USINTERNETWORKING INC, 10-Q, 1999-05-24

USINTERNETWORKING INC
10-Q, 1999-05-24
COMPUTER PROGRAMMING SERVICES

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<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(MARK ONE)

/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31,
1999

/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____________ TO _____________

Commission file number 25737

USINTERNETWORKING, INC.

DELAWARE 52-2078325
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)

ONE USI PLAZA, ANNAPOLIS, MD 21401-7478
(Address of principal executive officers)
(Zip Code)

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

Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes / / No /X/

Shares outstanding of the Registrant's common stock

<TABLE>
<S> <C>
Class Outstanding at May 24, 1999
Common Stock, $.001 par value 39,768,276
</TABLE>

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<PAGE>
INDEX
USINTERNETWORKING, INC.

<TABLE>
<CAPTION>
PAGE
---------
<S> <C> <C>
Part I. Financial Information

Item 1. CONSOLIDATED FINANCIAL STATEMENTS OF USINTERNETWORKING, INC.
Consolidated Balance Sheets as of December 31, 1998 and March 31, 1999 (unaudited).......... 3
Consolidated Statements of Operations for the period January 14, 4
1998 (date of inception) through March 31, 1998 (unaudited) and
for the three months ended March 31, 1999 (unaudited).....................................
Consolidated Statements of Stockholders' Equity (Deficit) for the 5
period January 14, 1998 (date of inception) through December 31, 1998
and for the three months ended March 31, 1999 (unaudited).................................
Consolidated Statements of Cash Flows for the period January 14, 6
1998 (date of inception) through March 31, 1998 (unaudited)
and for the three months ended March 31, 1999 (unaudited).................................
Notes to the Consolidated Financial Statements.............................................. 7

CONSOLIDATED FINANCIAL STATEMENTS OF I.I.T HOLDING, INC. AND SUBSIDIARIES (PREDECESSOR)
Consolidated Statement of Operations for the three months ended March 31, 1998 13
(unaudited)...............................................................................
Consolidated Statement of Cash Flows for the three months ended March 31, 1998 14
(unaudited)...............................................................................
Note to the Consolidated Financial Statements............................................... 15

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....... 16
Item 3. Quantitative and Qualitative Disclosure of Market Risk...................................... 30

Part II. Other Information

Item 1. Legal Proceedings........................................................................... 30
Item 2. Changes In Securities....................................................................... 31
Item 4. Submission of Matters to a Vote of Security Holders......................................... 31
Item 6. Exhibits and Reports on Form 8-K............................................................ 31

Signatures..
</TABLE>

2
<PAGE>
PART I. FINANCIAL INFORMATION

USINTERNETWORKING, INC.

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
MARCH 31,
DECEMBER 31, MARCH 31, 1999
1998 1999 PRO FORMA
------------- ------------- -------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.............................................. $ 43,802,465 $ 15,509,538 $ 149,366,538
Restricted cash........................................................ 581,712 581,712 581,712
Accounts receivable, less allowance of $142,000 in 1998 and 1999....... 2,882,119 4,196,689 4,196,689
Prepaid expenses and other current assets.............................. 2,436,247 2,393,737 2,393,737
------------- ------------- -------------
Total current assets..................................................... 49,702,543 22,681,676 156,538,676

Deferred IMAP costs...................................................... -- 1,158,998 1,158,998
Software licenses, net of accumulated amortization of $789,941 in 1999... 9,596,760 8,974,719 8,974,719
Property and equipment, net of accumulated depreciation of $1,567,885 and
$3,340,750 in 1998 and 1999, respectively.............................. 21,640,145 28,132,376 28,132,376
Goodwill, net of accumulated amortization of $1,611,763 and $2,952,763 in
1998 and 1999, respectively............................................ 25,137,296 23,749,546 23,749,546
Other assets............................................................. 439,734 427,024 427,024
------------- ------------- -------------
Total assets............................................................. $ 106,516,478 $ 85,124,339 $ 218,981,339
------------- ------------- -------------
------------- ------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable....................................................... $ 6,571,767 $ 8,973,605 $ 8,973,605
Accrued compensation................................................... 4,870,690 4,603,647 4,603,647
Other accrued expenses................................................. 1,569,570 1,060,240 1,060,240
Deferred revenue....................................................... 51,247 472,529 472,529
Due to former shareholders of acquired businesses...................... 10,826,735 2,326,735 2,326,735
Current portion of capital lease obligations........................... 1,503,947 1,579,472 1,579,472
Current portion of long-term debt...................................... 1,757,588 4,837,080 4,837,080
Dividends payable...................................................... -- 3,406,854 3,406,854
------------- ------------- -------------
Total current liabilities................................................ 27,151,544 27,260,162 27,260,162

Short-term obligations expected to be refinanced......................... 5,282,450 -- --
Capital lease obligations, less current portion.......................... 3,427,254 3,164,268 3,164,268
Long-term debt, less current portion..................................... 5,231,794 10,337,868 10,337,868
Dividends payable........................................................ 1,503,004 -- --
------------- ------------- -------------
Total liabilities........................................................ 42,596,046 40,762,298 40,762,298

Series B Convertible Redeemable Preferred Stock, $.01 par value, 115,000
shares authorized, 59,279 shares issued and outstanding in 1998 and
1999, none pro forma; $62,242,500 aggregate liquidation preference..... 62,242,500 62,242,500 --

Common stock subject to repurchase, 1,343,750 shares issued and
outstanding in 1998 and 1999, none pro forma........................... 4,145,000 28,218,750 --

Commitments and contingent liabilities................................... -- -- --

Stockholders' equity (deficit):
Series A Convertible Preferred Stock, $.01 par value, 110,000 shares
authorized, 55,000 shares issued and outstanding in 1998 and 1999,
none pro forma; $33,000,000 aggregate liquidation preference......... 550 550 --
Common stock, $.001 par value, 75,000,000 shares authorized, 625,000
shares issued and outstanding in 1998 and 1999, 39,768,276 shares
issued pro forma..................................................... 625 625 39,768
Additional paid-in capital............................................. 29,985,069 4,043,898 228,956,739
Unearned compensation.................................................. -- -- (633,184)
Accumulated deficit.................................................... (32,453,312) (50,144,282) (50,144,282)
------------- ------------- -------------
Total stockholders' equity (deficit)................................... (2,467,068) (46,099,209) 178,219,041
------------- ------------- -------------

Total liabilities and stockholders' equity (deficit)..................... $ 106,516,478 $ 85,124,339 $ 218,981,339
------------- ------------- -------------
------------- ------------- -------------
</TABLE>

SEE ACCOMPANYING NOTES.

3
<PAGE>
USINTERNETWORKING, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
FOR THE PERIOD
FROM JANUARY 14,
1998 (DATE OF
INCEPTION) THREE MONTHS
THROUGH MARCH 31, ENDED MARCH 31,
1998 1999
----------------- -----------------
<S> <C> <C>
(UNAUDITED)
Revenue:
IMAP revenue.............................................................. $ -- $ 1,203,127
Professional IT services revenue.......................................... -- 3,188,979
----------------- -----------------
Total revenue............................................................... -- 4,392,106
Costs and expenses:
Direct IMAP costs......................................................... -- 1,625,002
Network and data center costs............................................. -- 2,420,079
Professional IT services costs............................................ -- 2,049,006
Selling, general and administrative....................................... 138,288 11,608,743
Non-cash stock compensation expense....................................... -- 135,681
Depreciation and amortization............................................. -- 3,933,625
----------------- -----------------
Total costs and expenses.................................................... 138,288 21,772,136
----------------- -----------------
Operating loss.............................................................. (138,288) (17,380,030)
Other income (expense):
Interest income........................................................... 845 258,447
Interest expense.......................................................... (789) (569,387)
----------------- -----------------
56 (310,940)
----------------- -----------------

Net loss.................................................................... (138,232) (17,690,970)
Dividends accrued on Series A and Series B Convertible Preferred Stock...... -- (1,903,850)
Accretion of common stock subject to repurchase to fair value............... -- (23,938,069)
Accretion of Series B Convertible Redeemable Preferred Stock to fair
value..................................................................... -- (99,252)
----------------- -----------------
Net loss attributable to common stockholders................................ $ (138,232) $ (43,632,141)
----------------- -----------------
----------------- -----------------
Basic and diluted loss per common share attributable to common
stockholders.............................................................. $ (0.22) $ (69.81)
----------------- -----------------
----------------- -----------------
</TABLE>

SEE ACCOMPANYING NOTES.

4
<PAGE>
USINTERNETWORKING, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
SERIES A CONVERTIBLE
PREFERRED STOCK COMMON STOCK
------------------------ ----------------------
SHARES PAR VALUE SHARES PAR VALUE
--------- ------------- --------- -----------
<S> <C> <C> <C> <C>
Balance at January 14, 1998..................................................... -- $ -- -- $ --
Issuance of common stock to founder upon inception............................ -- -- 625,000 625
Issuance of Series A Convertible Preferred Stock on May 28, 1998 for cash..... 38,333 383 -- --
Issuance of Series A Convertible Preferred Stock on May 28, 1998 in exchange
for $1,000,000 note......................................................... 1,667 17 -- --
Issuance of Series A Convertible Preferred Stock on June 22, 1998 for cash.... 6,167 62 -- --
Issuance of Series A Convertible Preferred Stock on July 2, 1998 for cash..... 5,833 58 -- --
Issuance of Series A Convertible Preferred Stock on July 30, 1998 for cash.... 3,000 30 -- --
Transaction costs associated with the issuance of Series A Convertible
Preferred Stock............................................................. -- -- -- --
Issuance of warrants to purchase 50,000 shares of common stock associated with
the acquisition of IIT on September 8, 1998................................. -- -- -- --
Issuance of warrants to purchase 974,450 shares of common stock in connection
with $9,095,000 of debt on September 7, 1998................................ -- -- -- --
Issuance of warrants to purchase 74,404 shares of common stock in connection
with a $5,000,000 financing commitment on September 22, 1998................ -- -- -- --
Issuance of warrants to purchase 971 shares of Series B Convertible Redeemable
Preferred Stock in connection with a $10,000,000 financing commitment on
September 30, 1998.......................................................... -- -- -- --
Issuance of warrants to purchase 62,500 shares of common stock associated with
the acquisition of ACR on October 2, 1998................................... -- -- -- --
Issuance of warrants to purchase 17,857 shares of common stock in connection
with a $2,000,000 financing commitment on December 18, 1998................. -- -- -- --
Dividends accrued on Series A Convertible Preferred Stock..................... -- -- -- --
Accretion of common stock subject to repurchase to fair value................. -- -- -- --
Accretion of Series B Convertible Redeemable Preferred Stock to fair value.... -- -- -- --
Net loss for the period January 14, 1998 through December 31, 1998............ -- -- -- --
--------- ----- --------- -----------
Balance at December 31, 1998.................................................... 55,000 550 625,000 625
--------- ----- --------- -----------
Dividends accrued on Series A and Series B Convertible Preferred Stock........ -- -- -- --
Accretion of common stock subject to repurchase to fair value................. -- -- -- --
Accretion of Series B Convertible Redeemable Preferred Stock to fair value.... -- -- -- --
Net loss for the period January 1, 1999 through March 31, 1999................ -- -- -- --
--------- ----- --------- -----------
Balance at March 31, 1999 (unaudited)........................................... 55,000 $ 550 625,000 $ 625
--------- ----- --------- -----------
--------- ----- --------- -----------

