<PAGE>

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

                                   FORM 10-Q

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

                 For the quarterly period ended June 30, 2000

                                      OR

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

                 For the transition period from _____ to _____

                          Commission File No. 0-27801

                            DATA RETURN CORPORATION
            (Exact name of registrant as specified in its charter)


                Texas                                   75-2725998
   (State or other jurisdiction of                   (I.R.S. Employer
    incorporation or organization)                  Identification No.)


                        222 West Las Colinas Boulevard
                                   Suite 450
                              Irving, Texas 75039
                  (Address, including zip code, of principal
                              executive offices)

                                (972) 869-0770
                  (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               NO    X
                             -----            -----

The registrant had 35,554,717 shares of Common Stock, par value $.001 per share,
outstanding as of August 10, 2000.

                                       1
<PAGE>

PART I - FINANCIAL INFORMATION

Item 1.  Condensed Financial Statements                                   Page
                                                                          ----

         Condensed Balance Sheets at March 31, 2000 and
            June 30, 2000 (Unaudited)                                       3

         Condensed Statements of Operations for the three months
            ended June 30, 1999 and 2000 (Unaudited)                        4

         Condensed Statements of Cash Flows for the three months
            ended June 30, 1999 and 2000 (Unaudited)                        5

         Notes to Condensed Financial Statements (Unaudited)                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        21


PART II - OTHER INFORMATION

Item 6.  Exhibits and Reports on Form 8-K                                  21

         Signatures                                                        22

                                       2
<PAGE>

                        PART I - FINANCIAL INFORMATION.

                            Data Return Corporation
                           Condensed Balance Sheets
                     (in thousands, except per share data)

<TABLE>
<CAPTION>
                                                                                             March 31,                June 30,
                                                                                               2000                     2000
                                                                                           -------------------------------------
Assets                                                                                                              (Unaudited)
<S>                                                                                        <C>                      <C>
Current assets:
   Cash                                                                                    $ 85,424                 $ 13,753
   Investment in marketable securities                                                            -                   32,476
   Accounts receivable, net of allowance for doubtful accounts
      of $328 and $592 at March 31, 2000 and June 30, 2000,
      respectively                                                                            5,429                    6,758
   Prepaid and other                                                                          1,349                    2,144
                                                                                           --------                 --------
Total current assets                                                                         92,202                   55,131
   Investment in marketable securities                                                            -                   25,790
   Property and equipment, net                                                               22,027                   32,194
   Other assets                                                                                 628                      725
                                                                                           --------                 --------

Total assets                                                                               $114,857                 $113,840
                                                                                           ========                 ========

Liabilities and shareholders' equity
Current liabilities:
   Accounts payable                                                                        $  2,021                 $  2,109
   Accrued expenses and other                                                                 2,205                    2,696
   Deferred revenue                                                                           2,207                    3,295
   Notes payable and capital lease obligations - current                                      5,799                    5,695
                                                                                           --------                 --------
Total current liabilities                                                                    12,232                   13,795

Notes payable and capital lease obligations - long term                                      11,324                   17,136
Commitments and contingencies                                                                     -                        -
Shareholders' equity:
   Preferred stock, $.001 par value; 20,000 shares
      authorized, none issued or outstanding                                                      -                        -
   Common stock, $.001 par value; 100,000 shares
      authorized; 35,398 and 35,520 issued and outstanding
      at March 31, 2000 and June 30, 2000, respectively                                          35                       36
   Additional paid-in capital                                                               109,718                  109,886
   Pre-paid broadband services                                                               (5,000)                  (5,000)
   Deferred stock compensation                                                                 (290)                    (190)
   Accumulated deficit including comprehensive earnings                                     (13,162)                 (21,823)
                                                                                           --------                 --------
Total shareholders' equity                                                                   91,301                   82,909
                                                                                           --------                 --------
Total liabilities and shareholders' equity                                                 $114,857                 $113,840
                                                                                           ========                 ========

</TABLE>

           See accompanying notes to Condensed Financial Statements.

                                       3
<PAGE>

                            Data Return Corporation
                      Condensed Statements of Operations
                     (in thousands, except per share data)
                                   Unaudited

<TABLE>
<CAPTION>
                                                                      Three Months Ended
                                                                            June 30,
                                                            -------------------------------------
                                                              1999                          2000
                                                            -------                       -------
<S>                                                         <C>                           <C>
Revenues                                                    $ 1,228                       $ 9,247

Costs and expenses:
   Cost of revenue                                              490                         9,011
   General and administrative                                   866                         5,003
   Marketing and sales                                          384                         4,597
   Stock based compensation                                     140                           100
                                                            -------                       -------
Total costs and expenses                                      1,880                        18,711
                                                            -------                       -------

Loss from operations                                           (652)                       (9,464)

Other income (expense):
   Interest income                                               23                         1,226
   Interest expense                                              (6)                         (445)
                                                            -------                       -------
Net Loss                                                    $  (635)                      $(8,683)
                                                            =======                       =======

Net loss per common share:

   Basic and diluted                                        $(0.03)                       $(0.24)
                                                            =======                       =======
Shares used in computing basic and diluted
net loss per share                                           22,273                        35,443
                                                            =======                       =======
</TABLE>

           See accompanying notes to Condensed Financial Statements.

                                       4
<PAGE>

                            Data Return Corporation
                      Condensed Statements of Cash Flows
                     (in thousands, except per share data)
                                   Unaudited

<TABLE>
<CAPTION>
                                                                        Three Months Ended June 30,
                                                                       -----------------------------
                                                                         1999                2000
                                                                       -------             ---------
<S>                                                                    <C>                 <C>
Operating activities:
Net Loss                                                               $ (635)             $ (8,683)

Adjustments to reconcile net loss to net cash
     used in operations:
   Noncash items included in net loss:
     Depreciation and amortization                                         89                 2,507
     Stock based compensation expense                                     140                   100
     Provision for bad debts                                               60                   221
   Changes in assets and liabilities
     Account receivable                                                  (488)               (1,550)
     Prepaids and other assets                                           (490)               (1,260)
     Accounts payable and accrued expenses                                811                   579
     Deferred revenue                                                     230                 1,088
                                                                       ------              --------
Net cash used in operations                                              (283)               (6,998)

Investing Activities:
     Capital expenditures                                                (696)               (4,878)
     Purchase of marketable securities                                      -               (57,920)
                                                                       ------              --------
Net cash used in investing activities                                    (696)              (62,798)

Financing activities:
     Payments on notes payable and capital lease obligations              (24)               (1,903)
     Net proceeds from issuance of stock                                3,275                    28
                                                                       ------              --------
Net cash provided by (used in) financing activities                     3,251                (1,875)
                                                                       ------              --------

Net increase (decrease) in cash                                         2,273               (71,671)

     Beginning cash                                                       843                85,424
                                                                       ------              --------
     Ending cash                                                       $3,116              $ 13,753
                                                                       ======              ========
</TABLE>

           See accompanying notes to Condensed Financial Statements.

