 --
                                                                         -------            -------
                                                                          51,565             29,131
Less accumulated depreciation and amortization...............              8,460              3,961
                                                                         -------            -------
                                                                         $43,105            $25,170
                                                                         =======            =======
</TABLE>

     Computer equipment and certain data center equipment recorded under
capital leases aggregated $13,436,000 and $4,419,000 as of June 30, 1998 and
December 31, 1997, respectively. Accumulated amortization for the assets
recorded under capital leases aggregated $1,561,000 and $722,000 as of June
30, 1998 and December 31, 1997, respectively.

                                       7
<PAGE>
 
NOTE 6 - BANK BORROWINGS AND DEBT

     The Company has a $7,000,000 bank line of credit bearing interest at the
bank's prime rate, which is collateralized by all of the Company's assets.  The
bank line of credit expires in December 1998. No amount was outstanding under
the bank line of credit as of June 30, 1998.

A summary of debt follows:

<TABLE> 
<CAPTION> 
                                                                                          JUNE 30,      DECEMBER 31,
                                                                                           1998            1997
                                                                                         --------        --------
                                                                                              (in thousands)
<S>                                                                                      <C>             <C> 
$850,000 equipment term loan with a financial institution;  prime rate plus 2.5%
   (11.0% as of June 30,  1998);  principal  and  interest  due  monthly  for 42
   months...........................................................................     $    134        $     178

$1,800,000  equipment  line  of  credit  facility;  effective  interest  rate of
   approximately  16.4%;  principal and interest due monthly  through  September
   2000; collateralized by equipment................................................        1,164            1,393

$3,000,000   equipment  line  of credit  facility;   effective   interest  rate  of
   approximately  12.9%;  principal and interest due monthly  through July 2001;
   collateralized by equipment......................................................        2,429           2,756

$6,500,000  equipment  line  of  credit  facility;  effective  interest  rate of
   approximately  15.9%;  principal and interest due monthly  through July 2001;
   collateralized by equipment......................................................        5,428           6,312

$3,000,000   equipment  line  of credit  facility;   effective   interest  rate  of
   approximately  16.2%;  principal  and interest due monthly  through May 2001;
   collateralized by equipment......................................................        2,477           2,787

$5,000,000  equipment  line  of  credit  facility;  effective  interest  rate of
   approximately  16.2%;  principal and interest due monthly  through  September
   2001; collateralized by equipment................................................        3,500           3,044

$10,000,000  equipment  line of  credit  facility;  effective  interest  rate of
   approximately  13.8%;  principal and interest due monthly  through July 2002;
   collateralized by equipment......................................................        5,622              --

$8,000,000 line of credit  facility;  effective  interest rate of  approximately
   12.8%;   principal   and  interest  due  monthly   through   January   2000;
   collateralized by all of the Company's assets....................................        8,000              --
                                                                                         --------        --------
                                                                                           28,754          16,470
Less current portion                                                                        7,301           3,777
                                                                                         --------        --------
Debt, less current portion                                                               $ 21,453        $ 12,693
                                                                                         ========        ========
</TABLE> 

                                       8
<PAGE>
 
NOTE 7 - COMPREHENSIVE INCOME

     Effective January 1, 1998, the Company adopted the provisions of Statement
of Financial Accounting Standards (SFAS) No. 130, Reporting of Comprehensive
Income.  SFAS No. 130 establishes standards for the reporting and display of
comprehensive income and its components in a full set of financial statements.
Comprehensive income includes all changes in equity during a period except those
resulting from the issuance of shares of stock and distributions to
stockholders.  There were no material differences between net loss and
comprehensive loss during the three and six months ended June 30, 1998 and 1997.


NOTE 8 - SUBSEQUENT EVENT

       On July 1, 1998, the Company issued $200 million of 11.25% Senior Notes
due 2008 for aggregate net proceeds of approximately $194,000,000. The Company
deposited approximately $42,400,000 with an escrow agent that will pay, when
due, the first four semi-annual interest payments on the Notes.


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

     This Form 10-Q contains forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A
of the Securities Act of 1933, as amended.  These forward-looking statements
involve a number of risks and uncertainties, including the timely expansion of
the Company's network and opening of additional Internet Centers, the ability of
the Company to execute its current business plan, retain customers, attract new
customers, and other factors described throughout this Form 10-Q, including
under "Revenues" and "Other Factors That May Affect Future Operating Results,"
(referred to herein as "Other Factors") and in the Company's final prospectus
filed pursuant to Rule 424(b) under the Securities Act of 1933, as amended, in
connection with the Company's Registration Statement on Form S-1 (File No. 333-
44469) (the "Final Prospectus").  The actual results that the Company achieves
may differ materially from any forward-looking statements due to such risks and
uncertainties.  The forward-looking statements within this Form 10-Q are
identified by words such as "believes," "anticipates," "expects," "intends,"
"will," "may" and other similar expressions.  In addition, any statements which
refer to expectations, projections or other characterizations of future events
or circumstances are forward-looking statements.  In addition, the section
labeled "Other Factors That May Affect Future Operating Results" consists
primarily of forward-looking statements.  The Company undertakes no obligation
to publicly release the results of any revisions to these forward-looking
statements which may be made to reflect events or circumstances occurring
subsequent to the filing of this Form 10-Q with the Securities and Exchange
Commission.  Readers are urged to carefully review and consider the various
disclosures made by the Company in this report and in the Company's other
reports filed with the Securities and Exchange Commission, including its Final
Prospectus, that attempt to advise interested parties of the risks and factors
that may affect the Company's business.

OVERVIEW

     Exodus is a leading provider of Internet system and network management
solutions for enterprises with mission-critical Internet operations. The
Company's solutions include server hosting, Internet connectivity, collaborative
systems management and Internet technology services, which together provide the
high performance, scalability and expertise that enterprises need to optimize
Internet operations. The Company delivers its services from geographically
distributed, state-of-the-art Internet Data Centers that are connected through a
redundant high-performance national Internet backbone ring.

                                       9
<PAGE>
 
     The Company is the successor to a Maryland Corporation that was formed in
August 1992 to provide computer consulting services. The Company began to offer
Internet connectivity services to enterprises in October 1994 and server hosting
services in late 1995. In August 1996, the Company opened its first dedicated
Internet Data Center and refocused its business strategy on providing Internet
system and network management solutions for enterprises with mission-critical
Internet operations. Since refocusing its business strategy, the Company has
derived most of its revenues (and substantially all of its growth in revenues)
from customers for which it provides these services. Each of the Company's
Internet Data Center customers initially purchases a subset of the Company's
service offerings to address specific departmental or enterprise Internet
computing needs, and some of these customers purchase additional services as the
scale and complexity of their Internet operations increase. The Company sells
its services under contracts that typically have terms of one year. Customers
pay monthly fees for the services utilized, as well as one-time fees for
installation and for any equipment that they choose to purchase from the
Company.  Equipment revenue has represented less than 10% of total revenues for
each quarterly period beginning in 1997, and the Company expects equipment
revenues to remain less than 10% of total revenues going forward.  However, the
foregoing forward-looking statement is subject to risks and uncertainties, such
as the level of customer equipment demands, which could cause actual results to
differ materially.

     The Company opened its first Internet Data Center in the San Francisco
metropolitan area in August 1996. Since that time, the Company has opened six
additional domestic Internet Data Centers in the metropolitan areas of New York
(March 1997), San Francisco (August 1997 and June 1998), Seattle (September
1997), Los Angeles (October 1997) and Washington, D.C. (December 1997) and has a
server hosting facility in London. Additionally, the Company plans to open
Internet Data Centers in the Boston metropolitan area in the third quarter of
1998, the Chicago metropolitan area in the first quarter of 1999 and the London
metropolitan area in the second quarter of 1999 as well as additional Internet
Data Centers in the Washington, D.C. and Seattle metropolitan areas.  See "Other
Factors--Risks Associated with Accelerated Business Expansion" for risks related
to the foregoing forward-looking statements.  These facilities serve as a base
for the array of solutions offered by the Company, including server hosting,
Internet connectivity, collaborative systems management and Internet technology
services. The building of these Internet Data Centers has required the Company
to obtain substantial equity and debt financing.  See "Other Factors--
Substantial Leverage and Debt Service" and "Liquidity and Capital Resources" 
below.