<CAPTION>
TOTAL
ADDITIONAL STOCKHOLDERS'

PAID-IN ACCUMULATED EQUITY
CAPITAL DEFICIT (DEFICIT)
---------- ------------ ------------
<S> <C> <C> <C>
Balance at January 14, 1998..................................................... $ -- $ -- $ --
Issuance of common stock to founder upon inception............................ 4,375 -- 5,000
Issuance of Series A Convertible Preferred Stock on May 28, 1998 for cash..... 22,999,617 -- 23,000,000
Issuance of Series A Convertible Preferred Stock on May 28, 1998 in exchange
for $1,000,000 note......................................................... 999,983 -- 1,000,000
Issuance of Series A Convertible Preferred Stock on June 22, 1998 for cash.... 3,699,938 -- 3,700,000
Issuance of Series A Convertible Preferred Stock on July 2, 1998 for cash..... 3,499,942 -- 3,500,000
Issuance of Series A Convertible Preferred Stock on July 30, 1998 for cash.... 1,799,970 -- 1,800,000
Transaction costs associated with the issuance of Series A Convertible
Preferred Stock............................................................. (205,225) -- (205,225)
Issuance of warrants to purchase 50,000 shares of common stock associated with
the acquisition of IIT on September 8, 1998................................. 40,000 -- 40,000
Issuance of warrants to purchase 974,450 shares of common stock in connection
with $9,095,000 of debt on September 7, 1998................................ 1,948,930 -- 1,948,930
Issuance of warrants to purchase 74,404 shares of common stock in connection
with a $5,000,000 financing commitment on September 22, 1998................ 148,810 -- 148,810
Issuance of warrants to purchase 971 shares of Series B Convertible Redeemable
Preferred Stock in connection with a $10,000,000 financing commitment on
September 30, 1998.......................................................... 606,875 -- 606,875
Issuance of warrants to purchase 62,500 shares of common stock associated with
the acquisition of ACR on October 2, 1998................................... 50,000 -- 50,000
Issuance of warrants to purchase 17,857 shares of common stock in connection
with a $2,000,000 financing commitment on December 18, 1998................. 35,714 -- 35,714
Dividends accrued on Series A Convertible Preferred Stock..................... (1,503,004) (1,503,004)
Accretion of common stock subject to repurchase to fair value................. (3,903,865) (3,903,865)
Accretion of Series B Convertible Redeemable Preferred Stock to fair value.... (236,991) (236,991)
Net loss for the period January 14, 1998 through December 31, 1998............ (32,453,312) (32,453,312)
---------- ------------ ------------
Balance at December 31, 1998.................................................... 29,985,069 (32,453,312) (2,467,068)
---------- ------------ ------------
Dividends accrued on Series A and Series B Convertible Preferred Stock........ (1,903,850) -- (1,903,850)
Accretion of common stock subject to repurchase to fair value................. (23,938,069) -- (23,938,069)
Accretion of Series B Convertible Redeemable Preferred Stock to fair value.... (99,252) -- (99,252)
Net loss for the period January 1, 1999 through March 31, 1999................ -- (17,690,970) (17,690,970)
---------- ------------ ------------
Balance at March 31, 1999 (unaudited)........................................... $4,043,898 ($50,144,282) ($46,099,209)

---------- ------------ ------------
---------- ------------ ------------
</TABLE>

SEE ACCOMPANYING NOTES.

5
<PAGE>
USINTERNETWORKING, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
FOR THE PERIOD
FROM JANUARY
14, 1998 (DATE THREE MONTHS
OF INCEPTION) ENDED
THROUGH MARCH MARCH 31,
31, 1998 1999
-------------- ------------
(UNAUDITED)
<S> <C> <C>
OPERATING ACTIVITIES
Net loss......................................................... $ (138,232) ($17,690,970)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation................................................... -- 2,592,625
Amortization................................................... -- 1,341,000
Non-cash stock compensation expense related to the issuance of
common stock................................................. -- 135,681
Non-cash interest expense...................................... -- 62,974
Changes in operating assets and liabilities:
Accounts receivable.......................................... -- (1,314,570)
Prepaid expenses and other current assets.................... -- 42,510
Deferred IMAP costs.......................................... -- (1,158,998)
Accounts payable............................................. 47,747 2,401,838
Accrued compensation......................................... -- (267,043)
Accrued expenses and other current liabilities............... -- (88,048)
-------------- ------------
Net cash used in operating activities............................ (90,485) (13,943,001)

INVESTING ACTIVITIES
Purchases of property and equipment.............................. (282,385) (8,302,152)
Change in other assets........................................... (104,835) 59,460
-------------- ------------
Net cash used in investing activities............................ (387,220) (8,242,692)

FINANCING ACTIVITIES
Proceeds from loan from officer, subsequently converted into
Series A Convertible Preferred Stock........................... 586,352 --
Proceeds (expenses) from issuance of Series B Convertible
Redeemable Preferred Stock..................................... -- (99,252)
Proceeds from issuance of long-term debt......................... 107,872 3,337,600
Payment to former shareholders of acquired businesses............ -- (8,500,000)
Payments on long-term debt....................................... -- (497,458)
Payments on capital lease obligations............................ -- (348,124)
-------------- ------------
Net cash provided by (used in) financing activities.............. 694,224 (6,107,234)
-------------- ------------
Net increase (decrease) in cash.................................. 216,519 (28,292,927)
Cash and cash equivalents at beginning........................... -- 43,802,465
-------------- ------------
Cash and cash equivalents at end of period....................... $ 216,519 $15,509,538
-------------- ------------
-------------- ------------
</TABLE>

SEE ACCOMPANYING NOTES.

6
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 1999 (UNAUDITED)

1. BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three month period ended March 31, 1999
are not necessarily indicative of the results that may be expected for the year
ended December 31, 1999.

The balance sheet at December 31, 1998 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.

For further information, refer to the consolidated financial statements for
the period from January 14, 1998 (date of inception) through December 31, 1998
included in the Company's registration statement on Form S-1, File No.
333-70717, effective April 8, 1999, as amended (the "Registration Statement").

2. LOSS PER SHARE

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

HISTORICAL:

<TABLE>
<CAPTION>
FOR THE PERIOD
FROM
JANUARY 14, 1998
(DATE OF
INCEPTION) THROUGH THREE MONTHS ENDED
MARCH 31, 1998 MARCH 31, 1999
------------------ -------------------
<S> <C> <C>
Numerator:
Net loss............................................................... $ (138,232) $ (17,690,970)
Dividends on Series A Convertible Preferred Stock...................... -- (1,903,850)
Accretion of common stock subject to repurchase to fair value.......... -- (23,938,069)
Accretion of Series B Convertible Redeemable Preferred Stock to fair
value................................................................ -- (99,252)
------------------ -------------------
$ (138,232) $ (43,632,141)
------------------ -------------------
------------------ -------------------
Denominator:
Weighted-average number of shares of common stock outstanding and not
subject to repurchase during the period.............................. 625,000 625,000
------------------ -------------------
Basic and diluted loss per common share.................................. $ (0.22) $ (69.81)
------------------ -------------------
------------------ -------------------
</TABLE>

Basic loss per share is based upon the average number of shares of common
stock outstanding during the periods. The computation excludes 1,343,750 shares
of common stock subject to repurchase at December 31, 1998 and March 31, 1999.

Dilutive loss per common share is equal to basic loss per common share
because if potentially dilutive securities were included in the computation, the
result would be anti-dilutive. These potentially dilutive securities consist of
common stock subject to repurchase, convertible preferred stocks, stock options
and warrants.

7
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

MARCH 31, 1999 (UNAUDITED)

2. LOSS PER SHARE (CONTINUED)
SUPPLEMENTAL PRO FORMA:

Pro forma basic and diluted loss per common share attributable to common
stockholders is presented to disclose the effect on loss per share of the
assumed conversion of securities which converted into common stock upon the
closing of the initial public offering in April 1999 and the lapse upon closing
of the initial public offering of the Company's repurchase obligation with
respect to 1,343,750 shares of common stock held by officers. For purposes of
the pro forma computation, the convertible securities are assumed to have been
converted or modified on the issuance date.

