USINTERNETWORKING INC, 10-Q, 1999-08-13

USINTERNETWORKING INC
10-Q, 1999-08-13
COMPUTER PROGRAMMING SERVICES

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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 JUNE 30, 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 /X/ No / /

Shares outstanding of the Registrant's common stock

<TABLE>
<S> <C>
Class Outstanding at July 31, 1999
Common Stock, $.001 par value 39,781,875
</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 June 30, 1999 (unaudited)........... 3
Consolidated Statements of Operations for the three months ended June 30, 1999 and 1998
(unaudited) and for the six months ended June 30, 1999 (unaudited) and for the period
January 14, 1998 (date of inception) through June 30, 1998 (unaudited).................... 4
Consolidated Statements of Stockholders' Equity (Deficit) for the
period January 14, 1998 (date of inception) through December 31, 1998
and for the six months ended June 30, 1999 (unaudited).................................... 5
Consolidated Statements of Cash Flows for the three months ended June 30, 1999 and 1998
(unaudited) and for the six months ended June 30, 1999 (unaudited) and for the period
January 14, 1998 (date of inception) through June 30, 1998 (unaudited).................... 6
Notes to the Consolidated Financial Statements.............................................. 7

CONSOLIDATED FINANCIAL STATEMENTS OF I.I.T HOLDING, INC. AND SUBSIDIARIES (PREDECESSOR)
Consolidated Statements of Operations for the three and six months ended June 30, 1998
(unaudited)............................................................................... 12
Consolidated Statements of Cash Flows for the three and six months ended June 30, 1998
(unaudited)............................................................................... 13
Note to the Consolidated Financial Statements............................................... 14

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....... 15
Item 3. Quantitative and Qualitative Disclosure of Market Risk...................................... 22

Part II. Other Information

Item 1. Legal Proceedings........................................................................... 22
Item 2. Changes In Securities....................................................................... 22
Item 6. Exhibits and Reports on Form 8-K............................................................ 23

Signatures..
</TABLE>

2
<PAGE>
PART I. FINANCIAL INFORMATION

USINTERNETWORKING, INC.

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1998 1999
------------- -------------
<S> <C> <C>
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents............................................................ $ 43,802,465 $ 37,257,760
Restricted cash...................................................................... 581,712 881,712
Available-for-sale securities........................................................ -- 47,847,968
Accounts receivable, less allowance of $142,000 and $341,012 in 1998 and 1999,
respectively....................................................................... 2,882,119 7,306,586
Prepaid expenses and other current assets............................................ 2,436,247 5,218,951
------------- -------------
Total current assets................................................................... 49,702,543 98,512,977

Deferred IMAP costs.................................................................... -- 2,996,981
Software licenses, net of accumulated amortization of $1,614,692 in 1999............... 9,596,760 11,926,521
Property and equipment, net of accumulated depreciation of $1,567,885 and $6,086,557 in
1998 and 1999, respectively.......................................................... 21,640,145 67,662,391
Goodwill, net of accumulated amortization of $1,611,763 and $4,293,763 in 1998 and
1999, respectively................................................................... 25,137,296 23,489,301
Other assets........................................................................... 439,734 402,534
------------- -------------
Total assets........................................................................... $ 106,516,478 $ 204,990,705
------------- -------------
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable..................................................................... $ 6,571,767 $ 6,842,612
Accrued compensation................................................................. 4,870,690 6,327,523
Other accrued expenses............................................................... 1,569,570 1,754,111
Deferred revenue..................................................................... 51,247 1,619,351
Due to former shareholders of acquired businesses.................................... 10,826,735 --
Current portion of capital lease obligations......................................... 1,503,947 2,957,488
Current portion of long-term debt.................................................... 1,757,588 4,975,428
------------- -------------
Total current liabilities.............................................................. 27,151,544 24,476,513

Short-term obligations expected to be refinanced....................................... 5,282,450 --
Capital lease obligations, less current portion........................................ 3,427,254 6,763,272
Long-term debt, less current portion................................................... 5,231,794 17,293,890
Dividends payable...................................................................... 1,503,004 --
------------- -------------
Total liabilities...................................................................... 42,596,046 48,533,675

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

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

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, none in 1999; $33,000,000 aggregate
liquidation preference............................................................. 550 --
Common stock, $.001 par value, 75,000,000 shares authorized, 625,000 shares issued
and outstanding in 1998, 39,709,623 shares outstanding in 1999..................... 625 39,709
Additional paid-in capital........................................................... 29,985,069 230,739,700
Accumulated other comprehensive income (loss)........................................ -- (86,533)
Unearned compensation................................................................ -- (497,503)
Accumulated deficit.................................................................. (32,453,312) (73,738,343)
------------- -------------
Total stockholders' equity (deficit)................................................. (2,467,068) 156,457,030
------------- -------------

Total liabilities and stockholders' equity (deficit)................................... $ 106,516,478 $ 204,990,705
------------- -------------
------------- -------------
</TABLE>

SEE ACCOMPANYING NOTES.