                                       5
<PAGE>

                            Data Return Corporation
                    Notes to Condensed Financial Statements
                                   Unaudited

1.   Organization and Basis of Presentation

Organization

     Data Return Corporation (the "Company") was incorporated in August 1997
under the laws of the State of Texas and commenced operations on September 22,
1997 (inception). The Company primarily provides advanced Microsoft Internet
hosting services to businesses, web site developers, application service
providers, and other organizations. The Company's advanced Microsoft hosting
services enable its customers to establish and maintain e-commerce and other
applications through which they can conduct transactions and manage information
on a worldwide basis over the Internet.

     The Company's computer equipment, principally servers, is primarily located
in separate facilities owned by one of its vendors. The vendor provides data
center facilities and bandwidth connectivity to the Company on a contractual
basis.

Basis of Presentation

     The accompanying unaudited condensed financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X.  Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) necessary to present fairly the information set
forth therein have been included. Operating results for the three-month period
ended June 30, 2000 are not necessarily an indication of the results that may be
expected for the year ending March 31, 2001.

     The balance sheet at March 31, 2000 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.

     The accompanying condensed financial statements should be read in
conjunction with the audited financial statements and footnotes included in the
Annual Report on Form 10-K for the Year Ended March 31, 2000.

2.   Net Loss Per Share

     Basic and diluted net loss per share is computed using the weighted average
number of shares of common stock outstanding during each period.  Common stock
equivalents are not considered in the calculation of diluted net loss per share
as the Company has incurred a loss for all periods presented and the effect of
common stock equivalents would be anti-dilutive.   Thus, 8,565,953 employee
stock options and warrants to acquire 345,910 shares of common stock are not
included in this calculation.

3.   Recent Accounting Pronouncements

     In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 101 (SAB 101), Revenue Recognition, which summarizes
some of the staff's views in applying generally accepted accounting principles
to revenue recognition in financial statements. On June 26, 2000, the SEC
changed the effective date of SAB 101 to require adoption of SAB 101 by the
fourth quarter of the first fiscal year beginning after December 15, 1999. As a
result the Company expects to adopt the new guidance as a change in accounting
principle effective January 1, 2001. The Company will change its method of
recognizing revenue on set up fees to defer the revenue and recognize it over
the initial term of the contracts with its customers, generally one year. The
change in accounting method will be accounted for as a cumulative effect
adjustment, which will result in (a) the financial information for the quarters
of fiscal 2001 prior to adoption of SAB 101 being restated and (b) the
cumulative effect adjustment being reflected in the quarter of adoption of SAB
101. As a result of the cumulative effect adjustment, revenue that has
previously been recognized in the Company's financial statements will be
amortized to income in financial reporting periods subsequent to the period of
adoption of SAB 101. While the Company anticipates that SAB 101 will have a
material effect on its operating results, the SEC is expected to issue

                                       6
<PAGE>

                            Data Return Corporation
                    Notes to Condensed Financial Statements
                                   Unaudited

additional guidance related to the implementation of SAB 101 that could affect
the Company's estimate.

4.   Investments

     The Company has classified all of its debt securities as available-for-
sale. Available-for-sale securities are carried at fair value, with unrealized
gains and losses reported as a separate component of stockholders' equity net of
applicable income taxes. Realized gains and losses and declines in value judged
to be other-than-temporary on available-for-sale securities are included in
other income. The cost basis for realized gains and losses on available-for-sale
securities is determined on a specific identification basis.

     As of June 30, 2000, the Company owned approximately $58.3 million of debt
securities (included in investments including available-for-sale securities)
with maturity dates in fiscal years 2001 and 2002.  Fair value of the debt
securities approximates market value.

5.   Property and Equipment

     Property and equipment consists of the following:

<TABLE>
<CAPTION>
                                                          March 31, 2000           June 30, 2000
                                                          --------------           -------------
<S>                                                        <C>                     <C>
Electronics and computer equipment.....................       $   20,910              $   29,112
Computer software......................................            1,397                   2,855
Furniture and office equipment.........................              792                   2,017
Leasehold improvements.................................              586                   1,408
Other depreciable assets...............................              520                   1,301
                                                              ----------              ----------
                                                                  24,205                  36,693
Less accumulated depreciation and amortization  .......           (2,178)                 (4,499)
                                                              ----------              ----------
                                                              $   22,027              $   32,194
                                                              ==========              ==========
</TABLE>

     Property and equipment includes assets acquired under capital leases,
principally computer equipment with a cost of $17,232,000 at March 31, 2000 and
$24,842,000 at June 30, 2000, respectively.  Related allowances for depreciation
and amortization are $1,121,000 and $2,757,000 respectively.

6.   Accrued Expenses

     Accrued expenses consist of the following:

<TABLE>
<CAPTION>
                                                          March 31, 2000           June 30, 2000
                                                          --------------           -------------
<S>                                                       <C>                      <C>
Professional fees......................................        $     157               $     197
Accrued employee benefits..............................            1,013                   1,197
Commissions............................................              184                     381
Other..................................................              851                     921
                                                               ---------               ---------
                                                               $   2,205               $   2,696
                                                               =========               =========
</TABLE>

                                       7
<PAGE>

ITEM 2.   Management's Discussion and Analysis of Financial Condition and
          Results of Operations.

     The following discussion of the financial condition and results of
operations of Data Return should be read in conjunction with the condensed
financial statements and the related notes thereto included elsewhere in this
Form 10-Q. This discussion contains, in addition to historical information,
forward-looking statements that involve risks and uncertainties. Our actual
results could differ materially from the results discussed in the forward-
looking statements. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed below, as well as those
discussed below under "Factors Affecting Future Operating Results." We disclaim
any obligation to update information contained in any forward-looking statement.
See "Forward-Looking Statements."

Overview

     Data Return provides advanced Internet hosting services based on Microsoft
technologies. We provide these services to businesses seeking to outsource the
deployment, maintenance and support of their complex web sites. Our services
include providing, configuring, operating and maintaining the hardware, software
and network technologies necessary to implement and support these web sites.

     Our business is rapidly evolving, and we have a limited operating history.
As a result, we believe that period-to-period comparisons of our revenue and
operating results, including our cost of revenue and other operating expenses as
a percentage of total revenue, are not meaningful and should not be relied upon
as indicators of future performance. We do not believe that our historical
growth rates are indicative of future results.

     Currently, we derive substantially all of our revenues from advanced
hosting services. Historically, we have also derived a nominal amount of revenue
from technical reviews and the resale of software and other products. Currently,
most of our advanced hosting revenues are generated from recurring monthly fees.
The remainder is derived from one-time set-up fees for installation. Revenues
are billed on a monthly basis and are recognized as the service is performed.

     Our expenses are comprised of:

     .    cost of revenue, which consists primarily of compensation and related
          expenses for technical operations, broadband services expenses, space
          in data centers and depreciation of equipment;

     .    general and administrative, which consists primarily of compensation
          and related expenses and occupancy costs;

     .    marketing and sales, which consists primarily of advertising and
          compensation and related expenses; and

     .    stock-based compensation, which relates to employee stock options
          granted at prices less than fair market value.

