e10-k

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.

The aggregate market value of voting Common Stock held by non-affiliates of the registrant was approximately $207.3 million as of March 23, 2001.

The registrant had 143,958,315 shares of Common Stock outstanding as of March 23, 2001.

Certain information in the Registrant’s definitive Proxy Statement for its 2001 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission pursuant to Regulation 14A on or about April 9, 2001 is incorporated by reference in Part III of this Report.

From time to time, USinternetworking, Inc.^TM (USi^TM) may report, through its press releases and/or Securities and Exchange filings, certain matters that would be characterized as forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Reform Act”). These statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected. This report contains statements that constitute forward-looking statements. These statements appear in a number of places in this report and include statements regarding the intent, belief or current expectations of USi, its directors or officers, primarily with respect to the future operating performance of the Company. Readers are cautioned that such forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and that actual results may vary materially from those in the forward-looking statements as a result of various factors. The information contained in this report identifies certain important factors that could cause such differences, beginning on page 26 below and elsewhere in this report.

USi was established in 1998 as a full service, enterprise Application Service Provider (ASP) delivering the functionality of complex enterprise software as a service. “Full Service” means we take total responsibility for delivering the latest enterprise, e-business, and managed web hosting solutions over our proprietary Global Service Platform^SM (GSP^SM). Our GSP environment is designed specifically to provide superior performance for ASP solutions. Our GSP environment is located in secure, fully redundant data centers that we control and operate and from which our technicians and engineers provide 24 by 7 monitoring and support. Our ASP services are primarily delivered as Internet Managed Applications Provider^SM (iMAP^SM) offerings, which seamlessly integrate the hardware and software, networking and security, and 24 by 7 Client Care we provide to our clients. We also back our iMAP offerings with some of the highest service level guarantees in the industry. Our full service, comprehensive approach enables our clients’ organizations to gain the competitive advantage of advanced applications and web-based technologies, without having to divert time and resources from their core businesses.


	•	the Enterprise Application Business Unit (EABU), and
	•	the E-Business Services Unit (EBSU).

The EABU focuses on providing solutions for financial and human resource management, customer relationship management, messaging and procurement business process needs. The EBSU solutions include e-business B2B and B2C solutions, Enterprise Portal solutions, and AppHost^SM solutions for clients who want to run their own applications in USi’s robust environment.

The Gartner Group forecasts that by the end of 2004, the world wide ASP market will be worth just over $25 billion. We believe that the trends that have fueled the growth to date will continue to be prevalent factors in the ASP market’s future growth:


	•	Scarcity of skilled IT Professionals
	•	Increasing opportunities for businesses to gain advantage by shifting business processes onto the Internet
	•	Increasing complexity and availability of web-enabled software business applications
	•	Increasing need of businesses to reduce costs and focus resources on their own core competencies rather than on their software applications

We primarily target large enterprise clients (1,000 employees and above), which, according to industry estimates, make up the fastest growing market for ASP services. We believe that our full service

By delivering complex, enterprise scale software functionality as a service, we enable clients to focus their scarce IT and management resources on their own core business, while simultaneously improving the speed of deployment, the quality of on-going operations and reducing the total cost of ownership of the clients’ software applications. We have leveraged our experiences, gained from implementing complex applications in the GSP environment, to continually refine our solutions. As a result, we believe we can provide our solutions more rapidly, more reliably, and more economically than other solution providers or the clients themselves.

Our ability to consistently deliver our value proposition to enterprise clients stems from the experience and expertise we have developed in the areas of application knowledge and integration, and infrastructure design and operations. Most of our competitors have strength in one or the other of these areas, but not both. Our iMAP services are designed around an integrated approach to application deployment and ongoing operations and support. As a result, we can often demonstrate a higher level of reliability and security than our competitors.

Moreover, the experience we have gained providing integrated solutions to 168 clients has taught us valuable lessons that we have incorporated into our designs, our implementation approaches, and our operating processes. These improvements have enabled us to reduce implementation times, enhance reliability, and reduce our own costs. We believe that by continually reinvesting our experience to improve subsequent implementations, we can continue to add more value as our client base grows, and we can do so at increasingly lower costs.

We are able to provide a range of solutions to our clients. We actively seek to increase our sales to our growing enterprise client base by cross-selling our products and services. We have also begun to focus our product development and marketing efforts on specific vertical markets such as Financial Services and the Federal Government. Increasing our vertical focus enhances the relevance and value of our prior experience to our new clients and prospects within those vertical markets.

Our specialized and proprietary GSP environment provides our clients with a reliable solution hosted in total security, enabling us to take complete responsibility for the clients’ software application needs. The GSP environment was designed and engineered to ensure network and application uptime, quickly and accurately scale to meet our clients’ evolving needs, protect our clients’ data, and allow our staff to proactively monitor our clients’ services.


	•	USiOASIS^SM — service provisioning, and management platform

	•	USiView^SM — service monitoring platform

	•	USiSAN^SM— shared data management platform

	•	USiLink^SM — private IP networking service

	•	USiPriorityPeering^SM — public IP networking service

	•	USiTotalSecurityArchitecture^SM — integrated security management service

	•	USiIntegrate^SM — flexible and reliable EAI service

We have built and institutionalized our own integrated service delivery methodology called the iMAP Process. Our team organization, roles, responsibilities, workflows, quality assurance, and other matrices are

We believe that leveraging the economies of scale and skill allowed by our growing client base will enable us to achieve profitability. We believe the experiences gained through servicing our enterprise client base and designing, engineering and operating our GSP environment will enable USi to maintain a market leadership position.

We offer a full range of complementary value-added services designed to satisfy the rapidly evolving requirements in the ASP market. Our iMAP offerings encompass e-business services and enterprise application services, and typically include application consulting and integration as well as managed hosting and ongoing support. We also offer stand-alone consulting services. Our iMAP contracts usually provide for a modest up-front payment and are generally not less than three years in length. Our iMAP contracts provide for payment reductions in the event that agreed upon service levels, as measured and quantified by system performance benchmarks, are not met.


	•	Application consulting, systems integration, and integrated client services. Our application consultants are experts in major business process areas including e-business, customer relationship management, human resource and financial management, procurement, and messaging and collaboration. iMAP consulting and systems integration teams define, develop and offer a service that is fully integrated within the environment in which it is operating. Our application experts design client access to a combination of our network services, application software and related hardware necessary to provide our service and meet a specific client’s needs, guaranteed by industry leading service level agreements.

	•	USi-managed hosting platforms via our GSP environment. USi-managed client application hosting platforms are housed in one of two primary data centers on dedicated USi-managed servers and available via our reliable, high-performance and secure global Internet network. Our network architecture is designed to ensure responsiveness and maintain the security of the applications we manage.

Once implemented, iMAP offerings are efficiently managed by our client care experts who provide support twenty-four hours a day, seven days a week, based on special training of the specific functional and technical aspects of each client implementation. The application consulting teams that implement each client system are in place to support the application over the life of the relationship.