3
<PAGE>
USINTERNETWORKING, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
FOR THE PERIOD
FROM JANUARY 14,
1998 (DATE OF
THREE MONTHS ENDED JUNE 30, SIX MONTHS INCEPTION)
----------------------------- ENDED JUNE 30, THROUGH JUNE 30,
1999 1998 1999 1998
-------------- ------------- -------------- -----------------
<S> <C> <C> <C> <C>
(UNAUDITED)
Revenue:
IMAP revenue................................. $ 3,376,658 $ -- $ 4,579,785 $ --
Professional IT services revenue............. 3,306,328 -- 6,495,307 --
-------------- ------------- -------------- -----------------
Total revenue.................................. 6,682,986 -- 11,075,092 --
Costs and expenses:
Direct IMAP costs............................ 3,106,671 -- 4,731,673 --
Network and data center costs................ 3,439,931 -- 5,860,010 --
Professional IT services costs............... 2,180,541 -- 4,229,547 --
Selling, general and administrative.......... 13,674,305 3,086,006 25,283,048 3,224,294
Non-cash stock compensation expense.......... 3,224,557 -- 3,360,238 --
Depreciation and amortization................ 4,912,417 37,016 8,846,042 37,016
-------------- ------------- -------------- -----------------
Total costs and expenses....................... 30,538,422 3,123,022 52,310,558 3,261,310
-------------- ------------- -------------- -----------------
Operating loss................................. (23,855,436) (3,123,022) (41,235,466) (3,261,310)
Other income (expense):
Interest income.............................. 1,162,918 99,621 1,421,365 100,466
Interest expense............................. (901,543) (53,056) (1,470,930) (53,845)
-------------- ------------- -------------- -----------------
261,375 46,565 (49,565) 46,621
-------------- ------------- -------------- -----------------

Net loss....................................... (23,594,061) (3,076,457) (41,285,031) (3,214,689)
Dividends accrued on Series A and Series B
Convertible Preferred Stock.................. (424,300) (185,262) (2,328,150) (185,262)
Accretion of common stock subject to repurchase
to fair value................................ -- (136,563) (23,938,069) (136,563)
Accretion of Series B Convertible Redeemable
Preferred Stock to fair value................ -- -- (99,252) --
-------------- ------------- -------------- -----------------
Net loss attributable to common stockholders... $ (24,018,361) $(3,398,282) $ (67,650,502) $ (3,536,514)
-------------- ------------- -------------- -----------------
-------------- ------------- -------------- -----------------
Basic and diluted loss per common share
attributable to common stockholders.......... $ (0.66) $ (5.44) $ (3.66) $ (5.66)
-------------- ------------- -------------- -----------------
-------------- ------------- -------------- -----------------
</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> <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.............................................................. -- -- -- --
Conversion of Series A Convertible Preferred Stock................... (55,000) (550) 12,374,994 12,375
Conversion of Series B Convertible Redeemable Preferred Stock........ -- -- 18,524,532 18,524
Conversion of common stock subject to repurchase..................... -- -- 1,343,750 1,344
Issuance of common stock upon initial public offering................ -- -- 6,900,000 6,900
Initial public offering issuance costs............................... -- -- -- --
Issuance of common stock upon exercise of stock options.............. -- -- 66,347 66
Repurchase of common stock........................................... -- -- (125,000) (125)
Amortization of stock based compensation............................. -- -- -- --
Stock compensation expense for issuance of common stock options at
below fair market value............................................ -- -- -- --
Comprehensive income:
Net loss for the period January 1, 1999 through June 30, 1999...... -- -- -- --
Other comprehensive income--unrealized loss on marketable
securities....................................................... -- -- -- --
Total comprehensive income (loss).................................... -- -- -- --
--------- ----- --------- -----------

Balance at June 30, 1999 (unaudited)................................... -- $ -- 39,709,623 $ 39,709
--------- ----- --------- -----------
--------- ----- --------- -----------