     We have incurred significant losses since our inception and, as of June 30,
2000, had an accumulated deficit of approximately $21.8 million.  We intend to
invest heavily in marketing and sales and the continued development of our
network infrastructure and technology.  We expect to continue to expand our
operations and workforce, including our network operations, technical support,
sales, marketing and administrative resources.  In particular, we intend to
continue to expand our existing inside and outside sales force to develop new
sales channels and relationships.  We expect to continue to incur substantial
losses for the foreseeable future.  We may not be able to successfully execute
our expansion plans.

                                       8
<PAGE>

Results of Operations

Comparison of quarters ended June 30, 1999 and 2000

Revenues

     Our revenues increased $8,019,000 to $9,247,000 for the quarter ended June
30, 2000 from $1,228,000 for the quarter ending June 30, 1999. The increase was
primarily due to the addition of new customers that generated higher average
monthly revenues. Growth from some existing customer accounts also contributed.
We increased our marketing and sales personnel to 65 at June 30, 2000 from 12 at
June 30, 1999.

Cost of revenue

     Our cost of revenue increased $8,521,000 to $9,011,000, or 97.4% of
revenue, for the quarter ended June 30, 2000 from $490,000, or 39.9% of revenue,
for the quarter ended June 30, 1999. The increase in cost of revenue was due
primarily to increases in personnel and related costs, including employee
recruiting fees, depreciation and bandwidth. The increase as a percent of
revenue was partially attributable to our incurring these costs in advance of
revenues. Personnel and related expenses increased approximately $4,276,000 to
$4,501,000, or 48.7% of revenue, for the quarter ended June 30, 2000 from
$225,000, or 18.3% of revenue, for the quarter ended June 30, 1999, as we
increased our systems and customer support personnel to 237 at June 30, 2000
from 25 at June 30, 1999. Depreciation expense increased approximately
$1,985,000 to $2,060,000 for the quarter ended June 30, 2000 as we added
approximately $27.6 million in computer and related equipment since June 30,
1999. Our broadband services expenses increased $1,029,000 to approximately
$1,174,000 for the quarter ended June 30, 2000 from $145,000 for the quarter
ended June 30, 1999 to support our increased business activities. Other hardware
and software equipment costs increased $261,000 to $284,000 for the quarter
ended June 30, 2000 to support the growth in our business. Facilities expense
increased $354,000 during the quarter ended June 30, 2000 as a result of the
addition of facilities to support our growth. Travel and professional services
increased $128,000 and $74,000, respectively, for the quarter ended June 30,
2000 reflecting the increased geographic dispersion of our customer base. We
expect our cost of revenue to continue to increase as our overall business
grows.

General and administrative

     General and administrative expense increased $4,137,000 to $5,003,000, or
54.1% of revenue, during the quarter ended June 30, 2000 from $866,000, or 70.5%
of revenue, during the quarter ended June 30, 1999. The increase is primarily
due to increases in personnel and related expenses, including employee
recruiting fees, travel and professional services. Personnel and related
expenses increased $2,724,000 to $3,175,000, or 34.3% of revenue, for the
quarter ended June 30, 2000 from $451,000, or 36.7% of revenue, for the quarter
ended June 30, 1999. We increased our number of employees in general and
administrative functions to 144 employees at June 30, 2000 from 13 employees at
June 30, 1999. Travel expenses increased approximately $85,000 to $172,000, or
1.9% of revenue, for the quarter ended June 30, 2000 from $87,000, or 7.1% of
revenue, for the quarter ended June 30, 1999. Professional services fees
increased approximately $538,000 to $558,000 for the quarter ended June 30, 2000
from $19,000 in the comparable period in 1999. Depreciation expense increased
$250,000 in the quarter ended June 30, 2000, which is a result of increased
internal equipment necessary to support the growth of our business. Facilities
and insurance expense increased $268,000 and $160,000, respectively, as a result
of our move into a larger facility and the growth in general and administrative
employees. Bad debt expense increased $161,000 as our customer base and revenues
continue to grow.

Marketing and sales

     Marketing and sales expense increased $4,212,000 to $4,597,000, or 49.7% of
revenue, during the quarter ended June 30, 2000 from $384,000, or 31.4% of
revenue, during the quarter ended June 30, 1999. The increase was due primarily
to an increase in marketing and sales personnel and related expenses, including
employee recruiting fees and advertising costs. Personnel and related expenses
increased $2,569,000 to $2,814,000, or 30.4% of revenue, for the quarter ended
June 30, 2000 from $245,000, or 20.0% of revenue, for the quarter ended June 30,
1999. Advertising costs increased $408,000 to $548,000 for the quarter ended
June 30, 2000 from $140,000 for the quarter ended June 30, 1999. We increased
our marketing and sales personnel to 65 at June 30, 2000 from 12 at

                                       9
<PAGE>

June 30, 1999.

Stock-based compensation

     Deferred stock compensation was recorded in connection with the grant of
employee stock options below fair value. Amortization of stock-based
compensation totaled $100,000 for the quarter ended June 30, 2000 and $140,000
for the quarter ended June 30, 1999. The amortization of stock-based
compensation is based on the vesting schedule of stock options held by our
employees.

Other income (expense)

     Other income (expense) consists primarily of interest income on our cash
balances and interest expense on our outstanding notes payable and capital lease
obligations. Interest earned on our cash and cash equivalents increased
$1,203,000 to $1,226,000 for the quarter ended June 30, 2000 from $23,000 for
the quarter ended June 30, 1999. This increase was due primarily to the closing
of our initial public offering in October 1999, which resulted in larger cash
balances available for investment. During the quarter ended June 30, 2000, we
increased interest expense $439,000 to $445,000 related primarily to equipment
capital leases entered into in the third and fourth quarter of the 2000 fiscal
year.

Income taxes

     No provision for federal income taxes has been recorded as we have incurred
net operating losses since our inception. We have recorded a valuation allowance
against all of our net deferred tax asset, which is primarily attributable to
net operating loss carry forwards, due to uncertainty that we will generate
sufficient taxable income during the carry forward period to realize the benefit
of our net deferred tax asset.

Net Loss

     Net loss increased $8,048,000 to $8,683,000 for the quarter ended June 30,
2000 from $635,000 for the quarter ended June 30, 1999. As more fully discussed
above, the increased net loss is primarily attributable to increased costs as we
continued to build our business for anticipated growth. We expect net losses to
increase in fiscal 2001 as we expand our business.

EBITDA

     EBITDA, as defined below, decreased $6,434,000 to negative $6,857,000 for
the quarter ended June 30, 2000 from negative $423,000 for the quarter ended
June 30, 1999. The decrease is primarily attributable to costs associated with
our growth strategy. We expect to generate negative EBITDA in fiscal 2001. Costs
associated with our investments in marketing and sales, the continued
development of our network infrastructure and technology and expansions of our
operations and workforce, including our network operations, technical support,
sales, marketing and administrative resources, will continue to represent a
large portion of our expenses during our planned expansion.

