<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 September 30, 2001

                                       OR

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

                 For the transition period from _____ to _____

                          Commission File 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    X              NO
                             ------              ------

The registrant had 36,172,350 shares of Common Stock, par value $.001 per share,
outstanding as of September 30, 2001.

                                       1
<PAGE>

PART I - FINANCIAL INFORMATION
<TABLE>
<CAPTION>

<S>                                                                                                    <C>
Item 1.   Condensed Financial Statements                                                                Page
                                                                                                        ----
          Condensed Balance Sheets at September 30, 2001
           (Unaudited) and March 31, 2001                                                                  3

          Condensed Statements of Operations for the three and six
           months ended September 30, 2001 and 2000 (Unaudited)                                            4

          Condensed Statements of Cash Flows for the six months
           ended September 30, 2001 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                                                                      10

          Risk Factors                                                                                    18

Item 3.   Quantitative and Qualitative Disclosures About Market Risk                                      30

PART II - OTHER INFORMATION

Item 2.   Changes in Securities and Use of Proceeds                                                       31

Item 6.  Exhibits and Reports on Form 8-K                                                                 31

         Signatures                                                                                       32
</TABLE>

                                       2
<PAGE>

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


<TABLE>
<CAPTION>
                                                                                            September 30,             March 31,
                                                                                               2001                     2001
                                                                                         -----------------------------------------
<S>                                                                                         <C>                 <C>
Assets                                                                                      (Unaudited)
Current assets:
     Cash                                                                                         $  8,576                 $  6,566
     Restricted cash and marketable securities                                                       2,000                        -
     Investment in marketable securities                                                                 -                   26,800
     Accounts receivable, net of allowance for doubtful accounts
      of $1,454 and $1,589 at September 30, 2001 and March 31, 2001,
      respectively                                                                                   5,779                    8,477
     Prepaid and other                                                                               1,380                    1,189
                                                                                         -----------------         ----------------
Total current assets                                                                                17,735                   43,032
     Property and equipment, net                                                                    39,060                   44,104
     Other Assets                                                                                      384                      496
     Due from officer                                                                                2,000                        -
                                                                                         -----------------         ----------------
Total assets                                                                                      $ 59,179                 $ 87,632
                                                                                         =================         ================
Liabilities and shareholders' equity
Current liabilities:
     Accounts payable                                                                             $  2,345                 $  2,443
     Accrued expenses and other                                                                      4,824                    4,265
     Deferred revenue                                                                                4,384                    5,717
     Other liability                                                                                 2,000                        -
     Capital lease obligations- short term                                                          15,985                   12,873
                                                                                         -----------------         ----------------
Total current liabilities                                                                           29,538                   25,298

Capital lease obligations - long term                                                               13,381                   18,173
Commitments and contingencies                                                                            -                        -
                                                                                         -----------------         ----------------

Total liabilities                                                                                   42,919                   43,471

Shareholders' equity:
     Preferred stock, $.001 par value; 20,000 shares
      authorized, none issued or outstanding                                                             -                        -
     Common stock, $.001 par value; 100,000 shares
      authorized; 36,172 and 35,979 issued and outstanding
      at September 30, 2001 and March 31, 2001, respectively                                            36                       36
     Additional paid-in capital                                                                    110,784                  110,497
     Prepaid broadband services                                                                     (3,571)                  (4,594)
     Deferred stock compensation                                                                       (89)                    (119)
     Accumulated deficit including comprehensive earnings                                          (90,900)                 (61,659)
                                                                                         -----------------         ----------------
Total shareholders' equity                                                                          16,260                   44,161
                                                                                         -----------------         ----------------

Total liabilities and shareholders' equity                                                        $ 59,179                 $ 87,632
                                                                                         -----------------         ----------------
</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                            Six Months Ended
                                                                September 30,                               September 30,
                                                           2001               2000                     2001               2000
                                                         --------           --------                 --------           --------
<S>                                                     <C>                 <C>                     <C>                <C>
Revenues                                                 $ 12,160           $ 12,356                 $ 25,743           $ 21,436

Costs and expenses:
       Cost of revenue                                     11,839             11,525                   24,997             20,536
       General and administrative                           5,269              5,755                   11,205              9,986
       Marketing and sales                                  4,671              7,050                   11,557             11,647
       Product research & development                       1,115              1,113                    2,334              1,885
       Stock-based compensation                                59                 25                       74                125
       Restructuring costs                                  1,343                  -                    3,534                  -
                                                         --------           --------                 --------           --------
Total costs and expenses                                   24,296             25,468                   53,701             44,179
                                                         --------           --------                 --------           --------
Loss from operations                                      (12,136)           (13,112)                 (27,958)           (22,743)

Other income (expense):
       Interest income                                        148              1,089                      555              2,315
       Interest expense                                      (788)              (541)                  (1,602)              (986)
                                                         --------           --------                 --------           --------
Loss before cumulative effect of change
in accounting principle                                  $(12,776)          $(12,564)                $(29,005)          $(21,414)

Cumulative effect of change in accounting
principle                                                       -                  -                        -             (1,626)
                                                         --------           --------                 --------           --------

Net loss                                                 $(12,776)          $(12,564)                $(29,005)          $(23,040)
                                                         ========           ========                 ========           ========

Basic and diluted net loss per common share:
       Before cumulative effect of change in
       accounting principle                              $  (0.35)          $  (0.35)                $  (0.80)          $  (0.60)

       Cumulative effect of change in
       accounting principle                              $      -           $      -                 $      -           $  (0.05)
                                                         --------           --------                 --------           --------

Net loss per common share:
       Basic and diluted                                 $  (0.35)          $  (0.35)                $  (0.80)          $  (0.65)
                                                         ========           ========                 ========           ========
Shares used in computing basic and diluted net
loss per share                                             36,148             35,625                   36,083             35,534
                                                         ========           ========                 ========           ========
</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>
                                                                          Six Months Ended
                                                                          ----------------
                                                                            September 30,
                                                                            -------------
                                                                    2001                  2000
                                                              ----------------      ----------------
<S>                                                           <C>                   <C>
Operating activities:
Net loss                                                              $(28,998)             $(23,040)

Adjustments to reconcile net loss to net cash
      (used in) operations:
   Noncash items included in net loss:
      Depreciation and amortization                                     10,243                 5,943
      Stock based compensation expense                                     122                   125
      Provision for bad debts                                            1,864                   789
      Amortization of warrants issued for services                         215                   279
      Loss on disposal of assets                                           392                     -
   Changes in assets and liabilities
      Accounts receivable                                                  834                (4,538)
      Prepaids and other assets                                           (315)               (1,135)
      Accounts payable and accrued expenses                              1,533                 1,514
      Deferred revenue                                                  (1,333)                3,643
                                                              ----------------      ----------------
Net cash (used in) operating activities                                (15,443)              (16,420)

Investing Activities:
      Capital expenditures                                              (2,634)              (10,939)
      Purchase of available-for-sale securities                              -               (44,316)
      Proceeds from available-for-sale securities                       26,800                     -
      Restricted cash and marketable securities                         (2,000)                   -
                                                              ----------------      ----------------
Net cash provided by (used in) investing activities                     22,166               (55,255)

Financing activities:
      Payments on notes payable and capital lease                       (4,741)               (4,020)
      obligations
      Net proceeds from issuance of common stock                            28                   153
                                                              ----------------      ----------------
Net cash provided by (used in) financing activities                     (4,713)               (3,867)
                                                              ----------------      ----------------
Net increase (decrease) in cash                                          2,010               (75,542)

      Beginning cash                                                     6,566                85,424
                                                              ----------------      ----------------
      Ending cash                                                     $  8,576              $  9,882
                                                              ================      ================

Non cash activities:
      Equipment acquired under capital lease                          $  3,075              $ 17,660
                                                              ================      ================
</TABLE>

           See accompanying notes to Condensed Financial Statements.

                                       5
<PAGE>

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.

  The Company closed its initial public offering of common stock on November 4,
1999.  The Company sold 7,187,500 shares of common stock to the public,
including the underwriters' overallotment, and received net proceeds of $85.9
million.