<CAPTION>
ACCUMULATED
ADDITIONAL OTHER
PAID-IN COMPREHENSIVE UNEARNED ACCUMULATED
CAPITAL INCOME COMPENSATION DEFICIT
------------ --------------- ------------- ------------
<S> <C>
Balance at January 14, 1998............................................ $ -- $ -- $ -- $ --
Issuance of common stock to founder upon inception................... 4,375 -- -- --
Issuance of Series A Convertible Preferred Stock on May 28, 1998 for
cash............................................................... 22,999,617 -- -- --
Issuance of Series A Convertible Preferred Stock on May 28, 1998 in
exchange for $1,000,000 note....................................... 999,983 -- -- --
Issuance of Series A Convertible Preferred Stock on June 22, 1998 for
cash............................................................... 3,699,938 -- -- --
Issuance of Series A Convertible Preferred Stock on July 2, 1998 for
cash............................................................... 3,499,942 -- -- --
Issuance of Series A Convertible Preferred Stock on July 30, 1998 for
cash............................................................... 1,799,970 -- -- --
Transaction costs associated with the issuance of Series A
Convertible Preferred Stock........................................ (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 -- -- --
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 -- -- --
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 -- -- --
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 -- -- --
Issuance of warrants to purchase 62,500 shares of common stock
associated with the acquisition of ACR on October 2, 1998.......... 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 -- -- --
Dividends accrued on Series A Convertible Preferred Stock............ (1,503,004) -- --
Accretion of common stock subject to repurchase to fair value........ (3,903,865) -- --
Accretion of Series B Convertible Redeemable Preferred Stock to fair
value.............................................................. (236,991) -- --
Net loss for the period January 14, 1998 through December 31, 1998... -- -- (32,453,312)
------------ --------------- ------------- ------------
Balance at December 31, 1998........................................... 29,985,069 -- -- (32,453,312)
------------ --------------- ------------- ------------
Dividends accrued on Series A and Series B Convertible Preferred
Stock.............................................................. (2,328,150) -- -- --
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) -- -- --
Conversion of Series A Convertible Preferred Stock................... (11,825) -- -- --
Conversion of Series B Convertible Redeemable Preferred Stock........ 62,223,976 -- -- --
Conversion of common stock subject to repurchase..................... 28,714,909 -- (633,184) --
Issuance of common stock upon initial public offering................ 144,893,100 -- -- --
Initial public offering issuance costs............................... (12,089,830) -- -- --
Issuance of common stock upon exercise of stock options.............. 175,090 -- -- --
Repurchase of common stock........................................... (9,875) -- -- --
Amortization of stock based compensation............................. 135,681 -- 135,681 --
Stock compensation expense for issuance of common stock options at
below fair market value............................................ 3,088,876 -- -- --
Comprehensive income:
Net loss for the period January 1, 1999 through June 30, 1999...... -- -- -- (41,285,031)
Other comprehensive income--unrealized loss on marketable
securities....................................................... -- (86,533) -- --

Total comprehensive income (loss).................................... -- -- -- --
------------ --------------- ------------- ------------
Balance at June 30, 1999 (unaudited)................................... $230,739,700 $ (86,533) $(497,503) ($73,738,343)

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

<CAPTION>
TOTAL
STOCKHOLDERS'
EQUITY
(DEFICIT)
------------
Balance at January 14, 1998............................................ $ --
Issuance of common stock to founder upon inception................... 5,000
Issuance of Series A Convertible Preferred Stock on May 28, 1998 for
cash............................................................... 23,000,000
Issuance of Series A Convertible Preferred Stock on May 28, 1998 in
exchange for $1,000,000 note....................................... 1,000,000
Issuance of Series A Convertible Preferred Stock on June 22, 1998 for
cash............................................................... 3,700,000
Issuance of Series A Convertible Preferred Stock on July 2, 1998 for
cash............................................................... 3,500,000
Issuance of Series A Convertible Preferred Stock on July 30, 1998 for
cash............................................................... 1,800,000
Transaction costs associated with the issuance of Series A
Convertible Preferred Stock........................................ (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
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
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
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
Issuance of warrants to purchase 62,500 shares of common stock
associated with the acquisition of ACR on October 2, 1998.......... 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
Dividends accrued on Series A Convertible Preferred Stock............ (1,503,004)
Accretion of common stock subject to repurchase to fair value........ (3,903,865)
Accretion of Series B Convertible Redeemable Preferred Stock to fair
value.............................................................. (236,991)
Net loss for the period January 14, 1998 through December 31, 1998... (32,453,312)
------------
Balance at December 31, 1998........................................... (2,467,068)
------------
Dividends accrued on Series A and Series B Convertible Preferred
Stock.............................................................. (2,328,150)
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)
Conversion of Series A Convertible Preferred Stock................... --
Conversion of Series B Convertible Redeemable Preferred Stock........ 62,242,500
Conversion of common stock subject to repurchase..................... 28,083,069
Issuance of common stock upon initial public offering................ 144,900,000
Initial public offering issuance costs............................... (12,089,830)
Issuance of common stock upon exercise of stock options.............. 175,156
Repurchase of common stock........................................... (10,000)
Amortization of stock based compensation............................. 271,362
Stock compensation expense for issuance of common stock options at
below fair market value............................................ 3,088,876
Comprehensive income:
Net loss for the period January 1, 1999 through June 30, 1999...... (41,285,031)
Other comprehensive income--unrealized loss on marketable
securities....................................................... (86,533)
------------
Total comprehensive income (loss).................................... (41,371,564)
------------
Balance at June 30, 1999 (unaudited)................................... $156,457,030
------------
------------
</TABLE>

SEE ACCOMPANYING NOTES.