     Prior to building an Internet Data Center in a new a geographic region, the
Company employs various means to evaluate the market opportunity in a given
location, including the use of focus groups and market research on Internet
usage statistics, the pre-selling of services into the proposed market and
analysis of specific financial criteria. The Company typically requires at least
six months to select the appropriate location for an Internet Data Center,
construct the necessary facilities, install equipment and telecommunications
infrastructure, and hire the operations and sales personnel needed to conduct
business at that site. Expenditures related to an Internet Data Center commence
well before the Internet Data Center opens, and it takes an extended period to
approach break-even capacity utilization at each site. As a result, the Company
expects that individual Internet Data Centers will experience losses in excess
of one year from the time they are opened. The Company experiences further
losses from sales personnel hired to test market the Company's services in
markets where there is no, and may never be an, Internet Data Center. As a
result, the Company expects to make investments in expanding the Company's
business rapidly into new geographic regions which, while potentially increasing
the Company's revenues in the long term, will lead to significant losses for the
foreseeable future.  See "Other Factors--Risks Associated with Accelerated
Business Expansion" for risks related to the foregoing forward-looking
statements.

     Since the Company began to offer server hosting services in 1995, it has
experienced operating losses and negative cash flows from operations in each
quarterly and annual period. As of June 30, 1998, the Company had an accumulated
deficit of approximately $58.0 million. The revenue and income potential of the
Company's business and market is unproven, and the Company's limited operating
history makes an evaluation of the Company and its prospects difficult.
Currently, the Company anticipates making 

                                       10
<PAGE>
 
significant investments in new Internet Data Centers, product development and
sales and marketing programs and personnel and therefore believes that it will
continue to experience net losses on a quarterly and annual basis for the
foreseeable future. The Company and its prospects must be considered in light of
the risks, expenses and difficulties encountered by companies in the new and
rapidly evolving market for Internet system and network management solutions.
See "Other Factors--Limited Operating History; History of Losses" for risks
related to the foregoing forward-looking statements.

RESULTS OF OPERATIONS

     The following table sets forth certain statement of operations data as a
percentage of total revenues for the three month and six month periods ended
June 30, 1998 and June 30, 1997. This information has been derived from the
Company's unaudited financial statements, which, in management's opinion, have
been prepared on substantially the same basis as the audited financial
statements and include all adjustments, consisting only of normal recurring
adjustments, necessary for a fair presentation of the financial information for
the quarters presented. This information should be read in conjunction with the
Financial Statements and Notes thereto included in the Company's Final
Prospectus. The operating results in any quarter are not necessarily indicative
of the results to be expected for any future period.
 
<TABLE> 
<CAPTION> 
                                                Three Months Ended             Six Months Ended
                                          ----------------------------------------------------------
                                              June 30,      June 30,        June 30,       June 30,
                                               1998           1997            1998           1997
                                          -------------  ------------    ------------   ------------
<S>                                       <C>            <C>             <C>            <C>  
Revenues                                          100.0%        100.0%          100.0%         100.0%
                                          -------------  ------------    ------------   ------------

Cost and expenses:
         Cost of revenues                         128.9         125.3           133.1          120.6
         Marketing and sales                       71.1         114.8            79.1          107.7
         General and administrative                29.8          48.6            32.9           51.2
         Product development                        7.2          16.1             8.0           14.5
                                          -------------  ------------    ------------   ------------

               Total cost and expenses            237.0         304.8           253.1          294.0
                                          -------------  ------------    ------------   ------------

               Operating loss                    (137.0)       (204.8)         (153.1)        (194.0)

Net interest expense                                2.8           3.3             6.4            3.3
                                          -------------  ------------    ------------   ------------

               Net loss                          (139.8)%      (208.1)%        (159.5)%       (197.3)%
                                          =============  ============    ============   ============
</TABLE> 

  Revenues
  --------

     Revenues consist of (i) monthly fees for server hosting, Internet
connectivity, collaborative systems management and Internet technology services,
(ii) revenues from sales of third-party equipment to customers and (iii) one-
time fees for installation.  Currently, substantially all of the Company's
revenue is derived from services fees.  Revenues (other than installation fees
and equipment sales to customers) are generally billed and recognized ratably
over the term of the contract, generally one year.  Installation fees are
typically recognized at the time the installation occurs, and equipment revenues
are typically recognized when the equipment is delivered to the customer or
placed into service at an Internet Data Center.  The Company sells third-party
equipment to its customers as an accommodation to facilitate their purchase of
services.

                                       11
<PAGE>
 
     The Company's revenues increased 321% to $10.1 million for the three months
ended June 30, 1998 from $2.4 million in the same period of the prior year.
Revenues increased 323% to $17.2 million for the six months ended June 30, 1998
from $4.1 in the same period of the prior year. This growth in revenues resulted
primarily from increases in the number of customers, increases in revenues from
existing customers and the opening of new Internet Data Centers.

  Cost of Revenues
  ----------------

     The Company's cost of  revenues is comprised primarily of the Company's
costs for its nationwide backbone network and local telco loops, salaries and
benefits for the Company's customer service and operations personnel (including
its network engineers, backbone engineers, network management and systems
personnel and installers), depreciation, rent, repairs and utilities related to
the Company's Internet Data Centers and costs of third-party equipment sold to
customers.

     The Company's cost of revenues increased 333% to $13.0 million for the
three month periods ended June 30, 1998 from $3.0 million in the same period
of the prior year. The cost of revenues increased 367% to $22.9 million for
the six months ended June 30, 1998 from $4.9 million in the same respective
period of the prior year. Cost of revenues as a percentage of revenues
increased to 129% and 133% for the three month and six month periods ended
June 30, 1998, from 125% and 121% for the same respective periods of the prior
year. These increases in cost of revenues in absolute dollars and as a
percentage of revenues were primarily the result of costs associated with the
opening of additional Internet Data Centers, including the hiring of
additional employees, and the Company's expansion and increased capacity of
its nationwide backbone network. The Company expects that its cost of revenues
as a percentage of revenues may remain above 100% through at least the
remainder of 1998.

  Marketing and Sales
  -------------------

     The Company's marketing and sales expenses are comprised primarily of
salaries and benefits for the Company's marketing and sales personnel, printing
and advertising costs, public relations costs, consultants' fees and travel and
entertainment expenses. The Company's marketing and sales expenses increased
161% and 210% to $7.2 million and $13.6 million (including a one-time non-cash
charge of $525,000 related to a warrant issued to At Home Corporation in the
first quarter of 1998 in connection with a distribution alliance) for the three
month and six month periods ended June 30, 1998 from $2.7 million and $4.4
million in the same respective periods of the prior year.  Marketing and sales
expenses increased as a result of increased marketing and sales personnel,
increased travel and entertainment expenses, increased trade shows and marketing
events, and increased public relations expenses. Marketing and sales expenses as
a percentage of revenues decreased to 71% and 79% for the three month and six
month periods ended June 30, 1998, compared to 115% and 108% for the same
respective periods in the prior year.  These declines were due primarily to
increased recurring revenues from existing customers, which tend to have lower
marketing and sales associated with them, as well as the Company's general
significant increase in revenues between the comparison periods.  The Company
expects that marketing and sales expenses will continue to increase in absolute
dollars during 1998 but will continue to decline as a percentage of total
revenues as recurring revenues from the existing customers, which tend to have
lower marketing and sales expenses associated with them, become a more
significant percentage of total revenues.  However, the foregoing forward-
looking statement is subject to risks and uncertainties which may cause actual
results to differ, such as risks associated with the Company's achievement of
anticipated levels of revenues and expenses, and the impact of competition.  See
"Other Factors--Competition"; "Dependence on New Market; Uncertainty of 
Acceptance of Services."

                                       12
<PAGE>
 
  General and Administrative
  --------------------------

     The Company's general and administrative expenses are comprised primarily
of salaries and benefits for the Company's administrative and management
information systems personnel and fees paid for professional services and
recruiting. The Company's general and administrative expenses increased 158% and
172% to $3.0 million and $5.7 million for the for the three month and six month
periods ended June 30, 1998, respectively, from $1.2 million and $2.1 million in
the same respective periods of the prior year. General and administrative
expenses increased as a result of additional personnel and increased
professional and recruiting services.  General and administrative expenses as a
percentage of revenues decreased to 30% and 33% for the three months and six
months ended June 30, 1998, respectively, from 49% and 51% in the same
respective periods of the prior year.  These declines were due to the Company's
significant increase in revenues between the comparison periods.  The Company
expects that general and administrative expenses will continue to increase in
absolute dollars but will continue to decline as a percentage of total revenues
as existing overhead is spread over more substantial operations.  However, the
foregoing forward-looking statement is subject to risks and uncertainties which
may cause actual results to differ materially, such as risks associated with the
Company's achievement of anticipated levels of revenues and expenses.  See
"Other Factors--Potential Fluctuations in Operating Results."