The e-business services includes e-business, B2B and B2C solutions, enterprise portal solutions, and AppHost solutions for clients’ custom application requirements. e-business solutions are based on both Microsoft Commerce Server 2000/BizTalk platforms and on BroadVision based platforms. Portal Solutions are based primarily on Plumtree, along with CS2K toolset and Broadvision InfoExchange. Apphost Solutions provide application hosting managed support, including platforms based on BEA WebLogic Server, Oracle RDBMS, Microsoft SQL Server, Windows 2000, Windows NT and UNIX.

The e-business services area constituted over 50% of our iMAP business as of December 31, 2000. The majority of our business in the year 2000 was centered around e-business and B2C opportunities, primarily utilizing the BroadVision set of applications. However, looking forward into 2001, we expect a shift of business toward B2B and enterprise Portal opportunities, and an emphasis on Microsoft based solutions. The AppHost business represented the balance of the business in this area, and we expect continuing demand for our managed hosting business in 2001.

The Enterprise Applications Services are focused on providing solutions for financial management, human resource management, customer relationship management, and messaging and procurement business process needs. Application expertise in the PeopleSoft and Lawson applications provides the basis for the iMAP offerings for financial management and human resource management services. Our relationship with Siebel is the basis for our set of services related to ebusiness customer relationship management. In messaging, we are the industry’s largest provider of hosted solutions providing Microsoft Exchange, and have implemented and supported large enterprise clients with over 10,000 end users. Finally, we have implemented procurement solutions based on Ariba to large enterprise clients.

The Enterprise Applications Services represented just under 50% of our iMAP business as of December 31, 2000. With the increasing demand for these front office application products, we expect to see a greater emphasis on Enterprise based opportunities in 2001.

Our application and technology experts are also utilized to supplement our iMAP offerings by providing consulting services to both iMAP and non-iMAP clients. We leverage the expertise gained by over 200 client implementations to provide application implementation and support services, networking consulting, database administration consulting, business process support and supplemental staffing services to clients. In 2000, consulting services accounted for approximately 15% of our revenue.

We designed our global network specifically to provide superior performance to USi’s iMAP offerings. By maintaining architectural and operational control over the entire network up to the point at which the client’s traffic leaves its ISP backbone, WAN provider or corporate LAN, our network is designed to:


	•	provide uptime of 99.5% or better to the entire network solution

	•	provide fast and predictable response time and access to customer content globally; and

	•	provide reliable and customized platform security.

Our network is designed around Cisco networking hardware, which minimizes multi-vendor integration and reduces the risks of hardware incompatibility and implementation delay. Cisco has designated our network as a Cisco Powered Network, indicating that Cisco has reviewed and approved the network design. Our network architecture relies on redundant network hardware, facilities infrastructure such as power supplies and telecommunications circuits. This infrastructure design supports geographical data replication to ensure that high available client requirements can be achieved seamlessly.

Our 24 by 7 Global Enterprise Management Center^TM (GEMC^TM) staff manages and monitors the entire GSP environment, including the network systems environment, telecommunications hardware and data content servers in all of our data centers. The GEMC engineers use USiView, our global enterprise management system, which we have developed over the past 3 years, to meet the specific needs of application hosting. USiView consists of an integrated suite of scalable software tools that allow the USi staff to proactively monitor systems-level events, processes and thresholds.

In order to facilitate the rapid user session response, we have designed our PriorityPeering network to avoid congestion areas on the Internet and have specifically designed our primary GEMC to support our integrated network. We seek to avoid the known Internet congestion points at the metro area exchanges (MAEs) and at the network access points (NAPs). In order to bypass the MAEs and NAPs, our network in North America connects directly with eight major Internet Service Providers’ backbones, which carry about 85% of all the traffic on the Internet today. Client data is routed directly over an ISP’s network to our network, bypassing congested public exchange points.

Security is paramount to our GSP environment. We employ a 24 by 7 security team to ensure that our clients’ data are protected. Each client solution is secured by multiple levels of security. Every one of our customers has dedicated, redundant firewalls. Every WAN connection is physically diverse and separated from all other connections and network services. In addition, access to our data centers is restricted to authorized personnel by card and/ or hand scan readers, which also monitor and record entrances and departures. We believe that these measures ensure complete separation and security between the public and private networks.

In developing our iMAP offerings, we have formed relationships with some of the best of breed software application providers including Ariba, BroadVision, Lawson, Microsoft, Oracle, PeopleSoft, Plumtree and Siebel. Each of our software agreements is unique, but most allow us to deploy packaged application software as a service to a client without transferring title to the licensed software. The agreements also generally include co-marketing, specialized product training and preferred pricing on the licenses to the software.

We are certified as a Microsoft Gold Certified Partner for Hosting and Application Services. As a Microsoft Gold Certified Partner for Hosting and Application Services, USi receives exclusive benefits from Microsoft Corp., including usage of the Gold Certified Partner logo, priority lead referrals, early access to product information and inclusion in various business development and marketing activities reserved for Gold Certified Partners.

We are the first ASP to provide a hosted corporate portal as part of the Plumtree Hosted Solutions Program. Through our agreement with Plumtree, our clients can take advantage of a new model for deploying the Plumtree Corporate Portal platform. Our agreement with Plumtree includes joint “go to market” strategy targeting mid to large enterprises, product development and testing, implementation and customer support, sales force training, and lead referral programs.

We offer our services via a direct sales organization which is managed geographically throughout the U.S. The sales management teams manage the sales representatives, who own the relationship with the client opportunity, as well as the sales engineers, who own the specific application and hosting technical knowledge specific to the services being offered. In addition, our business development team cultivates sales opportunities through relationships with our hardware and software systems integrator channel partners. Our sales relationship with the client is relationship-centric, meaning that our clients become long term opportunities for selling service upgrades and cross-selling our services.

We target primarily North American-based enterprises and divisions of larger multinational organizations. We believe that these organizations will gain the most competitive advantage from our iMAP offerings and that they provide the greatest opportunity for the outsourcing of information technology operations. Currently, business software application vendors are providing software predominantly to larger organizations. International Data Corporation projects that large enterprise businesses (1,000 employees or more) to be the fastest growing ASP market segment.

We currently have clients for both our iMAP offerings and traditional information technology services. Revenues from our iMAP offerings comprised 85% of total revenue for the year ended December 31, 2000. As of December 31, 2000 we had 233 signed contracts with 168 clients for our iMAP offerings, representing over $354 million in expected contract revenue (assuming payments over the full contract terms) and approximately

We were the first ASP on the federal government’s GSA schedule. We have entered into contracts with a number of government agencies, such as the Federal Railroad Administration, which can be terminated for convenience by the government. The loss of these contracts would not have a material adverse effect on our business.

For the year ended December 31, 2000, sales to SiebelNet accounted for approximately 10.2% of our revenues.

The market for Internet-related services is extremely competitive. We anticipate that competition will continue to intensify as the use of the Internet grows. In the market for Internet-enabled application software and network solutions, we compete on the basis of performance, price, software functionality and overall network design & infrastructure. While our competition comes from many industry segments, we believe that no single segment provides the integrated, single-source solution that we provide.