5
<PAGE>
USINTERNETWORKING, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
FOR THE PERIOD
FROM JANUARY 14,
1998 (DATE OF
THREE MONTHS ENDED JUNE 30, SIX MONTHS INCEPTION)
---------------------------- ENDED THROUGH JUNE 30,
1999 1998 JUNE 30, 1999 1998
------------- ------------- ------------- -----------------
(UNAUDITED)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss.......................................... $(23,594,061) $(3,076,457) $(41,285,031) $(3,214,689)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation.................................... 3,571,417 37,016 6,164,042 37,016
Amortization.................................... 1,341,000 -- 2,682,000 --
Non-cash stock compensation expense related to
the issuance of common stock.................. 135,681 5,000 271,362 5,000
Non-cash compensation expense related to the
issuance of common stock options.............. 3,088,876 -- 3,088,876
Non-cash interest expense....................... 62,973 -- 125,947 --
Changes in operating assets and liabilities:
Accounts receivable........................... (3,109,897) -- (4,424,467) --
Prepaid expenses and other current assets..... (2,825,214) (94,820) (2,782,704) (94,820)
Deferred IMAP costs........................... (1,837,983) -- (2,996,981) --
Accounts payable.............................. (2,130,993) 472,364 270,845 520,111
Accrued compensation.......................... 1,723,876 -- 1,456,833 --
Accrued expenses and other current
liabilities................................. 1,840,693 921,892 1,752,645 921,892
------------- ------------- ------------- -----------------
Net cash used in operating activities............. (21,733,632) (1,735,005) (35,676,633) (1,825,490)

INVESTING ACTIVITIES
Purchases of property and equipment............... (40,761,482) (4,037,321) (49,063,634) (4,319,706)
Increase in restricted cash....................... (300,000) (479,729) (300,000) (479,729)
Purchase of available-for-sale securities......... (47,934,501) -- (47,934,501) --
Change in other assets............................ (22,260) (148,138) 37,200 (252,973)
------------- ------------- ------------- -----------------
Net cash used in investing activities............. (89,018,243) (4,665,188) (97,260,935) (5,052,408)
------------- ------------- ------------- -----------------

FINANCING ACTIVITIES
Proceeds from issuance of Series A Convertible
Preferred Stock................................. -- 26,700,000 -- 26,700,000
Proceeds from loan from officer, subsequently
converted into Series A Convertible Preferred
Stock........................................... -- 413,648 -- 1,000,000
Expenses from issuance of Series B Convertible
Redeemable Preferred Stock...................... (99,252) --
Proceeds from issuance of common stock upon
initial public offering, net of issuance
costs........................................... 132,800,179 132,800,179 --
Dividends paid to preferred stockholders.......... (3,831,154) (3,831,154) --
Proceeds from exercise of stock options........... 175,147 175,147 --
Proceeds from issuance of long-term debt.......... 7,943,029 663,000 11,280,629 770,872
Payment to former shareholders of acquired
businesses...................................... (3,360,740) -- (11,860,740) --
Payments on long-term debt........................ (911,632) (3,104) (1,409,090) (3,104)
Payments on capital lease obligations............. (314,732) -- (662,856) --
------------- ------------- ------------- -----------------
Net cash provided by financing activities......... 132,500,097 27,773,544 126,392,863 28,467,768
------------- ------------- ------------- -----------------
Net increase (decrease) in cash................... 21,748,222 21,373,351 (6,544,705) 21,589,870
Cash and cash equivalents at beginning of
period.......................................... 15,509,538 216,519 43,802,465 --
------------- ------------- ------------- -----------------
Cash and cash equivalents at end of period........ $37,257,760 $21,589,870 $37,257,760 $21,589,870
------------- ------------- ------------- -----------------
------------- ------------- ------------- -----------------
</TABLE>

SEE ACCOMPANYING NOTES.