  Product Development
  -------------------

     The Company's product development expenses are comprised primarily of
salaries and benefits for the Company's product development personnel and fees
paid to consultants, all of whom focus their efforts primarily on the
integration of best-of-breed products and services developed by leading
technology vendors with the Company's services and the development of the
Company's proprietary technologies.  The Company's product development expenses
increased 87% and 132% to $719,000 and $1.4 million for the three month and six
month periods ended June 30, 1998, respectively, from $385,000 and $588,000 in
the same respective periods of the prior year. Product development expenses
increased as a result of additional personnel and the increase in fees paid to
consultants.  Product development expenses as a percentage of revenues decreased
to 7% and 8% for the three month and six month periods ended June 30, 1998,
respectively, from 16% and 14% in the same respective periods of the prior year.
These declines were due to the Company's significant increase in revenues
between the comparison periods.  The Company expects that product development
expenses will continue to increase in absolute dollars as the Company makes
additional investments in developing proprietary technology, particularly
related to its collaborative systems management services, but will decline as a
percentage of total revenues as existing costs are spread over a larger revenue
base.  However, the foregoing forward-looking statement is subject to risks and
uncertainties that may cause actual results to differ materially, such as risks
associated with the Company's achievement of anticipated levels of revenues and
expenses. See "Other Factors--Potential Fluctuations in Operating Results."


   Net Interest Expense
   --------------------

    The Company's net interest expense increased to $282,000 and $1.1 million
for the three month and six month periods ended June 30, 1998, respectively,
from $81,000 and $137,000 in the same periods of the prior year. The increase in
net interest expense between the comparison periods was primarily the result of
substantially increased borrowings as the Company entered into equipment loans
and lease agreements to finance the construction of its Internet Data Centers
and working capital lines of credit to finance working capital for its
operations. The Company expects that net interest expense will increase
substantially, as the Company begins to incur interest payment obligations for
the $200 million senior notes which bear interest at 11 1/4% that it
issued on July 1, 1998 (the "Senior Notes"), and as the Company enters into
additional equipment leases and loans and obtains additional borrowings.   See
"Part II, Item 5. Other Information" of this Form 10-Q.

                                       13
<PAGE>
 
  Deferred Compensation Expense
  -----------------------------

     The Company's deferred compensation expense increased to $635,000 and $1.0
million for the three month and six month periods ended June 30, 1998 from $0 in
the same periods of the prior year. The Company has recorded deferred stock
compensation in connection with the grant of certain stock options and stock
from March 1997 through May 1998.  Deferred compensation expense associated with
the grant of stock options is generally being amortized over the 50 month
vesting period of such options.  This amortization is being recorded in a manner
consistent with FASB Interpretation No. 28.  These amortization amounts are
allocated among the expense categories discussed above.


  EBITDA
  ------

     The Company's loss before interest, taxes, depreciation, amortization and
other non-cash charges ("EBITDA") increased to $10.4 million and $20.1 million
for the three month and six month periods ended June 30, 1998, respectively,
from a loss of $4.3 million and $6.9 million in the same respective periods of
the prior year. The increase in the level of EDITDA losses between the
comparison periods was primarily due to increased expenditures needed to
support the Company's growth in operations, including salaries and benefits
for additional employees, network costs, rent, utilities and other costs
related to the increase in the number of Company's Internet Data Centers as
well as increased marketing and sales expenses, consulting fees and
professional services. Although EBITDA should not be used as an alternative to
operating loss or net cash provided by (used for) operating activities,
investing activities or financing activities, each as measured under generally
accepted accounting principles, the Company's management believes that EBITDA
is an additional meaningful measure of performance and liquidity.


LIQUIDITY AND CAPITAL RESOURCES

     Since inception and through June 30, 1998, the Company has financed its
operations primarily through private sales of preferred stock, its initial
public offering in March 1998 and through various types of equipment loans and
lease lines and working capital lines of credit. At June 30, 1998, the principal
source of liquidity for the Company was $60.7 million of cash and cash
equivalents. As of that date, the Company also had equipment loans and lease
lines and working capital lines of credit under which it could borrow up to an
additional aggregate of $10.4 million for purchases of equipment and for working
capital. As of June 30, 1998, the Company's total bank borrowings, debt and
capital lease obligations were $40.5 million.  On July 1, 1998, the Company
incurred an additional $200 million of indebtedness in connection with the
issuance of the Senior Notes.  See Note 8 of Notes to Financial Statements and
"Item 5. Other Information" of this Form 10-Q.  In addition, the Company
expects to enter into a credit facility with Goldman Sachs Credit Partners L.P.
(the "Credit Facility"), under which the Company will be permitted to borrow up
to approximately $25.0 million or up to approximately $50.0 million upon meeting
certain financial tests.  Loans to the Company will be guaranteed by any future
subsidiaries of the Company.  The Credit Facility is expected to be secured by a
first priority lien on substantially all of the Company's assets (subject to
certain exceptions) and the assets and stock of any future subsidiaries.  The
Credit Facility is subject to the satisfaction of certain material conditions
precedent and the specific terms of the Credit Facility are subject to change
pursuant to final loan documentation.  There can be no assurance as to whether,
or on what terms, the Company will enter into the Credit Facility.

     Since the Company began to offer server hosting services in 1995, the
Company has had significant negative cash flows from operating activities. Net
cash used for operating activities for the six months ended June 30, 1998 was
$16.7 million, primarily due to net losses, offset in part by increases in
accounts payable and accrued expenses and depreciation and amortization.  This
compares to net cash used for operating activities for the six months ended June
30, 1997 of $5.5 million, primarily due to net losses, offset in part by
increases in accounts payable.

                                       14
<PAGE>
 
     Net cash used for investing activities for the six months ended June 30,
1998 was $17.8 million compared to $6.2 million for the six months ended June
30, 1997.  Net cash used for investing activities was due to capital
expenditures for the continued construction of Internet Data Centers, leasehold
improvements, furniture and fixtures, and computers and other equipment.  Cash
provided by financing activities for the six months ended June 30, 1998 was
$85.0 million, primarily due to the proceeds from the Company's initial public
offering.  This compares to net cash provided by financing activities for the
six months ended June 30, 1997 of $23.9 million due primarily to the proceeds of
the issuance of preferred stock and warrants.

     As of June 30, 1998, the Company had commitments under capital leases and
under noncancellable operating leases of $11.8 million and $31.9 million,
respectively, through 2010.  The Company intends to make significant
expenditures during the next 12 months primarily for property and equipment, in
particular equipment needed for existing and future Internet Data Centers, as
well as office equipment, computers and telephones.  The Company expects to
finance such capital expenditures primarily through existing and future
equipment loans and lease lines, net proceeds from the Senior Notes and
borrowings under the expected Credit Facility.  The Company expects to meet its
working capital and capital expenditure requirements over the next 12 months
with existing cash and cash equivalents and short-term investments, the proceeds
from the Senior Notes, borrowings under the expected Credit Facility, cash from
sales of services and proceeds from existing and future working capital lines of
credit.  Currently, the Company is negotiating to enter into additional
equipment loans and capital leases and believes that it will obtain such
facilities on terms that are comparable to its existing facilities.  The Company
may also seek to raise additional funds through public or private financing,
strategic relationships or other arrangements.  There can be no assurance that
the Company will be successful generating sufficient cash flows from operations
or raising capital in sufficient amounts on terms acceptable to it.  See "Risk
Factors--Risks Associated with Accelerated Business Expansion."


OTHER FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS

     As referenced in the first paragraph of this Item 2, this section consists
primarily of forward-looking statements and accompanying risks.  In addition to
the factors set forth above, the following additional factors may affect the
Company's future operating results.

     LIMITED OPERATING HISTORY; HISTORY OF LOSSES.  While the Company began
operations in 1992, it did not offer server hosting services until 1995 and did
not open its first dedicated Internet Data Center until August 1996, at which
time it refocused its business strategy on providing Internet system and network
management solutions for enterprises' mission-critical Internet operations.  As
a result, the Company's business model is still in an emerging state.  Since it
began to offer server hosting services in 1995, the Company has experienced
operating losses and negative cash flows from operations in each quarterly and
annual period.  The revenue and income potential of the Company's business and
market is unproven, and the Company's limited operating history makes an
evaluation of the Company and its prospects difficult.  Currently, the Company
anticipates making significant investments in new Internet Data Centers and
product development and sales and marketing programs and personnel and therefore
believes that it will continue to experience net losses on a quarterly and
annual basis for the foreseeable future.  The Company and its prospects must be
considered in light of the risks, expenses and difficulties encountered by
companies in the new and rapidly evolving market for Internet system and network
management solutions.  To address these risks, among other things, the Company
must market its brand name effectively, provide scalable, reliable and cost-
effective services, ensure and enhance customer satisfaction, continue to grow
its infrastructure to accommodate new Internet Data Centers and increased
bandwidth use of its network, expand its channels of distribution, retain and
motivate qualified personnel and continue to respond to competitive
developments.  Failure of the Company's services to achieve market acceptance
would have a material adverse effect on the Company's business, results of
operations and financial condition.  Although the Company has experienced
significant growth in revenues in recent periods, the Company does not believe
that this growth rate necessarily is indicative of future operating results, and
there can be no 

                                       15
<PAGE>
 
assurance that the Company will ever achieve profitability on a quarterly or an
annual basis or will sustain profitability if achieved.