The following table summarizes the computations of supplemental pro forma
basic and diluted loss per share presented in the accompanying consolidated
statements of operations:

<TABLE>
<CAPTION>
FOR THE PERIOD
JANUARY 14, 1998
(DATE OF
INCEPTION)
THROUGH THREE MONTHS ENDED
MARCH 31, 1998 MARCH 31, 1999
----------------- -------------------
<S> <C> <C>
Numerator:
Net loss................................................................ $ (138,232) $ (17,690,970)
----------------- -------------------
----------------- -------------------
Denominator:
Shares used in historical calculation................................... 625,000 625,000
Add:
Pro forma effect of lapse of repurchase obligation for common stock
subject to repurchase............................................... 1,343,750 1,343,750
Pro forma conversion of Series A Convertible Preferred Stock.......... -- 12,374,994
Pro forma conversion of Series B Convertible Redeemable Preferred
Stock............................................................... -- 18,524,532
----------------- -------------------
Denominator for pro forma loss per share.............................. 1,968,750 32,868,276
----------------- -------------------
----------------- -------------------
Supplemental pro forma basic and diluted loss per common share............ $ (0.07) $ (0.54)
----------------- -------------------
----------------- -------------------
</TABLE>

3. LONG-TERM DEBT

Long-term debt consists of the following:

<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
------------- -------------
<S> <C> <C>
Note payable to a bank due June 30, 2001 and bearing interest at 9.0% per annum.
The note is payable in monthly installments of principal and interest of $6,644
with all unpaid principal and interest due at maturity. The note is secured by a
mortgage on the real property purchased with the proceeds and with a $79,929
letter of credit pledged as additional security.................................. $ 639,517 $ 634,424

Note payable to a bank due July 21, 2001 and bearing interest at 9.0% per annum.
The note is payable in monthly installments of principal and interest of $2,249
with all unpaid principal and interest due at maturity. The note is secured by a
mortgage on the property purchased with the proceeds and with a $26,984 letter of
credit pledged as additional security............................................ 217,689 215,994
</TABLE>

8
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

MARCH 31, 1999 (UNAUDITED)

3. LONG-TERM DEBT (CONTINUED)

<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
------------- -------------
<S> <C> <C>
Notes payable due on August 1, 2001 and bearing interest at 13.0% per annum. The
notes are payable in monthly installments of principal and interest of $77,429
and are collateralized by certain furniture, fixtures, equipment and software
purchased by the Company......................................................... $ 2,081,563 $ 1,915,685

Note payable due on September 1, 2001 and bearing interest at 13.0% per annum. The
note is payable in monthly installments of principal and interest of $4,868 and
is collateralized by certain furniture, fixtures, equipment and software
purchased by the Company......................................................... 134,519 124,165

Note payable due on October 1, 2001 and bearing interest at 17.1% per annum. The
note is payable in monthly installments of principal and interest of $158,000
with all unpaid principal and interest due at maturity. This note is
collateralized by certain software licenses purchased by the Company............. 4,501,175 4,216,913

Notes payable due on February 1, 2002 and bearing interest at 15.0% per annum. The
note is payable in monthly installments of principal and interest ranging from
$35,730 to $40,348 and is collateralized by certain furniture, fixtures,
equipment and software purchased by the Company.................................. -- 2,096,517

Note payable due on October 1, 2002 and bearing interest at 13.6% per annum. The
note is payable in monthly installments of principal and interest of $58,522 and
is collateralized by certain furniture, fixtures and equipment purchased by
Company.......................................................................... -- 2,020,327

Note payable due on April 1, 2002 and bearing interest at 17.1% per annum. The note
is payable in monthly installments of principal and interest of $78,650 and is
collateralized by certain furniture, fixtures, equipment and software purchased
by the Company................................................................... -- 2,355,877

Note payable due on January 1, 2002 and bearing interest at 11.9% per annum. The
note is payable in monthly installments of principal and interest of $209,028 and
is collateralized by certain software licenses purchased by the Company.......... -- 2,121,271
</TABLE>

9
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

MARCH 31, 1999 (UNAUDITED)

3. LONG-TERM DEBT (CONTINUED)

<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
------------- -------------
<S> <C> <C>
Notes payable due between February 28, 2003 and March 11, 2004 and bearing interest
at rates ranging from 8.25% to 9.99% per annum. The notes are payable in monthly
installments of principal and interest ranging from $542 to $1,274 and are
secured by automobiles purchased with the proceeds............................... $ 107,630 $ 103,512
------------- -------------
Total.............................................................................. 7,682,093 15,804,685
Less: current portion.............................................................. 1,757,588 4,837,080
Less: discounts.................................................................... 692,711 629,737
------------- -------------
$ 5,231,794 $ 10,337,868
------------- -------------
------------- -------------
</TABLE>

Aggregate maturities of long-term debt at March 31, 1999 are as follows:

<TABLE>
<S> <C>
April 1, 1999 through December 31, 1999........................................ $3,132,985
2000........................................................................... 4,897,474
2001........................................................................... 6,231,540
2002........................................................................... 1,523,209
2003 and thereafter............................................................ 19,477
----------
Total.......................................................................... $15,804,685
----------
----------
</TABLE>

At March 31, 1999, the fair value of long-term debt approximates its
carrying value.

4. SHORT-TERM OBLIGATIONS EXPECTED TO BE REFINANCED

At December 31, 1998, the Company had outstanding current liabilities for
the purchase of fixed assets of $7,500,000, for which the Company had
outstanding commitments to finance on a long-term basis. The Company executed
the financings in early 1999, and therefore classified at December 31, 1998
$5,282,450, or the portion of the $7,500,000 financing that is due after 1999,
as long-term. The remaining $2,217,550, which is due in 1999, is included in
accounts payable at December 31, 1998. These obligations bear interest at rates
from 9% to 17% per annum, and will mature in varying installments through
January 2002. The balance sheet at March 31, 1999 includes these amounts in
long-term debt.

5. BUSINESS AND GEOGRAPHIC SEGMENT INFORMATION

The Company is organized into two business units. The Company's IMAP
division provides an Internet-based network which enables clients to use leading
business software applications without the burden of owning or managing the
underlying technology. These services are delivered to customers through a
network of Enterprise Data Centers located in Maryland, California, Amsterdam
and Tokyo. The Professional IT Services division provides focused software
implementation services on a traditional time and materials basis.

The Company's reportable segments are business units that offer distinct
services. The segments have different customer bases and delivery channels.

10
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

MARCH 31, 1999 (UNAUDITED)

5. BUSINESS AND GEOGRAPHIC SEGMENT INFORMATION (CONTINUED)
The Company in 1998 evaluated the performance of its segments based
primarily on operating profit before depreciation, amortization and interest. In
1999, the Company modified its definition of segment profit to also exclude
selling, general and administrative expenses. The Company does not prepare
information regarding segment assets. The accounting policies used by the
reportable segments are the same as those used by the Company as described in
Note 1 to the December 31, 1998 consolidated financial statements.

The following tables set forth information on the Company's reportable
segments. The 1998 information has been restated for the change in definition of
segment profit.

<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1999
----------------------------------------------
PROFESSIONAL
IT
IMAP SERVICES CONSOLIDATED
-------------- -------------- --------------
<S> <C> <C> <C>
Revenues......................................................... $ 1,203,127 $ 3,188,979 $ 4,392,106
Segment operating (loss) profit.................................. (2,841,954) 1,139,973 (1,701,981)
</TABLE>

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

<TABLE>
<CAPTION>
FOR THE PERIOD
JANUARY 14, 1998
(DATE OF
INCEPTION) THREE MONTHS
THROUGH MARCH 31, ENDED
1998 MARCH 31, 1999
----------------- -----------------
<S> <C> <C>
Segment operating loss for all segments.................................... $ -- $ (1,701,981)
Selling, general and administrative........................................ (138,288) (11,608,743)
Non-cash stock compensation expense........................................ -- (135,681)
Depreciation and amortization.............................................. -- (3,933,625)
Interest income............................................................ 845 258,447
Interest expense........................................................... (789) (569,387)
----------------- -----------------
Net loss................................................................... $ (138,232) $ (17,690,970)
----------------- -----------------
----------------- -----------------
</TABLE>

6. PRO FORMA BALANCE SHEET AND SUBSEQUENT EVENTS

In April 1999 the Company completed an initial public offering of 6,900,000
shares of common stock which resulted in net proceeds of approximately
$133,857,000, after deducting underwriting discounts, commissions and offering
expenses. Upon the closing of the offering, the Series A Preferred Stock and
Series B Preferred Stock automatically converted into 30,899,526 shares of
common stock, and the common stock subject to repurchase no longer became
mandatorily redeemable by the Company upon the occurrence of certain events.

In February 1999, the Company's Board of Directors approved an 8 for 1
reverse stock split of common stock, options and warrants which became effective
on April 8, 1999. Accordingly, all share and per share data including stock
option, warrant and loss per share information have been restated in the
consolidated financial statements to retroactively reflect the stock split.

11
<PAGE>
USINTERNETWORKING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

MARCH 31, 1999 (UNAUDITED)

6. PRO FORMA BALANCE SHEET AND SUBSEQUENT EVENTS (CONTINUED)
The following table summarizes the pro forma effects of the April 1999
initial public offering on the Company's consolidated financial position had the
initial public offering closed on March 31, 1999:

<TABLE>
<CAPTION>
PRO
HISTORICAL FORMA
MARCH 31, ADJUSTMENTS MARCH 31,
1999 FOR IPO 1999
-------------- -------------- --------------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents..................................... $ 15,509,538 $ 133,857,000 $ 149,366,538
Other current assets.......................................... 7,172,138 -- 7,172,138
-------------- -------------- --------------
Total current assets............................................ 22,681,676 133,857,000 156,538,676
Property and equipment, net..................................... 28,132,376 -- 28,132,376
Other noncurrent assets......................................... 34,310,287 -- 34,310,287
-------------- -------------- --------------
Total assets.................................................... $ 85,124,339 $ 133,857,000 $ 218,981,339
-------------- -------------- --------------
-------------- -------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and accrued expenses......................... $ 14,637,492 $ -- $ 14,637,492
Other current liabilities..................................... 12,622,670 -- 12,622,670
-------------- -------------- --------------
Total current liabilities....................................... 27,260,162 -- 27,260,162
Other noncurrent liabilities.................................... 13,502,136 -- 13,502,136
Series B Preferred Stock........................................ 62,242,500 (62,242,500) --
Common stock subject to repurchase.............................. 28,218,750 (28,218,750) --
Stockholders' equity (deficit):
Series A Preferred Stock...................................... 550 (550) --
Common stock.................................................. 625 39,143 39,768
Additional paid-in capital.................................... 4,043,898 224,912,841 228,956,739
Unearned compensation......................................... -- (633,184) (633,184)
Accumulated deficit........................................... (50,144,282) -- (50,144,282)
-------------- -------------- --------------
Total stockholders' equity (deficit)............................ (46,099,209) 133,857,000 178,219,041
-------------- -------------- --------------
Total liabilities and stockholders' equity (deficit)............ $ 85,124,339 $ 133,857,000 $ 218,981,339
-------------- -------------- --------------
-------------- -------------- --------------
</TABLE>

Further, in April 1999, the Company purchased an office building for total
consideration of $11,750,000. The seller financed $7,500,000 of the purchase
price at an interest rate 7.5% per annum, maturing in May 2006.