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

JUNE 30, 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 six months ended June 30, 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:

<TABLE>
<CAPTION>
FOR THE PERIOD
FROM
THREE MONTHS ENDED JANUARY 14, 1998
JUNE 30, (DATE OF
------------------------ SIX MONTHS ENDED INCEPTION) THROUGH
1999 1998 JUNE 30, 1999 JUNE 30, 1998
----------- ----------- ---------------- ------------------
<S> <C> <C> <C> <C>
Numerator:
Net loss............................................ $(23,594,061) $(3,076,457) $(41,285,031) $ (3,214,689)
Dividends on Series A Convertible Preferred Stock... (424,300) (185,262) (2,328,150) (185,262)
Accretion of common stock subject to repurchase to
fair value........................................ -- (136,563) (23,938,069) (136,563)
Accretion of Series B Convertible Redeemable
Preferred Stock to fair value..................... -- -- (99,252) --
----------- ----------- ---------------- ------------------
$(24,018,361) $(3,398,282) $(67,650,502) $ (3,536,514)
----------- ----------- ---------------- ------------------
----------- ----------- ---------------- ------------------
Denominator:
Weighted-average number of shares of common stock
outstanding and not subject to repurchase during
the period........................................ 36,322,047 625,000 18,473,524 625,000
----------- ----------- ---------------- ------------------
Basic and diluted loss per common share............... $ (0.66) $ (5.44) $ (3.66) $ (5.66)
----------- ----------- ---------------- ------------------
----------- ----------- ---------------- ------------------
</TABLE>

Basic loss per share is based upon the average number of shares of common
stock outstanding during the periods. The 1998 computations exclude 718,750
shares of common stock subject to repurchase.

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)

JUNE 30, 1999 (UNAUDITED)

2. LONG-TERM DEBT

Long-term debt consists of the following:

<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
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 $ 628,872

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............................................ 217,689 214,144

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 1,744,313

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......................................................... 134,519 113,471

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 3,917,553

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.................................. -- 1,996,179

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.......................................................................... -- 1,961,024

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................................................................... -- 2,268,413

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.......... -- 2,074,924
</TABLE>

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

JUNE 30, 1999 (UNAUDITED)

2. LONG-TERM DEBT (CONTINUED)

<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1998 1999
------------- -------------
<S> <C> <C>
Note payable due on May 1, 2006 and bearing interest at 7.5% per annum. The note is
payable in monthly installments of principal and interest of $44,063 with all
unpaid principal and interest due at maturity. The note is secured by a mortgage
on the real property purchased with the proceeds. $ -- $ 7,044,768

Note payable due on March 1, 2001 and bearing interest at 6.6% per annum. The note
is payable in monthly installments of principal and interest ranging from $19,908
to $28,237 and is collateralized by the general assets of the Company............ -- 774,410

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 98,011
------------- -------------
Total.............................................................................. 7,682,093 22,836,082
Less: current portion.............................................................. 1,757,588 4,975,428
Less: discounts.................................................................... 692,711 566,764
------------- -------------
$ 5,231,794 $ 17,293,890
------------- -------------
------------- -------------
</TABLE>

Aggregate maturities of long-term debt at June 30, 1999 are as follows:

<TABLE>
<S> <C>
July 1, 1999 through December 31, 1999......................................... $2,429,144
2000........................................................................... 5,400,550
2001........................................................................... 6,441,335
2002........................................................................... 1,595,036
2003 and thereafter............................................................ 6,970,017
----------
Total.......................................................................... $22,836,082
----------
----------
</TABLE>

At June 30, 1999, the fair value of long-term debt approximates its carrying
value.

3. 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 June 30, 1999 includes these amounts in
long-term debt.

4. 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

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

JUNE 30, 1999 (UNAUDITED)

4. SEGMENT INFORMATION (CONTINUED)
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.

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 JUNE 30, 1999
--------------------------------------------
<S> <C> <C> <C>
PROFESSIONAL
IT
IMAP SERVICES CONSOLIDATED
------------- -------------- -------------
Revenues.................................................................. $ 3,376,658 $ 3,306,328 $ 6,682,986
Segment operating
(loss) profit............................................................ (3,169,944) 1,125,787 (2,044,157)
</TABLE>

<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1999
----------------------------------------------
<S> <C> <C> <C>
PROFESSIONAL IT
IMAP SERVICES CONSOLIDATED
------------- ---------------- -------------
Revenues............................................................... $ 4,579,785 $ 6,495,307 $ 11,075,092
Segment operating (loss) profit........................................ (6,011,898) 2,265,760 (3,746,138)
</TABLE>

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

<TABLE>
<CAPTION>
FOR THE PERIOD
FROM
JANUARY 14, 1998
(DATE OF
THREE MONTHS ENDED JUNE 30, INCEPTION)
---------------------------------------- SIX MONTHS ENDED THROUGH
1999 1998 JUNE 30, 1999 JUNE 30, 1998
------------------- ------------------- ---------------- ------------------
<S> <C> <C> <C> <C>
Segment operating loss for all segments.. $ (2,044,157) $ -- $ (3,746,138) $ --
Selling, general and administrative...... (13,674,305) (3,086,006) (25,283,048) (3,224,294)
Non-cash stock compensation expense...... (3,224,557) -- (3,360,238) --
Depreciation and amortization............ (4,912,417) (37,016) (8,846,042) (37,016)
Interest income.......................... 1,162,918 99,621 1,421,365 100,466
Interest expense......................... (901,543) (53,056) (1,470,930) (53,845)
------------------- ------------------- ---------------- ------------------
Net loss................................. $ (23,594,061) $ (3,076,457) $ (41,285,031) $ (3,214,689)
------------------- ------------------- ---------------- ------------------
------------------- ------------------- ---------------- ------------------
</TABLE>

5. INITIAL PUBLIC OFFERING

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
$132,800,000, after deducting underwriting discounts,

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

JUNE 30, 1999 (UNAUDITED)

5. INITIAL PUBLIC OFFERING (CONTINUED)
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.

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.