     POTENTIAL FLUCTUATIONS IN OPERATING RESULTS.  The Company has experienced
significant fluctuations in its results of operations on a quarterly and an
annual basis.  The Company expects to continue to experience significant
fluctuations in its future quarterly and annual results of operations due to a
variety of factors, many of which are outside the Company's control, including:
demand for and market acceptance of the Company's services and enhancements;
introductions of services or enhancements by the Company and its competitors;
capacity utilization of its Internet Data Centers; reliable continuity of
service and network availability; the ability to increase bandwidth as
necessary; the timing of customer installations; providing customer discounts
and credits; the mix of services sold by the Company; customer retention and
satisfaction; the timing and success of marketing efforts and service
introductions by the Company; the timing and magnitude of capital expenditures,
including construction costs relating to the expansion of operations; the timely
expansion of existing Internet Data Centers and completion of new Internet Data
Centers; costs related to the acquisition of backbone capacity; the introduction
by third parties of new Internet and networking technologies; increased
competition in the Company's markets; changes in the pricing policies of the
Company and its competitors; fluctuations in bandwidth used by customers; the
retention of key personnel; economic conditions specific to the Internet
industry; and other general economic factors.  In addition, a relatively large
portion of the Company's expenses are fixed in the short-term, particularly with
respect to telecommunications, depreciation, certain substantial interest
expenses, real estate and interest expenses and personnel, and therefore the
Company's operating results are particularly sensitive to fluctuations in
revenues.  Also, if the Company's agreement with Computer Associates
International, Inc. ("Computer Associates") were to terminate and the Company
continued to require Computer Associates' software, the license fees paid by the
Company could increase fixed costs significantly.  Furthermore, if the Company
were to become unable to continue leveraging third party products in the
Company's services offerings, the Company's product development costs could
increase significantly.  Although the Company has not encountered significant
difficulties in collecting upon accounts receivable in the past, many of the
Company's customers are in an emerging stage, and there can be no assurance that
the Company will be able to collect receivables on a timely basis.  For these
and other reasons, in some future quarters, the Company's results of operations
may fall below the expectations of securities analysts or investors, which could
have a material adverse effect on the market price of the Company's Common
Stock.

     RISKS ASSOCIATED WITH ACCELERATED BUSINESS EXPANSION.  A key element of the
Company's business strategy is the expansion of the Company's network through
the opening of additional Internet Data Centers in geographically diverse
locations.  The Company currently has seven Internet Data Centers located in
five metropolitan areas:  San Francisco (3), New York, Los Angeles, Seattle and
Washington, D.C. and has a server hosting facility in the London metropolitan
area.  The Company intends to expand domestically and internationally, including
the expected addition of Internet Data Centers in the Boston metropolitan area
in the third quarter of 1998, the Chicago metropolitan area in the first quarter
of 1999 and the London metropolitan area in the second quarter of 1999 as well
as additional Internet Data Centers in the Washington, D.C. and Seattle
metropolitan areas.  The Company intends to apply a portion of the proceeds from
the Senior Notes to complete this accelerated geographic expansion.  The
Company's continued expansion and development of its network will depend on,
among other things, the Company's ability to assess markets, identify Internet
Data Center sites, install facilities and establish local peering
interconnections with Internet service providers ("ISPs"), all in a timely
manner, at reasonable costs and on terms and conditions acceptable to the
Company.  The Company's ability to manage this expansion effectively will
require it to continue to implement and improve its operational and financial
systems and to expand, train and manage its employee base.  The Company's
inability to establish additional Internet Data Centers or manage effectively
its expansion would have a material adverse effect upon the Company's business,
results of operations and financial condition.

                                       16
<PAGE>
 
     The establishment of each additional Internet Data Center will require the
Company to expend substantial resources for leases of real estate, significant
improvements of such facilities, purchase of equipment, implementation of
multiple telecommunications connections and hiring of network, administrative,
customer support and sales and marketing personnel.   The failure to generate
sufficient cash flows from sales of services or to raise sufficient funds from
outside sources may require the Company to delay or abandon some or all of its
development and expansion plans or otherwise forego market opportunities and may
make it difficult for the Company to respond to competitive pressures, any of
which could have a material adverse effect on the Company's business, results of
operations and financial condition.  See "--Liquidity and Capital Resources."

     The Company expects to make investments in expanding the Company's business
rapidly into new geographic regions which, while potentially increasing the
Company's revenues in the long term, will lead to significant losses for the
foreseeable future.  See "Overview."  There can be no assurance that the Company
will be able to anticipate accurately the customer demand for such additional
Internet Data Centers or that the Company will be able to attract a sufficient
number of customers to such facilities.  The Company's inability to attract
customers to new Internet Data Centers in a timely manner, or at all, would have
a material adverse effect on the Company's business, results of operations and
financial condition.

     SUBSTANTIAL LEVERAGE AND DEBT SERVICE.  The Company has significant amounts
of outstanding indebtedness and interest cost.  The Company's level of
indebtedness presents various risks, including the possibility that the Company
may be unable to generate cash sufficient to pay the principal of and interest
on the indebtedness when due.  At June 30, 1998, the Company's total bank
borrowings, debt and capital lease obligations were approximately $40.5 million
and its borrowings available under existing equipment loans and working capital
lines of credit was approximately $10.4 million, subject to the borrowing
conditions contained therein.  At June 30, 1998, on an as adjusted basis after
giving effect to the sale of the Senior Notes, the Company would have had
indebtedness of approximately $240.5 million. In addition, the Company will
have the right to issue additional Senior Notes on or prior to July 1, 1999 in
an aggregate principal amount not to exceed $75.0 million. Furthermore, the
Company expects to enter into a new secured Credit Facility, and the Senior
Notes would be effectively subordinated to any borrowings under the Credit
Facility. The Company expects to incur additional equipment loans and lease
lines to finance capital expenditures for its Internet Data Centers and may
obtain additional working capital lines of credit and lease lines.

     The Company's ability to make principal and interest payments on the 
Senior Notes, and service other existing and future indebtedness, will be
dependent on the Company's future operating performance, which is itself
dependent on a number of factors, many of which are outside of the Company's
control. These factors include prevailing economic conditions and financial,
competitive, legislative, regulatory and other factors affecting the Company's
business and operations, and may be dependent on the availability of
borrowings under the expected Credit Facility or other borrowings. Although
the Company believes, based on current levels of operations, that its cash
flow from operations, together with other sources of liquidity, will be
adequate to make required payments of principal and interest on its debt
(including the Senior Notes), whether at or prior to maturity, finance
anticipated capital expenditures and fund working capital requirements, there
is no assurance in this regard. If the Company is unable to generate
sufficient cash flow from operations, or additional equipment loans or
equipment and working capital lines of credit, in the future to service its
debt, it may be required to sell assets, reduce capital expenditures,
refinance all or a portion of its existing indebtedness or obtain other
sources of financing. There can be no assurance that any such refinancing
would be available on commercially reasonable terms, or at all, or that any
other financing could be obtained, particularly in view of the Company's high
level of indebtedness and the fact that substantially all of the Company's
assets have been pledged to secure obligations under certain existing
indebtedness.

     The degree to which the Company is leveraged could have important
consequences to the 

                                       17
<PAGE>
 
Company's future operations, including but not limited to: (i) increasing the
Company's vulnerability to general adverse economic and industry conditions;
(ii) limiting the Company's ability to obtain additional financing to fund
future working capital, capital expenditures, acquisitions and other general
corporate requirements; (iii) requiring the dedication of a substantial portion
of the Company's cash flow from operations to the payment of principal of, and
interest on, its indebtedness, thereby reducing the availability of such cash
flow to fund working capital, capital expenditures or other general corporate
requirements; (iv) limiting the Company's flexibility in planning for, or
reacting to, changes in its business and the industry in which it competes; and
(v) placing the Company at a competitive disadvantage vis-a-vis less leveraged
or better capitalized competitors. Certain of the Company's indebtedness is
secured by the Company's assets. A default under such indebtedness could result
in the foreclosure on such collateral, which would have a material adverse
effect on the Company's business, results of operations and financial condition.