In May 1999 the Company granted non-qualified stock options to purchase
561,250 shares of common stock at $6.00 per share. These options vested
immediately, but any shares exercised will be subject to the Company's right to
repurchase them at the option exercise price upon the termination of employment.
The repurchase right will lapse with respect to one-third of the shares
purchasable upon exercise of an option in March 2000, and the remainder of the
shares purchasable upon exercise of an option will lapse in equal quarterly
installments over the subsequent eight calendar quarters.

The options were granted at an exercise price less than the quoted market
value of the Company's common stock at the date of grant. The Company expects to
record stock compensation expense of approximately $15.4 million as a result of
these option grants that will be recognized ratably over the four-year period
that the employees earn the right to retain the shares obtained upon exercise of
the stock options without regard to continued employment.

12
<PAGE>
I.I.T. HOLDING, INC. AND SUBSIDIARIES (PREDECESSOR)

CONSOLIDATED STATEMENT OF OPERATIONS

<TABLE>
<CAPTION>
THREE MONTHS
ENDED
MARCH 31, 1998
(UNAUDITED)
--------------
<S> <C>
Consulting revenue............................................................ $ 1,461,778
Cost of revenue............................................................... 623,355
--------------
Gross profit.................................................................. 838,423

Operating expenses:
General and administrative.................................................. 481,187
Sales and marketing......................................................... 2,740
Stock compensation expense.................................................. --
Depreciation................................................................ 1,771
--------------
485,698
--------------
Income from operations........................................................ 352,725
Interest expense.............................................................. (6,162)
--------------
Net income.................................................................... $ 346,563
--------------
--------------
</TABLE>

SEE ACCOMPANYING NOTE.

13
<PAGE>
I.I.T. HOLDING, INC. AND SUBSIDIARIES (PREDECESSOR)

CONSOLIDATED STATEMENT OF CASH FLOWS

<TABLE>
<CAPTION>
THREE MONTHS
ENDED
MARCH 31, 1998
(UNAUDITED)
--------------
<S> <C>
OPERATING ACTIVITIES
Net income.................................................................... $ 346,563
Adjustments to reconcile net loss to net cash provided by operating
activities:
Depreciation................................................................ 1,771
Change in assets and liabilities:
Accounts receivable....................................................... (154,318)
Other current assets...................................................... (85,552)
Accounts payable.......................................................... 56,006
Accrued expenses.......................................................... (8,506)
--------------
Net cash provided by operating activities..................................... 155,964

INVESTING ACTIVITIES
Acquisition of equipment and vehicle.......................................... (21,660)
--------------
Net cash used in investing activities......................................... (21,660)

FINANCING ACTIVITIES
Proceeds from note payable to stockholder..................................... 29,431
Bank overdraft................................................................ (157,056)
Repayments of note payable.................................................... (10,036)
--------------
Net cash used in financing activities......................................... (137,661)

Effect of exchange rate changes on cash....................................... 24,209
--------------
Net increase in cash and cash equivalents..................................... 20,852
Cash and cash equivalents at beginning of year................................ 14,443
--------------
Cash and cash equivalents at end of year...................................... $ 35,295
--------------
--------------
</TABLE>

SEE ACCOMPANYING NOTE.

14
<PAGE>
I.I.T. HOLDING, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 1998 (UNAUDITED)

1. BASIS OF PRESENTATION

I.I.T. Holding, Inc. and subsidiaries was acquired by USINTERNETWORKING,
Inc. on September 8, 1998, and is considered a predecessor to USINTERNETWORKING,
Inc. For further information, refer to the consolidated financial statements for
the period from January 1, 1998 through September 7, 1998 included in
USINTERNETWORKING, Inc.'s registration statement on Form S-1, File No.
333-70717, effective April 8, 1999, as amended.

15
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

YOU SHOULD READ THE FOLLOWING DISCUSSION OF OUR RESULTS OF OPERATIONS AND
FINANCIAL CONDITION IN CONJUNCTION WITH OUR CONSOLIDATED FINANCIAL STATEMENTS
AND RELATED NOTES AND THE CONSOLIDATED FINANCIAL STATEMENTS OF IIT HOLDING INC.
AND RELATED NOTES INCLUDED ELSEWHERE IN THIS FORM 10-Q. THIS DISCUSSION CONTAINS
FORWARD-LOOKING STATEMENTS BASED ON CURRENT EXPECTATIONS THAT INVOLVE RISKS AND
UNCERTAINTIES. ACTUAL RESULTS AND THE TIMING OF CERTAIN EVENTS MAY DIFFER
SIGNIFICANTLY FROM THOSE PROJECTED IN SUCH FORWARD-LOOKING STATEMENTS DUE TO A
NUMBER OF FACTORS, INCLUDING THOSE SET FORTH IN THE SECTION ENTITLED "RISK
FACTORS" BELOW.

OVERVIEW

I.I.T. Holding, Inc., a predecessor of USI, specializes in systems analysis
and design and systems integration solutions. IIT is a provider of PeopleSoft
human resource management and financial system implementation. IIT's consulting
professionals have expertise in human resource management as well as accounting
and financial systems.

We acquired IIT in September 1998 as a part of our program to develop a new
Internet-based service offering. IIT provides implementation capabilities that
enable us to provide human resource and financial management functionality as
part of our IMAP offerings.

We have developed an advanced, integrated service offering that provides our
clients the ability to use leading business software applications through our
state-of-the-art Internet-based network. Since our inception in January 1998, we
have devoted substantially all of our efforts to developing our network
infrastructure, recruiting and training personnel, establishing strategic
business partnerships with application software providers, completing two
strategic acquisitions and raising capital. We have incurred a cumulative net
loss since inception and expect to incur additional losses for at least the next
twelve months, due primarily to additional start-up costs related to
implementation of our services and the continued expansion and enhancement of
our network. As of March 31, 1999, we have an accumulated deficit of
approximately $50.1 million.

REVENUE. We currently generate revenue from both traditional IT services
and IMAP services. We expect that as IMAP services grow, they will represent an
increasing proportion of our revenue. Revenue from IMAP services consists of
monthly recurring fees from ongoing services and is recognized ratably as earned
over the contract term. Non-refundable client deposits, if any, are recognized
as revenue ratably over the contract term. Revenue from the delivery of
professional information technology services not included in IMAP solutions is
recognized as the services are performed.

COSTS AND EXPENSES. We incur operating costs and expenses related to the
delivery of IMAP services. Costs and expenses include product development,
network and data center support, marketing, and selling, general and
administrative expenses. Since inception, we have incurred expenses consisting
primarily of compensation and benefits, recruiting, occupancy and consulting. We
have expensed all start-up costs as incurred.

We incur up-front costs related to the delivery of IMAP services. Product
development costs and the cost to operate our network and data centers are
recognized as period costs. Costs related to the acquisition of hardware are
capitalized and depreciated over the estimated useful life of the hardware of
five years. Costs related to the acquisition of software licenses are
capitalized and amortized over either the term of the license agreement, or the
term of the individual client contract, depending on the nature of the software
license agreement. Amortization is based on current and future revenue from each
product and annual amortization will not be less than that computed on a
straight-line basis over the remaining useful life. Direct costs related to the
integration of software applications for a client on our network are capitalized
and amortized over the related contract period.

16
<PAGE>
HISTORICAL RESULTS OF OPERATIONS--USINTERNETWORKING

COMPARISON OF THE PERIOD ENDED MARCH 31, 1999 TO THE PERIOD ENDED MARCH 31, 1998

REVENUE. For the three months ended March 31, 1999, we generated $1.2
million in IMAP revenue, and $3.2 million in professional IT services revenue.
We generated no revenue for the period January 14, 1998, our date of inception,
through March 31, 1998 as we were in our development stage.

GROSS MARGINS, COSTS OF SALES AND EXPENSES. We incurred $4.0 million in the
delivery of our IMAP services and $2.0 million in the delivery of our
professional IT services during the three months ended March 31, 1999;
generating gross margins of (233)% and 35.7%, respectively.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. For the three months ended
March 31, 1999, we incurred $11.6 million of selling, general and administrative
expenses compared to $138,288 for the period January 14, 1998, our date of
inception, through March 31, 1998. The significant increase reflects the costs
associated with the continued development and maintenance of our infrastructure
required to support our IMAP services during a full quarter of operation in the
period ended March 31, 1999, compared to start-up activities during 1998.

NON-CASH STOCK COMPENSATION EXPENSE. For the three months ended March 31,
1999, we incurred $0.1 million in non-cash compensation expense. This reflects
the period's expense in connection with employee stock options issued at an
exercise price of $6.00 and an estimated fair market value of $20 per share at
the date of grant. There was no non-cash compensation expense for the comparable
period in 1998. The Company will record stock compensation expense of
approximately $39.9 million through 2003 as a result of 1999 stock option
grants.

DEPRECIATION AND AMORTIZATION. Depreciation and amortization for the three
months ended March 31, 1999 totaled $3.9 million. Of this amount, $1.3 million
represents the amortization of the goodwill recorded upon our acquisitions of
ACR and IIT; the remaining $2.6 million represents depreciation of our property
and equipment and the amortization of our prepaid software licenses. There was
no depreciation or amortization expense for the comparable period in 1998.