6. STOCK COMPENSATION PLAN

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 will
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.

7. COMMITMENTS

As of March 1999, the Company had entered into forward looking commitments
to purchase 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 print advertising campaigns.

In June 1999, the Company renegotiated this agreement to terminate upon
payment of the June 1999 quarterly payments.

11
<PAGE>
I.I.T. HOLDING, INC. AND SUBSIDIARIES (PREDECESSOR)

CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 1998 JUNE 30, 1998
-------------- -------------
<S> <C> <C>
(UNAUDITED)
Consulting revenue............................................. $ 1,611,470 $ 3,073,248
Cost of revenue................................................ 1,117,653 1,741,008
-------------- -------------
Gross profit................................................... 493,817 1,332,240

Operating expenses:
General and administrative................................... 552,549 1,033,736
Sales and marketing.......................................... 838 3,578
Stock compensation expense................................... -- --
Depreciation................................................. 16,208 17,979
-------------- -------------
569,595 1,055,293
-------------- -------------
Income (loss) from operations.................................. (75,778) 276,947
Interest expense............................................... (7,461) (13,623)
-------------- -------------
Net income (loss).............................................. $ (83,239) $ 263,324
-------------- -------------
-------------- -------------
</TABLE>

SEE ACCOMPANYING NOTE.

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

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED ENDED
JUNE 30, 1998 JUNE 30, 1998
------------- -------------
<S> <C> <C>
(UNAUDITED)
OPERATING ACTIVITIES
Net income...................................................... $ (83,239) $ 263,324
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation.................................................. 16,208 17,979
Change in assets and liabilities:
Accounts receivable......................................... (95,190) (249,508)
Other current assets........................................ 55,408 (30,144)
Other assets................................................ (32,854) (32,854)
Accounts payable............................................ (57,798) (1,792)
Accrued expenses............................................ 426,509 418,003
------------- -------------
Net cash provided by operating activities....................... 229,044 385,008

INVESTING ACTIVITIES
Acquisition of equipment and vehicle............................ (21,670) (43,330)
Proceeds from sale of vehicle................................... 17,504 17,504
------------- -------------
Net cash used in investing activities........................... (4,166) (25,826)

FINANCING ACTIVITIES
Repayment of note payable to stockholder........................ (37,207) (7,776)
Bank overdraft.................................................. -- (157,056)
Repayments of note payable...................................... -- (10,036)
Repayment of capital leases..................................... (11,158) (11,158)
------------- -------------
Net cash used in financing activities........................... (48,365) (186,026)

Effect of exchange rate changes on cash......................... 7,931 32,140
------------- -------------
Net increase in cash and cash equivalents....................... 184,444 205,296
Cash and cash equivalents at beginning of period................ 35,295 14,443
------------- -------------
Cash and cash equivalents at end of period...................... $ 219,739 $ 219,739
------------- -------------
------------- -------------
</TABLE>

SEE ACCOMPANYING NOTE.

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 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.

14
<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.

OVERVIEW

I.I.T. Holding, Inc., a predecessor of USI for accounting purposes,
specialized in systems analysis and design and systems integration solutions.
IIT provided 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 costs related to implementation of our services
and the continued expansion and enhancement of our network. As of June 30, 1999,
we have an accumulated deficit of approximately $73.7 million.

In April 1999, we completed an initial public offering of our common stock.
The net proceeds from the sale of the 6,900,000 shares of common stock offered
therein were approximately $132.8 million. The initial public offering of common
stock met the criteria for the automatic conversion of our outstanding Series A
Convertible Preferred Stock and Series B Redeemable Convertible Preferred Stock
into common stock. In addition, the repurchase rights lapsed with respect to all
common stock subject to repurchase.

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

15
<PAGE>
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.

HISTORICAL RESULTS OF OPERATIONS--USINTERNETWORKING

COMPARISON OF THE THREE MONTH PERIOD ENDED JUNE 30, 1999 TO THE PERIOD ENDED
JUNE 30, 1998

REVENUE. For the three months ended June 30, 1999, we generated $3.4
million in IMAP revenue, and $3.3 million in professional IT services revenue.
We generated no revenue for the same period in 1998 as we were in our
development stage.