  During the quarter ended September 30, 2001, the Company began to implement a
cost savings plan with an objective of becoming substantially cash flow
breakeven at current revenue levels by reducing cash outflows.  As part of this
plan, the Company reduced its real estate lease expenses by $193,000 per month,
personnel expenses by $961,000 per month and discretionary expenses by $296,000
per month.  The Company expects to begin to realize the full effect of these
costs savings during the quarter ending December 31, 2001.  The Company expected
to negotiate a reduction of its other fixed operating expenses (including
capital leases). As a result, the Company was not making its lease payments, or
was making partial lease payments, under these leases and was in default under
these leases at September 30, 2001. Because the restructuring of these leases
would likely have impacted its capital structure, it did not negotiate the
restructuring while it was engaged in the negotiations that resulted in the
execution of the merger agreement described below in "Subsequent Events."

  In connection with the execution of the merger agreement (see Note 9), the
Company entered into a credit agreement with divine, inc. on November 1, 2001
pursuant to which divine has agreed to make available to the Company interim
financing of up to a maximum of $12.8 million. Outstanding balances bear
interest at 10%. The facility is secured by all of the Company's assets other
than certain assets that are already encumbered or cannot be pledged. The credit
facility contains standard events of default and other covenants. The Company
received its first advance, in the amount of $4.3 million, on November 5, 2001,
and plans to use a substantial portion of such amount to make past-due payments
to its capital lease vendors. The Company currently expects that its cash and
investment balances available at September 30, 2001 and the amounts available to
it under the credit agreement should be sufficient to meet its working capital
and capital expenditure requirements at least through the end of its current
fiscal year (March 31, 2002). However, the Company's ability to access the
remaining amounts is subject to its meeting certain financial covenants and
other conditions. In addition, under certain circumstances, divine would be
entitled to either restrict the Company's borrowing ability or declare the
entire unpaid balance due, or both. The Company expects the merger agreement to
close in January 2002, subject to regulatory and shareholder approval.

  If the merger agreement is terminated, in addition to funding its ongoing
expenses, the Company could be required to repay outstanding amounts under the
credit agreement and, under certain circumstances, termination fees and expenses
totaling $2.2 million. If divine terminates the merger agreement because the
Company has breached a covenant or agreement or representation or warranty or
the Company's board of directors withdraws its recommendation of the merger or
takes certain actions with respect to another acquisition proposal, the Company
would be required to repay all outstanding amounts within 90 days after the
termination date. If the Company terminates the merger agreement because
divine's stock price closes for 10 consecutive trading days below $0.329, the
Company would be required to repay all outstanding amounts within 180 days after
the termination date. If the Company terminates the merger agreement because
divine has breached a covenant or agreement or representation or warranty or
divine's board of directors withdraws its recommendation of the merger, all
outstanding amounts convert to shares of the Company's common stock at $0.94 per
share. If the Company is required to repay outstanding loans

                                       6
<PAGE>

from divine and some or all of the other expenses as a result of the termination
of the merger agreement, the Company would be required to raise a significant
amount of capital and the covenants in the credit agreement with divine prohibit
the Company from raising additional capital or incurring additional debt without
repaying divine in full. As a result, it is likely that, if the merger agreement
is terminated and the outstanding loans did not convert to equity, the Company
would not be able to continue as a going concern unless the Company is able
raise this additional capital quickly. In any event, the Company would be
required to significantly curtail its operations to allow the Company to
continue to operate while the Company attempted to secure additional sources of
capital. If the Company requires additional financing for any reason, there can
be no assurance that such additional financing will be available to the Company
on acceptable terms, or at all. If the Company requires additional capital and
is unable to raise it, the Company may be required to substantially reduce or
curtail its operations.

  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- and six-month
periods ended September 30, 2001 are not necessarily an indication of the
results that may be expected for the year ending March 31, 2002.

  The balance sheet at March 31, 2001 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 Company's
Annual Report on Form 10-K for the Year Ended March 31, 2001.

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, 9,691,961 employee
stock options and 345,910 warrants to acquire shares of common stock are not
included in this calculation.

3.   Recent Accounting Pronouncements

  In December 1999, the Securities and Exchange Commission (SEC) issued SAB 101,
which summarizes some of the SEC staff's views in applying generally accepted
accounting principles to revenue recognition in financial statements. We adopted
the new guidance as a change in accounting principle beginning January 1, 2001
but effective April 1, 2000. We changed 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. The change in accounting method has been accounted
for as a cumulative effect adjustment, which resulted 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 first
quarter of the year of adoption of SAB 101. As a result of the cumulative effect
adjustment on prior years, which totals approximately $1,626,000, revenue that
has previously been recognized in our financial statements has been and will
continue to be amortized to income in financial reporting periods subsequent to
the period of adoption of  SAB 101.

  In July 2001, the Financial Accounting Standard Board issued Statement of
Financial Accounting Standards No. 141, Business Combinations ("SFAS 141"), and
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets ("SFAS 142"). SFAS 141 requires that the purchase method of
accounting be used for all business combinations initiated after June 30, 2001
as well as all purchase method business combinations completed after June 30,
2001. Under SFAS 141, the Company must recognize and report intangible

                                       7
<PAGE>

assets acquired in a purchase method business combination apart from goodwill,
if specific criteria are met. Purchase price previously allocated to an
assembled workforce may no longer be accounted for separately; rather, it is
subsumed into goodwill. Beginning January 1, 2002, SFAS 142 will require that
goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead tested for impairment at least annually in accordance
with the provisions of SFAS 142. SFAS 142 will also require that intangible
assets with definite useful lives be amortized over their respective estimated
useful lives to their estimated residual values, and reviewed for impairment in
accordance with Statement of Financial Accounting Standards No. 121, accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of. The adoption of SFAS 141 and SFAS 142 will not have an impact on the
Company.

4.   Restricted Cash and Marketable Securities

  The Company has classified $2.0 million as restricted cash and marketable
securities which is composed of $635,000 in cash and $1,365,000 in marketable
securities. This secures a guarantee issued by the Company to a financial
institution of up to $2.0 million of the margin debt of a Texas family limited
partnership (an estate planning entity) owned by Sunny C. Vanderbeck, the
Chairman of the Board and Chief Executive Officer of the Company. On November 6,
2001, the financial institution exercised its rights under the guarantee and
took possession of the $2.0 million securing the guarantee. Pursuant to a letter
agreement with the limited partnership and Mr. Vanderbeck, the limited
partnership and Mr. Vanderbeck are required to repay the $2.0 million paid by
the Company under the guarantee. Mr. Vanderbeck has also granted to the Company
a security interest in certain properties. The Company has recorded $2.0 million
due from Mr. Vanderbeck and a corresponding $2.0 million liability related to
fulfillment of the guarantee obligation. Also see Note 9, Subsequent Events, and
the Recent Developments section in Management's Discussion and Analysis.

5.   Investments in Available for Sale Securities

  Available-for-sale securities are comprised of debt securities for which there
is a determinable fair market value and for which there are no restrictions on
the Company's ability to sell the security. In accordance with the provisions of
Statement of Financial Accounting Standards No. 115, Accounting for Certain
Investments in Debt and Equity Securities, available-for-sale securities are
carried at fair value, with unrealized gains and losses reported as a separate
component of shareholders' equity. Realized gains and losses and declines in
value deemed 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.

  At March 31, 2001, the realized gains on sales of available-for-sale
securities totaled $55,000. The net adjustment of unrealized gains of $281,000
has been recorded as a separate component of shareholders' equity. There were no
available-for-sale securities as of September 30, 2001.

6.   Property and Equipment

  Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
                                                                     September 30, 2001         March 31, 2001
                                                                     ------------------         --------------
                                                                        (unaudited)
<S>                                                                  <C>                        <C>
Electronics and computer equipment  ..................................   $ 47,556                    $ 44,313
Computer software  ...................................................      4,147                       3,961
Furniture and office equipment  ......................................      4,544                       4,592
Leasehold improvements   .............................................      5,363                       5,767
Other depreciable assets  ............................................      4,480                       2,547
                                                                         --------                    --------
                                                                           66,090                      61,180
Less accumulated depreciation and amortization  ......................    (27,030)                    (17,076)
                                                                         --------                    --------
                                                                         $ 39,060                    $ 44,104
                                                                         ========                    ========
</TABLE>
  Property and equipment includes assets acquired under capital leases,
principally computer equipment with a cost of $43,994,000 at September 30, 2001
and $40,918,000 at March 31, 2001, respectively.  Related allowances for
depreciation and amortization are $18,055,000 and $11,337,000 respectively.