INTEREST INCOME AND EXPENSE. For the three months ended March 31, 1999, we
incurred $0.6 million in interest expense and generated $0.2 million of interest
income. We had minimal interest income and expense during the period ended March
31, 1998.

HISTORICAL RESULTS OF OPERATIONS--PREDECESSOR

COMPARISON OF THE PERIOD ENDED MARCH 31, 1999 OF USI TO THE PERIOD ENDED MARCH
31, 1998 OF PREDECESSOR

REVENUE. For the three months ended March 31, 1999, we generated $1.2
million in IMAP revenue, and $3.2 million in professional IT services revenue.
For the three months ended March 31, 1998, IIT generated $1.5 million in
professional IT services revenue and no IMAP revenue. The increase in
professional IT services revenue is attributable to the acquisition of ACR in
October 1998, and the inclusion of its professional IT services revenue in the
period ended March 31, 1999.

GROSS MARGINS, COSTS OF SALES AND EXPENSES. We incurred $4.0 million in
expenses in the delivery of our IMAP services and $2.0 million in expenses in
the delivery of our professional IT services during the three months ended March
31, 1999, generating gross margins of (233)% and 35.7%, respectively. IIT
incurred $0.6 million in expenses in the delivery of its professional IT
services for the three months ended March 31, 1998, resulting in a gross margin
of 57.3%. The significant decrease in the professional IT services gross margin
for the period ended March 31, 1999 is attributable to the inclusion of the
historically lower margin revenues from ACR and a greater use of subcontractors
by IIT to deliver professional IT services in the period ended March 31, 1999.

17
<PAGE>
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. For the three months ended
March 31, 1999, we incurred $11.6 million of selling, general and administrative
expenses compared to IIT's $0.5 million for the period ended March 31, 1998. The
significant increase reflects costs associated with the continued development
and maintenance of a much larger infrastructure required to support our IMAP
services in the period ended March 31, 1999.

NON-CASH STOCK COMPENSATION EXPENSE. For the three months ended March 31,
1999, we incurred $0.1 million in non-cash compensation expense. IIT had no
non-cash stock compensation expense for the three months ended March 31, 1998.

DEPRECIATION AND AMORTIZATION. Depreciation and amortization for the three
months ended March 31, 1999 totaled $3.9 million. Of this amount, $1.3 million
represents the amortization of the goodwill created through our acquisitions of
ACR and IIT; the remaining $2.6 million represents depreciation of our property
and equipment and the amortization of our prepaid software licenses. IIT
incurred approximately $10,000 in depreciation expense for the three months
ended March 31, 1998.

INTEREST INCOME AND EXPENSE. For the three months ended March 31, 1999, we
incurred $0.6 million in interest expense and generated $0.2 million of interest
income. IIT had minimal interest expense and no interest income during the
period ended March 31, 1998.

ACQUIRED COMPANIES

The acquisitions of IIT and ACR were made primarily with cash and were
accounted for using the purchase method of accounting. The assets and
liabilities of the acquired companies have been recorded at their fair market
value as of the acquisition closing date. The excess of the purchase price over
the fair market value of the identifiable net assets of IIT and ACR has been
accounted for as goodwill, which is being amortized over its estimated useful
life of 5 years.

LIQUIDITY AND CAPITAL RESOURCES

At March 31, 1999 we had pro forma cash and cash equivalents of $149.4
million, which includes $133.9 million generated through the sale of 6.9 million
shares of common stock in early April 1999. Through December 31, 1998, we had
used $20.6 million through operating activities and $37.7 million in investing
activities. The principal investing activities were the acquisitions of ACR and
IIT for $16.9 million and the purchase of property and equipment totaling $20.1
million. For the three months ended March 31, 1999 we have used $13.9 million in
operating activities, $8.2 million in investing activities and $6.1 million in
financing activities. Included in financing activities were payments of $8.5
million to the former shareholders of ACR.

USI has used debt and capital leases to partially finance its capital
purchases. As of March 31, 1999, we had obtained commitments for secured
financing from several sources including: Cisco System Capital Corporation
($10.0 million), Venture Lending & Leasing II, Inc. ($10.0 million),
Transamerica Business Credit Corporation ($5.0 million), Leasing Technologies
International, Inc. ($2.0 million) and Hewlett Packard Company ($1.0 million),
among others. The total of the secured financing commitments at March 31, 1999
was $33.0 million, of which $23.6 million had been funded. We have continued to
seek secured financing, and at April 30, 1999, we had secured commitment letters
from several additional sources including Charter Financial, Inc. ($5.0
million), Finova Capital Corporation ($5.0 million), Commercial Finance
Corporation ($5.0 million), LINC Capital, Inc. ($3.0 million), and Vision
Financial Corporation ($2.0 million). In March 1999, we entered into forward
looking commitments for the purchase of software and advertising totaling $22.5
million. The agreement provides for eight minimum payments of $2.5 million to be
paid over eight fiscal quarters commencing on March 31, 1999, for the purchase
of software licenses. Additionally, the agreement provides for eight quarterly
minimum payments of $312,500 commencing in March 1999 for co-marketed
advertising campaigns.

18
<PAGE>
In April 1999 we purchased an office building for $11.75 million. The seller
financed $7.5 million of the purchase price, due in May 2006, with interest at
7.5% per annum. We expect to spend $5.0 million in 1999 on improvements to the
building, and have arranged financing for $1.5 million of these improvements.

We believe that these resources, as well as anticipated debt and capital
lease financing, will be sufficient to fund our operations for the foreseeable
future. As of March 31, 1999 the majority of the base infrastructure required to
provide our IMAP services has been purchased. As a result our capital
expenditures for the next several years will largely be success-based,
consisting of software licenses and hardware required to implement new
customers. These new customer contracts are expected to have an average term of
three years; however, we anticipate many of our customers will renew their
contracts due to the cost and complexity of switching service providers.

If we expand more rapidly than currently anticipated, if our working capital
needs exceed our current expectations or if we make acquisitions, we will need
to raise additional capital from equity or debt sources. We cannot be sure that
we will be able to obtain the additional financing to satisfy our cash
requirements or to implement our growth strategy on acceptable terms or at all.
If we cannot obtain such financing on terms acceptable to us, we may be forced
to curtail our planned business expansion and may be unable to fund our ongoing
operations.

RECENT ACCOUNTING PRONOUNCEMENTS

In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-1, ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE
DEVELOPED FOR OR OBTAINED FOR INTERNAL USE (SOP 98-1). This SOP requires the
capitalization of costs to purchase or develop internal-use software, including
external direct costs of materials and services, payroll and payroll related
costs for employees who are directly associated with and devote time to an
internal-use software development project. Allocations of overhead to
capitalized costs are not permitted. Computer software costs related to research
and development are expensed as incurred, as are training and maintenance costs.
SOP 98-1 is effective for years beginning after December 15, 1998 and
application is prospective. Through December 31, 1998, approximately $1 million
of costs related to the implementation of internal use software were expensed.
We have adopted SOP 98-1 in the first quarter of 1999, and have capitalized $0.5
million of costs in implementing our internal use software.

In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position 98-5, REPORTING THE COSTS OF START-UP ACTIVITIES (SOP
98-5). This SOP requires that start-up costs and organizational costs be
expensed as incurred. Start-up activities include one-time activities related to
opening a new facility, introducing a new product or service, conducting
business in a new territory, conducting business with a new class of customer,
initiating new process in an existing facility, or commencing some new
operation. SOP 98-5 is effective for years beginning after December 15, 1998. We
currently expense the costs of all start-up and organizational activities.

YEAR 2000 COMPLIANCE

YEAR 2000 ISSUE. The Year 2000 issue is a result of computer programs or
systems which store or process date-related information using only two digits to
represent the year. These programs or systems may not be able to properly
distinguish between a year in the 1900's and a year in the 2000's. Failure of
these programs or systems to distinguish between the two centuries could cause
the programs or systems to yield erroneous results or even to fail.

STATE OF READINESS. Since its inception in January 1998, USI has been
cognizant of the Year 2000 issue. Hardware and software selections, network
architecture, and client contract terms have all been designed with the Year
2000 issue in mind.

19
<PAGE>
We have established a Year 2000 compliance team to carry out a program of
testing and remediation on our information technology and
non-information-technology systems, for systems used by USI as well as those
provided by USI to its clients. The compliance team includes a Year 2000
consulting firm we hired and members from all levels of our management,
engineering and operations organization. The compliance team meets as a group on
a regular basis and subgroups of the team will meet as needed to address
specific issues.

The compliance team is in the process of carrying out a program consisting
of the following phases:

- inventory of all potentially affected software products and software-
related services;

- analysis of such products and services to identify any areas that require
change or replacement;

- development of appropriate changes or replacements for the identified
areas;

- testing;

- implementation of the changes or replacements; and

- contingency planning.

Because USI is not only a user of software products and software-related
services, but also provides software products and software-related services to
its clients, the compliance program is addressing both software products and
software-related services used by USI and those provided by USI to its clients.
While different areas of USI face different Year 2000 problems, USI has given
priority to software products and software-related services that it provides to
its clients.

Our compliance team has completed the following tasks under our compliance
program.

- We have conducted in depth discussions with all of our software suppliers.
We have received assurances from all our software suppliers that the
programs provided to us are in compliance, and we do not believe that any
of the software applications provided to our clients requires remediation.
Even so, we continue to perform testing on the programs and applications
in production.

- We have inventoried existing hardware and software used in our systems.
Our hardware and software purchases were made beginning in March 1998 and
no systems were in service before then, excluding systems maintained by
the acquired companies. Systems manufactured and released after 1996 are
generally believed to be free of Year 2000 compliance problems.

- Although the companies we recently acquired have been in existence longer
than we have and have older systems in place, we concluded, based on Year
2000 assessments performed for the acquired companies, that there are no
material exposures related to the hardware or software used by the
acquired companies.

- We are performing Year 2000 and subsequent leap year roll-over tests up to
the year 2008 on each of our server platforms. To date, these tests have
found only one system to be non-compliant. This system was brought into
compliance with an operating system upgrade in October 1998.