	•	In-house corporate IT staff

	•	Other ASP’s

	•	Web-hosting and managed hosting service providers

	•	Local, regional, and national commercial Internet Service Providers and telecommunications companies

	•	Local, regional and national commercial systems integrators

	•	Hardware and enterprise software application vendors

Our competitors may operate in one or more of these areas and include such companies as Accenture, AT&T, Corio, Digex, EDS, IBM, Oracle, Qwest Communications, SAP and Sprint. While we believe our “full service” methodology of delivering best of breed software applications sets us apart from these competitors, some of these competitors have significantly greater network coverage, market presence, and financial, technical and personnel resources than we do.

It is possible that new competitors or alliances may emerge and gain market share. Such competitors could materially affect our ability to obtain new contracts. Further, competitive pressure could require us to reduce the price of our products and services thus affecting our business, financial condition and results from operations.

We rely on a combination of copyright, trademark, service mark and trade secret laws and contractual restrictions in order to establish and protect certain proprietary rights which are important to our business. We obtained federal trademark protection for “USinternetworking” on October 19, 1999, “USi” logo on

October 19, 1999, “IMAP” on October 17, 2000, “Internet Managed Application Provider” on August 1, 2000, and “PriorityPeering” on September 19, 2000. We obtained trademark protection in Benelux for “USINTERNETWORKING” on May 19, 1999, “iMAP” on May 19, 1999, and “USI” logo on May 19, 1999, while various other domestic and foreign trademark and patent applications are pending. There is no guarantee that these pending applications will be granted. We also rely upon certain software and technologies we license from third parties which are incorporated into the services we provide to our clients. There can be no assurance that these third party technology licenses will continue to be available to us on commercially reasonable terms. The loss of such software or technology could require us to obtain substitutes of lower quality or performance standards, or at greater cost, which could harm our business.

We incur product research and development costs related to expanding our portfolio of iMAP offerings. These costs primarily include labor costs associated with the testing of new product offerings, including the evaluation of hardware and software applications functionality in an iMAP offering environment.

As of March 23, 2001, we employed approximately 1,134 full-time employees, of which approximately 78% were technicians and engineers. None of our employees are covered by a collective bargaining agreement. We believe that our employee relations are good.

The following sets forth certain information regarding our current directors and executive officers as of December 31, 2000.

Christopher R. McCleary is a co-founder of USi and has served as the Chairman of USi since July 2000. He also served as Chairman and Chief Executive Officer from January 1998 to July 2000. Prior to founding USi, he was the Chairman and Chief Executive Officer of DIGEX, Inc. from January 1996 to December 1997. Prior to serving at DIGEX, Mr. McCleary served as Vice President and General

Manager for Satellite Telephone Service at American Mobile Satellite Corporation, a satellite communications company, from October 1990 to January 1996. He currently serves on the board of directors of Carescience, Inc., Internet Cable Corporation, Radware, Inc. and Empower Media, Inc.

Andrew A. Stern has been Chief Executive Officer and a Director since July 2000. Previously, he served as Executive Vice President and Chief Operating Officer, with responsibility for the Company’s Business Units, Sales, and Marketing. He originally joined USi in July 1998 as Executive Vice President and Chief Financial Officer. Prior to joining USi, Mr. Stern held positions at USF&G Corporation, an insurance company, from May 1993 to July 1998, most recently as Executive Vice President, Strategic Planning and Reinsurance Operations. In addition, Mr. Stern was a partner of Booz Allen & Hamilton, an international management and technology consulting firm with whom he was employed from August 1981 to May 1993.

Harold C. Teubner, Jr. has been Executive Vice President and Chief Operating Officer of USi since July 2000. From May to June 2000, Mr. Teubner was Executive Vice President of Network Applications Group. He joined USi as Executive Vice President and Chief Financial Officer in October 1999. From July 1998 until joining USi,Mr. Teubner worked as an independent consultant in the technology industry. Mr. Teubner served as the Executive Vice President and Chief Operating Officer at Concept Five Technologies from July 1997 to July 1998. During September 1996, Mr. Teubner served as COO of Nat Systems International, a French software company. Prior to joining Concept Five Technologies, Mr. Teubner was President and CEO of Visix Software, a company that builds high-end, object oriented, application development tools. Mr. Teubner was with Visix from July 1995 to June 1996. Mr. Teubner held positions with Sybase Inc. from January 1988 to April 1995. While at Sybase, Mr. Teubner served as the Senior Vice President of North American Operations from July 1992 to April 1995.

Gary J. Rogers has been Senior Vice President, Worldwide Marketing and Sales since January 2001. Mr. Rogers joined USi in October 1999 as Senior Vice President, Worldwide Sales. Prior to joining USi, Mr. Rogers was with CMS/ Data, a division of PC Docs Group International, Inc. from September 1997 to September 1999. While at CMS/ Data, he served in various capacities including: Vice President, Sales and Marketing and President, Chief Operating Officer. From May 1994 to July 1997, Mr. Rogers was with SQL Financials International, Inc. where he worked as Vice President of Sales and Regional Sales Manager. Mr. Rogers was an Area Sales Manager with The ASK Group/ Ingres from August 1990 to April 1994.

Mary T. Weaver has been Chief Administrative Officer since August 2000. She was promoted to Senior Vice President and Chief Administrative Officer in February 2001. She is responsible for USi’s administrative functions including Human Resources, Management Information Systems, Facilities, Telecommunications, Legal, Corporate Asset Security, Internal Communications and Administration. Ms. Weaver joined USi as Vice President Solutions Engineering for the Enterprise Application Business Unit in July 2000. From October 1988 to May 2000 she was with The Hunter Group, where she served most recently as Senior Vice President of Human Resources Information Technology and Facilities and was a member of the board of directors. Ms. Weaver’s prior roles at The Hunter Group included Senior Vice President of Education Services and CFO/Treasurer. She is a CPA in the state of Maryland.

Mark J. McEneaney joined USi in April 1998 as its Vice President and Corporate Controller. In October 1999 Mr. McEneaney was promoted to Senior Vice President and Controller and in May 2000 was promoted to Chief Financial Officer. Prior to USi, he was Chief Financial Officer of Questar Builders, Inc., from November 1997 to March 1998 and of William Ryan Homes, Inc. from April 1995 to October 1997. Mr. McEneaney held several positions with Ernst & Young from January 1986 through March 1995, most recently Senior Manager in the audit department.

Stephen E. McManus is a co-founder of USi and has served as a director since April 1998. He served as President of USi until June 1999, at which time he became President of our E-Business Services Unit. Prior to joining USi, Mr. McManus was Director of U.S. Sales for the telecommunications unit of Data General Corporation from January 1998 to March 1998. From June 1995 to December 1997 Mr. McManus served as a Branch Manager for Silicon Graphics. Prior to joining Silicon Graphics,

Michael Harper has been President and General Manager, Enterprise Application Business Unit since January 2001. Mr. Harper joined USi in April 1998 as Vice President of Product Marketing. In January 1999, Mr. Harper was promoted to Vice President and General Manager of our PeopleSoft Business Unit. In July 1999, Mr. Harper was named President and General Manager of the PeopleSoft Business Unit. Prior to joining USi, Mr. Harper served as the Mid-Atlantic Systems Manager for Silicon Graphics, Inc. from July 1997 to April 1998 with responsibility for pre-sales and professional service to federal and commercial customers. Prior to Silicon Graphics, Mr. Harper was with IBM in various marketing, sales and professional service capacities from July 1989 to July 1994.