7.   Accrued Expenses

  Accrued expenses consist of the following (in thousands):
<TABLE>
<CAPTION>
                                                                    September 30, 2001           March 31, 2001
                                                                    ------------------           --------------
                                                                        (unaudited)
<S>                                                                 <C>                          <C>
Professional fees  .......................................................   $  161                   $  183
Marketing costs...........................................................      579                    1,306
Accrued payroll  .........................................................    1,143                    1,700
Commissions  .............................................................       88                      137
Other taxes  .............................................................      794                      337
Restructuring costs.......................................................    1,172                        -
Other  ...................................................................      936                      602
                                                                             ------                   ------
</TABLE>

                                       8
<PAGE>

<TABLE>
<CAPTION>
<S>                                                                 <C>                          <C>
                                                                             $4,873                   $4,265
                                                                             ======                   ======
</TABLE>

8.  Restructuring Costs

  On May 10, 2001 the Company initiated a restructuring plan intended to reduce
its workforce and eliminate excess office space and furniture and fixtures at
its headquarters.  In determining net loss during the June 30, 2001 quarter, the
Company recorded restructuring costs of $2,191,000 related to that plan, which
included $1,690,000 for costs associated with lease terminations and asset write
offs and $501,000 for severance costs.  During the September 30, 2001 quarter,
the Company was able to execute terminations on one of its leases. The Company
continues to maintain an accrued reserve of $455,000 at September 30, 2001 for
anticipated costs of restructuring certain facilities and furniture leases.

  On August 11, 2001, the Company initiated a voluntary separation benefit
program to reduce the Company's workforce.  108 employees were approved to
participate in this program.  Restructuring costs, consisting of severance and
benefits, were $1,392,000 during the quarter ended September 30, 2001 and are
included in restructuring costs in determining net loss. The remaining estimated
restructuring accrual of $717,000 at September 30, 2001 relates to severance and
benefits for those employees participating in the voluntary separation program.

9.   Subsequent Events

  On November 1, 2001, the Company signed a merger agreement with divine, inc.,
a Delaware corporation, and TD Acquisition Corp., a Texas corporation and wholly
owned subsidiary of divine.  Under the terms of the merger agreement, except as
provided in the following sentence, each of the approximately 36.3 million
shares of the Company's common stock currently outstanding will be converted
into the right to receive 1.9876 shares of divine class A common stock.  If
divine would be required to issue more than 72,250,000 shares of its class A
common stock because warrants or options to purchase more than 167,934 shares of
the Company's common stock are exercised prior to closing of the transaction,
the exchange ratio of 1.9876 will be decreased so that the number of shares of
divine common stock being issued will equal 72,250,000.  The transaction is
expected to be tax-free to the shareholders of both companies.  Subject to the
Company's shareholder approval, divine's stockholder approval, if necessary, and
customary closing conditions, the transaction is expected to close in January
2002. The details of the transaction are discussed in the Company's Current
Report on Form 8-K filed with the SEC on November 2, 2001.

  In January 2001, the Company entered into a guarantee with a financial
institution pursuant to which the Company guaranteed up to $5.0 million of the
margin debt of a Texas family limited partnership (an estate planning entity)
owned by Sunny C. Vanderbeck, the Chairman of the Board and Chief Executive
Officer of the Company.  In June 2001, this guarantee was replaced with a new
guarantee that reduced the amount to $2.0 million.   On October 26, 2001, the
financial institution sold the remaining shares of common stock securing the
margin debt and, on November 6, 2001, exercised its rights under the guarantee
and took possession of the $2.0 million securing the guarantee. Pursuant to a
letter agreement with the limited partnership and Mr. Vanderbeck, the limited
partnership and Mr. Vanderbeck are required to repay the $2.0 million paid by
the Company under the guarantee.  Mr. Vanderbeck has also granted to the Company
a security interest in certain properties.  The Company has recorded $2.0
million due from Mr. Vanderbeck and a corresponding $2.0 million liability
related to fulfillment of the guarantee obligation.

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
and the Data Return Annual Report on form 10-K for the year ended March 31,
2001.

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
"plan", "may," "will," "expect," "intend," "anticipate," "estimate" and similar
words, or by discussions of strategies and plans, although

                                       9
<PAGE>

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, external competitive market factors, changes in our business
strategy or an inability to execute our strategy or plans, changes in the
hosting industry, the economy in general and changes in the use of the Internet
and the viability of Internet-based businesses. We cannot guarantee future
results, levels of activity, performance or achievements. Our actual results
could differ materially from those anticipated in forward-looking statements as
a result of certain factors, including those set forth in the section of this
report entitled "Risk Factors." 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 "Risk Factors" 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.

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.

  We derive substantially all of our revenue from hosting and managed services.
This includes revenue from our dedicated server offerings, including clustered
servers, and our shared server offering.  With our dedicated server offerings,
each server is dedicated to providing service to one customer.  In a clustered
configuration, we utilize two or more dedicated servers to distribute content
and functionality across multiple servers or, in the case of multi-site
clusters, across multiple data centers.  Hosting and managed services revenue
also includes shared hosting, in which more than one customer shares the same
server.  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 and managed services revenues are generated from
recurring monthly fees. Substantially all of the remainder is derived from one-
time set-up fees for installation and from sales of services, such as time and
materials billing and certain lab or consulting services.

  Services are billed on a monthly basis and, except as described below, are
recognized as the service is performed. As a result of our adoption of Staff
Accounting Bulletin No. 101, Revenue Recognition in Financial Statements ("SAB
101"), revenues from set-up, or installation, services are recognized over the
longer of the length of the customer contract and the estimated life of the
customer contract. See "Recent Accounting Pronouncements" for a description of
our adoption and the effect of SAB 101.

  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 compensation and related
    expenses, advertising expenses and occupancy costs;

  . product research and development, which consists primarily of compensation
    and related expenses and occupancy costs;

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

  . restructuring costs, which consists primarily of severance compensation and
    related expenses,

                                       10
<PAGE>

    occupancy costs and restructuring costs on assets.

  We have incurred significant losses since our inception and, as of September
30, 2001, had an accumulated deficit of approximately $90.9 million.  We expect
to continue to incur substantial losses for the foreseeable future.  We may not
be able to successfully execute our plans.

Pending Merger

   On November 1, 2001, we signed a merger agreement with divine, inc., a
Delaware corporation, and TD Acquisition Corp., a Texas corporation and wholly
owned subsidiary of divine.  Under the terms of the merger agreement, except as
provided in the following sentence, each of the approximately 36.3 million
shares of our common stock currently outstanding will be converted into the
right to receive 1.9876 shares of divine class A common stock.  If divine would
be required to issue more than 72,250,000 shares of its class A common stock
because warrants or options to purchase more than 167,934 shares of our common
stock are exercised prior to closing of the transaction, the exchange ratio of
1.9876 will be decreased so that the number of shares of divine common stock
being issued will equal 72,250,000.  The transaction is expected to be tax-free
to the shareholders of both companies.  Subject to our shareholder's approval,
divine's stockholder approval, if necessary, and customary closing conditions,
the transaction is expected to close before year end. The details of the
transaction are discussed in our Current Report on Form 8-K filed with the SEC
on November 2, 2001.

Results of Operations

Comparison of quarters ended September 30, 2001 and 2000

Revenues

  Our revenues decreased $196,000 to $12,160,000 for the quarter ended September
30, 2001 from $12,356,000 for the quarter ended September 30, 2000. The decrease
is a result of our continued loss of customers.  Dedicated hosting revenue and
managed services fees increased $176,000 to $10,380,000, or 85.4% of revenue,
for the quarter ended September 30, 2001 from $10,204,000, or 82.6% of revenue,
for the quarter ended September 30, 2000.  Shared hosting revenue decreased
$133,000 to $613,000, or 5.0% of revenue, for the quarter ended September 30,
2001 from $746,000, or 6.0% of revenue, for the quarter ended September 30,
2000.  The continued shift towards dedicated revenues reflects our focus on our
dedicated hosting and managed services product offerings.  Set-up fees decreased
$226,000 to $714,000, or 5.9% of revenue, for the quarter ended September 30,
2001 from $940,000, or 7.6% of revenue, for the quarter ended September 30,
2000, due to a decline in new customer orders.