     EBITDA consists of loss from operations of $652,000 and $9,464,000 plus
depreciation and amortization of $89,000 and $2,507,000 and amortization of
unearned stock-based compensation of $140,000 and $100,000 for the quarters
ended June 30, 1999 and 2000, respectively. EBITDA does not represent funds
available for management's discretionary use and is not intended to represent
cash flow from operations as measured under generally accepted accounting
principles. EBITDA should not be considered as an alternative to net loss or net
cash used in operating activities, but may be useful to investors as an
indication of operating performance. This caption excludes components that are
significant in understanding and assessing the results of operations and cash
flows. In addition, EBITDA is not a term defined by generally accepted
accounting principles and, as a result, our calculations of EBITDA may not be
consistent with calculations of EBITDA used by other companies. However, we
believe that EBITDA is relevant and useful information that is often reported
and widely used by analysts, investors and other interested parties in the
advanced hosting industry. Accordingly, we are disclosing this information to
permit a more comprehensive analysis of our operating performance, as an
additional meaningful measure of performance and liquidity, and to provide
additional information with respect to our ability to meet future working
capital

                                       10
<PAGE>

requirements.

Liquidity and Capital Resources

     We have historically financed our operations primarily through sales of
equity securities. Since our inception, we have raised $15.9 million through
private placements of our common stock. In November 1999, we raised $85.9
million in net proceeds from our initial public offering. As of June 30, 2000,
we had cash and cash equivalents of $13.8 million and investments in marketable
securities of $58.3 million.

     Net cash used in our operating activities for the three months ended June
30, 2000 was $7 million. The net cash used in operations was comprised primarily
of working capital requirements and our net loss, net of depreciation and
amortization. Net cash used in investment activities was $62.8 million for the
three months ended June 30, 2000 and was comprised of the purchase of marketable
debt securities of $57.9 million and purchases of property and equipment of
approximately $4.9 million. Our purchases of property and equipment consisted
primarily of leasehold improvements and purchases of furniture and equipment for
new employees. We acquired $7.6 million in computer and related equipment under
new capital leases. Net cash used in financing activities was approximately $1.9
million consisting primarily of principal payments on our notes payable and
capital leases.

     Total borrowings under our notes payable and capital lease obligations as
of June 30, 2000 were approximately $22.8 million.

     To help manage short-term liquidity needs without disrupting our investment
strategies, in December 1999 we entered into a revolving credit facility with
Bank One, Texas, N.A. This credit facility matures on July 31, 2000 and
outstanding balances accrue interest at the bank's base rate. We may borrow up
to $2 million under the credit facility but have not borrowed any amounts to
date. The facility is secured by all of our equipment that was unencumbered on
the date we entered into the facility and all accounts receivable outstanding
from time to time. Under certain limited circumstances, we could be required to
deposit cash with the bank to secure the loan. The credit facility contains
standard events of default and other covenants.

     We believe that our current cash and investment balances will be sufficient
to meet our working capital and capital expenditure requirements for at least
the next 12 months.  Under our agreement with Level 3, we are required to
purchase at least an additional $9.2 million of bandwidth and colocation
services over the next five years.  Our quarterly commitment is $200,000 in the
first year (ending in July 2000), $300,000 in the second year, $400,000 in the
third year, $600,000 in the fourth year and $1.0 million in the fifth year of
the agreement. We anticipate that further expansion of our operations will cause
us to continue to incur negative cash flows and, therefore, require us to use
our cash and other liquid resources to support our growth. Our operating and
investing activities on a long-term basis may require us to obtain additional
equity or debt financing. We have no present understandings, commitments or
agreements with respect to any acquisition of other businesses, products,
services or technologies. However, we may evaluate potential acquisitions of
other businesses, products and technologies from time to time. In order to
consummate potential acquisitions, we may need additional equity or debt
financings in the future.

Recent Accounting Pronouncements

     In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 (SAB 101), Revenue Recognition, which
summarizes some of the SEC staff's views in applying generally accepted
accounting principles to revenue recognition in financial statements. On June
26, 2000, the SEC changed the effective date of SAB 101 to require adoption of
SAB 101 by the fourth quarter of the first fiscal year beginning after December
15, 1999. As a result, we expect to adopt the new guidance as a change in
accounting principle effective January 1, 2001. We will change our method of
recognizing revenue on set up fees to defer the revenue and recognize it over
the initial term of the contracts with our customers, generally one year. The
change in accounting method will be accounted for as a cumulative effect
adjustment, which will result in (a) the financial information for the quarters
of fiscal 2001 prior to adoption of SAB 101 being restated and (b) the
cumulative effect adjustment being reflected in the quarter of adoption of SAB
101. As a result of the cumulative effect adjustment, revenue that has
previously been recognized in our financial statements will be amortized to
income in financial reporting periods subsequent to the period of adoption of
SAB 101. While we anticipate that SAB 101 will have a material effect on our
operating results, the SEC is expected to issue additional guidance related to
the

                                       11
<PAGE>

implementation of SAB 101 that could affect our estimate.

Forward-Looking Statements

     The statements contained in this Report that are not historical facts are
"forward-looking statements" (as such term is defined in Section 27A of the
Securities Act of 1933 and section 21E of the Securities Exchange Act of 1934).
Forward-looking statements are typically identified by the use of terms such as
"may," "will," "expect," "intend," "anticipate," "estimate" and similar words,
or by discussions of strategy that involve risks and uncertainties, although
some forward-looking statements are expressed differently. You should be aware
that our actual results could differ materially from those contained in the
forward-looking statements due to a number of factors, including without
limitation, changes in external competitive market factors, changes in our
business strategy or an inability to execute our strategy, changes in the
hosting industry, the economy in general and changes in the use of the Internet.
We cannot guarantee future results, levels of activity, performance or
achievements. Our actual results could differ materially from those anticipated
in such forward-looking statements as a result of certain factors, including
those set forth in the section entitled "Factors Affecting Future Operating
Results." Readers are cautioned not to place undue reliance on any forward-
looking statements contained in this report. All written and oral forward-
looking statements made in connection with this report that are attributable to
us or persons acting on our behalf are expressly qualified in their entirety by
the "Factors Affecting Future Operating Results" and other cautionary statements
included herein. We disclaim any obligation to update information contained in
any forward-looking statement. We undertake no obligation to publish the results
of any adjustments to these forward-looking statements that may be made to
reflect events on or after the date of this report or to reflect the occurrence
of unexpected events.

Factors Affecting Future Operating Results

Our business and prospects are difficult to evaluate because we have a limited
operating history and our business model is still evolving.

     We were incorporated in August 1997 and commenced operations in September
of that year with a focus on advanced hosting services. As a result, we have a
limited operating history and our business model is evolving. We may not be able
to successfully implement our business plan or adapt it to changes in the
market. If we are not able to do so, our business, results of operations and
financial condition will be adversely affected.

We have a history of substantial losses, and we anticipate continuing and
increasing losses.