     RISKS ASSOCIATED WITH FINANCING ARRANGEMENTS.  Certain of the Company's
existing financing arrangements are secured by substantially all of the
Company's assets. These financing arrangements require that the Company satisfy
certain financial covenants and currently prohibit the payment of dividends and
the repurchase of capital stock of the Company without, in each case, the
lender's consent. The Company's secured lenders would be entitled to foreclose
upon those assets in the event of a default under the financing arrangements and
to be repaid from the proceeds of the liquidation of those assets before the
assets would be available for distribution to the holders of the Senior Notes or
equity securities in the event that the Company is liquidated. In addition, the
collateral security arrangements under the Company's existing financing
arrangements may adversely affect the Company's ability to obtain additional
borrowings.

     COMPETITION.  The market served by the Company is intensely competitive,
and such competition is increasing. There are few substantial barriers to entry,
and the Company expects that it will face additional competition from existing
competitors and new market entrants in the future.  The principal competitive
factors in this market include Internet system engineering expertise, customer
service, network capability, reliability, quality of service and scalability,
broad geographic presence, brand name, technical expertise and functionality,
the variety of services offered, the ability to maintain and expand distribution
channels, customer support, price, the timing of introductions of new services,
network security, financial resources and conformity with industry standards.

     The Company's current and potential competitors in the market include:  (i)
providers of server hosting services; (ii) national and regional ISPs; (iii)
global, regional and local telecommunications companies and Regional Bell
Operating Companies ("RBOCs"); and (iv) large IT outsourcing firms.  Many of the
Company's competitors have substantially greater financial, technical and
marketing resources, larger customer bases, longer operating histories, greater
name recognition and more established relationships in the industry than the
Company.  As a result, certain of these competitors may be able to develop and
expand their network infrastructures and service offerings more quickly, adapt
to new or emerging technologies and changes in customer requirements more
quickly, take advantage of acquisition and other opportunities more readily,
devote greater resources to the marketing and sale of their products and adopt
more aggressive pricing policies than can the Company.

     Certain of the Company's competitors may be able to provide customers with
additional benefits in connection with their Internet system and network
management solutions, including reduced communications costs, which could reduce
the overall costs of their services relative to the Company's.  There can be no
assurance that the Company will be able to offset the effects of any such price
reductions.  In addition, the Company believes that the businesses in which the
Company competes are likely to encounter consolidation in the near future, which
could result in increased price and other competition that could have a material
adverse effect on the Company's business, results of operations and financial
condition.

                                       18
<PAGE>
 
     DEPENDENCE ON NEW MARKET; UNCERTAINTY OF ACCEPTANCE OF SERVICES.  The
market for Internet system and network management solutions has only recently
begun to develop, is evolving rapidly and likely will be characterized by an
increasing number of market entrants.  There is significant uncertainty
regarding whether this market ultimately will prove to be viable or, if it
becomes viable, that it will grow.  The Company's future growth, if any, will be
dependent on the willingness of enterprises to outsource the system and network
management of their mission-critical Internet operations and the Company's
ability to market its services in a cost-effective manner to a sufficiently
large number of customers.  In addition, in order to be successful in this
emerging market, the Company must be able to differentiate itself from its
competition through its service offerings, such as its recently introduced
collaborative systems management and Internet technology services.  There can be
no assurance that the Company will be successful in differentiating itself or
achieving market acceptance of its services, or that it will not experience
difficulties that could delay or prevent the successful development,
introduction or marketing of these services.  If the Company incurs increased
costs or is unable, for technical or other reasons, to develop and introduce new
services or enhancements of existing services in a timely manner, or if new
products or services do not achieve market acceptance in a timely manner or at
all, the Company's business, results of operations and financial condition could
be materially adversely affected.

     RISK OF SYSTEM FAILURE.  The Company's operations are dependent upon its
ability to protect its network infrastructure and customers' equipment against
damage from human error, fire, earthquakes, floods, power loss,
telecommunications failures, sabotage, intentional acts of vandalism and similar
events.  Despite precautions taken by, and planned to be taken by the Company,
the occurrence of a natural disaster or other unanticipated problems at one or
more of the Company's Internet Data Centers could result in interruptions in the
services provided by the Company or significant damage to customer equipment.
In addition, failure of any of the Company's telecommunications providers, such
as WorldCom and Qwest Communications Corporation ("Qwest"), to provide the data
communications capacity required by the Company, as a result of human error, a
natural disaster or other operational disruption, could result in interruptions
in the Company's services.  Any damage to or failure of the systems of the
Company or its service providers could result in reductions in, or terminations
of, services supplied to the Company's customers, which could have a material
adverse effect on the Company's business, results of operations and financial
condition.  In addition, the Company's reputation could be materially adversely
affected. The Company has from time to time experienced interruptions in
specific circuits within its network resulting from events outside the Company's
control, which interruptions have caused short-term degradation in the level of
performance of the Company's network.  Should the Company incur significant
obligations in connection with system downtime in the future, there can be no
assurance that the Company's liability insurance would be adequate to cover such
expenses.


     UNPROVEN NETWORK SCALABILITY.  The Company must continue to expand and
adapt its network infrastructure as the number of users and the amount of
information they wish to transport increase and to meet changing customer
requirements.  The expansion and adaptation of the Company's telecommunications
infrastructure will require substantial financial, operational and management
resources as the Company negotiates telecommunications capacity with its
existing and other network infrastructure suppliers.  If the Company is required
to expand significantly and rapidly its network due to increased usage,
additional stress will be placed upon the Company's network hardware and traffic
management systems.  Due to the limited deployment of the Company's services to
date, the ability of the Company's network to connect and manage a substantially
larger number of customers at high transmission speeds is as yet unknown, and
the Company faces risks related to the network's ability to be scaled up to its
expected customer levels while maintaining superior performance.  As customers'
usage of bandwidth increases, the Company will need to make additional
investments in its infrastructure to maintain adequate downstream data
transmission speeds, the availability of which may be limited or the cost of
which may be significant.  In addition, as the Company adds new customers that
have significant bandwidth needs, it may be required 

                                       19
<PAGE>
 
to increase quickly its network capacity which may be difficult in light of
current lead times within the industry for adding capacity. There can be no
assurance that additional network capacity will be available from third-party
suppliers as it is needed by the Company. As a result, there can be no assurance
that the Company's network will be able to achieve or maintain a sufficiently
high capacity of data transmission, especially if the usage of the Company's
customers increases. The Company's failure to achieve or maintain high capacity
data transmission could significantly reduce consumer demand for its services
and have a material adverse effect on its business, results of operations and
financial condition. In addition, as the Company upgrades its telecommunications
infrastructure to increase bandwidth available to its customers, it is likely to
encounter a certain level of equipment or software incompatibility which may
cause delays in implementation. There can be no assurance that the Company will
be able to expand or adapt its telecommunications infrastructure to meet
additional demand or its customers' changing requirements, including its plans
to add OC-12 circuits, on a timely basis and at a commercially reasonable cost,
or at all.

     DEPENDENCE UPON NETWORK INFRASTRUCTURE.  The Company's success will depend
upon the capacity, scalability, reliability and security of its network
infrastructure, including the capacity leased from its telecommunications
network suppliers.  In particular, the Company is dependent on WorldCom and
Qwest and certain other telecommunications providers for its backbone capacity
(including the Company's dedicated clear channel network and transit access to
ISPs) and is therefore dependent on such companies to maintain the operational
integrity of its backbone.  In addition, the Company relies on a number of
public and private peering interconnections to deliver its services.  If the
carriers that operate the Internet exchange points ("IXPs") were to discontinue
their support of the peering points and no alternative providers were to emerge,
or such alternative providers were to increase the cost of utilizing the IXPs,
the distribution of content through the IXPs, including content distributed by
the Company, would be significantly constrained.  Furthermore, as traffic
through the IXPs increases, if commensurate increases in bandwidth are not
added, the Company's ability to distribute content rapidly and reliably through
these networks will be adversely affected.  Many of the operators of the private
peering interconnections are competitors of the Company.  Currently, the Company
does not pay a fee for its public and private peering interconnections.  The
Company and the operators of these public and private peering interconnections
have mutually agreed not to charge each other a fee for the exchange of traffic
between their respective networks, which is a standard industry practice.  If
these organizations were to refuse to continue to peer directly with the
Company, the Company might be required to purchase transit access services from
or to these organizations in order to allow the Company's customers to reach the
customers of these organizations.  If the Company chose not to purchase such
access, there would be a lack of communication between the Company's customers
and the customers of such organization.  For example, the Company has received
notice from one of its peering partners, GTE Internetworking, that GTE
Internetworking intends to discontinue its peering relationship with the
Company.  The Company is working to resolve this situation, but in the event
that no agreement is reached, communication between the Company's customers and
those of GTE Internetworking would cease if neither the Company nor GTE
Internetworking obtained access to the other party's network through a third
party.  Any such lack of communication between GTE Internetworking and the
Company could result in customer dissatisfaction.  In those cases where the
Company currently purchases backup capacity from other organizations, if these
organizations were to increase the pricing associated with such capacity, the
Company might be required to identify alternative methods through which it can
distribute its customers' content. If the Company were unable to access on a
cost-effective basis alternative networks to distribute its customers' content
or pass through any additional costs of utilizing these networks to its
customers, the Company's business, results of operations and financial
condition could be materially adversely affected.