Cost of revenue

  Our cost of revenue increased $313,000 to $11,838,000, or 97.4% of revenue,
for the quarter ended September 30, 2001 from $11,525,000, or 93.3% of revenue,
for the quarter ended September 30, 2000. The increase in cost of revenue was
due primarily to increases in communication and bandwidth expenses, and
increases in depreciation and amortization expenses, offset by decreases in
personnel and related costs and facilities related expenses.   Communication and
bandwidth expenses increased $1,197,000 to approximately $3,181,000, or 26.2% of
revenue, for the quarter ended September 30, 2001 from $1,984,000, or 16.1% or
revenue, for the quarter ended September 30, 2000 due to increased usage by our
customers.  In particular, one customer accounted for a significant portion of
the increase.  Depreciation and amortization expenses increased approximately
$1,181,000 to $3,990,000, or 32.8% of revenue, for the quarter ended September
30, 2001 from $2,809,000, or 22.7% of revenue, for the quarter ended September
30, 2000, as we added approximately $15.3 million in computer and related
equipment since September 30, 2000.  Personnel and related expenses decreased
approximately $1,754,000 to $3,789,000, or 31.2% of revenue, for the quarter
ended September 30, 2001 from $5,543,000, or 44.9% of revenue, for the quarter
ended September 30, 2000, as we decreased our systems and customer support
personnel to 158 at September 30, 2001 from 251 at September 30, 2000.
Facilities expense decreased approximately $267,000 to $229,000 as we terminated
leases on office space due to decreases in personnel.

General and administrative

                                       11
<PAGE>

  General and administrative expense decreased $589,000 to $5,166,000, or 42.5%
of revenue, during the quarter ended September 30, 2001 from $5,755,000, or
46.6% of revenue, during the quarter ended September 30, 2000.  The decrease is
primarily due to decreases in personnel and related expenses, professional
services expense, and facilities expense offset by an increase in bad debt
expense.  Bad debt expense increased $581,000 to $1,150,000, or 9.5% of revenue,
in the quarter ended September 30, 2001 as many of our customers ceased
operations or reduced or eliminated the web site operations hosted by us.
Personnel and related expenses decreased $964,000 to $1,783,000, or 14.7% of
revenue, for the quarter ended September 30, 2001 from $2,747,000, or 22.2% of
revenue, for the quarter ended September 30, 2000 due to a decrease in general
and administrative personnel to 56 employees at September 30, 2001 from 138
employees at September 30, 2000.  Professional service expense decreased
$229,000 to $226,000 for the quarter ended September 30, 2001 from $455,000 due
to the completion of various projects and the reduction of contract employees.
Facilities expense decreased $180,000 to $430,000 as we terminated leases on
office space as a result of decreases in personnel.

Marketing and sales

  Marketing and sales expense decreased $2,379,000 to $4,671,000, or 38.4% of
revenue, during the quarter ended September 30, 2001 from $7,050,000, or 57.1%
of revenue, for the quarter ended September 30, 2000. The decrease was primarily
due to a decrease in marketing and sales personnel to 76 at September 30, 2001
from 90 at September 30, 2000, decreases in sales commissions, and to decreases
in advertising costs.  Personnel and related expenses, including sales
commissions, decreased $1,665,000 to $2,955,000, or 24.3% of revenue, for the
quarter ended September 30, 2001 from $4,620,000, or 37.4% of revenue, for the
quarter ended September 30, 2000. Advertising costs decreased $794,000 to
$767,000 for the quarter ended September 30, 2001 from $1,561,000 for the
quarter ended September 30, 2000.


Product research and development

  Product research and development expense remained constant at $1,115,000, or
9.2% of revenue, during the quarter ended September 30, 2001 compared to
$1,113,000, or 9.0% of revenue, during the quarter ended September 30, 2000.

Stock-based compensation

  Deferred stock compensation was recorded in connection with the grant of
employee stock options below fair value in 1998 and 1999. Amortization of stock-
based compensation totaled $107,000 for the quarter ended September 30, 2001 and
$25,000 for the quarter ended September 30, 2000. The amortization of stock-
based compensation is based on the vesting schedule of stock options held by our
employees.

Restructuring costs

  On August 11, 2001, we initiated a voluntary separation benefit program to
reduce our workforce. 108 employees were approved for this program.
Restructuring costs relating to this program, consisting of severance pay and
benefits, were $1,392,000 during the quarter ended September 30, 2001.

Other income (expense)

  Other income (expense) consists primarily of interest income on our cash
balances and investments in marketable securities and interest expense on our
outstanding notes payable and capital lease obligations. Interest earned on our
cash and cash equivalents decreased $941,000 to $148,000 for the quarter ended
September 30, 2001 from $1,089,000 for the quarter ended September 30, 2000.
This decrease was due primarily to having lower cash balances for investments as
cash has been used to fund operating losses. During the quarter ended September
30, 2001, interest expense increased $247,000 to $788,000 related primarily to
equipment acquired under capital leases during the last four quarters.

                                       12
<PAGE>

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.

Cumulative effect of change in accounting principle

  Effective April 1, 2000, we changed our method of accounting for set-up fees
in accordance with SAB 101.  We recorded a cumulative effect adjustment of $1.6
million as of April 1, 2000 and amortized set-up fees into revenues during
fiscal 2001.  Set-up fees are now amortized over the longer of the length of the
customer contract and the estimated life of the customer contract.

Net loss

  Net loss increased $205,000 to $12,769,000 for the quarter ended September 30,
2001 from $12,564,000 for the quarter ended September 30, 2000. As more fully
discussed above, the increased net loss is primarily attributable to the
decrease in revenues.

EBITDA

  EBITDA, as defined below, increased $2,621,000 to negative $6,741,000 for the
quarter ended September 30, 2001 from negative $9,362,000 for the quarter ended
September 30, 2000.  The increase is primarily attributable to the cost
reduction efforts described above.  We expect to generate negative EBITDA for
fiscal 2002.  Costs associated with our personnel and our fixed commitments will
continue to represent a large portion of our expenses.

  EBITDA for the quarters ended September 30, 2001 and 2000 consists of loss
from operations of $12,129,000 and $13,112,000 plus depreciation and
amortization of $5,281,000 and $3,725,000 and amortization of unearned stock-
based compensation of $107,000 and $25,000, 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 others. 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 requirements.

Comparison of six-month periods ended September 30, 2001 and 2000

Revenues

  Our revenues increased $4,307,000 to $25,743,000 for the six-month period
ended September 30, 2001 from $21,436,000 for the six-month period ended
September 30, 2000. The increase is as a result of an increase in the number of
customers and the growth in revenues from some existing customers.  Dedicated
hosting revenue and managed services fees increased $4,790,000 to $21,852,000,
or 84.9% of revenue, for the six-month period ended September 30, 2001 from
$17,062,000, or 79.6% of revenue, for the six-month period ended September 30,
2000.  Shared hosting revenue decreased $264,000 to $1,274,000, or 4.9% of
revenue, for the six-month period ended September 30, 2001 from $1,538,000, or
7.2% of revenue, for the six-month period ended September 30, 2000.  These
changes reflect our continued focus on our dedicated hosting and managed
services product offerings.  Set-up fees decreased $402,000 to $1,435,000, or
5.6% of revenue, for the six-month period ended September 30, 2001 from
$1,837,000, or 8.6% of revenue, for the six-month period ended September 30,
2000, due to a decline in new

                                       13
<PAGE>

customer orders.

Cost of revenue

  Our cost of revenue increased $4,460,000 to $24,996,000, or 97.1% of revenue,
for the six-month period ended September 30, 2001 from $20,536,000, or 95.8% of
revenue, for the six-month period ended September 30, 2000.  The increase in
cost of revenue was due primarily to increases in communication and bandwidth
expenses, and increases in depreciation and amortization expenses offset by
decreases in personnel and related costs and facilities related expenses.
Communication and bandwidth expenses increased $3,255,000 to approximately
$6,724,000 for the six-month period ended September 30, 2001 from $3,469,000 for
the six-month period ended September 30, 2000. This was due to our having
purchased higher-performance bandwidth from more costly vendors to support our
increased business activities and increased usage by our customers. Depreciation
and amortization expenses increased approximately $3,027,000 to $7,850,000 for
the six-month period ended September 30, 2001, as we added approximately $15.3
million in computer and related equipment since September 30, 2000. Personnel
and related expenses decreased approximately $1,467,000 to $8,581,000, or 33.3%
of revenue, for the six-month period ended September 30, 2001 from $10,048,000,
or 46.9% of revenue, for the six-month period ended September 30, 2000, as we
decreased our systems and customer support personnel to 158 at September 30,
2001 from 251 at September 30, 2000. Facilities expense decreased approximately
$412,000 to $438,000 as we terminated leases on office space due to the decrease
in personnel.