     We have experienced operating losses and negative cash flows from
operations in each quarterly and annual period since incorporating in 1997. We
experienced net losses of approximately $8.7 million, or negative 93.9% of
revenues, for the quarter ended June 30, 2000. As of June 30, 2000, we had an
accumulated deficit of approximately $21.8 million. We expect our operating
expenses to increase significantly as we attempt to expand our business. We
believe that we will need to hire over 250 additional personnel in all areas of
our business over the next 12 months. We are also required to purchase $1.5
million of colocation and bandwidth services, primarily from Level 3, during
fiscal 2001. In addition, we expect to incur significant expenses to develop our
distribution channel, fund research and development, support and improve our
operational and financial systems and broaden customer service and support. We
cannot assure you that we will ever be profitable on a quarterly or annual basis
or that, if we achieve profitability, it will be sustainable.

Our quarterly and annual results may fluctuate, resulting in fluctuations in the
price of our common stock.

     Our operating results may fluctuate significantly in the future on a
quarterly and annual basis. Because of these fluctuations, comparisons of our
operating results from period to period are not necessarily meaningful and
should not be relied upon as an indicator of future performance. We expect to
continue to experience significant fluctuations as a result of a variety of
factors, many of which are outside of our control. The following factors could
affect our operating results:

     .    size and timing of customer installations and related payments;

                                       12
<PAGE>

     .    fluctuations in data and voice communications costs;

     .    fluctuations in hardware and software costs;

     .    timing and magnitude of capital expenditures;

     .    costs relating to the expansion of operations;

     .    termination of customer contracts, some of which can be terminated on
          30 days' notice;

     .    customer discounts and credits;

     .    changes in our pricing policies or those of our competitors; and

     .    economic conditions specific to the hosting industry, as well as
          general economic conditions.

     We plan to increase our operating expenses to develop our business. If our
revenues do not increase as quickly as our expenses, our operating results will
suffer.

     For these and other reasons, in future periods our operating results may
fall below the expectations of securities analysts or investors, which could
result in widely varying stock prices and negatively affect the market price of
our common stock.

We rely on our strategic relationship with Level 3, and if this relationship is
terminated or deteriorates our business may suffer.

     In July 1999, we entered into a strategic relationship with Level 3. Level
3 is a communications and information services company that is building an
advanced facilities-based communications network through which it provides
colocation, Internet connectivity and other services. As part of our
relationship, we have committed to purchase a fixed amount of services from
Level 3, including, among other things, bandwidth, colocation space,
installation and maintenance services, over the next five years. We will incur
these expenses even if anticipated increases in sales do not materialize or, in
some circumstances, if the agreement is terminated. We have also agreed that if
Level 3 is capable of providing the services we request, and if those services
are substantially similar to other services that we purchase, we will purchase
75% of these services from Level 3 from July 2000 through December 2000 and 90%
of these services from Level 3 from January 2001 through June 2004. We are
required to purchase these services from Level 3 even if these services are
available at lower prices from alternative vendors. We route the network traffic
of our customers through multiple backbone providers to increase network
performance. To enable us to do this, we obtain Internet connectivity through a
number of providers, and Level 3 may not be able to provide all of the
connectivity services that we require. As a result, we may purchase less than
the applicable percentages of these services from Level 3.

     We also currently rely on Level 3 to provide substantially all of the data
center capacity that we need to provide our hosting services, and in the future
we may be required to purchase most of our data center capacity from Level 3.
Further, Level 3 may provide personnel at these data centers to install
equipment and assist with support as necessary for us to deliver service in
these facilities. If Level 3 fails to provide this data center capacity or
perform these services in a timely or effective manner, or at all, we would be
required to make alternate arrangements. As demand for colocation space
increases, Level 3 may not be able or willing to provide the data center
capacity we require to deliver our services. If our relationship with Level 3 is
terminated or if Level 3 does not provide the data center capacity that we need,
or provide it on acceptable terms, we would be required to seek arrangements
with other data center providers or construct our own data centers. We cannot be
certain that alternate data center capacity will be available on commercially
reasonable terms or at all. We currently rely, and for the foreseeable future
will continue to rely, on Level 3 to provide a substantial part of our bandwidth
and other networking services. If we are unable to obtain these services from
Level 3, we would be required to seek arrangements with other providers of these
services, and we cannot be certain that alternate services will be available on
commercially reasonable terms or at all.

                                       13
<PAGE>

Our success depends on Microsoft's continued success, and the loss or
deterioration of our relationship with Microsoft could harm our business and
have an adverse impact on our revenues.

     We focus on advanced hosting services for Microsoft-based Internet
technologies. If these technologies are not widely used building blocks for
advanced Internet sites in the future, the demand for our services would
decrease and our business would be adversely affected. The final outcome of the
antitrust case against Microsoft is uncertain, but the outcome could cause the
acceptance of Microsoft products to decrease. Except for our relationship with
Microsoft as a customer, our relationship with Microsoft is generally informal.
We believe this relationship provides us with access to developments in
Microsoft products before they are generally available, which allows us to
maintain and enhance our technical expertise. If our relationship with Microsoft
deteriorates or if we lose some of the status or privileges we currently enjoy,
our technical expertise could be adversely affected. Our ability to market our
services as a provider of advanced hosting services for Microsoft-based Internet
technologies would also be adversely affected if Microsoft does not continue to
confer certifications and designations on us, or changes our current
certifications and designations or ceases to be our customer. We do not have a
written agreement with Microsoft relating to all of these certifications or
designations. Some of our competitors also have received these certifications
and designations. Microsoft generally confers these certifications unilaterally
and in its sole discretion and could change them at any time. We cannot be
certain that we will continue to enjoy them.

If we are unable to expand our network infrastructure to meet increasing demand,
we could lose customers and our operating results could suffer.

     We must continue to expand and adapt our network infrastructure to
accommodate an increasing number of customers, the amount of information they
wish to transmit and their changing requirements. We face risks related to our
network's ability to be scaled to meet increasing customer levels while
maintaining acceptable performance levels. The continued expansion and
adaptation of our networking and hosting facility infrastructure will continue
to require substantial financial, operational and management resources as we
negotiate bandwidth capacity with existing and other network infrastructure
suppliers. If we are required to expand our network significantly and rapidly
due to increased usage, additional stress will be placed upon our network
hardware, traffic management systems and hosting facilities as well as our
financial, operational and management resources. The ability of our network to
support a substantially larger number of customers at high transmission speeds
is unknown. Furthermore, it may be difficult for us to increase quickly our
network capacity in light of current lead times to purchase circuits and other
critical items. If the network providers upon which we rely fail to provide
reliability, capacity and performance for our network, we could lose customers
and our operating results could suffer.