     DEPENDENCE ON THE INTERNET AND INTERNET INFRASTRUCTURE DEVELOPMENT.  The
increased use of the Internet for retrieving, sharing and transferring
information among businesses, consumers, suppliers and partners has only
recently begun to develop, and the Company's success will depend in large part
on continued growth in the use of the Internet.  Critical issues concerning the
commercial use of the Internet, including security, reliability, cost, ease of
access, quality of service and necessary increases in bandwidth 

                                       20
<PAGE>
 
availability, remain unresolved and are likely to affect the development of the
market for the Company's services. If the Internet as a commercial or business
medium fails to develop or develops more slowly than expected, the Company's
business, results of operations and financial condition could be materially
adversely affected. The recent growth in the use of the Internet has caused
frequent periods of performance degradation, requiring the upgrade of routers
and switches, telecommunications links and other components forming the
infrastructure of the Internet by ISPs and other organizations with links to the
Internet. Any perceived degradation in the performance of the Internet as a
whole could undermine the benefits of the Company's services.

     RAPID TECHNOLOGICAL CHANGE; EVOLVING INDUSTRY STANDARDS.  The Company's
future success will depend, in part, on its ability to offer services that
incorporate leading technology, address the increasingly sophisticated and
varied needs of its current and prospective customers and respond to
technological advances and emerging industry standards and practices on a timely
and cost-effective basis.  The market for the Company's services is
characterized by rapidly changing and unproven technology, evolving industry
standards, changes in customer needs, emerging competition and frequent new
service introductions.  There can be no assurance that future advances in
technology will be beneficial to, or compatible with, the Company's business or
that the Company will be able to incorporate such advances on a cost-effective
and timely basis into its business.  Moreover, technological advances may have
the effect of encouraging certain of the Company's current or future customers
to rely on in-house personnel and equipment to furnish the services currently
provided by the Company.  In addition, keeping pace with technological advances
in the Company's industry may require substantial expenditures and lead time.

     The Company believes that its ability to compete successfully is also
dependent upon the continued compatibility and interoperability of its services
with products, services and architectures offered by various vendors.  Although
the Company often works with various vendors in testing newly developed
products, there can be no assurance that such products will be compatible with
the Company's infrastructure or that such products will adequately address
changing customer needs.  Although the Company currently intends to support
emerging standards, there can be no assurance that industry standards will be
established or, that if they become established, the Company will be able to
conform to these new standards in a timely fashion and maintain a competitive
position in the market.  In addition, there can be no assurance that products,
services or technologies developed by others will not render the Company's
services uncompetitive or obsolete.

     SYSTEM SECURITY RISKS.  A significant barrier to electronic commerce and
communications is the secure transmission of confidential information over
public networks.  Certain of the Company's services rely on encryption and
authentication technology licensed from third parties to provide the security
and authentication necessary to effect secure transmission of confidential
information.  Despite the Company's design and implementation of a variety of
network security measures, there can be no assurance that unauthorized access,
computer viruses, accidental or intentional actions and other disruptions will
not occur.  The Company's Internet Data Centers have in the past experienced and
may in the future experience delays or interruptions in service as a result of
the accidental or intentional actions of Internet users, current and former
employees or others.  Furthermore, such inappropriate use of the network by
third parties could also potentially jeopardize the security of confidential
information, such as credit card and bank account numbers, stored in the
computer systems of the Company and its customers, which could result in
liability to the Company and the loss of existing customers or the deterrence of
potential customers.  Although the Company intends to continue to implement
industry-standard security measures, such measures have been circumvented in the
past, and there can be no assurance that any such measures implemented by the
Company will not be circumvented in the future.  The costs required to eliminate
computer viruses and alleviate other security problems could be prohibitively
expensive and the efforts to address such problems could result in
interruptions, delays or cessation of service to the Company's customers, which
could have a material adverse effect on the Company's business, results of
operations and financial condition.

                                       21
<PAGE>
 
     DEPENDENCE ON THIRD-PARTY SUPPLIERS.  The Company is dependent on other
companies to supply certain key components of its telecommunications
infrastructure and system and network management solutions, including
telecommunications services and networking equipment that, in the quantities and
quality demanded by the Company, are available only from sole or limited
sources.  See "--Dependence Upon Network Infrastructure."  The routers, switches
and modems used in the Company's telecommunications infrastructure are currently
supplied primarily by Cisco Systems Inc. ("Cisco").  The Company purchases these
components pursuant to purchase orders placed from time to time, does not carry
significant inventories of these components and has no guaranteed supply
arrangements with these vendors.  Any failure to obtain required products or
services on a timely basis and at an acceptable cost would have a material
adverse effect on the Company's business, results of operations and financial
condition.  In addition, any failure of the Company's sole or limited source
suppliers to provide products or components that comply with evolving Internet
and telecommunications standards or that interoperate with other products or
components used by the Company in its communications infrastructure could have a
material adverse effect on the Company's business, results of operations and
financial condition. In addition, the Company expects to be dependent for a time
on third parties to deliver its services from and manage its international
operations, including its site in London.

     The Company has also licensed certain software from Computer Associates
which allows the Company to monitor its customers' Internet operations and
assist in resolving performance issues that arise from time to time.  Under the
agreement with Computer Associates, if the Company desires to offer a service
that has a substantially similar functionality to that provided by Computer
Associates' Unicenter(R) TNG(TM) family of software, or its ARCserve or InocuLAN
products (the "CA Products"), the Company must generally utilize the CA
Products, as long as they meet the Company's requirements.  In addition, the
Company is a beta test site for new versions of the CA Products and must, upon
commercial deployment, replace existing software with new CA Products if they
are substantially similar in functionality.  During the term of the agreement,
the Company is obligated to pay Computer Associates a royalty equal to one
percent of the Company's gross revenues.  Either party may terminate this
agreement upon 60 days' prior written notice with no penalties.  Should Computer
Associates or the Company decide to terminate this agreement, the Company has
the right to continue licensing software from Computer Associates at a forty
percent discount from Computer Associates' prevailing standard prices for five
years and the Company will no longer be obligated to pay a royalty to Computer
Associates.

     MANAGEMENT OF GROWTH.  The Company is currently experiencing a period of
rapid growth with respect to the building of its Internet Data Centers,
expansion of its customer base and increase in the number of Company employees.
This growth has placed, and if it continues, will place, a significant strain on
the Company's financial, management, operational and other resources, including
its ability to ensure customer satisfaction.  In addition, the Company may be
required to manage multiple relationships with a growing number of third parties
as it seeks to complement its service offerings.  There can be no assurance that
the Company's management, personnel, systems, procedures and controls will be
adequate to support the Company's existing and future operations.  The Company's
ability to manage its growth effectively will require it to continue to expand
its operating and financial procedures and controls, to replace or upgrade its
operational, financial and management information systems and to attract, train,
motivate, manage and retain key employees.  The Company has recently hired many
key employees and officers, including its President, and as a result, the
Company's entire management team has worked together for only a brief time.  The
Company also has plans to hire additional executive management personnel in the
near future, including a new Vice President, Marketing to fill the existing
vacancy for that position.  If the Company's executives are unable to manage
growth effectively, the Company's business, results of operations and financial
condition could be materially adversely affected.

     GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES.  The Company is not
currently subject to direct federal, state or local government regulation, other
than regulations applicable to businesses generally.  There is currently only a
small body of laws and regulations directly applicable to access to or commerce
on 

                                       22
<PAGE>
 
the Internet. However, due to the increasing popularity and use of the Internet,
it is possible that a number of laws and regulations may be adopted at the
federal, state and local levels with respect to the Internet, covering issues
such as user privacy, freedom of expression, pricing, characteristics and
quality of products and services, taxation, advertising, intellectual property
rights, information security and the convergence of traditional
telecommunications services with Internet communications. In addition,
applicability to the Internet of existing laws governing issues such as property
ownership, copyrights and other intellectual property issues, taxation, libel,
obscenity and personal privacy is uncertain. The vast majority of such laws were
adopted prior to the advent of the Internet and related technologies and, as a
result, do not contemplate or address the unique issues of the Internet and
related technologies. Changes to such laws intended to address these issues,
including some recently proposed changes, could create uncertainty in the
marketplace which could reduce demand for the services of the Company or
increase the cost of doing business as a result of costs of litigation or
increased service delivery costs, or could in some other manner have a material
adverse effect on the Company's business, results of operations and financial
condition. In addition, as the Company's services are available over the
Internet in multiple states and foreign countries, and as the Company
facilitates sales by its customers to end users located in such states and
foreign countries, such jurisdictions may claim that the Company is required to
qualify to do business as a foreign corporation in each such state or foreign
country. Any such new legislation or regulation, or the application of laws or
regulations from jurisdictions whose laws do not currently apply to the
Company's business, could have a material adverse effect on the Company's
business, results of operations and financial condition.