General and administrative

  General and administrative expense increased $1,116,000 to $11,102,000, or
43.1% of revenue, during the six-month period ended September 30, 2001 from
$9,986,000, or 46.6% of revenue, during the six-month period ended September 30,
2000.  The increase is primarily due to increases in bad debt expense, other
taxes expense, depreciation and amortization expense, and facilities expense,
offset by decreases in personnel and related expenses, and professional services
expense.   Bad debt expense increased $1,074,000 to $1,864,000 in the six-month
period ended September 30, 2001 as many of our customers ceased operations or
reduced or eliminated the web site operations hosted by us. Other taxes, which
include primarily property tax, were $677,000 for the six-month period ended
September 30, 2001.  Depreciation and amortization expense increased $405,000 to
$1,115,000 in the six-month period ended September 30, 2001, due to increased
computer and office equipment necessary to support the growth of our business.
Facilities expense increased $330,000 to $1,212,000 as a result of our move into
a larger facility and the growth in the average number of general and
administrative employees during the first quarter of fiscal 2001.  Personnel and
related expenses decreased $810,000 to $4,290,000, or 16.7% of revenue, for the
six-month period ended September 30, 2001 from $5,100,000, or 23.8% of revenue,
for the six-month period ended September 30, 2000 due to a decrease in the
number of general and administrative personnel to 56 employees at September 30,
2001 from 138 employees at September 30, 2000.  Professional services expense
decreased $557,000 to $456,000 for the six-month period ended September 30, 2001
due to the completion of various projects and the reduction of contract
employees.

Marketing and sales

  Marketing and sales expense decreased $90,000 to $11,557,000, or 44.9% of
revenue, during the six-month period ended September 30, 2001 from $11,647,000,
or 54.3% of revenue, during the six-month period ended September 30, 2000. The
decrease was due primarily to a decrease in marketing and sales personnel and
related expenses, a decrease in sales commissions due to lower sales, and an
increase in depreciation expenses.  Personnel and related expenses, including
sales commissions,  decreased $631,000 to $6,803,000, or 26.4% of revenue, for
the six-month period ended September 30, 2001 from $7,434,000, or 34.7% of
revenue, for the six-month period ended September 30, 2000. Depreciation and
amortization expenses increased $494,000 to $655,000 for the six-month period
ended September 30, 2001 due to our move into a larger facility.   We decreased
our marketing and sales personnel to 76 at September 30, 2001 from 90 at
September 30, 2000.

Product research and development

  Product research and development expense increased $449,000 to $2,334,000, or
9.1% of revenue, during the six-month period ended September 30, 2001 from
$1,885,000, or 8.8% of revenue, during the six-month period ended September 30,
2000.  The increase was due primarily to an increase in product research and
development

                                       14
<PAGE>

personnel and related expenses and depreciation and amortization expenses.
Personnel and related expenses increased $292,000 to $1,865,000, or 7.2% of
revenue, for the six-month period ended September 30, 2001 from $1,573,000, or
7.3% of revenue, for the six-month period ended September 30, 2000. Depreciation
and amortization increased $64,000 to $136,000 for the six-month period ended
September 30, 2001 from $72,000 for the six-month period ended September 30,
2000.

Stock-based compensation

  Deferred stock compensation was recorded in connection with the grant of
employee stock options below fair value in 1998 and 1999. Amortization of stock-
based compensation totaled $122,000 for the six-month period ended September 30,
2001 and $125,000 for the six-month period ended September 30, 2000. The
amortization of stock-based compensation is based on the vesting schedule of
stock options held by our employees.

Restructuring costs

  Restructuring costs totaled $3,583,000 during the six month ended September
30, 2001.  The May 10, 2001 restructuring plan resulted in estimated costs
associated with termination of leases and asset write offs of $1,694,000 and
severance costs of $503,000.  The August 11, 2001 restructuring plan resulted in
severance and benefit costs of $1,392,000.

  On May 10, 2001, we initiated a restructuring plan intended to reduce our
workforce and eliminate excess office space and furniture and fixtures at our
headquarters.  On May 11, 2001, we reduced our workforce by 94 employees.  We
renegotiated the lease for our headquarters facilities and anticipate that we
will renegotiate certain excess furniture and fixtures leases.  We have also
recorded a charge for the net book value of leasehold improvements related to
the excess office space at our headquarters facilities.  The reduction in
workforce was a result of slower than anticipated growth and increased process
and other operational efficiencies.

  On August 11, 2001, we initiated a voluntary separation benefit program to
reduce our workforce.  108 employees were approved for the program.

Other income (expense)

  Other income (expense) consists primarily of interest income on our cash
balances and investments in marketable securities and interest expense on our
outstanding notes payable and capital lease obligations. Interest earned on our
cash and cash equivalents decreased $1,760,000 to $555,000 for the six-month
period ended September 30, 2001 from $2,315,000 for the six-month period ended
September 30, 2000. This decrease was due primarily to having lower cash
balances for investments as cash has been used to fund operating losses. During
the six-month period ended September 30, 2001, interest expense increased
$616,000 to $1,602,000 related primarily to equipment acquired under capital
leases during the last four quarters.

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.

Cumulative effect of change in accounting principle

  Effective April 1, 2000, we changed our method of accounting for set-up fees
in accordance with SAB 101.  We recorded a cumulative effect adjustment of $1.6
million as of April 1, 2000 and amortized set-up fees into revenues during
fiscal 2001.  Set-up fees are now amortized over the longer of the length of the
customer contract and the estimated life of the customer contract.

Net loss

                                       15
<PAGE>

  Net loss increased $5,958,000 to $28,998,000 for the six-month period ended
September 30, 2001 from $23,040,000 for the six-month period ended September 30,
2000. As more fully discussed above, the increased net loss is primarily
attributable to increased expenses.

EBITDA

  EBITDA, as defined above, decreased $985,000 to negative $17,371,000 for the
six-month period ended September 30, 2001 from negative $16,386,000 for the six-
month period ended September 30, 2000.  The decrease is primarily attributable
to costs associated with anticipated growth partially  offset by cost reduction
efforts.  We expect to generate negative EBITDA for fiscal 2002. Costs
associated with our personnel and our fixed commitments will continue to
represent a large portion of our expenses during our anticipated expansion.
EBITDA for the six-month periods ended September 30, 2001 and 2000 consists of
loss from operations of $27,951,000 and $22,743,000 plus depreciation and
amortization of $10,458,000 and $6,232,000 and amortization of unearned stock-
based compensation of $122,000 and $125,000, respectively.

Liquidity and Capital Resources

  We have historically financed our operations primarily through sales of equity
securities and capital leases. 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 September
30, 2001, we had cash and cash equivalents of $8.6 million.

  Net cash used in our operating activities for the six-month period ended
September 30, 2001 was $15.4 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 provided by investing activities was
$22.2 million for the six-month period ended September 30, 2001 and consisted of
the sale of marketable debt securities of $25.4 million and purchases of
property and equipment of approximately $2.6 million. Our purchases of property
and equipment consisted primarily of equipment to provide services to our
customers. We acquired $3.1 million in computer and related equipment under
capital leases for the six-month period ended September 30, 2001.  Net cash used
in financing activities was approximately $4.7 million for the six-month period
ended September 30, 2001 and consisted primarily of principal payments on our
notes payable and capital leases.

  Total borrowings under our notes payable and capital lease obligations as of
September 30, 2001 were approximately $29.4 million.

  In December 1999 we entered into a revolving credit facility with Bank One,
Texas, N.A. This $2.0 million credit facility matured on July 31, 2001, and we
did not renew it.  We did not borrow any amounts under the facility.

  Under our agreement with Level 3, we are required to purchase at least an
additional $7.6 million of bandwidth and colocation services over the next three
years.  Our quarterly commitment was $300,000 per quarter through July 2001, is
$400,000 per quarter through July 2002 and is $600,000 per quarter during the
next 12 months and $1.0 million per quarter during the final 12 months of the
agreement.