William T. Price has been Vice President, Secretary and General Counsel of USi since April 1998. Prior to joining USi, Mr. Price was the senior trial associate in the Baltimore-based law firm of Albright, Brown & Goertemiller from April 1997 to April 1998, where he represented major corporate clients in antitrust, copyright, intellectual property and other commercial matters in various state and federal courts. Prior to joining Albright, Brown & Goertemiller, Mr. Price was a litigator and Managing Attorney for the New York based law firm of Finklestein and Levine. Mr. Price was with Finklestein and Levine from April 1993 to October 1996.

Frank A. Adams was appointed to the board of directors in June 1998 as a designee of the Grotech Capital Group. He is the Managing General Partner of Grotech Capital Group, which he co-founded in August 1984. Mr. Adams served as President of the Mid-Atlantic Venture Association from July 1985 through December 1998 and is currently its Chairman. He has served on the board of directors of a number of technology companies including Thunderbird Technologies, Inc. Interspec, DIGEX and Quality Software Products.

Cathy M. Brienza was appointed to the board of directors in May 1999 as a designee of Waller-Sutton Media Partners, L.P. She is a principal and co-founder of WallerSutton 2000, L.P., and, since July 1997, of Waller-Sutton Media Partners, L.P. Prior to joining Waller-Sutton Media, she was a principal of Sutton Capital Associates, Inc., and its affiliated companies, which engaged in the ownership and operation of cable television and cellular telephone systems.

Michael C. Brooks was appointed to the board of directors in December 1998 as a designee of the Whitney Group. He joined Venrock Associates in May 2000 as a General Partner, where he concentrates on information technology, focusing on the Internet. Prior to joining Venrock, Mr. Brooks was a general partner of J. H. Whitney & Co. from 1984. He is also a director of SunGard Data Systems, Inc. and several private companies.

Benjamin Diesbach was appointed to the board of directors in May 1998 as a designee of Mr. McCleary in his role as Chief Executive Officer of USi. He has been President of Midwest Research, Inc., a consulting firm, since he formed it in January 1995. Prior to forming Midwest Research, Mr. Diesbach was Chief Executive Officer of Continental Broadcasting, Ltd., a broadcasting company, from September 1993 to January 1995.

William F. Earthman was appointed to the board of directors in June 1998 as a designee of the Massey Burch Group. He has been a Partner of Massey Burch Capital Corporation since January 1994. Prior to becoming a Partner at Massey Burch Capital Corporation, Mr. Earthman served from January 1990 as a Vice President of Massey Burch Investment Group. Prior to Massey Burch, he worked for the investment banks J.C. Bradford & Co. from September 1975 to October 1981, Prudential-Bache Securities from October 1981 to November 1985 and First Nashville Corp. from December 1985 to December 1989. He currently serves on the board of directors of several private companies.

R. Dean Meiszer has been a director of USi since it was founded. Currently, Mr. Meiszer serves as the President of Lattice Communications, Ltd. Lattice Communications was formed in January 1999 by the principals and associates of Crisler Company to own, operate, and manage wireless transmission towers and related businesses. Mr. Meiszer has been President and Managing Director of The Crisler Company, a

David J. Poulin was appointed to the board of directors in May 1998 as a designee of Mr. McCleary in his role as Chief Executive Officer of USi. He has been the head hockey coach at the University of Notre Dame since May 1995. Prior to joining Notre Dame as hockey coach, Mr. Poulin played in the National Hockey League for 13 years.

Ray A. Rothrock was appointed to the board of directors in June 1998 as a designee of the Venrock Group. He has been a General Partner of Venrock Associates, the high technology venture capital investment firm of the Rockefeller Family, since June 1988. Mr. Rothrock serves on the boards of directors of CheckPoint Software Technologies and several private companies.

John H. Wyant was appointed to the board of directors in June 1998 as a designee of the Blue Chip Group. He is a General Partner and President of Blue Chip Venture Company, which he founded in 1990. Mr. Wyant is currently a director of Regent Communications, @plan, and several private companies. He previously served as a director of DIGEX.

Joseph R. Zell was appointed to the board of directors in July 1998 as a designee of U S WEST, and appointed as an independent outside director in April 2000. He is President and Chief Executive Officer, and a director of Convergent Communications, Inc. From November 1991 to April 2000, he held several positions with the !NTERPRISE Networking division of U S WEST Communications, Inc., including Director of Product Development for !NTERPRISE, Executive Director of Applications Innovation, President of U S WEST’s Wholesale Division and Vice President of Markets and innovation at !NTERPRISE. He was President of the division from March 1997 to April 2000.

We are headquartered in Annapolis, Maryland. Our training and conference facilities are located in a building we own in Annapolis, Maryland. We believe that the building we own, due to its age, may contain limited amounts of asbestos containing materials. We do not believe that the limited asbestos presence would subject us to any material liability.

On April 30, 1999, we purchased land and a building in which our headquarters resides in Annapolis, Maryland for $11.8 million. The seller financed $8.6 million of the purchase price through a first mortgage note. A second mortgage of $4.75 million was obtained on the property in December 1999. The second mortgage was provided by a major institutional lender and partially guaranteed by the State of Maryland.

In May 2000, a limited liability company, GEMC Properties, LLC, of which we are the sole member, purchased the land and building in which our original data center resides in Annapolis, Maryland for $9 million. GEMC Properties, LLC, obtained financing for the purchase in the amount of $6,750,000 from a major institutional lender.

We lease space in a number of other locations, primarily for data center installations and to house our sales, consulting and implementation staff. We believe that our leased facilities are adequate to meet our current needs in the markets in which we have begun to deploy our services, and that additional facilities are available to meet our expansion needs in our target markets for the foreseeable future.

Our leases are for terms varying from 30 to 84 months and generally contain renewal options of two to three years as well as rent escalation clauses. During 2000 we incurred approximately $7.8 million in rent expense.

From time to time we may be involved in litigation that arises in the normal course of business operations. As of the date of this report, we are not a party to any litigation that we believe could reasonably be expected to have a material adverse effect on our business or results of operations.

No matters were submitted to a vote of security holders during the fourth quarter of 2000.

Item 5. Market for Registrant’s Common Equity and Related Shareholder Matters

On April 9, 1999, we sold 15,525,000 shares of our common stock pursuant to a Registration Statement on Form S-1 (Registration No. 333-70717), which was declared effective by the Commission on April 9, 1999. Credit Suisse First Boston Corporation was the managing underwriter. The net proceeds were approximately $132.8 million, all of which have been used:


	•	to continue expanding and enhancing our network and facilities,

	•	to add additional services to our iMAP offerings, and

	•	for working capital and other general corporate purposes.