     RISKS ASSOCIATED WITH INFORMATION DISSEMINATED THROUGH THE COMPANY'S
NETWORK.  The law relating to the liability of online services companies and
Internet access providers for information carried on or disseminated through
their networks is currently unsettled.  It is possible that claims could be made
against online services companies and Internet access providers under both
United States and foreign law for defamation, negligence, copyright or trademark
infringement, or other theories based on the nature and content of the materials
disseminated through their networks.  Also, certain businesses, organizations
and individuals have in the past sent unsolicited commercial e-mails from
servers hosted at the Company's facilities to massive numbers of people,
typically to advertise products or services.  This practice, known as
"spamming," can lead to complaints against service providers that enable such
activities, particularly where recipients view the materials received as
offensive.  In addition, certain ISPs and other online services companies could
deny network access to companies that allow undesired content or spamming to be
transmitted through their networks.  The Company has in the past received, and
may in the future receive, letters from recipients of information transmitted by
the Company's customers objecting to such transmission.  Although the Company
prohibits its customers by contract from spamming, there can be no assurance
that its customers will not engage in this practice, which could have a material
adverse effect on the Company's business, results of operations and financial
condition.

     RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS.  A component of the
Company's long-term strategy is to expand into international markets, and the
Company recently opened a site in the London metropolitan area.  If revenue
generated by any current or future international Internet Data Center is not
adequate to offset the expense of establishing and maintaining any such
international operation, the Company's business, results of operations and
financial condition could be materially adversely affected.  There can be no
assurance that the Company will be able to market, sell and deliver successfully
its services outside the United States.  In order to expand its international
operations, the Company may, among other things, enter into joint ventures or
outsourcing agreements with third parties, acquire rights to high-bandwidth
transmission capability, acquire complementary businesses or operations, or
establish and maintain new operations outside of the United States. In addition,
the rate of development and adoption of the Internet has been slower outside of
the United States, and the cost of bandwidth has been higher, which may
adversely affect the Company's ability to expand its operations and may increase
its cost of operations internationally.  In addition to the uncertainty as to
the Company's ability to expand into international markets, there are certain
risks inherent in conducting business internationally, such as unexpected
changes 

                                       23
<PAGE>
 
in regulatory requirements, export restrictions, tariffs and other trade
barriers, challenges in staffing and managing foreign operations, differing
technology standards, employment laws and practices in foreign countries, longer
payment cycles, problems in collecting accounts receivable, political
instability, fluctuations in currency exchange rates, imposition of currency
exchange controls, seasonal reductions in business activity and potentially
adverse tax consequences, any of which could adversely affect the Company's
international operations. Furthermore, certain foreign governments, such as
Germany, have enforced laws and regulations related to content distributed over
the Internet that are more strict than those currently in place in the United
States.

     DEPENDENCE ON KEY PERSONNEL.  The Company's success depends in significant
part upon the continued services of its key technical, sales and senior
management personnel, including the Company's Chief Executive Officer and
Chairman of the Board of Directors, K.B. Chandrasekhar.  The Company's future
success will also depend on its ability to attract, train, retain and motivate
highly qualified technical, marketing, sales and management personnel.  The
Company is currently seeking certain additional executive management personnel,
including a Vice President, Marketing.  Competition for such personnel is
intense, and there can be no assurance that the Company will be able to attract
and retain key personnel.  The loss of the services of one or more of the
Company's key employees or the Company's failure to attract additional qualified
personnel could have a material adverse effect on the Company's business,
results of operations and financial condition.

     RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS.  The Company believes that
its future growth depends, in part, upon the acquisition of complementary
businesses, products, services or technologies. There can be no assurance that
the Company will successfully identify, acquire on favorable terms or integrate
such businesses, products, services or technologies. The Company may face
competition for acquisition opportunities, which may inhibit the Company's
ability to consummate suitable acquisitions and increase the costs of completing
and the time required to complete such acquisitions. Any such acquisitions will
require the Company to manage and integrate such acquired businesses, products,
services or technologies, coordinate (and possibly change) the diverse operating
structures, policies and practices of the acquired entities and to integrate new
employees into the Company's organization and culture. Failure to integrate and
manage acquired businesses, products, services and technologies successfully
could have a material adverse effect on the Company's business, financial
condition and results of operations. In addition, future acquisitions by the
Company may result in the incurrence of additional debt, large one-time write-
offs and the creation of goodwill or other intangible assets that could result
in amortization expenses. These factors could have a material adverse effect on
the Company's business, results of operations and financial condition.

     RISKS ASSOCIATED WITH LEGAL PROCEEDINGS.  From time to time the Company has
been, and expects to continue to be, subject to legal proceedings and claims in
the ordinary course of its business, including, among others, contractual
disputes with vendors and customers, claims by employees and claims of alleged
infringement of the trademarks and other intellectual property rights of third
parties by the Company.  Such claims, even if not meritorious, could result in
the expenditure of significant financial and managerial resources.

     PROTECTION AND ENFORCEMENT OF INTELLECTUAL PROPERTY RIGHTS.  The Company
relies on a combination of copyright, trademark, service mark and trade secret
laws and contractual restrictions to establish and protect certain proprietary
rights in its products and services, but there can be no assurance that the
measures taken by the Company will be sufficient to prevent misappropriation of
its technology.  The Company currently has no patented technology that would
preclude or inhibit competitors from entering the Company's market.  The laws of
certain foreign countries may not protect the Company's products, services or
intellectual property rights to the same extent as do the laws of the United
States.  The Company also relies on certain technologies that it licenses from
third parties, such as Computer Associates.  There can be no assurance that
these third-party technology licenses will continue to be available to the

                                       24
<PAGE>
 
Company on commercially reasonable terms.  The loss of such technology could
require the Company to obtain substitute technology of lower quality or
performance standards or at greater cost, which could materially adversely
affect the Company's business, results of operations and financial condition.

     The Company has determined increasingly to develop or acquire additional
proprietary intellectual property in addition to licensing technologies from
third parties.  To date, the Company has not been notified that the Company's
products or services infringe the proprietary rights of third parties, but there
can be no assurance that third parties will not claim infringement by the
Company with respect to current or future products, particularly if such
products or services include one or more of its own proprietary technologies.
The Company expects that participants in its markets will be increasingly
subject to infringement claims as the number of products and services and
competitors in the Company's industry segment grows.  Any such claim, whether
meritorious or not, could be time-consuming, result in costly litigation, cause
product installation delays or require the Company to enter into royalty or
licensing agreements.

     YEAR 2000 RISKS.  Many currently installed computer systems are not capable
of distinguishing 21st century dates from 20th century dates.  As a result, in
less than two years, computer systems or applications used by many companies in
a wide variety of industries will experience operating difficulties unless the
systems or applications are modified to process information related to the
century change adequately.  Significant uncertainty exists in the software and
other industries concerning the scope and magnitude of problems associated with
the century change.  To the extent Year 2000 issues cause significant delay in,
or cancellation of, decisions to purchase the Company's products or product
support, due to the reallocation of resources to address Year 2000 issues or
otherwise, the Company's business, results of operations and financial condition
could be materially adversely affected.

     PRODUCTS.  Based on its assessment to date, the Company believes that the
current versions of its products are either "Year 2000 compliant" or will not
require substantial effort or cost to make them Year 2000 compliant.  However,
many of the Company's customers maintain their Internet operations on servers
which may be impacted by Year 2000 complications.  The failure of the Company's
customers to ensure that their servers are Year 2000 compliant could have a
material adverse effect on the Company's customers, which in turn could have a
material adverse effect on the Company's business, results of operations and
financial condition.  In addition, the costs of defending and resolving Year
2000 related disputes, and any liability of the Company for Year 2000-related
damages, including consequential damages, could have a material adverse effect
on the Company's business, results of operations and financial condition.

     OPERATIONS.  The Company has reviewed, and continues to review, its
internal management information and other systems in order to identify and
modify those products, services or systems that may not be Year 2000 compliant.
Based on its assessment to date, the Company believes that its internal
management information and other systems are either Year 2000 compliant or will
not require substantial effort or cost to make them Year 2000 compliant.  The
total cost of these Year 2000 compliance activities has not been material to
date.  There can be no assurance that the Company will identify and remedy any
Year 2000 problems in a timely fashion, that remedial efforts in this regard
will not involve significant time and expense, or that such problems will not
have a material adverse effect on the Company's business, results of operations
and financial condition.  The Company faces additional risk to the extent that
suppliers of products, services and systems purchased by the Company and others
with whom the Company transacts business are not Year 2000 compliant. In the
event that any such third parties cannot provide the Company with products,
services or systems that are Year 2000 compliant on a timely basis (or in the
event that Year 2000 issues prevent such third parties from delivering products,
services or systems required by the Company on a timely basis), the Company's
business, results of operations and financial condition could be materially
adversely affected.