GROSS MARGINS, COSTS OF SALES AND EXPENSES. We incurred $6.5 million in the
delivery of our IMAP services and $2.2 million in the delivery of our
professional IT services during the three months ended June 30, 1999 generating
gross margins of (93.9)% and 34.0%, respectively.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. For the three months ended
June 30, 1999, we incurred $13.7 million of selling, general and administrative
expenses compared to $3.1 million for the same period in 1998. The increase of
$10.6 million reflects the costs associated with the continued development and
maintenance of our products and infrastructure required to support our IMAP
services during a full quarter of operation in the period ended June 30, 1999,
compared to start-up activities during 1998.

NON-CASH STOCK COMPENSATION EXPENSE. For the three months ended June 30,
1999, we incurred $3.2 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 June 30, 1999 totaled $4.9 million. Of this amount, $1.3 million
represents the amortization of the goodwill recorded upon our acquisitions of
ACR and IIT; the remaining $3.6 million represents depreciation of our property
and equipment and the amortization of our prepaid software licenses. There was
minimal depreciation and no amortization expense for the comparable period in
1998.

INTEREST INCOME AND EXPENSE. For the three months ended June 30, 1999, we
incurred $0.9 million in interest expense and generated $1.2 million of interest
income. We had minimal interest income and expense during the period ended June
30, 1998.

COMPARISON OF THE SIX-MONTH PERIOD ENDED JUNE 30, 1999 TO THE PERIOD ENDED JUNE
30, 1998

REVENUE. For the six months ended June 30, 1999, we generated $4.6 million
in IMAP revenue, and $6.5 million in professional IT services revenue. We
generated no revenue for the period January 14, 1998, our date of inception,
through June 30, 1998 as we were in our development stage.

GROSS MARGINS, COSTS OF SALES AND EXPENSES. We incurred $10.6 million in
the delivery of our IMAP services and $4.2 million in the delivery of our
professional IT services during the six months ended June 30, 1999; generating
gross margins of (131.3)% and 34.9%, respectively.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. For the six months ended June
30, 1999, we incurred $25.3 million of selling, general and administrative
expenses compared to $3.2 million for the period January 14, 1998, our date of
inception, through June 30, 1998. The increase of $22.1 million reflects the
costs associated with the continued development and maintenance of our products
and infrastructure required to support our IMAP services during two full
quarters of operation in the period ended June 30, 1999, compared to start-up
activities during 1998.

16
<PAGE>
NON-CASH STOCK COMPENSATION EXPENSE. For the six months ended June 30,
1999, we incurred $3.4 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.

DEPRECIATION AND AMORTIZATION. Depreciation and amortization for the six
months ended June 30, 1999 totaled $8.9 million. Of this amount, $2.7 million
represents the amortization of the goodwill recorded upon our acquisitions of
ACR and IIT; the remaining $6.2 million represents depreciation of our property
and equipment and the amortization of our prepaid software licenses. There was
minimal depreciation and no amortization expense for the comparable period in
1998.

INTEREST INCOME AND EXPENSE. For the six months ended June 30, 1999, we
incurred $1.5 million in interest expense and generated $1.4 million of interest
income. We had minimal interest income and expense during the period ended June
30, 1998.

HISTORICAL RESULTS OF OPERATIONS--PREDECESSOR

COMPARISON OF THE SIX MONTH PERIOD ENDED JUNE 30, 1999 OF USI TO THE PERIOD
ENDED JUNE 30, 1998 OF PREDECESSOR

REVENUE. For the six months ended June 30, 1999, we generated $4.6 million
in IMAP revenue, and $6.5 million in professional IT services revenue. For the
six months ended June 30, 1998, IIT generated $3.1 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 June 30,
1999.

GROSS MARGINS, COSTS OF SALES AND EXPENSES. We incurred $10.6 million in
expenses in the delivery of our IMAP services and $4.3 million in expenses in
the delivery of our professional IT services during the six months ended June
30, 1999, generating gross margins of (151)% and 34.9%, respectively. IIT
incurred $1.7 million in expenses in the delivery of its professional IT
services for the six months ended June 30, 1998, resulting in a gross margin of
43.3%. The significant decrease in the professional IT services gross margin for
the period ended June 30, 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 June 30, 1999.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. For the six months ended June
30, 1999, we incurred $25.3 million of selling, general and administrative
expenses compared to IIT's $1.0 million for the period ended June 30, 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 June 30, 1999.

NON-CASH STOCK COMPENSATION EXPENSE. For the six months ended June 30,
1999, we incurred $3.4 million in non-cash compensation expense. IIT had no
non-cash stock compensation expense for the six months ended June 30, 1998.