In addition, we used some of the proceeds to pay accrued dividends on our shares of convertible preferred stock. Some of the net proceeds were also used:


	•	to repay current or future debts,

	•	to fund acquisitions or acquire complementary products, or

	•	to obtain the right to use complementary technologies.

On February 17, 2000, we sold 3,000,000 shares of our common stock and some of our shareholders sold an aggregate of 7.35 million shares of our common stock pursuant to a Registration Statement on Form S-1 (Registration No. 333-95543), which was declared effective by the Commission on February 17, 2000. Credit Suisse First Boston Corporation was the managing underwriter. The net proceeds were approximately $119.2 million, all of which has been used:


	•	to continue expanding and enhancing our network and facilities;

	•	to increase marketing efforts;

	•	to invest in licenses, research and product development in order to add new applications to our iMAP offerings;

	•	to finance debt service;

	•	to acquire complementary products; and

	•	for working capital and other general corporate purposes.


	•	to repay current or future debts;

	•	to obtain the right to use complementary technologies; and

	•	to fund acquisitions that we may pursue on an opportunistic basis.

On November 15, 2000, we sold 3,126,038 shares of our common stock for an aggregate purchase price of $10,000,000 to Acqua Wellington North American Funds Equities, Ltd. This sale was pursuant to a registration statement on Form S-3 (Registration no. 333-47858), which was declared effective by the Commission on November 15, 2000. The proceeds have been and will be used for general corporate purposes, including working capital to fund anticipated operating losses, expenses and capital expenditures.

On February 15, 2001, we sold 1,612,755 shares of our common stock for an aggregate purchase price of $5,000,000 to Acqua Wellington North American Funds Equities, Ltd. This sale was pursuant to a

registration statement on Form S-3 (Registration No. 333-47858), which was declared effective on February 15, 2001. The proceeds will be used for general corporate purposes, including working capital to fund anticipated operating losses, expenses and capital expenditures.

Our common stock has been traded on The Nasdaq National Market under the symbol “USIX” since the completion of our initial public offering in April 1999.

The following table sets forth, for the periods indicated, the high and low prices of our common stock on The Nasdaq National Market for the second, third and fourth quarters of 1999, each of the four quarters of 2000 and the first quarter of 2001:

The last sale price of the common stock on The Nasdaq National Market on March 23, 2001 was $1.44

As of March 23, 2001, there were 2,791 stockholders of record and approximately 64,960 beneficial stockholders of record of our common stock.

We have never paid cash dividends on our common stock and have no plans to do so in the forseeable future. The declaration and payment of any dividends in the future will be determined by the board of directors and will depend on a number of factors, including our earnings, capital requirements and overall financial condition. The payment of dividends is also restricted by the terms of our indebtedness.

Set forth in chronological order is information regarding all securities sold and employee stock options granted by the Company since January 14, 1998. Further included is the consideration, if any, received by the Company for such securities, and information relating to the section of the Securities Act of 1933, as amended (the “Securities Act”), and the rules of the Securities and Exchange Commission under which exemption from registration was claimed. All awards of options did not involve any sale under the Securities Act. None of these securities were registered under the Securities Act. Except as described below, no sale of securities involved the use of an underwriter and no commissions were paid in connection with the sales of any securities.


	1.	At various times during the period from January 1998 through March 22, 1999, the Company granted to employees and directors options to purchase an aggregate of 7,710,455 shares of Common Stock with exercise prices ranging from $1.17 per share to $2.67 per share. The issuance of these securities


		were not registered under the Securities Act in reliance upon Rule 701 of the rules promulgated under the Securities Act.

	2.	On January 14, 1998, the Company issued 1,406,250 shares of Common Stock to Christopher R. McCleary for $5,000 in cash.

	3.	On April 1, 1998, the Company issued a total of 1,617,187 shares of Common Stock to Stephen E. McManus and Christopher Poelma for an aggregate purchase price of $57,500. The purchase price for the Common Stock was paid with cash and notes payable to the Company.

	4.	On May 31, 1998, the Company issued 38,333.33 shares of Series A Preferred Stock for an aggregate purchase price of $23 million to the Initial Series A Investors. The purchase price for such shares was paid in cash at the time of the issuance. The Company simultaneously issued 1,666.67 shares of Series A Preferred Stock for an aggregate purchase price of $1 million to Christopher R. McCleary. The purchase price for such shares was paid by the forgiveness by Mr. McCleary of $1 million of debt that the Company owed him.

	5.	On June 18, 1998, the Company issued 5,000 shares of Series A Preferred Stock for an aggregate purchase price of $3 million to certain of the Initial Series A Purchasers. The Company simultaneously issued 5,833.33 shares of Series A Preferred Stock for $3.5 million to U S WEST. The purchase price for such shares was paid in cash at the time of issuance.

	6.	On June 19, 1998, the Company issued 3,000 shares of Series A Preferred Stock for an aggregate purchase price of $1.6 million to HAGC Partners, Chris Horgan (who later transferred his interest to his affiliate, Southeastern Technology Fund, L.P.) and the Account Management Purchasers. The purchase price for such shares was paid in cash at the time of issuance. The Company simultaneously issued 1,166.67 shares of Series A Preferred Stock for a purchase price of $700,002 to USi Partners. The purchase price for such shares was paid in cash at the time of issuance.

	7.	On July 27, 1998, the Company issued to Andrew A. Stern 1,406,250 shares of Common Stock with a fair market value of $1,000,000. Mr. Stern paid $5,000 in cash for these shares, and the remainder was recorded as a compensation expense to the Company.

	8.	On September 8, 1998, the Company issued convertible promissory notes in the aggregate amount of $9,095,000, together with warrants to purchase 2,192,512 shares of Common Stock for $1.53 per share, to certain of the existing holders of the Series A Preferred Stock. The purchase price for such notes and warrants was paid in cash at the time of issuance. The Company also issued warrants to purchase 112,500 shares of Common Stock for $7.11 per share, to IIT as part of the purchase price paid in the acquisition of IIT.

	9.	On September 22, 1998, the Company issued warrants to purchase 167,409 shares of Common Stock for $1.49 per share to Trans America Business Credit in connection with loans the Company obtained from it.


10.	On September 30, 1998, the Company issued warrants to purchase 971 shares of Series B Preferred Stock for $1,050.00 per share, to Venture Lending and Leasing in connection with loans the Company obtained from it.

11.	On October 2, 1998, the Company issued warrants to purchase 140,625 shares of Common Stock for $7.11 per share, to ACR as part of the purchase price paid in the acquisition of ACR.

12.	On December 16, 1998, the Company issued convertible promissory notes in the aggregate amount of $8 million to certain of the existing holders of the Series A Preferred Stock. The purchase price for such notes was paid in cash at the time of issuance.

13.	On December 18, 1998, the Company issued warrants to purchase 40,178 shares of Common Stock for $1.49 per share, to Leasing Technology, Inc. in connection with loans the Company obtained from it.


14.	On December 24, 1998, the Company issued convertible promissory notes in the amount of $5 million to U S WEST. The purchase price for such notes was paid in cash at the time of issuance.