- Our network infrastructure units, like routers and switches, were put
through a Year 2000 roll-over test and found to be compliant.

- We have inventoried our internally developed source code and determined
that there is a minimal amount, consisting primarily of custom web scripts
and UNIX shell scripts, which require testing.

The Year 2000 compliance team has the following tasks to complete.

20
<PAGE>
- Determine if additional analysis, remediation, testing or implementation
of new or existing systems, including software developed by the acquired
companies, are required.

- Complete analysis and, if necessary, testing and remediation of warranted
consulting services provided by ACR and IIT.

- Complete implementation of any necessary changes and replacements to
software products and software-related services used and provided by USI.

- Implement procedures to ensure that any future software products and
software-related services, as well as enhancements to existing software
products and software-related services, are developed in accordance with
USI's Year 2000 compliance program. We anticipate that inventory and
analysis of our existing systems will be completed by the second quarter
of 1999. We anticipate that implementation of any required changes or
replacements to existing systems as well as contingency planning for
systems identified as having a high risk of non-compliance will be
completed by the third quarter of 1999.

- Design contingency and business continuation plans in the event of the
failure of the systems used by USI due to the Year 2000 millennium change.

COSTS. As of March 31, 1999, USI has incurred $0.3 million in expenses in
connection with its Year 2000 compliance program. All expenses relating to Year
2000 compliance to date have been incurred in the normal course of our business,
as we have developed our products, network, and implemented specific client
applications. The cost of completing the Year 2000 compliance program is
expected to be principally in the form of the opportunity costs of employees'
time. USI may also need to purchase replacement products or other providers to
assist in Year 2000 compliance efforts. Currently, the estimated cost of the
Year 2000 compliance program is approximately $0.7 million, which includes
internal labor costs, the hiring of the Year 2000 consulting firm and reserves
for additional outside consultants and additional hardware and software. We
expect that this estimate will be refined as the analysis phase is completed.

RISKS. Should we fail to solve a Year 2000 compliance problem to one of our
systems the result could be a failure or interruption of normal business
operations. We believe that, due to the relative newness of our systems and the
tasks undertaken and completed by our compliance team, the potential for
significant interruptions to normal operations should be minimized. Our primary
risks with regard to Year 2000 failures are those which impact our IMAP
business.

The reasonably likely worst-case risks inherent in our business are as
follows.

- If a product or service provided by USI is found to cause damage or injury
to a client because of Year 2000 noncompliance, USI could be liable to the
client for breach of warranty. USI's client contracts generally limit
USI's liability. USI cannot accurately predict what legal claims may be
brought against it. In addition, USI cannot predict the outcome of any
legal claims. USI has several contracts which make Year 2000 warranties.
Some of these contracts make broader warranties than those made by the
manufacturers of the software provided. The potential liability arising
from some of these warranties is not capped and does not exclude
consequential damages.

- Significant and protracted interruption of electrical power to our data
center operations could materially and negatively impact our ability to
provide data center operations. To mitigate this risk, we have deployed
back-up power systems at our data systems and have the capability to
transfer all of the operations of one data center to another. However,
electrical power interruptions that impact Internet connectivity providers
could adversely impact us because of our reliance upon Internet-based
operations for our day-to-day business.

21
<PAGE>
- Significant and protracted interruption of telecommunications and data
network services in any of our data centers could materially and
negatively impact our ability to provide data center operations. We have
conducted detailed assessments of the components of our telecommunications
infrastructure and are working to identify appropriate system testing
guidelines. In addition, we have plans to seek additional assurances and a
better understanding of the compliance programs of its telecommunications
and data circuit providers.

- The failure of components of our systems used in the data centers could
materially and negatively impact our business. However, based on the time
period in which the data centers were developed we believe the risk of
failure is small. In addition, we have conducted a technical assessment of
the current systems and believe them to be compliant.

- In the course of our business, USI uses software products provided by
other companies, and some of USI's products and services interface to
other companies' systems. USI has received information from various other
third-party providers regarding the Year 2000 readiness of their products
and it continues to review such information. USI is also sending requests
to other third parties for information regarding the Year 2000 readiness
of their products and systems. As USI does not have any control over these
third parties, it cannot guarantee that such third-party products and
systems will not suffer any adverse effects due to the Year 2000 issue
which may result in a material adverse effect on our business.

- USI has not yet completed its Year 2000 contingency plans. If USI does not
complete its contingency plans, its potential Year 2000 liabilities may be
increased. The lack of a contingency plan could result in USI responding
late or not at all to problems caused by the date changeover at the end of
1999. In addition, any response USI does make may be poorly conceived or
executed. However, USI's compliance program includes the development of a
contingency plan. The development of the plan is currently underway.

22
<PAGE>
RISK FACTORS

In addition to the factors discussed in the "Overview", "Liquidity and
Capital Resources" and "Year 2000 Compliance" sections of this "Management's
Discussion and Analysis of Financial Condition and Results of Operations", the
following additional factors may affect our future results. Unless specified
otherwise as used herein, the terms "we," "us" or "our" refers to
USINTERNETWORKING, Inc. and its wholly-owned subsidiaries.

OUR BUSINESS IS DIFFICULT TO EVALUATE BECAUSE WE HAVE A LIMITED OPERATING
HISTORY.

We began operating in January 1998. Our limited operating history makes
predicting future results difficult. Since our inception, we have focused on
developing our business and only since September 1998 have we begun to contract
with customers for our IMAP offerings. Because of our limited operating history
and the emerging nature of our markets, our historical financial information is
of limited value in projecting our future results. Therefore, it is difficult to
evaluate our business and prospects.

OUR HISTORICAL REVENUES WERE DERIVED PRIMARILY FROM SERVICES THAT WE DO NOT
EXPECT TO BE THE FOCUS OF
OUR BUSINESS IN THE FUTURE.

Because our IMAP offerings are at an early stage, we currently derive the
majority of our revenue primarily from professional services provided by IIT and
ACR. These businesses were acquired on September 1998 and October 1998,
respectively, and their services are substantively different than our IMAP
offerings. As a result, historical financial information of IIT and ACR does not
reflect the results we expect from our core business offering in the future.

WE EXPECT TO CONTINUE TO INCUR LOSSES AND EXPERIENCE NEGATIVE CASH FLOW.

We expect to have significant operating losses and to record significant net
cash outflow before financing in the near term. Our business has not generated
sufficient cash flow to fund our operations without resorting to external
sources of capital. Starting up our company and building our network required
substantial capital and other expenditures. As a result, we reported a net loss
of $17.7 million for the first quarter of 1999 and EBITDA of negative $13.3
million for the same period. Further developing our business and expanding our
network will require significant additional capital and other expenditures.

WE MAY NEED ADDITIONAL CAPITAL TO FUND OUR OPERATIONS AND FINANCE OUR GROWTH,
AND WE MAY NOT BE ABLE TO OBTAIN IT ON TERMS ACCEPTABLE TO US OR AT ALL.

We believe that our existing assets, anticipated debt and capital lease
financing and expected revenue growth will be sufficient to fund our operations
for the foreseeable future. However, if we expand more rapidly than currently
anticipated, if our working capital needs exceed our current expectations or if
we make acquisitions, we will need to raise additional capital from equity or
debt sources. If we cannot obtain financing on terms acceptable to us or at all,
we may be forced to curtail our planned business expansion and may be unable to
fund our ongoing operations.

OUR SUCCESS DEPENDS ON THE ACCEPTANCE AND INCREASED USE OF INTERNET-BASED
BUSINESS SOFTWARE SOLUTIONS, AND WE CANNOT BE SURE THAT THIS WILL HAPPEN.

Our business model depends on the adoption of Internet-based business
software solutions by commercial users. Our business could suffer dramatically
if Internet-based solutions are not accepted or not perceived to be effective.
The market for Internet services, private network management solutions and
widely distributed Internet-enabled packaged application software has only
recently begun to develop. It is now evolving rapidly.

23
<PAGE>
The growth of Internet-based business software solutions could also be
limited by:

- concerns over transaction security and user privacy;

- inadequate network infrastructure for the entire Internet; and

- inconsistent performance of the Internet.

We cannot be certain that this market will become viable or, if it becomes
viable, that it will grow.

THE GROWTH IN DEMAND FOR OUTSOURCED BUSINESS SOFTWARE APPLICATIONS BY MIDDLE
MARKET COMPANIES IS HIGHLY UNCERTAIN.

Growth in demand for and acceptance of outsourced business software
applications, including our IMAP offerings, by middle market companies is highly
uncertain. We believe that many of our potential customers are not fully aware
of the benefits of outsourced solutions. It is possible that these solutions may
never achieve market acceptance. If the market for our products does not grow or
grows more slowly than we currently anticipate, our business, financial
condition and operating results would be materially adversely affected.

OUR BUSINESS STRATEGY MAY NOT EFFECTIVELY ADDRESS OUR MARKET AND WE MAY NEVER
REALIZE A RETURN ON THE RESOURCES WE HAVE INVESTED TO EXECUTE OUR STRATEGY.

We have made substantial investments to pursue our strategy. These
investments include:

- building a global network of data centers;

- allying with particular software providers;

- investing to develop unique service offerings; and

- developing implementation resources around specific applications.

These investments may not be successful. More cost effective strategies may
be available to compete in this market. We may have chosen to focus on the wrong
application areas or to work with the wrong partners. Potential customers may
not value the specific product features in which we have invested. There is no
assurance that our strategy will prove successful.

OTHERS MAY SEIZE THE MARKET OPPORTUNITY WE HAVE IDENTIFIED BECAUSE WE MAY NOT
EFFECTIVELY EXECUTE OUR STRATEGY.

If we fail to execute our strategy in a timely or effective manner, our
competitors may be able to seize the marketing opportunities we have identified.
Our business strategy is complex and requires that we successfully and
simultaneously complete many tasks. In order to be successful, we will need to:

- build and operate a highly-reliable, complex global network;

- negotiate effective partnerships and develop economically attractive
products;

- attract and retain IMAP customers;

- attract and retain highly-skilled employees;

- integrate acquired companies into our operations;

- evolve our business to gain advantages in an increasingly competitive
environment; and

- expand our international operations.