  During the quarter ended September 30, 2001, we began to implement a cost
savings plan with an objective of becoming substantially cash flow breakeven at
current revenue levels by reducing cash outflows.  As part of this plan, we
reduced our real estate lease expenses by $193,000 per month, personnel expenses
by $961,000 per month and discretionary expenses by $296,000 per month.  We
expect to begin to realize the full effect of these costs savings during the
quarter ending December 31, 2001.  We expected to negotiate a reduction of our
other fixed operating expenses (including capital leases).  As a result, we were
not making our lease payments, or were making partial lease payments, under
these leases and were in default under these leases at September 30, 2001.
Because the restructuring of these leases would likely have impacted our capital
structure, we did not negotiate the restructuring while we were engaged in the
negotiations that resulted in the execution of the merger agreement described
above in "Pending Merger."

  In connection with the execution of the merger agreement, we entered into a
credit agreement with divine on November 1, 2001 pursuant to which divine has
agreed to make available to us interim financing of up to a

                                       16
<PAGE>

maximum of $12.8 million. Outstanding balances bear interest at 10%. The
facility is secured by all of our assets other than certain assets that are
already encumbered or cannot be pledged. The credit facility contains standard
events of default and other covenants. We received our first advance, in the
amount of $4.3 million, on November 5, 2001, and plan to use a substantial
portion of such amount to make past-due payments to our capital lease vendors.
We currently expect that our cash and investment balances available at September
30, 2001 and the amounts available to us under the credit agreement should be
sufficient to meet our working capital and capital expenditure requirements at
least through the end of our current fiscal year (March 31, 2002). However, our
ability to access the remaining amounts is subject to our meeting certain
financial covenants and other conditions. In addition, under certain
circumstances, divine would be entitled to either restrict our borrowing ability
or declare the entire unpaid balance due, or both. We expect the merger
agreement to close in January 2002, subject to regulatory and shareholder
approval.

  If the merger agreement is terminated, in addition to funding our ongoing
expenses, we could be required to repay outstanding amounts under the credit
agreement and, under certain circumstances, termination fees and expenses
totaling $2.2 million. If divine terminates the merger agreement because we have
breached a covenant or agreement or representation or warranty or our board of
directors withdraws its recommendation of the merger or takes certain actions
with respect to another acquisition proposal, we would be required to repay all
outstanding amounts within 90 days after the termination date. If we terminate
the merger agreement because divine's stock price closes for 10 consecutive
trading days below $0.329, we would be required to repay all outstanding amounts
within 180 days after the termination date. If we terminate the merger agreement
because divine has breached a covenant or agreement or representation or
warranty or divine's board of directors withdraws its recommendation of the
merger, all outstanding amounts convert to shares of our common stock at $0.94
per share. If we are required to repay outstanding loans from divine and some or
all of the other expenses as a result of the termination of the merger
agreement, we would be required to raise a significant amount of capital and the
covenants in the credit agreement with divine prohibit us from raising
additional capital or incurring additional debt without repaying divine in full.
As a result, it is likely that, if the merger agreement is terminated and the
outstanding loans did not convert to equity, we would not be able to continue as
a going concern unless we were able raise this additional capital quickly. In
any event, we would be required to significantly curtail our operations to allow
us to continue to operate while we attempted to secure additional sources of
capital. If we require additional financing for any reason, there can be no
assurance that such additional financing will be available to us on acceptable
terms, or at all. Further, if we raise additional funds through the issuance of
additional equity securities, the percentage ownership of our shareholders would
be substantially diluted. Any new equity securities may have rights, preferences
or privileges senior to those of our common stock.

Recent Developments

  In January 2001, we entered into a guarantee with a financial institution
pursuant to which we guaranteed up to $5.0 million of the margin debt of a Texas
family limited partnership (an estate planning entity) owned by Sunny C.
Vanderbeck, our Chairman of the Board and Chief Executive Officer.  In June
2001, this guarantee was replaced with a new guarantee that reduced the amount
to $2.0 million.   On October 26, 2001, the financial institution sold the
remaining shares of common stock securing the margin debt and, on November 6,
2001, exercised its rights under the guarantee and took possession of the $2.0
million securing the guarantee. Pursuant to a letter agreement with the limited
partnership and Mr. Vanderbeck, the limited partnership and Mr. Vanderbeck
are required to repay the $2.0 million paid by us under the guarantee.
Mr. Vanderbeck has also granted us a security interest in certain properties.

Recent Accounting Pronouncements

  In December 1999, the Securities and Exchange Commission issued SAB 101, which
summarizes some of the SEC staff's views in applying generally accepted
accounting principles to revenue recognition in financial statements. We adopted
the new guidance as a change in accounting principle in January 2001 but
effective April 1, 2000. We changed 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. The change in accounting method has been accounted
for as a cumulative effect adjustment, which resulted 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 first
quarter of the year of adoption of SAB 101. As a result of the cumulative effect
adjustment on prior years, which totals

                                       17
<PAGE>

approximately $1,626,000, revenue that has previously been recognized in our
financial statements has been and will continue to be amortized to income in
financial reporting periods subsequent to the period of adoption of SAB 101.

  In July 2001, the Financial Accounting Standard Board issued Statement of
Financial Accounting Standards No. 141, Business Combinations ("SFAS 141"), and
Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets ("SFAS 142"). SFAS 141 requires that the purchase method of
accounting be used for all business combinations initiated after June 30, 2001
as well as all purchase method business combinations completed after June 30,
2001. Under SFAS 141, the Company must recognize and report intangible assets
acquired in a purchase method business combination apart from goodwill, if
specific criteria are met. Purchase price previously allocated to an assembled
workforce may no longer be accounted for separately; rather, it is subsumed into
goodwill. Beginning January 1, 2002, SFAS 142 will require that goodwill and
intangible assets with indefinite useful lives no longer be amortized, but
instead tested for impairment at least annually in accordance with the
provisions of SFAS 142. SFAS 142 will also require that intangible assets with
definite useful lives be amortized over their respective estimated useful lives
to their estimated residual values, and reviewed for impairment in accordance
with Statement of Financial Accounting Standards No. 121, accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
The adoption of SFAS 141 and SFAS 142 will not have an impact on the Company.

Risk Factors

  The risks and uncertainties described below are not the only risks we face.
Additional risks and uncertainties not presently known to us, or that are
currently deemed immaterial may also impair our business operations. If any of
the following risks actually occur, our financial condition and operating
results could be materially adversely affected.

Our business and stock price may be adversely affected if the merger with divine
is not completed.

     On November 1, 2001, we entered into an agreement with divine, inc.
pursuant to which divine would acquire all of the outstanding shares of our
common stock.  Consummation of the transaction is conditioned upon our
shareholders' approval and, if required by Nasdaq rules, the approval of
divine's stockholders, as well as the satisfaction of other customary conditions
to closing.  If the transaction is not completed, we could be subject to a
number of risks that may adversely affect our business and stock price.  First,
we would not realize the strategic benefits or the enhanced financial and
competitive position we expect to realize from being part of a combined company
with divine.  In addition, the diversion of our management's attention from the
day to day business and the disruption to our employees and our relationships
with customers as a result of efforts and uncertainties relating to the
anticipated merger may detract from our ability to grow revenues and minimize
costs.  Also, under certain circumstances we could be required to pay divine a
termination fee equal to $1,700,000 and up to $500,000 of its transaction
related expenses, as well as our own transaction expenses and up to $12.8
million that we may, under certain circumstances, borrow from divine under our
credit facility with divine.

If the merger agreement is terminated and the outstanding loans under the credit
agreement with divine become payable, we may not be able to raise enough capital
to repay the loans, which could result in our inability to continue as a going
concern.