     Our success partly depends upon the capacity, reliability and security of
our network infrastructure, including the capacity leased from our network
suppliers. Our network currently delivers service through Level 3, InterNap, MCI
WorldCom, Inc., including UUNET Technologies, Inc., e.spire Communications,
Inc., Sprint Corporation, Digex, Incorporated, Cable & Wireless plc and SAVVIS
Communications Enterprises, LLC. Some of these suppliers are also our
competitors. In the future, we will be required to purchase most of our network
capacity from Level 3 to the extent that it provides capacity that is
substantially similar to the capacity of other providers. We depend on these
companies to provide uninterrupted and error-free service through their
telecommunications networks. As our customers' usage of telecommunications
capacity increases, we will need to make additional investments in our
infrastructure to maintain adequate data transmission speeds, the availability
of which may be limited or the cost of which may be significant. We monitor all
network links to prevent their being utilized in excess of their recommended
capacity. If capacity is not available to us as our customers' usage increases,
our network may not be able to achieve or maintain sufficiently high data
transmission capacity, reliability or performance. In addition, our business
would suffer if our network suppliers increased the prices for their services
and we were unable to pass along any increased costs to our customers. Any
failure on our part or the part of our third-party suppliers to achieve or
maintain high data transmission capacity, reliability or performance could
significantly reduce customer demand for our services and damage our business.

                                       14
<PAGE>

We may not be able to deliver our services and our business may suffer if our
third-party suppliers do not provide us with key components of our network
infrastructure.

     We depend on other companies to supply key components of our network
infrastructure. Any failure to obtain needed products or services in a timely
fashion or at an acceptable cost could adversely affect our business. We buy
servers, routers and switches on an as-needed basis and therefore do not carry
significant inventories of them. We also have no guaranteed supply arrangements
with our vendors. We currently only use servers from Compaq and rely on Compaq
to provide us with access to Compaq technical personnel. In July 1999, we
entered into an agreement with Compaq under which we agreed for the immediately
following three years to purchase from Compaq the lesser of 2,000 servers or the
number of servers reasonably necessary to adequately operate our business
consistent with our business plan. Through June 30, 2000, we had purchased
approximately 930 servers from Compaq under this agreement. Our requirement to
purchase these servers is contingent upon Compaq providing financing for the
servers on competitive terms, upon the price, performance and quality of the
Compaq servers being reasonably satisfactory to us and upon Compaq's commitment
to deliver these servers on the schedule we request. In addition, we rely on
Cisco Systems, Inc. and others to supply equipment critical to our network, but
we do not have a supply agreement with any of them. If this equipment were to
become unavailable on terms acceptable to us, we would be forced to find
alternative equipment. The inability to obtain equipment or technical services
from Compaq, Cisco or others on terms acceptable to us would force us to spend
time and money selecting and obtaining new equipment, training our personnel to
use different equipment and deploying alternative components needed to integrate
the new equipment, and as a result our business could be adversely affected. In
addition, if our sole or limited source suppliers do not provide products or
components that comply with evolving Internet and telecommunications standards
or that interoperate with other products or components we use, our business
would be harmed. For example, we have experienced performance problems,
including previously unknown software and firmware bugs, with routers and
switches that have caused temporary disruptions in and impairment of network
performance.

Because we operate in a new and evolving market with uncertain prospects for
growth, we may be unable to sustain growth in our customer base and our
operating results may suffer.

     Our market is new and rapidly evolving. Growth in demand for and acceptance
of advanced hosting services are highly uncertain. Businesses may not be aware
of the potential benefits of outsourcing or may find it cheaper, more secure or
otherwise preferable to host their web sites internally. Internet technologies,
such as e-commerce applications, which require advanced hosting, may not grow as
rapidly as we expect. If the market for advanced hosting services fails to grow
or grows more slowly than we anticipate, our business, operating results and
financial condition will be adversely affected. Growth in the demand for our
products and services may be inhibited, and we may be unable to sustain growth
in our customer base for a number of reasons, including:

     .    our inability to market our products and services in a cost-effective
          manner to new customers;

     .    the inability of customers to differentiate the products and services
          we offer from those of our competitors;

     .    our inability to strengthen awareness of our brand; and

     .    reliability, quality or compatibility problems with our services.

We may not be able to adapt to evolving technologies and customer demands, which
could cause our business to suffer.

     Our market is characterized by rapidly changing technology, evolving
industry standards and frequent new product announcements. These characteristics
are magnified by the recent growth of the Internet and the intense competition
in our industry. We are also subject to risks from technological changes in the
way hosting solutions are marketed and delivered. To be successful, we must
adapt to our rapidly changing market by continually improving the performance,
features and reliability of our services and modifying our business strategies
accordingly. We could also incur substantial costs if we need to modify our
services or infrastructure in order to adapt to these changes. In addition, our
internal costs to provide service to our customers could be adversely affected.
Our business would suffer if we fail to respond to these changes in a timely and
cost-effective manner or

                                       15
<PAGE>

at all. Our business will suffer if Internet usage does not continue to increase
or if the Internet fails to perform reliably.

Our business will not grow unless Internet usage grows and Internet performance
remains adequate.

     Use of the Internet for retrieving, sharing and transferring information
among businesses, consumers, suppliers and partners has recently begun to
increase rapidly. Our success depends in large part on continued growth in the
use of the Internet. In addition, our business plan anticipates extensive growth
in the web site hosting and application hosting markets. The growth of the
Internet, including the web site hosting and application hosting markets, is
subject to a high level of uncertainty and Internet usage and growth may be
inhibited for a number of reasons, such as:

     .    inadequate network infrastructure;

     .    security concerns, including viruses and denial of service attacks;

     .    uncertainty of legal and regulatory issues concerning the use of the
          Internet;

     .    inconsistent quality of service;

     .    the inability of Internet-focused businesses to develop and maintain
          successful business models;

     .    failure of Internet-dependent businesses;

     .    lack of availability of cost-effective, reliable, high-speed service;
          and

     .    failure of Internet use to expand internationally.

     If Internet usage grows, the Internet infrastructure may not be able to
support the demands placed on it by this growth, or its performance and
reliability may decline. For example, web sites have experienced interruptions
in service as a result of outages and other delays occurring throughout the
Internet network infrastructure. If these outages or delays occur frequently,
use of the Internet as a commercial or business medium could in the future grow
more slowly or decline, which would adversely affect our business.

Failure of our operating and financial systems to keep pace with the anticipated
growth in our business could result in customer dissatisfaction, operating
inefficiencies and lost revenue opportunities.

     The rapid growth of our business and our service offerings has placed, and
is likely to continue to place, a significant strain on our operating and
financial resources. Our future performance will partly depend on our ability to
manage our growth effectively, which will require that we further develop our
operating and financial system capabilities and controls. If our information
systems and other infrastructure, including customer service and support, are
unable to support the demands placed on them by the rapid growth in our
business, we may be forced to implement new systems. If we fail to improve our
operational systems or to expand our customer service capabilities to keep pace
with the growth of our business, we could experience customer dissatisfaction,
cost inefficiencies and lost revenue opportunities, which could harm our
operating results. We may not be able to successfully implement these systems
when needed or they may not perform reliably.

We may not be able to successfully sustain our growth if we are unable to
attract and retain additional highly skilled personnel.