In addition, most of our management team has worked together for less than
one year. There can be no assurance that we will be able to successfully execute
all elements of our strategy.

24
<PAGE>
FAILURE OF COMPUTER SYSTEMS AND SOFTWARE PRODUCTS TO BE YEAR 2000 COMPLIANT
COULD INCREASE OUR COSTS, DISRUPT OUR SERVICE AND REDUCE DEMAND FROM OUR
CLIENTS.

We confront the Year 2000 problem in three contexts.

OUR SERVICES. We sell computer-related services, so our risk of lawsuits
relating to Year 2000 issues is likely to be greater than that of companies in
some other industries. Because computer products and services may incorporate
components from different providers, it may be difficult to determine which
component may cause a Year 2000 problem. As a result, we may be subjected to
Year 2000-related lawsuits whether or not our products and services are Year
2000 compliant. We have executed contracts which make Year 2000 warranties. Some
of these contracts make broader warranties than those made by the manufacturers
of the software provided. The potential liability arising from these warranties
is not capped. We cannot be certain at this time what the outcomes or impact of
any lawsuits may be.

OUR CUSTOMERS. Many of our customers and potential customers maintain their
Internet operations on UNIX-based servers, which may be impacted by Year 2000
complications. The failure of our customers to ensure that their servers are
Year 2000 compliant could have a material adverse effect on them, which in turn
could have a material adverse effect on our business, results of operations and
financial condition. In addition, customers or potential customers may delay
purchasing software and related products, including our IMAP offerings, due to
concerns related to the Year 2000 problem.

OUR SUPPLIERS. Our business could be adversely affected if we cannot obtain
products, services or systems that are Year 2000 compliant when we need them. In
addition, if vendors and service providers cannot deliver their products because
of Year 2000 compliance problems, our business, results of operations and
financial condition could be materially adversely affected.

WE PLAN TO EXPAND VERY RAPIDLY, AND MANAGING OUR GROWTH MAY BE DIFFICULT.

We have rapidly expanded our operations since USI was founded in January
1998. We expect our business to continue to grow both geographically and in
terms of the number of products and services we offer. We cannot be sure that we
will successfully manage our growth. In order to successfully manage our growth
we must:

- enlarge our network and infrastructure;

- improve our management, financial and information systems and controls;
and

- expand, train and manage our employee base effectively.

There will be additional demands on our customer service support and sales,
marketing and administrative resources as we increase our service offerings and
expand our target markets. The strains imposed by these demands are magnified by
the start-up nature of our operations. If we cannot manage our growth
effectively, our business, financial condition or results of operations could be
adversely affected.

25
<PAGE>
OUR GROWTH COULD BE LIMITED IF WE ARE UNABLE TO ATTRACT AND RETAIN QUALIFIED
PERSONNEL.

We believe that our short- and long-term success depends largely on our
ability to attract and retain highly skilled technical, managerial and marketing
personnel. We particularly require additional management personnel in the areas
of application integration and technical support. Individuals with information
technology skills are in short supply and competition for application
integration personnel is particularly intense. We may not be able to hire the
necessary personnel to implement our business strategy, or we may need to pay
higher compensation for employees than we currently expect. We cannot be sure
that we will succeed in attracting and retaining the personnel we need to
continue to grow.

WE DEPEND ON A LIMITED NUMBER OF KEY PERSONNEL WHO WOULD BE DIFFICULT TO
REPLACE.

Our success also depends in significant part on the continued services of
our key technical, sales and senior management personnel. Losing one or more of
our key employees could have a material adverse effect on our business, results
of operations and financial condition. We have employment agreements with
certain key employees, including Christopher R. McCleary, Stephen E. McManus,
Jeffery L. McKnight and Andrew A. Stern, but few other officers or key employees
are party to employment agreements.

WE MAY NOT BE ABLE TO DELIVER OUR IMAP SERVICES IF THIRD PARTIES DO NOT PROVIDE
US WITH KEY COMPONENTS OF OUR INFRASTRUCTURE.

We depend on other companies to supply key components of our
telecommunications infrastructure and system and network management solutions.
Any failure to obtain needed products or services in a timely fashion and at an
acceptable cost could have a material adverse effect on our business, results of
operations and financial condition. Although we lease redundant capacity from
multiple suppliers, a disruption in telecommunications capacity could prevent us
from maintaining our standard of service. Some of the key components of our
system and network are available only from sole or limited sources in the
quantities and quality we demand. For example, the hardware we use to support
our real-time mirroring and disaster recovery functions is supplied only by EMC
Corporation. We buy these components from time to time, do not carry significant
inventories of them and have no guaranteed supply arrangements with our vendors.

OUR ABILITY TO PROVIDE OUR IMAP SERVICES DEPENDS ON STRATEGIC RELATIONSHIPS WITH
SOFTWARE VENDORS THAT WE MAY NOT BE ABLE TO MAINTAIN.

Our IMAP offerings are central to our business strategy. We obtain software
products under license agreements with PeopleSoft USA, Inc.; Siebel Systems
Inc.; Sagent Technology, Inc. and BroadVision, Inc. and package them as part of
our IMAP solutions. The agreements are for terms ranging from one to three
years. All the agreements may be terminated upon a breach of the agreement,
subject to cure periods. The agreement with PeopleSoft may be terminated by
either party for convenience upon 90 days notice. However, if we terminate the
agreement for convenience, we would still be obligated to make the required
payments under the agreement. PeopleSoft has, in fact, on one occasion notified
us of its intention to terminate the agreement. After significant discussion,
the issues in dispute were resolved, our agreement with PeopleSoft was
renegotiated and PeopleSoft retracted its notification of its intent to
terminate the agreement. However, we cannot be sure that one or more of our
agreements with software vendors will not be terminated in the future. If these
agreements were to be terminated or not renewed or we otherwise could not
continue to use this software, we might have to discontinue products or services
or delay or reduce their introduction unless we could find, license and package
equivalent technology.

26
<PAGE>
All but one of our agreements with software vendors are non-exclusive. Our
agreement with Siebel gives us exclusivity as the outsource provider of Siebel
enterprise relationship management application hosting and rental services for
direct customers of Siebel located in North America. Our vendors may choose to
compete with us directly or to enter into strategic relationships with our
competitors. These relationships may take the form of strategic investments or
marketing or other contractual arrangements. Our competitors may also license
and utilize the same technology in competition with us. We cannot be sure that
the vendors of technology used in our products will continue to support this
technology in its current form. Nor can we be sure that we will be able to adapt
our own products to changes in this technology. In addition, we cannot be sure
that the financial or other difficulties of our vendors will not have a material
adverse effect upon the technologies incorporated in our products, or that, if
these technologies become unavailable, we will be able to find suitable
alternatives.

IF WE CANNOT OBTAIN ADDITIONAL APPLICATION SOFTWARE WE WILL BE UNABLE TO EXPAND
OR ENHANCE OUR IMAP SERVICE OFFERINGS.

Our business strategy also depends on obtaining additional application
software. We cannot be sure, however, that we will be able to obtain the new or
enhanced applications we may need to keep our IMAP solutions competitive. If we
cannot obtain these applications and as a result must discontinue, delay or
reduce the availability of our IMAP solutions or other products or services, our
business, results of operations and financial condition may be materially
adversely affected.

DEVELOPING AND EXPANDING OUR OPERATIONS WILL DEPEND, AMONG OTHER THINGS, ON OUR
MANAGEMENT'S ABILITY TO SUCCESSFULLY INTEGRATE ACQUIRED COMPANIES.

In September and October of 1998, we acquired IIT and ACR. We cannot be sure
that we will be able to continue to successfully integrate the businesses of IIT
and ACR into our own, or that these businesses will perform as expected. In
addition, we cannot be sure that we will be able to successfully integrate any
business acquired in the future into our own. Our failure to successfully
integrate an acquired company or its subsequent underperformance could have a
material adverse effect on our business, results of operations and financial
condition.

WE MAY UNDERTAKE ADDITIONAL ACQUISITIONS WHICH POSE RISKS TO OUR BUSINESS.

Our business plan contemplates additional acquisitions which we may or may
not undertake. If we do, our risks may increase because:

- we may pay more than the acquired company is worth;

- we may not fully understand the business we acquire;

- we may be entering markets in which we have little or no direct prior
experience;

- our ongoing business may be disrupted and resources and management time
diverted; and

- our accounting for acquisitions could require us to amortize substantial
goodwill, adversely affecting our reported results of operations.

In addition, once we have made an acquisition we will face additional risks:

- it may be difficult to assimilate acquired operations and personnel;

- we may not be able to retain the management and other key personnel of the
acquired business;

- we may not be able to maintain uniform standards, controls, procedures and
policies; and

- changing management may impair relationships with an acquired business's
employees or customers.

27
<PAGE>
TECHNOLOGY MAY CHANGE FASTER THAN WE CAN UPDATE OUR NETWORK AND TECHNOLOGY.

The markets we serve are characterized by rapidly changing technology,
evolving industry standards, emerging competition and the frequent introduction
of new services, software and other products. Our success depends partly on our
ability to enhance existing or develop new products, software and services that
meet changing customer needs in a timely and cost-effective way. We cannot be
sure, however, that we will do some or all of these things. For example, if
software application architecture changes in significant ways, the software for
which we have licenses could become obsolete, we may be forced to update our
hardware and network configurations or we may be forced to replace our mirroring
technology. This may require substantial time and expense, and even then we
cannot be sure that we will succeed in adapting our businesses to these and
other technological developments.

WE COULD BE HARMED IF OUR SYSTEMS ARE NOT COMPATIBLE WITH OTHER PRODUCTS AND
SERVICES.

We believe that our ability to compete successfully also depends on the
continued compatibility of our services with products, services and
architectures offered by various vendors. Our failure to conform to a prevailing
standard, or the failure of a common standard to emerge, could have a material
adverse effect on our business, results of operations and financial condition.
Although we will work with vendors to test new products, we cannot be sure that
their products will be compatible with ours or that they will adequately address
changing customer needs. Although we currently plan to support emerging
standards, we cannot be sure what new industry standards will develop. We also
cannot be sure that we will be able to conform to these new standards quickly
enough to stay competitive. In addition, we cannot be sure that products,
services or technologies developed by others will not make ours noncompetitive
or obsolete.