  If the merger agreement is terminated, in addition to funding our ongoing
expenses, we could be required to repay outstanding amounts under the credit
agreement and, under certain circumstances, termination fees and other fees and
expenses totaling $2.2 million. If divine terminates the merger agreement
because we have breached a covenant or agreement or representation or warranty
or our board of directors withdraws its recommendation of the merger or takes
certain actions with respect to another acquisition proposal, we would be
required to repay all outstanding amounts within 90 days after the termination
date. If we terminate the merger agreement because divine's stock price closes
for 10 consecutive trading days below $0.329, we would be required to repay all
outstanding amounts within 180 days after the termination date. If we terminate
the merger agreement because divine has breached a covenant or agreement or
representation or warranty or divine's board of directors withdraws its
recommendation of the merger, all outstanding amounts convert to shares of our
common stock at $0.94 per share. If we are required to repay outstanding loans
from divine or some or all of the other expenses as a result of the termination
of the merger agreement, we would be required to

                                       18
<PAGE>

raise a significant amount of capital and the covenants in the credit agreement
with divine prohibit us from raising additional capital or incurring additional
debt without repaying divine in full. As a result, it is likely that, if the
merger agreement is terminated and the outstanding loan balance is not converted
into equity, we would not be able to continue as a going concern unless we were
able raise this additional capital quickly. In any event, we would be required
to significantly curtail our operations to allow us to continue to operate while
we attempted to secure additional sources of capital. If we require additional
financing for any reason, there can be no assurance that such additional
financing will be available to us on acceptable terms, or at all. Further, if we
raise additional funds through the issuance of additional equity securities, the
percentage ownership of our shareholders would be substantially diluted. Any new
equity securities may have rights, preferences or privileges senior to those of
our common stock.

We have a history of substantial losses, and we anticipate continuing 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 $12.8 million, or negative 105% of revenues, for the
quarter ended September 30, 2001. As of September 30, 2001, we had an
accumulated deficit of approximately $90.9 million. We are required to purchase
an additional $800,000 of colocation and bandwidth services from Level 3 during
the remainder of fiscal 2002. We expect to incur operating losses for at least
the next fiscal year. 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 business and prospects are difficult to evaluate because we have a limited
operating history and our business model is still evolving.

  It is difficult to evaluate our business operations and our prospects because
of our limited operating history and the pace of change in our business.  We
were incorporated in August 1997 and commenced operations in September of that
year with a focus on hosting services, and our business model is still new and
evolving. The revenue and income potential of our business is unproven.  Our
limited operating history and the relative newness of the industry in which we
operate makes predicting future results difficult.  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.

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 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:

  .    demand for our services;

  .    size and timing of customer installations and related payments;

  .    reliable services and network availability;

  .    ability and costs associated with increasing network and data center
       capacity;

  .    fluctuations in data and voice communications costs;

  .    fluctuations in hardware and software costs;

  .    timing and magnitude of capital expenditures and other expenses;

  .    costs relating to operations;

                                       19
<PAGE>

  .    customer retention and satisfaction;

  .    introduction by third parties, including our competitors, of new products
       and services;

  .    termination or reduction of services by customers, including terminations
       by customers that do not have sufficient funding to continue their
       operations, either at all or at the level contemplated by our agreements
       with them;

  .    customer discounts and credits;

  .    timing and success of marketing efforts and service introductions by us;

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

  .    retention of our key personnel; and

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

A portion of our operating costs is fixed.  If our revenues do not exceed our
costs, our operating results will suffer.

  A portion of our operating costs are fixed at certain minimum levels,
including our expenses for data center capacity, depreciation, interest,
hardware lease payments, minimum bandwidth charges, real estate lease payments
and personnel.  Therefore, our results of operations are particularly sensitive
to fluctuations in revenue.  We will have to pay these fixed costs regardless of
our revenues and our results of operations and financial condition would be
adversely affected, if our revenues are not at the level we expect.
Furthermore, many of our customers are relatively new business, or Internet-
focused business initiatives of more established companies, and these businesses
or initiatives may have negative cash flows or may not be successful, or both.
As a result, we may not be able to collect revenues for the services we provide
on a timely basis or at all.

  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.

Our customer base includes a significant number of businesses that currently
face increasing difficulty in obtaining funding to support their operations.

  Many of our customers are businesses, including Internet-based businesses,
that have traditionally been initially funded by venture capital firms and then
through public securities offerings. Funding alternatives for these businesses
have become more limited than in the past.  The unproven business models of many
of our customers and the uncertain economic climate make their continued
viability uncertain.  Many of these customers have ceased or reduced their
operations, and it has become increasingly difficult for us to collect our
accounts receivable from these businesses.  If the market for technology and
Internet-based businesses is not supported by the private and public investors
who have funded these customers or if their business models prove to be
unsuccessful, we face the risk that these customers may cease, curtail or limit
web site operations hosted by us. If this continues to occur, we would likely
experience a loss of revenue associated with these customers and will then have
to increase sales to other businesses in order to preserve and grow our revenue.
If we are successful in increasing sales to other businesses, we will incur the
expenses associated with these new customers, such as sales and marketing
expenses, including commissions, and implementation costs.  As a result, to
preserve and grow our revenue, we will have to increase sales by substantially
more than the amount of lost revenue.

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.

                                       20
<PAGE>

  Our market is new and rapidly evolving. Growth in demand for and acceptance of
advanced hosting services is highly uncertain. Businesses may not be aware of
the potential benefits of outsourcing or may find it less expensive, 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. We currently incur costs that are greater
than our revenues.  If we cannot grow and retain our customer base, we will not
be able to offset our fixed and operating costs.  Our future growth, if any,
will depend on businesses outsourcing the management of their Internet and other
applications and our ability to sell our services to these businesses in a cost-
effective manner to a sufficient number of these businesses.  If the market for
advanced hosting services fails to grow or grows more slowly than anticipated or
if we are unable to respond effectively to changes in this market, 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 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, and
installation and maintenance services, over the next three years. We will incur
these expenses regardless of our revenues 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 90% of these
services from Level 3 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. If 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 were not able 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.

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

                                       21
<PAGE>

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, and under
the Development, License, and Co-Marketing Agreement, 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. 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.

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 companies, including
many large, established companies, have announced that they will begin to
provide or plan to greatly expand their service offerings that are competitive
with ours. These companies and many of our other 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. The market in which we compete has
experienced consolidation, and we believe that it is likely to continue to
experience consolidation in the future, which could result in increased
competition on price and other factors that could adversely affect our business.

  Some of our competitors may be able to provide their 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 ours. We may not be able to offset
the effects of any price reductions. In addition, we believe our market is
likely to experience further consolidation in the near future, which could
result in increased competition, including price competition.

  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.

If we are unable to expand our network infrastructure when needed, we could lose
customers and our operating results could suffer.

                                       22
<PAGE>

  We may have to expand and adapt our network infrastructure to accommodate our
customers' requirements, 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 these requirements while maintaining acceptable performance
levels. The continued expansion and adaptation of our networking and hosting
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.

If the networks through which we deliver services do not have sufficient
capacity, reliability or security, we could lose customers and our business
would 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,
AT&T, GTE, Netcom/Mindspring, PSINet, Qwest, Verio, MCI WorldCom, Inc.,
including UUNET Technologies, 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. If 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 our customers' usage increases and
capacity is not available to us, 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.

Increased costs associated with our private transit Internet connections could
result in the loss of customers or significant increases in operating costs.

  Our private transit Internet connections are more costly than other
arrangements commonly utilized to move Internet traffic. If providers increase
the pricing associated with utilizing their bandwidth, we may be required to
identify alternative methods to distribute our customers' digital content. We
cannot assure you that our customers will continue to be willing to pay the
higher costs associated with direct private transit or that we could effectively
move to another network approach. If we are unable to access alternative
networks to distribute our customers' digital content on a cost-effective basis
or to pass any additional costs on to our customers, our operating costs would
increase significantly.

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 during 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 September 30, 2001, we had
purchased approximately 1,965 servers from Compaq under this agreement. Our
requirement to purchase these servers is contingent upon Compaq

                                       23
<PAGE>

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 disruptions in and
impairment of network performance.

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

  Our future success will depend on our ability to offer services that
incorporate leading technology and address the increasingly sophisticated needs
of our current and prospective customers.  Our market is characterized by
rapidly changing and unproven technology, evolving industry standards, changes
in customer needs and frequent new product announcements. These characteristics
are magnified by the 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. Future advances in technology may
not be beneficial to or compatible with our business.  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 at all. Our business will suffer if Internet usage does
not continue to increase or if the Internet fails to perform reliably.

Our ability to successfully market our services could be substantially impaired
if we are unable to deploy new Internet technologies or service offerings or if
new Internet technologies or service offerings deployed by us prove to be
unreliable, defective or incompatible.