                                       25
<PAGE>
 
     VOLATILITY OF STOCK PRICE.  The market price of the shares of Common Stock
is highly volatile and is subject to wide fluctuations in response to factors
such as actual or anticipated variations in the Company's results of operations,
announcements of technological innovations or new Internet Data Centers, new
products or services introduced by the Company or its competitors, changes in
financial estimates by securities analysts, conditions and trends in the
Internet, general market conditions and other factors.  Further, the stock
markets, and in particular the Nasdaq National Market, have experienced extreme
price and volume fluctuations that have particularly affected the market prices
of equity securities of many technology companies and that often have been
unrelated or disproportionate to the operating performance of such companies.
The trading prices of many technology companies' stocks are at or near
historical highs and reflect price to earnings ratios substantially above
historical levels.  There can be no assurance that these trading prices and
price to earnings ratios will be sustained.  These market fluctuations, as well
as general economic, political and market conditions such as recessions,
interest rates or international currency fluctuations, may adversely affect the
market price of the Common Stock.

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

     Not applicable.

II.  OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS

     As previously disclosed in its Final Prospectus, the Company had been
engaged in litigation with a former consultant, Michael Blackman, regarding
certain compensation matters related to his consulting relationship with the
Company.  On June 2, 1998, the Company settled this litigation for an immaterial
amount.  Mr. Blackman's suit has since been dismissed with prejudice.

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

     The Company's initial public offering of Common Stock was effected through
a Registration Statement on Form S-1 (File No. 333-44469) that was declared
effective by the SEC on March 18, 1998 and pursuant to which the Company sold an
aggregate of 5,125,000 share of its Common Stock.

     As of June 30, 1998, the Company had used the estimated aggregate net
proceeds of $69,743,750 from its initial public offering as follows:

Construction of plant, building and facilities:             $1.0 million

Purchase and installation of machinery and equipment:       $1.7 million

Purchases of real estate:                                   $0

Acquisition of other businesses:                            $0

Repayment of indebtedness:                                  $2.8 million

Working capital:                                            $7.5 million

Temporary investments (short term, interest bearing
treasury securities):                                       $56.7 million

Other purposes:                                             $0

                                       26
<PAGE>
 
     The foregoing amounts represent the Company's best estimate of its use of
proceeds for the period indicated.  No such payments were made to directors or
officers of the Company or their associates, holders of 10% or more of any class
of equity securities of the Company or to affiliates of the Company.

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES

     Not applicable.

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

     Not applicable.

ITEM 5.  OTHER INFORMATION

     On July 27, 1998, Mark Bonham's employment relationship with the Company
terminated.  Mr. Bonham previously held the position of vice-president,
marketing of the Company.  Effective July 28, 1998, Ellen Hancock, the Company's
President, assumed Mr. Bonham's responsibilities and will serve as the acting
vice-president, marketing, until a permanent replacement is hired.

     On July 1, 1998, the Company issued $200 million of 11.25% Senior Notes due
2008 for aggregate net proceeds of approximately $194,000,000. The Company
deposited approximately $42,400,000 with an escrow agent that will pay, when
due, the first four semi-annual interest payments on the Notes.  In addition,
the Company will have the right to issue additional Senior Notes on or prior to
July 1, 1999 in an aggregate principal amount not to exceed $75.0 million.  The
terms and conditions of the Senior Notes are described in, and this summary is
qualified by reference to, the Indenture filed as Exhibit 10.30 hereto, the
Exchange and Registration Rights Agreement filed as Exhibit 10.31 hereto, the
Escrow Agreement filed as Exhibit 10.32 hereto and the Purchase Agreement filed
as Exhibit 10.33 hereto.

                                       27
<PAGE>
 
ITEM 6.  EXHIBITS AND REPORTS ON FORM 8K

a.  Exhibits

   Exhibit No.  Description of Exhibit
   -----------  ----------------------

    10.30       Indenture between Exodus Communications, Inc. as Issuer and 
                Chase Manhattan Bank and Trust Company, National Association, as
                Trustee dated July 1, 1998.

    10.31       Exchange and Registration Rights Agreement among Exodus
                Communications, Inc., Goldman, Sachs & Co., Donaldson Lufkin &
                Jenrette Securities Corporation, BT Alex. Brown Incorporated and
                NationsBanc Montgomery Securities LLC dated July 1, 1998.

    10.32       Escrow Agreement among Chase Manhattan Bank and Trust Company,
                National Association, as escrow agent, Chase Manhattan Bank and
                Trust Company, National Association, as trustee, and Exodus
                Communications, Inc., dated July 1, 1998.

    10.33       Purchase Agreement among Exodus Communications, Inc., Goldman,
                Sachs & Co., Donaldson Lufkin & Jenrette Securities Corporation,
                BT Alex. Brown Incorporated and NationsBanc Montgomery
                Securities LLC dated June 26, 1998.

    10.34       Form of Notice of Debt Offering and Waiver of Registration 
                Rights among the Company and certain holders of stock of the 
                Company.

    10.35       Amended and Restated Master Loan and Security Agreement
                between Exodus Communications, Inc. and Transamerica Business
                Credit Corporation dated June 30, 1998.

    10.36       Agreement between Cisco Systems Capital Corporation and Exodus
                Communications, Inc. dated June 1, 1998.

    10.37*      Qwest Communications Private Line Service Agreement  Business
                Services, between Qwest Comunications Corporation and the
                Registrant, dated as of July 17, 1998.

    27.1        Financial Data Schedule
    _______
    *  Confidential treatment has been requested for certain portions of this 
       document.

b.  Reports on Form 8-K

  The Company filed reports on Form 8-K dated June 11 and June 26, 1998.  Both
  reports included information under Items 5 and 7 with respect to the initial
  announcement and pricing, respectively, of the Company's privately placed
  Senior Note offering.

                                       28
<PAGE>
 
                                   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.


                                       EXODUS COMMUNICATIONS, INC.


 
       August 14, 1998                 /s/ K.B. Chandrasekhar
------------------------------         ------------------------------------
          Date                                 K.B. Chandrasekhar
                                           Chief Executive Officer and
                                        Chairman of the Board of Directors
 


       August 14, 1998                 /s/ Richard S. Stoltz
------------------------------         ------------------------------------
          Date                                   Richard S. Stoltz
                                             Chief Financial Officer and
                                               Chief Operating Officer
                                            (Duly Authorized Officer and 
                                              Chief Accounting Officer)

                                       29
<PAGE>
 
                                EXHIBIT INDEX


   Exhibit No.  Description of Exhibit
   -----------  ----------------------

    10.30       Indenture between Exodus Communications, Inc. as Issuer and 
                Chase Manhattan Bank and Trust Company, National Association, as
                Trustee dated July 1, 1998.

    10.31       Exchange and Registration Rights Agreement among Exodus
                Communications, Inc., Goldman, Sachs & Co., Donaldson Lufkin &
                Jenrette Securities Corporation, BT Alex. Brown Incorporated and
                NationsBanc Montgomery Securities LLC dated July 1, 1998.

    10.32       Escrow Agreement among Chase Manhattan Bank and Trust Company,
                National Association, as escrow agent, Chase Manhattan Bank and
                Trust Company, National Association, as trustee, and Exodus
                Communications, Inc., dated July 1, 1998.

    10.33       Purchase Agreement among Exodus Communications, Inc., Goldman,
                Sachs & Co., Donaldson Lufkin & Jenrette Securities Corporation,
                BT Alex. Brown Incorporated and NationsBanc Montgomery
                Securities LLC dated June 26, 1998.

    10.34       Form of Notice of Debt Offering and Waiver of Registration 
                Rights among the Company and certain holders of stock of the 
                Company.

    10.35       Amended and Restated Master Loan and Security Agreement
                between Exodus Communications, Inc. and Transamerica Business
                Credit Corporation dated June 30, 1998.

    10.36       Agreement between Cisco Systems Capital Corporation and Exodus
                Communications, Inc. dated June 1, 1998.

    10.37*      Qwest Communications Private Line Service Agreement  Business
                Services, between Qwest Comunications Corporation and the
                Registrant, dated as of July 17, 1998.

    27.1        Financial Data Schedule
    _______
    *  Confidential treatment has been requested for certain portions of this 
       document.