15.	On December 31, 1998, the Company issued 59,278.56 shares of Series B Preferred Stock for an aggregate purchase price of $62,242,500 to certain holders of the convertible promissory notes described above, certain holders of Series A Preferred Stock, and a number of new investors. Of the total purchase price for such shares, $40,147,500 was paid in cash and $22,095,000 was paid by conversion of outstanding convertible promissory notes with an equivalent principal amount, all at the time of issuance.

16.	On October 29, 1999 the Company issued $100,000,000 7% Convertible Subordinated Notes Due November 1, 2004. The purchase price of such notes was paid in cash at the time of issuance. The issuance of these notes was not registered under the Securities Act in reliance on the exemption from registration provided by Section 4(2) of the Securities Act, and resales of these Notes have been exempt from registration under Rule 144A.

17.	On November 5, 1999 the Company issued $25,000,000 7% Convertible Subordinated Notes Due November 1, 2004. The purchase price of such notes was paid in cash at the time of issuance. The issuance of these notes was not registered under the Securities Act in reliance on the exemption from registration provided by Section 4(2) of the Securities Act, and resales of these Notes have been exempt from registration under Rule 144A.

18.	On June 30, 2000, the Company issued a warrant to purchase 80,000 shares of common stock for $20.44 per share, to AT&T Corp. in connection with a joint marketing agreement with the Company.

19.	On November 3, 2000, the Company issued 9,007,353 shares of its common stock with certain registration rights for an aggregate purchase price of $30,625,000 to the Company Chairman Christopher R. McCleary, Chief Executive Officer Andrew A. Stern, certain venture investors, Microsoft, Inc., CFE, Inc. (a wholly owned subsidiary of GE Capital) and Aether Systems. The Company also issued to these holders warrants to purchase 3,152,573 shares of common stock for $4.08 per share.

20.	On December 1, 2000 the Company issued warrants to purchase 18,394 shares of common stock for $3.00 per share, to TCG Holdings, LLC, two of its employees and one independent consultant in connection with Innovative Software Engineering Practices, Inc.’s (a wholly-owned subsidiary of TGC Holdings, LLC) consulting work for the Company.

21.	On January 2, 2001, the Company issued 27,022,059 shares of its common stock with certain registration rights for an aggregate purchase price of $91,875,000 to the Company Chairman Christopher R. McCleary, Chief Executive Officer Andrew A. Stern, certain venture investors, Microsoft, Inc., CFE, Inc. (a wholly owned subsidiary of GE Capital) and Aether Systems. The Company also issued to these holders warrants to purchase 9,457,721 shares of common stock for $4.08 per share.

The issuances and resales of the securities above were made in reliance on one or more exemptions from registration under the Securities Act, including those provided by Section 4(2) and Rules 144A and 701 thereunder. The purchasers of these securities represented that they had adequate access, through their employment with the Company or otherwise, to information about the Company.


	•	our historical consolidated financial data for the period from our date of inception, January 14, 1998, through December 31, 1998 and as of December 31, 1998;

	•	our historical consolidated financial data for the two years ended December 31, 2000 and as of December 31, 1999 and 2000.

The selected financial data have been derived from, and is qualified by reference to, our audited consolidated financial statements for the periods presented. Our audited consolidated financial statements for the period from our inception through December 31, 1998 include the results of I.I.T. Holding, Inc., or IIT, from September 8, 1998 through December 31, 1998 and the results of Advanced Communication Resources, Inc., or ACR, from October 2, 1998 through December 31, 1998. Our audited consolidated financial statements for the year ended December 31, 1999 include the results of Conklin & Conklin, Inc. from October 8, 1999 through December 31, 1999. Our audited consolidated financial statements for the year ended December 31, 2000 include the results of EnableVision, LLC from September 1, 2000 through December 31, 2000.

You should also read “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and related notes of USi and IIT included in Part II, item 7 of this Form 10-K.


	•	the Series B preferred stock is not presented as a part of our stockholders’ equity in 1998 because it was mandatorily redeemable upon the eighth anniversary of its issuance (the Series B was converted into common stock upon the closing of our initial public offering); and

	•	we do not present 3,023,438 shares of common stock held by three officers as part of our stockholders’ equity in 1998 because we would have been obligated to repurchase these shares at fair market value if any of these officers had died or had become disabled before our initial public offering. See Note 12 of the Notes to USi’s Consolidated Financial Statements. These provisions terminated upon the consummation of our initial public offering.

On September 8, 1998, we acquired I.I.T. Holding, Inc. and its two wholly-owned subsidiaries, International Information Technology Inc., a U.S. subsidiary, and International Information Technology IIT, C.A., a Venezuelan subsidiary. We refer to these businesses collectively as IIT. IIT’s operations commenced on May 20, 1994 upon the incorporation of the U.S. subsidiary. The Venezuelan subsidiary was formed on March 6, 1996. For accounting purposes, IIT is the predecessor of USi, which was incorporated in January 1998.


	•	the historical consolidated financial data of IIT for the fiscal years ended December 31, 1996 and 1997 and as of December 31, 1996 and 1997; and

	•	the historical consolidated operating statement data of IIT for the eight month period ended August 31, 1997; and

	•	the historical consolidated operating statement data of IIT for the period from January 1, 1998 through September 7, 1998.

The financial statement data for the periods 1996 and eight months ended August 31, 1997 have been derived from the unaudited financial statements of IIT. The selected financial data as of December 31, 1996 and 1997 and for the years then ended and the selected financial data for the period from January 1, 1998 through September 7, 1998, has been derived from, and is qualified by reference to, the audited consolidated financial statements of IIT included elsewhere in this report. You should also read “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and related notes of USi and IIT included in this report.

Item 7. 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 included elsewhere in this Form 10-K. 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. Dollar amounts stated herein are in thousands except per share amounts.

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 GSP environment. During 1998, we 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. During our first full year of operations in 1999, we continued the development activities started in 1998 and began to market and sell our new iMAP offerings. In 2000, we completed our development activities, increased our client base, and expanded our iMAP offerings. We have incurred a cumulative net loss since inception and expect to incur additional losses for at least the next twelve months primarily because we have developed our network infrastructure and the overhead to support it in anticipation of a larger client base in the next several years. As of December 31, 2000, we

had an accumulated deficit of $310,731. As of December 31, 2000, we had 233 signed contracts with 168 clients accounting for total revenue, assuming payment over the full contract terms, of over $354,000. While we have experienced significant growth in revenue under contract in recent periods and currently expect continued growth in revenue, prior growth rates should not be considered as necessarily indicative of future growth rates or operating results for 2001.

In September 2000, we purchased the assets of EnableVision, LLC, a comprehensive provider of Lawson financial and human resources system implementation services. The purchase price consisted of cash of $2,000 and 290,640 shares of restricted stock valued at $4,000 on the purchase date.

In October 1999, we purchased the assets of Conklin & Conklin, Inc., a comprehensive provider of Lawson financial and human resources system implementation services and a certified reseller of Lawson software licenses. The purchase price consisted of cash of $7,700, assumed liabilities of $1,500, and a $2,000 secured note. The secured note is due on October 8, 2001, and bears interest at 10%, with interest payable monthly until the maturity date. In addition, the purchase price consists of contingent payments of up to $4,600 in cash. Portions of the contingent payments can be earned by Conklin shareholders through December 2001 upon the attainment of specified financial milestones.