DEPRECIATION AND AMORTIZATION. Depreciation and amortization for the six
months ended June 30, 1999 totaled $8.8 million. Of this amount, $2.7 million
represents the amortization of the goodwill created through our acquisitions of
ACR and IIT; the remaining $6.1 million represents depreciation of our property
and equipment and the amortization of our prepaid software licenses. IIT
incurred approximately $18,000 in depreciation expense for the six months ended
June 30, 1998.

INTEREST INCOME AND EXPENSE. For the six months ended June 30, 1999, we
incurred $1.5 million in interest expense and generated $1.4 million of interest
income. IIT had minimal interest expense and no interest income during the
period ended June 30, 1998.

17
<PAGE>
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 June 30, 1999 we had cash and cash equivalents of $37.3 million and
available-for-sale securities of $47.8 million.

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 six months
ended June 30, 1999 we have used $35.7 million in operating activities, $97.3
million in investing activities and generated $126.4 million from financing
activities. Included in financing activities was $132.8 million raised from our
initial public offering which was completed in April 1999.

USI has used debt and capital leases to partially finance its capital
purchases. As of June 30, 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), Nationwide
Mutual ($7.1 million), Transamerica Business Credit Corporation ($5.0 million),
Charter Financial, Inc. ($5.0 million), EMC Corporation ($4.2 million), LINC
Capital, Inc. ($3.0 million), Oracle Credit Corporation ($2.7 million), Leasing
Technologies International, Inc. ($2.0 million), Vision Financial Corporation
($2.0 million) and Hewlett Packard Company ($1.0 million), among others. The
total of the secured financing commitments at June 30, 1999 was $55.1 million,
of which $36.8 million had been funded. We have continued to seek secured
financing, and at July 31, 1999, we had secured commitments from several
additional sources, including Finova Capital Corporation ($11.7 million) and
Commercial Finance Corporation ($5.0 million).

In April 1999 we purchased an office building for $11.8 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 $7.7 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 next 12
months. As of June 30, 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 may need to
raise additional capital from equity or debt sources sooner than currently
anticipated. 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

18
<PAGE>
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 $1.0
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.

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 outside
consulting firm 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.

19
<PAGE>
- 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.

- Determine if additional analysis, remediation, testing or implementations
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 end of the third
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 middle of the fourth 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 June 30, 1999, USI has incurred approximately $0.5 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 and consulting fees. USI may also need to purchase replacement
products or other providers to assist in Year 2000 compliance efforts.
Currently, the estimated final cost of the Year 2000 compliance program is
approximately $0.8 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.

20
<PAGE>
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.

- 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.

21
<PAGE>
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 June 30, 1999, we invested our excess cash in cash equivalents.
Our long-term debt outstanding at June 30, 1999 requires the payment of interest
at fixed rates of interest. As of June 30, 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.

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 $2.0 million in other related expenses, the net proceeds to
USINTERNETWORKING were approximately $132.8 million.

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.

(d) The Company filed its first registration statement under the Securities
Act effective April 8, 1999, File No. 333-70717. From the effetive date of the
registration statement to June 30, 1999, the Company's use of net offering
proceeds was as follows:

<TABLE>
<CAPTION>
<S> <C>
Net offering proceeds to issuer............................... $132,800,000
-----------
-----------

Use of proceeds:
Property and equipment...................................... $32,818,000
Working Capital............................................. 6,457,000
Repayment of indebtness..................................... 1,227,000
Payments to former Shareholders of acquired businesses...... 3,361,000

Temporary investments:
Cash and cash equivalents................................... 37,258,000
Available-for-sale securities............................... 47,848,000

Other expenses:
Payment of accrued dividends................................ 3,831,000
-----------

$132,800,000
-----------
-----------
</TABLE>

22
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits.

27.1 Financial Data Schedule

(b) Reports on Form 8-K.

None

23
<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 AUGUST 13, 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>

24
<PAGE>
EXHIBIT INDEX

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

<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
OUR SECOND QUARTER 1999 FINANCIAL STATEMENTS
</LEGEND>
<MULTIPLIER>1,000

<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> MAR-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 37,258
<SECURITIES> 47,848
<RECEIVABLES> 7,648
<ALLOWANCES> (341)
<INVENTORY> 0
<CURRENT-ASSETS> 98,513
<PP&E> 73,749
<DEPRECIATION> (6,087)
<TOTAL-ASSETS> 204,991
<CURRENT-LIABILITIES> 24,477
<BONDS> 0
0
0
<COMMON> 39,709
<OTHER-SE> 116,748
<TOTAL-LIABILITY-AND-EQUITY> 204,991
<SALES> 6,683
<TOTAL-REVENUES> 6,683
<CGS> 0
<TOTAL-COSTS> 30,583
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 902
<INCOME-PRETAX> (23,594)
<INCOME-TAX> 0
<INCOME-CONTINUING> (23,594)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (23,594)
<EPS-BASIC> (0.66)
<EPS-DILUTED> (0.66)

</TABLE>