  We cannot assure you that we will not experience difficulties that could delay
or prevent the successful development, introduction or marketing of Internet
technologies in the future. If any newly introduced Internet technologies or our
service offerings suffer from reliability, quality or compatibility problems,
market acceptance of our services could be greatly hindered and our ability to
attract new customers could be adversely affected. In addition, technological
advances may have the effect of encouraging our customers or prospective
customers to rely on in-house personnel and equipment to provide the services we
provide.  We cannot assure you that new applications or services deployed by us
will be free from any reliability, quality or compatibility problems. If we
incur increased costs or are unable, for technical or other reasons, to offer
and deploy new Internet technologies or enhancements of existing technologies,
our ability to successfully market our services could be substantially impaired.

  We believe that our ability to successfully compete is also dependent upon the
continued compatibility of our services with products, services and
architectures offered by various other companies.  While we work with many
vendors to test newly developed products, these products may not be compatible
with our infrastructure or adequate to address changing customer needs.  Any
incompatibility could require us to make significant investments to achieve
compatibility.  If industry standards emerge, we may not be able to comply with
them.  Our failure to conform with any industry standards, or the failure of a
common standard to emerge, could adversely affect our business.

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

                                       24
<PAGE>

and partners has increased rapidly. Our success depends in large part on
continued growth in the use of the Internet. In addition, our business plan
anticipates significant 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-based businesses to develop and maintain
     successful business models;

  .  failure of Internet-based 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.

  Any degradation in the performance of the web sites and other applications we
host could undermine the benefits customers perceive in our services.
Ultimately, the performance of the web sites and other applications we host
relies upon the speed and reliability of networks operated by third parties.  As
a result, the growth of the market for our services and our ability to grow
depends on the continued improvement of the entire Internet infrastructure.
Many of the companies that have historically built new network capacity do not
have access to the capital resources they did in the past.  Consequently, they
may not continue to invest in new network capacity at the same rates as they
have in the past, or at all, which could adversely affect our business,
operating results and financial condition.

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

  The rapid growth of our business and our service offerings in the past has
placed a significant strain on our operating and financial resources. Our future
performance will partly depend on our ability to manage our resources
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 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 are currently developing internally a software application on which we
intend to run our business.  We expect that this application will provide the
framework in which we provide services to our customers, including provisioning
and service and support.  We have expended, and will continue to expend
significant resources in developing this application.  If we are unable to
develop this system in a cost-effective and timely manner, or at all, or if the
functionality we develop in this system does not support our business, our
business, financial condition and operating results could be adversely affected.

                                       25
<PAGE>

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

  Our business requires individuals with significant levels of specific
technical expertise.  Competition for such personnel is intense, making it
increasingly difficult to retain and attract the highly skilled employees
necessary to provide the level of services that our customers expect.  In light
of the recent reduction in our work force and the decline in our stock price
over the last 12 months, it may be difficult for us to retain and attract
qualified personnel. We expect that we will gradually expand our sales and
marketing staff to generate increased revenues.  We may not be able to attract
qualified personnel to fill new positions or to replace any of our current
employees that we lose.  We may be forced to provide higher compensation to such
personnel than we currently anticipate, and the costs associated with training
and integrating such new employees could be significant.  If we are unable to
effectively retain and attract qualified personnel on a cost-efficient basis,
our operations and financial results could be adversely affected.

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

  To succeed, we must be able to operate our network management infrastructure
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. The occurrence of a natural
disaster or other unanticipated problems at any of the data centers from which
we provide services 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 or service credits 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.

Our customer's satisfaction with our services is critical to our business.

  Our customers demand a high level of service.  As customers outsource the
hosting and management of business-critical applications to us, we are subject
to liability claims and customer dissatisfaction if our systems fail or if we
fail to maintain the availability of these applications.  Our customer contracts
generally provide some service level commitment that provides for remedies if
their applications do not maintain a specified level of availability.  If we
incur significant service level commitment obligations in connection with
downtime or system failures, we could be required to issue significant credits
or pay significant damages, or both.  Our liability insurance might not be
adequate to cover such credits or damages.  Any significant interruptions of
service could result in claims and adversely affect our business, financial
condition and results of operations.

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

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<PAGE>

proprietary software tools. Complex software often contains defects,
particularly when first introduced or when new 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 and other colocation
vendors 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
many of our contracts 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. 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, which could 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 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

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<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 is adopted in the
U.S. or internationally that makes transacting business over the Internet, such
as e-commerce, less favorable or otherwise curtails the growth of the Internet,
our business would suffer.

We may be subject to legal claims in connection with the information
disseminated through our network, which could have the effect of diverting
management's attention and require us to expend significant financial resources.

  We may face potential direct and indirect liability for claims of defamation,
negligence, copyright, patent or trademark infringement, violation of securities
laws and other claims based on the nature and content of the materials
disseminated through our network. For example, lawsuits may be brought against
us claiming that content distributed by some of our current or future customers
may be regulated or banned. In these and other instances, we may be required to
engage in protracted and expensive litigation, which could have the effect of
diverting management's attention and require us to expend significant financial
resources. Our liability insurance may not cover any of these claims or may not
be adequate to protect us against all liability that may be imposed or claimed.

  In addition, on a limited number of occasions in the past, businesses,
organizations and individuals have sent unsolicited commercial e-mails from
servers hosted at our 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. We have in the past
received, and may in the future receive, letters from recipients of information
transmitted by our customers objecting to such transmission. Although we
prohibit our customers by contract from spamming, we cannot assure you that our
customers will not engage in this practice, which could subject us to claims for
damages.

The loss of key personnel including our Chairman and Chief Executive Officer,
our President and our 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, Michelle R. Chambers, our President, and Robert A. Prosen,
our Chief Operating Officer. We have entered into employment agreements with Mr.
Vanderbeck, Ms. Chambers and Mr. Prosen expiring in June 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.

Difficulties presented by international economic, political, legal, accounting
and business factors could harm our business in international markets.

  A component of our strategy is to expand into international markets. 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 our ability to expand operations and may increase our cost of operations
internationally. The risks inherent in conducting business internationally
include:

  .   unexpected changes in regulatory requirements, export restrictions,
      tariffs and other trade barriers;

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<PAGE>

  .   challenges in staffing and managing foreign operations;

  .   differences in technology standards;

  .   less protective intellectual property laws;

  .   employment laws and practices in foreign countries;

  .   longer payment cycles and problems in collecting accounts receivable;

  .   political instability;

  .   fluctuations in currency exchange rates and imposition of currency
      exchange controls; and

  .   potentially adverse tax consequences.

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
November 1999 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 37.5% 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 37.5% 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;

  .  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

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<PAGE>

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

We have also adopted a shareholders' rights plan 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 September 30, 2001, 36,172,350 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.

  Substantially 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
other investment securities 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.

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<PAGE>

                          PART II - OTHER INFORMATION

Item 2.   Changes in Securities and Use of Proceeds.

     In connection with the merger agreement with divine, the Company has
amended its Rights Agreement, dated as of September 27, 1999, between the
Company and Mellon Investor Services LLC (formerly Chasemellon Shareholder
Services, L.L.C.), as Rights Agent.  The description and terms of the amendment
are set forth in our Current Report on Form 8-K filed with the SEC on November
2, 2001.


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

(a)  Exhibits:


     2.1*   Agreement and Plan of Merger, dated as of November 1, 2001, among
            divine, inc., TD Acquisition Corp. and the Registrant.

     4.1*   First Amendment to Rights Agreement, dated as of October 26, 2001,
            between the Registrant and Chasemellon Shareholder Services, L.L.C.,
            as Rights Agent.

     10.1*  Credit Agreement, dated as of November 1, 2001, between the
            Registrant as Borrower and divine, inc. as Lender.

     99.1*  Form of Shareholders Voting Agreement to be entered into between
            divine, inc. and the shareholders of the Registrant named therein.

    ---------------
     *   Filed as an exhibit to the Registrant's Current Report on Form 8-K
         dated November 1, 2001 and incorporated herein by this reference.

(b)   Reports on Form 8-K:

        Form 8-K filed August 1, 2001.
        Form 8-K filed November 2, 2001.

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<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.


                              Data Return Corporation



Dated: November 14, 2001      By:  / s/ Stuart A. Walker
                                 ----------------------------------------
                              Stuart A. Walker, Vice President
                              Chief Financial Officer
                              (Principal Financial & Accounting Officer &
                               Authorized Officer)

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