Revenue. We generate revenue from iMAP services and information technology services. Revenues from professional IT services are recognized as services are provided. iMAP revenues consist of fees for the Company’s iMAP services. iMAP service fees are consideration for access to our network of Enterprise Data Centers or EDCs, hosting application software, and the implementation and management of that software. iMAP contracts generally have a three-to-five year term and revenues are recognized ratably over the contract term. Payments received in advance of revenue recognition, even if non-refundable, are recorded as deferred revenue and recognized ratably over the term of the iMAP service contract. Some contracts permit termination without cause by the clients. Contracts permitting termination without cause generally provide for termination payments to us that will be recognized as revenue when collectibility is assured.

Costs and expenses. We incur operating costs and expenses related to the delivery of iMAP and professional IT services. They include direct cost of services, network and infrastructure costs, general and administrative, sales and marketing, product research and development, non-cash stock compensation, and depreciation and amortization expenses.

We incur up-front costs related to the delivery of iMAP services. Product research and 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 the lesser of either three years or the term of the individual client contract, depending on the terms of the software license agreement. Amortization is recorded 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.

Comparison of the year ended December 31, 2000 to the year ended December 31, 1999

Revenue. For the year ended December 31, 2000, we generated $109,544 of revenue as compared to $35,513 for the same prior year period.

The increase of $71,165 in iMAP revenue is attributable to the increase in client iMAP contracts. At December 31, 2000, we had 233 iMAP contracts versus 109 at December 31, 1999. Included in our 2000 iMAP revenues was a termination fee of $3,198 related to the early termination of an enterprise application contract. Professional IT services revenue increased $2,866 in 2000, mainly due to the increased revenue from Conklin & Conklin, Inc., acquired in October 1999.

The increase of $30,864 in Enterprise Applications revenue is mainly attributable to additional iMAP contracts for our financial management, human resource and customer relationship management products. At December 31, 2000, we had 112 Enterprise Application iMAP contracts compared to 39 at the end of the prior year. The increase of $43,167 in E-Business Services is mainly attributable to additional client iMAP contracts for our e-commerce and e-business products. At December 31, 2000, we had 121 E-Business Services contracts compared to 70 at the end of the prior year.

Gross margins, direct costs of services, network and infrastructure costs (excluding non-cash stock compensation expense). For the year ended December 31, 2000, we incurred $96,327 for direct costs of services and network and infrastructure costs as compared to $39,809 for the same prior year period.

For the year ended December 31, 2000, we incurred $59,016 and $10,593 of direct costs related to the delivery of our iMAP and professional IT services, respectively. For the same period in 1999, we incurred $14,743 of direct costs related to iMAP services and $8,827 of direct costs related to professional IT services. The increase in iMAP services costs is directly attributable to our increase in iMAP contracts. In addition, we also wrote-off $220 of deferred iMAP costs related to the early termination of a contract for which we received a termination fee. We also wrote-off $3,193 of deferred iMAP costs related to contracts with early stage clients who experienced unexpected financial difficulties in the last six months of 2000.

In addition, we incurred $26,718 of costs related to the maintenance of our network and infrastructure costs for the year ended December 31, 2000 and $16,239 in related costs during the same period in 1999. The increase of $10,479 is attributable to costs required to complete our infrastructure buildout and to support our increase in iMAP contracts.

For the year ended December 31, 2000, we incurred $31,977 and $37,632 of direct costs related to the delivery of our enterprise applications and e-business services, respectively. For the same period in 1999, we incurred $8,919 related to Enterprise Applications and $14,651 of direct costs related to E-Business Services. Both increases are directly attributable to incremental client costs associated with our increase in iMAP client contracts.

Gross margins, including iMAP network and infrastructure costs, for the year ended December 31, 2000 were 8% and 36% for iMAP and professional IT services, respectively. These margins for the comparable 1999 period were (43)% and 36%, respectively. The increase in our iMAP services margin is due to the fact we built an infrastructure base in 1998 and 1999 to support a large number of clients. During 2000 we began to utilize the excess capacity that we had developed. Our margins for iMAP services are expected to continue to improve because our business model contemplates a much smaller increase in network and infrastructure costs as revenues increase.

Segment operating profit margins, which exclude iMAP networking and infrastructure costs, for enterprise applications were 34% and 50% for the year ended December 31, 2000 and 1999, respectively. The decrease in operating profit margin from the prior period is due to a high-margin contract becoming a smaller percentage of revenue and margins for the year ended December 31, 2000 as compared to the same period in 1999. Segment operating profit margins for E-Business Services improved to 38% for the year ended December 31, 2000 as compared to 17% for the same period in 1999. This improvement reflects the utilization of the investment made in 1999 to support the increase in iMAP contracts. Our margins for the year ended December 31, 2000 for these operating segments are more indicative of expected performance than in the same prior year period.

General and administrative expenses. For the year ended December 31, 2000, we incurred $27,615 of general and administrative expenses compared to $22,052 for the same period in 1999. The increase of $5,563 principally reflects the costs associated with increased executive, finance, human resource, corporate information systems and facilities personnel required to support the growth in operations.

Sales and marketing expenses. For the year ended December 31, 2000, we incurred $68,943 of sales and marketing expenses compared to $36,595 for the same period in 1999. The increase of $32,348 reflects the costs associated with our increased efforts to market and brand our service offerings, the sales commissions related to the increase in iMAP revenue, and the increase in sales, marketing, business unit management and product management personnel required to manage the growth in operations. In addition, we also incurred $981 of non-cash expense related to the issuance of common stock warrants in connection with a cooperative marketing agreement. This agreement was later terminated in October 2000.

Product research and development expenses. For the year ended December 31, 2000, we incurred $3,276 of product research and development expenses compared to $5,352 for the same period in 1999. The decrease of $2,076 is due to the fact that we developed a majority of our iMAP offerings in 1998 and 1999. We expect our research and development expenses to decline further in future periods.

Non-cash stock compensation expense. For the year ended December 31, 2000, we incurred a total of $20,998 in non-cash stock compensation expenses compared to $10,351 for the same period in 1999. Of the $10,647 increase, $6,136 reflects the period’s expense in connection with employee stock options we granted for nominal exercise prices in lieu of cash bonuses. The remaining amount of $4,511 reflects the Company’s contribution of common stock to an employee benefit plan and the amortization of unearned compensation for awards in prior periods. We expect to incur up to $14,384 in non-cash stock compensation expense through 2002 related to the intrinsic value of 1999 and 2000 stock option grants. We also expect to incur up to an additional $14,565 of non-cash stock compensation expense over the next three to four years as a result of a stock option swap program implemented in November 2000. This program allowed employees to exchange stock options granted since January 2000 at a rate of two options for one share of restricted stock.