     We are currently experiencing rapid growth and intend to continue
expanding. Since incorporating in August 1997, we have grown to 461 employees as
of June 30, 2000. We believe that we will need to hire over 250 additional
personnel in all areas of our business over the next 12 months. If we do not
succeed in attracting and retaining new, qualified personnel and/or retaining
our current personnel, our business could suffer.

                                       16
<PAGE>

     We must expand our direct and indirect sales operations to increase market
awareness of our products and generate increased revenues. We cannot be certain
that we will be successful in these efforts. We plan to increase our sales force
significantly in fiscal 2001. Newly-hired employees will require training and it
will take time for them to achieve full productivity. We cannot be certain that
we will be able to hire enough qualified individuals in the future or that
newly-hired employees will achieve necessary levels of productivity.

We may need additional capital to fund our operations and finance our growth,
and we may not be able to obtain it on terms acceptable to us or at all.

     We believe that our existing capital resources, including the proceeds from
our initial public offering in October 2000, will enable us to maintain our
current and planned operations for at least the next 12 months. However, we may
require additional funds during or after that 12-month period. In particular, if
we expand our existing business plan to focus on growth in international markets
or in other ways, we could require additional funding. Any required financing
may not be available or may be available only on terms that are not favorable to
us. Further, if additional funds are raised through the issuance of additional
equity securities, the percentage ownership of our shareholders would be
diluted. Any new equity securities may have rights, preferences or privileges
senior to those of our common stock.

We could experience system failures that could harm our business and reputation.

     To succeed, we must be able to operate our network management
infrastructure around the clock without interruption. Our operations depend upon
our ability to protect our network infrastructure, equipment and customer files
against damage from human error, fire, earthquakes, hurricanes, floods, power
loss, telecommunications failures, intrusion (including hackers), sabotage,
intentional acts of vandalism and similar events. Our servers and network
infrastructure are located primarily in the Dallas/Ft. Worth, Texas metropolitan
area. We are continuing to develop a comprehensive disaster recovery plan and
the occurrence of a natural disaster or other unanticipated problems at any of
our data centers could result in interruptions in the services we provide to our
customers.

     Although we have attempted to build redundancy into our network and hosting
infrastructure, we have experienced interruptions in service in the past. We
have experienced partial system failures due to routing problems, hard drive
failures, database corruption and other computer failures. Our network is
subject to various points of failure, and a problem with our routers, switches
or other equipment could cause an interruption in the services we provide to
some or all of our customers. Any future interruptions could:

     .    cause customers or end users to seek damages for losses incurred;

     .    require us to replace existing equipment or add redundant facilities;

     .    damage our reputation for reliable service;

     .    cause existing customers to cancel their contracts; or

     .    make it more difficult for us to attract new customers.

Any of these results could damage our business.

     We also often provide our customers with service level agreements. If we do
not meet the required service levels, we may have to provide credits to our
customers, which could significantly reduce our revenues. Additionally, in the
event of any resulting harm to customers, we could be held liable for damages.
Awards for such damages might exceed our liability insurance by an unknown but
significant amount and could seriously harm our business.

Disruption of our services caused by unknown software defects could harm our
business and reputation.

     Our service offerings depend on complex software, including software
licensed from third parties and our proprietary software tools. Complex software
often contains defects, particularly when first introduced or when new

                                       17
<PAGE>

versions are released. We may not discover software defects that affect our new
or current services or enhancements until after they are deployed. These defects
could cause service interruptions or performance issues, which could damage our
reputation or increase our service costs, cause us to lose revenue, delay market
acceptance or divert our development resources.

Our business and reputation will suffer if we do not prevent security breaches.

     Unauthorized access, computer viruses, denial of service attacks,
accidents, misconduct resulting in disruptions and other disruptions could
occur. In addition, we may incur significant costs to prevent breaches in
security or to alleviate problems caused by breaches. We work with Level 3 to
protect our equipment and hardware against breaches in physical security and
with other vendors of software and hardware to protect other breaches in
security. We cannot be certain that they will provide adequate security. We have
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 of Data Return or others. Furthermore, inappropriate use of
the network by third parties could also jeopardize the security of confidential
information, such as customer and Data Return passwords as well as credit card
and bank account numbers, stored in our computer systems or those of our
customers. As a result, we could become liable to others and lose existing or
potential customers. The costs required to eliminate computer viruses and
alleviate other security problems could be prohibitively expensive. In addition,
the efforts to address these problems could result in interruptions, delays or
cessation of service to our customers.

Providing services to customers with mission-critical Web sites and Web-based
applications could potentially expose us to lawsuits for customers' lost profits
or other damages.

     Because our hosting services are critical to many of our customers'
businesses, any significant interruption in our services could result in lost
profits or other indirect or consequential damages to our customers. Although
our standard terms and conditions disclaim our liability for any such damages, a
customer could still bring a lawsuit against us claiming lost profits or other
consequential damages as the result of a service interruption or other web site
or application problems that the customer may ascribe to us. There can be no
assurance a court would enforce any limitations on our liability, and the
outcome of any lawsuit would depend on the specific facts of the case and legal
and policy considerations. We also believe we would have meritorious defenses to
any such claims, but there can be no assurance we would prevail. In such cases,
we could be liable for substantial damage awards. Such damage awards might
exceed our liability insurance by unknown but significant amounts, which would
seriously harm our business.

Our limited ability or failure to protect our intellectual property may
adversely affect our ability to compete.

     Third parties may infringe or misappropriate our technology or proprietary
rights, which could have an adverse effect on our business, results of
operations or financial condition. In addition, our competitors or potential
competitors may independently develop technologies that are equivalent or
superior to our technology. We rely on a combination of copyright, trademark,
service mark and trade secret laws to protect our intellectual property. We have
filed federal registrations for the mark "Data Return" and other marks. We also
have internally developed software and other tools that are important to our
business for which we rely on copyright protection. We have entered into
contractual arrangements with some of our employees and contractors as well as
suppliers, distributors and some of our key customers in order to limit access
to, and any disclosure of, our proprietary information. The steps we have taken
to protect our intellectual property may be insufficient. We may need to take
legal action to protect our intellectual property rights, which could be costly
and divert the attention of our technical and management personnel.

We may be accused of infringing the proprietary rights of others, which could
subject us to costly and time-consuming litigation.

     In addition to the technologies we develop or have developed, we license
certain technologies from third parties and may license additional technologies
in the future. We could become subject to infringement actions based upon our
internally developed technologies or technologies licensed from third parties.
Any of these claims, with or without merit, could subject us to costly
litigation and divert the attention of our technical and management personnel.
In addition, third parties may change the terms of their license agreements in
ways that would prevent us

                                       18
<PAGE>

from using technologies licensed from them on commercially reasonable terms or
that would prevent us from using them at all. We may not be able to replace
those technologies with technologies that have the same features or
functionality on commercially reasonable terms or at all.

Regulatory and legal uncertainties could result in significant costs or
otherwise harm our business.