THE MARKETS WE SERVE ARE HIGHLY COMPETITIVE AND MANY OF OUR COMPETITORS HAVE
MUCH GREATER RESOURCES.

Our current and potential competitors include systems integrators, national
and regional Internet Service Providers, software and hardware vendors, and
global, regional and local telecommunications companies and Regional Bell
Operating Companies. Our competitors, which may operate in one or more of these
areas, include companies such as GTE Corporation; MCI WorldCom, Inc.;
International Business Machines Corporation; Frontier Corporation; CORIO, Inc.;
FutureLink Distribution Corp.; Quest Communications International Inc.; PSINet,
Inc.; DIGEX, Inc.; Exodus Communications, Inc.; Andersen Consulting;
PricewaterhouseCoopers; AT&T Corporation; and Sprint Corporation. Our strategic
partners and suppliers could also become competitors either directly or through
strategic relationships with other of our competitors. These relationships may
take the form of strategic investments or marketing or other contractual
arrangements.

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

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

- better adapt to new or emerging technologies and changing customer needs;

- take advantage of acquisitions and other opportunities more readily;

- negotiate more favorable licensing agreements with software application
vendors;

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

- adopt more aggressive pricing policies.

28
<PAGE>
Some of our competitors may also be able to provide customers with
additional benefits at lower overall costs. We cannot be sure that we will be
able to match cost reductions by our competitors. In addition, we believe that
there is likely to be consolidation in our markets. Consolidation could increase
price competition and other competitive forces in ways that materially adversely
affect our business, results of operations and financial condition. Finally,
there are few substantial barriers to entry, and we have no patented technology
that would bar competitors from our market.

BECAUSE WE HAVE INTERNATIONAL OPERATIONS, WE FACE ADDITIONAL RISKS RELATED TO
FOREIGN POLITICAL AND ECONOMIC CONDITIONS.

We have established Enterprise Data Centers in Europe and Japan as well as
operations in Venezuela. We intend to expand further into international markets.
We cannot be sure that we will be able to obtain the necessary
telecommunications infrastructure in a cost-effective manner or compete
effectively in international markets. In addition, there are risks inherent in
conducting business internationally. These include:

- unexpected changes in regulatory requirements;

- export restrictions;

- tariffs and other trade barriers;

- challenges in staffing and managing foreign operations;

- differing technology standards;

- employment laws and practices in foreign countries;

- political instability;

- fluctuations in currency exchange rates;

- imposition of currency exchange controls; and

- potentially adverse tax consequences.

Any of these could adversely affect our international operations. We cannot
be sure that one or more of these factors will not have a material adverse
effect on our current or future international operations and, consequently, on
our business, results of operations and financial condition.

GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES COULD ADD ADDITIONAL COSTS TO
DOING BUSINESS ON THE INTERNET AND COULD LIMIT OUR CLIENTS' USE OF THE
INTERNET.

Laws and regulations directly applicable to communications or commerce over
the Internet are becoming more prevalent. The adoption or modification of laws
or regulations relating to the Internet could adversely affect our business. The
last session of the United States Congress resulted in Internet laws regarding
children's privacy, copyrights, taxation and the transmission of sexually
explicit material. The European Union recently enacted its own privacy
regulations. The law of the Internet, however, remains largely unsettled, even
in areas where there has been some legislative action. It may take years to
determine whether and how existing laws such as those governing intellectual
property, privacy, libel and taxation apply to the Internet. In addition, the
growth and development of the market for online commerce may prompt calls for
more stringent consumer protection laws, both in the United States and abroad,
that may impose additional burdens on companies conducting business online. For
example, Germany, and the European Union have enforced laws and regulations on
content distributed over the Internet that are more strict than those currently
in place in the United States.

29
<PAGE>
INTELLECTUAL PROPERTY INFRINGEMENT CLAIMS AGAINST US, EVEN WITHOUT MERIT, COULD
COST A SIGNIFICANT AMOUNT OF MONEY TO DEFEND AND DIVERT MANAGEMENT'S ATTENTION
AWAY FROM OUR BUSINESS.

As the number of software products in our target markets increases and the
functionality of these products further overlap, software industry participants
may become increasingly subject to infringement claims. Someone may even claim
that our technology infringes their proprietary rights. Any infringement claims,
even if without merit, can be time consuming and expensive to defend. They may
divert management's attention and resources and could cause service
implementation delays. They also could require us to enter into costly royalty
or licensing agreements. If successful, a claim of product infringement against
us and our inability to license the infringed or similar technology could
adversely affect our business.

WE COULD BE REQUIRED TO USE OUR FINANCIAL RESOURCES TO REPURCHASE SHARES OF
COMMON STOCK FROM U S WEST.

We could be required to repurchase some of the shares of our capital stock
owned by U S WEST for cash. This would require us to divert our resources at a
time of rapid growth. If we engage in activities in which U S WEST would be
prohibited from engaging and we were considered an affiliate of U S WEST under
regulations of the Federal Communications Commission, U S WEST could force us to
repurchase the number of shares required to make us no longer an affiliate. We
are not presently considered an affiliate of U S WEST under these regulations.
Although we believe the possibility of this occurring is remote, repurchasing
the shares held by U S WEST could be costly.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk principally as a result of changes in interest
rates. Through March 31, 1999, we invested our excess cash in cash equivalents.
Our long-term debt outstanding at March 31, 1999 requires the payment of
interest at fixed rates of interest. As of March 31, 1999, our exposure to
reasonably possible near-term changes in interest rates was not significant to
our financial position, results of operations, and cash flows.

Our exposure to interest rate changes subsequent to March 31, 1999 is
greater as a result of investing the proceeds of our initial public offering in
April 1999 in cash equivalents. At March 31, 1999, our pro forma cash and cash
equivalents assuming the completion of the initial public offering at that date
is $149.4 million.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company is not a party to any material legal proceedings.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

(a) -- (c) None.

On April 8, 1999, in connection with USINTERNETWORKING's initial public
offering, a Registration Statement on Form S-1 (No. 333-70717) was declared
effective by the Securities and Exchange Commission, pursuant to which 6,900,000
shares of USINTERNETWORKING's common stock were offered and sold for the account
of USINTERNETWORKING at a price of $21 per share. Generating gross offering
proceeds of $144.9 million. The managing underwriters were Credit Suisse First
Boston, Bear, Stearns & Co. Inc., BT Alex. Brown and Legg Mason Wood Walker
Incorporated. After deducting approximately $10.1 million in underwriting
discounts and $.9 million in other related expenses, the net proceeds to
USINTERNETWORKING were approximately $133.8 million.

30
<PAGE>
The net proceeds to USINTERNETWORKING were invested in short-term,
investment-grade interest-bearing securities. USINTERNETWORKING used a portion
of the net proceeds to pay accrued dividends on its preferred stock.
USINTERNETWORKING has no specific plans at this time for the use of the
remaining proceeds and expects to use such proceeds for working capital and
general corporate purposes.

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

By written consent effective as of March 22, 1999, holders of the
outstanding shares of common stock, Series A Preferred Stock and Series B
Preferred Stock (1) approved the Amended and Restated 1998 Stock Option Plan of
USINTERNETWORKING; (2) approved two amendments to the Amended and Restated
Certificate of Incorporation--the first amendment provided for changes to the
terms of the Series A and Series B Preferred Stock to allow for an increase in
the number of shares available for issuance under the stock option plan, the
second amendment effected an eight into one reverse stock split to be effective
immediately prior to the effective date of the registration statement relating
to the initial public offering of USINTERNETWORKING's common stock; (3) approved
the adoption of the Second Restated Certificate of Incorporation effective upon
the closing of the initial public offering and (4) the adoption of the Amended
and Restated Bylaws affective upon the closing of the initial public offering.

All of the holders of common stock; holders of 52,000 shares of Series A
Preferred Stock, representing 94.55% of such class; and holders of 54,492.84
shares of Series B Preferred Stock, representing 91.93% of such class consented
to such actions.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits.

27.1 Financial Data Schedule

(b) Reports on Form 8-K.

None

31
<PAGE>
SIGNATURES

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1934, AS AMENDED,
USINTERNETWORKING, INC. HAS DULY CAUSED THIS REGISTRATION STATEMENT TO BE SIGNED
ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN ANNAPOLIS,
MARYLAND ON MAY 24, 1999.

<TABLE>
<S> <C> <C>
USINTERNETWORKING, INC.

By: /s/ --CHRISTOPHER R. MCCLEARY--
-----------------------------------------
Christopher R. McCleary
CHAIRMAN OF THE BOARD
AND CHIEF EXECUTIVE OFFICER

By: /s/ --ANDREW A. STERN--
-----------------------------------------
Andrew A. Stern
EXECUTIVE VICE PRESIDENT
AND CHIEF FINANCIAL OFFICER
(PRINCIPAL FINANCIAL AND ACCOUNTING
OFFICER)
</TABLE>

32
<PAGE>
EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
<C> <S>
27.1 Financial Data Schedule (EDGAR version only)
</TABLE>

<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000

<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 15,510
<SECURITIES> 0
<RECEIVABLES> 4,339
<ALLOWANCES> 142
<INVENTORY> 0
<CURRENT-ASSETS> 22,682
<PP&E> 31,473
<DEPRECIATION> 3,341
<TOTAL-ASSETS> 85,124
<CURRENT-LIABILITIES> 27,260
<BONDS> 0
62,243
550
<COMMON> 625
<OTHER-SE> (46,100)
<TOTAL-LIABILITY-AND-EQUITY> 85,124
<SALES> 4,392
<TOTAL-REVENUES> 4,392
<CGS> 0
<TOTAL-COSTS> 21,772
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 569
<INCOME-PRETAX> (17,691)
<INCOME-TAX> 0
<INCOME-CONTINUING> (17,691)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
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</TABLE>