     The success of our business depends on the growth of the Internet. Laws and
regulations directly applicable to commerce or communications over the Internet
are becoming increasingly prevalent. However, the law of the Internet remains
largely unsettled. The adoption or modification of laws or regulations relating
to the Internet could adversely affect our business if they impose a direct cost
on us or if they curtail the growth of the Internet. If liability for materials
carried on or disseminated through their systems is imposed on service
providers, we would make efforts to implement measures to reduce our exposure to
such liability. Such measures could require us to expend substantial resources
or discontinue certain product or service offerings. In addition, increased
attention to liability issues, as a result of lawsuits, legislation and
legislative proposals, could divert management attention, result in
unanticipated expenses and harm our business. If legislation that makes
transacting business over the Internet, such as e-commerce, less favorable or
otherwise curtails the growth of the Internet is adopted in the U.S. or
internationally, our business would suffer.

The loss of key personnel including our Chairman and Chief Executive Officer or
our President and Chief Operating Officer could harm our business.

     We depend on the continued service of our key technical, sales and senior
management personnel, including Sunny C. Vanderbeck, our Chairman and Chief
Executive Officer, and Michelle R. Chambers, our President and Chief Operating
Officer. We have entered into employment agreements with Mr. Vanderbeck and Ms.
Chambers expiring in 2002, but any of our officers or employees can quit at any
time. Losing one or more of our key employees could harm our business.

We operate in an extremely competitive market, and our business would suffer if
we are unable to compete effectively.

     The market for hosting and Internet services is highly competitive.  There
are few substantial barriers to entry to keep new competitors from entering this
market. We expect that we will face additional competition from existing
competitors and new market entrants in the future. Many of our 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 we do. As a result, some of these
competitors may be able to:

     .    develop and expand their network infrastructures and service offerings
          more rapidly;

     .    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 sales of their services;
          and

     .    adopt more aggressive pricing policies.

     In addition, some of our competitors have entered and will likely continue
to enter into joint ventures or other arrangements to provide additional
services competitive with those provided by us. We believe that the market in
which we compete is likely to experience consolidation in the near future, which
could result in increased competition on price and other factors that could
adversely affect our business.

     In an effort to gain market share, some of our competitors have offered
incentives not matched by us. In addition, some of our competitors may be able
to provide customers with additional benefits that could reduce the overall
costs of their services relative to ours. We may not be able to reduce the
pricing of our services or offer incentives in response to the actions of our
competitors without an adverse impact on our business.

                                       19
<PAGE>

Because we have international customers and are beginning to operate in foreign
markets, our business may be adversely affected by foreign political and
economic conditions.

     In fiscal 2000, approximately 4.1% of our revenues were derived from our
customers located in Europe and Asia. In addition, we are beginning to operate
in London, England.  We expect that we will expand our operations in London and
may begin operating in other foreign markets during fiscal 2001.  Our success
depends in part on expanding our customer base internationally and our ability
to successfully operate from data centers in foreign markets. Because our
international sales are denominated in U.S. dollars, currency fluctuations may
deter foreign customers from purchasing our services. In addition, we face risks
in operating and servicing customers in foreign markets, such as:

     .    different Internet access fees;

     .    different technology standards;

     .    different privacy, censorship and service provider liability standards
          and regulations; and

     .    less protective intellectual property laws.

Any of these risks could adversely affect our ability to operate or expand
internationally, which would limit the growth of our business.

Our management will have significant flexibility in applying the proceeds from
our initial public offering and our use of proceeds may not yield a favorable
return.

     We have used and intend generally to continue to use the net proceeds from
our initial public offering to fund our capital expenditures and for working
capital and other general corporate purposes. We may also acquire or make
investments in other businesses, products, services or technologies and, if we
do, we may not be able to make those acquisitions or investments on commercially
acceptable terms or we could have difficulty assimilating and integrating any
acquired businesses, technologies, services or products. We have not yet
determined all expected expenditures and thus cannot estimate the amounts to be
used for each specified purpose. Our management has significant flexibility in
applying the net proceeds of our initial public offering. We cannot be certain
that our use of the proceeds will yield a favorable return.

Our principal shareholders, directors and executive officers currently own
approximately 67.3% of our common stock, which may allow them to exert influence
over us or to prevent a change of control.

     Our directors and executive officers and shareholders who currently own
over 5% of our common stock collectively beneficially own approximately 67.3% of
our outstanding common stock. These shareholders would be able to exercise
significant influence over all matters requiring shareholder approval, including
the election of directors and approval of significant corporate transactions.
This concentration of ownership could also delay or prevent a change in control
of Data Return even if beneficial to our shareholders.

Some provisions of our articles, bylaws and rights plan and of Texas law could
delay or prevent a change of control, which could adversely affect our stock
price.

     Our articles of incorporation and bylaws contain provisions that could make
it more difficult for a third party to acquire us, even if doing so would be
beneficial to our shareholders. These provisions could limit the price that
investors might be willing to pay in the future for shares of our common stock.
Some of these provisions:

     .    authorize the issuance of preferred stock which can be created and
          issued by our board of directors without prior shareholder approval,
          commonly referred to as "blank check" preferred stock, with rights
          senior to those of common stock;

     .    prohibit certain shareholder actions by written consent;

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     .    establish advance notice requirements for submitting nominations for
          election to our board of directors and for proposing matters that can
          be acted upon by shareholders at a meeting; and

     .    provide for a board of directors with staggered three-year terms.

We are also subject to certain provisions of Texas law that could delay, deter
or prevent a change in control of us.

     In September 1999, we adopted a shareholder rights plan. This plan entitles
our shareholders to rights to acquire additional shares of our common stock when
a third party acquires 15% of our common stock or commences or announces its
intent to commence a tender offer for at least 15% of our common stock. This
plan could delay, deter or prevent a change in control of us.

Future sales of our common stock could cause our stock price to decline.

     At June 30, 2000, 35,519,972 shares of our common stock were issued and
outstanding. We cannot be sure what effect, if any, future sales of our common
stock or the availability of shares for future sale will have on the market
price of our common stock. The market price of our common stock could drop due
to sales of a large number of shares of our common stock in the market or the
perception that these sales could occur. These factors could also make it more
difficult to raise funds through future offerings of our common stock.

Item 3.   Quantitative and Qualitative Disclosures About Market Risk.

     All our customer contracts are currently denominated in United States
dollars, and we do not currently invest in derivative financial instruments.
However, we invest our excess cash balances in cash equivalents and are
therefore subject to market risk related to changes in interest rates. We
believe, but cannot be certain, that the effect on our financial position,
results of operation and cash flows of any reasonably likely changes in interest
rates would not be material.


                          PART II - OTHER INFORMATION

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

(a)       Exhibits:

          27   Financial Data Schedule (1).

(b)       Reports on Form 8-K:

          None

----------------

(1)       Included with EDGAR version only.

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                                  SIGNATURES
                                  ----------


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


                                 Data Return Corporation



Dated: August 14, 2000      By:    / s/ Stuart A. Walker
                                 -------------------------------------------
                                 Stuart A. Walker, Vice President
                                 Chief Financial Officer
                                 (Principal Financial & Accounting Officer &
                                  Authorized Officer)

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