Depreciation and amortization. For the year ended December 31, 2000, we incurred $52,687 in depreciation and amortization expenses, compared to $22,480 for the same period in 1999. Of the $30,207 increase, $28,006 represents depreciation of our increasing investment in property and equipment and the amortization of our prepaid software licenses. The remaining amount of $2,201 represents the amortization of the goodwill recorded upon our acquisitions of Conklin, ACR, IIT and EnableVision.

Interest income and expense. For the year ended December 31, 2000, we incurred $21,361 in interest expense and generated $8,813 of interest income. For the year ended December 31, 1999, we incurred

$4,115 of interest expense and generated $6,307 of interest income. Our interest expense has increased as we continue to finance through long-term debt and capital lease obligations investments in our client solutions and in our network and infrastructure. See Notes 8 and 9 to our December 31, 2000 consolidated financial statements for a summary of our long-term debt and capital lease obligations at December 31, 2000.

We generated interest income in 2000 from the temporary investment of the proceeds of our February 2000 common stock offering and November 1999 debt offering. During the same prior year period, we generated interest income from the temporary investment of the proceeds of our initial public offering.

Comparison of the year ended December 31, 1999 to the period ended December 31, 1998

Revenue. For the year ended December 31, 1999, we generated $21,743 in iMAP revenue and $13,770 in professional IT services revenue. For the period January 14, 1998, our date of inception, through December 31, 1998 we generated $69 in iMAP revenue and $4,053 in professional IT services revenue. The increase of $21,674 in iMAP revenue is a result of signing a total of 102 iMAP client contracts during 1999. The 1998 professional IT services revenue can be attributable to our subsidiaries IIT ($2,000) and ACR ($2,000) which were acquired during the third and fourth quarters of 1998, respectively. The increase of $9,717 in professional IT services revenue can be attributed to a full year of operations during 1999.

Gross margins, direct costs of services, network and infrastructure costs. For the year ended December 31, 1999, we incurred $14,743 and $8,827 of direct costs related to the delivery of our iMAP and professional IT services, respectively. For the period from January 14, 1998, our date of inception, through December 31, 1998, we incurred $895 and $2,530 of direct costs related to the delivery of our iMAP and professional IT services, respectively. Additionally, we incurred $16,239 of costs related to the maintenance of our network and infrastructure for the year ended December 31, 1999 and $2,186 of such costs during the period ended December 31, 1998. Gross margins, including iMAP network and infrastructure costs, for the year ended December 31, 1999 were (43)% and 36% for iMAP and professional IT services, respectively. Gross margins for professional IT services for the period ended December 31, 1998 were 38%.

General and administrative expenses. For the year ended December 31, 1999, we incurred $22,052 of general and administrative expenses compared to $19,426 for the period from January 14, 1998, our date of inception, through December 31, 1998. The increase of $2,626 reflects the costs required to support an additional 59 general and administrative personnel during a full year of operations in 1999, offset by one time start-up costs incurred in 1998.

Sales and marketing expenses. For the year ended December 31, 1999, we incurred $36,595 of sales and marketing expenses compared to $5,123 for the period from January 14, 1998, our date of inception, through December 31, 1998. The increase of $31,472 reflects the costs associated with our increased efforts to market and brand our service offerings, and the sales commissions related to the increase in iMAP revenue for the year ended December 31, 1999.

Product research and development expenses. For the year ended December 31, 1999, we incurred $5,352 of product research and development expenses compared to $690 for the period from January 14, 1998, our date of inception, through December 31, 1998. The increase of $4,662 reflects the costs associated with the continued development of our new products and infrastructure during a full year of operations for the year ended December 31, 1999, compared to start-up activities during 1998.

Non-cash stock compensation expense. For the year ended December 31, 1999, we incurred $10,351 in non-cash compensation expense. Of this amount, $8,588 resulted from employee stock options issued at an exercise price of $2.67 and an estimated fair market value of $8.87 to $14.89 per share at the date of grant. We will record an additional $26,500 over the next two years in relation to those options. The

remaining amount of $1,763 resulted from our contribution of common stock to the employee benefit plan and the amortization of unearned compensation from restricted stock grants. There was minimal non-cash stock compensation expense for the comparable period in 1998.

Depreciation and amortization. Depreciation and amortization for the year ended December 31, 1999 totaled $22,480. Of this amount, $5,955 represents the amortization of the goodwill recorded upon our acquisitions of ACR, IIT and Conklin; the remaining $16,525 represents depreciation of our property and equipment and the amortization of our prepaid software licenses. Depreciation expense for 1999 was approximately $382 lower as a result of changing our useful life of computer equipment from 3 to 5 years in July 1999. There was minimal depreciation and no amortization expense for the comparable period in 1998.

Interest income and expense. For the year ended December 31, 1999, we incurred $6,307 in interest expense principally from increased borrowings including $1,458 of expense from our convertible subordinated notes. We generated $4,115 of interest income principally from the investment of the proceeds from our initial public offering and convertible subordinated notes offering. We had minimal interest income and expense during the period ended December 31, 1998.

Comparison of the period ended September 7, 1998 to the period ended August 31, 1997

Revenue. Revenues for the period ended September 7, 1998, increased 194% over the period ended August 31, 1997. This increase is attributable to the growth in IIT’s PeopleSoft implementation services.

Gross margins, costs of sales and services. IIT incurred $3,000 and $1,100 of expenses in the delivery of its PeopleSoft implementation services for the periods ended September 7, 1998 and August 31, 1997, respectively. As a result, IIT’s PeopleSoft implementation services generated gross margins of 32.4% and 25.8% for the periods ended September 7, 1998 and August 31, 1997, respectively. The improved gross margins from period to period is attributable to a reduction in the use of subcontractors, an increase in IIT’s staff utilization and continued improvement in the demand for PeopleSoft implementation services.

Selling, general and administrative expenses. IIT incurred $1,800 and $1,300 of selling, general and administrative expenses for the periods ended September 7, 1998, and August 31, 1997, respectively. Selling, general and administrative expenses for the period ended August 31, 1997 include $1,000 attributable to non-cash compensation expense related to the issuance of stock to three of IIT’s officers. Selling, general and administrative expenses increased $1,300 for the period ended September 7, 1998, as a result of bonuses and related payroll taxes. The remaining increase of approximately $200 is attributable to the additional selling, general and administrative support required to support IIT’s growing customer base.

In connection with our acquisition of IIT, ACR, Conklin, and EnableVision LLC, we recorded goodwill that is being amortized on a straight-line basis over its estimated useful life. At December 31, 2000, the unamortized portion of these intangibles was $27,560, which represented 7% of total assets and 24% of stockholders’ equity. Goodwill represents the amount that we paid for these acquired businesses in excess of the fair value of the acquired tangible and separately measurable intangible net assets. We have estimated the useful life of our goodwill to be between three to five years based upon several factors, the most significant of which is the susceptibility of acquired businesses to change as a result of technological advances and the rapidly changing needs of their customers.

We periodically review the carrying value and recoverability of our unamortized goodwill and other intangible assets for impairment. If the facts and circumstances suggest that the goodwill or other intangible assets may be impaired, the carrying value of this goodwill will be adjusted by an immediate charge against income during the period of the adjustment. The length of the remaining amortization period may also be shortened, which will result in an increase in the amount of goodwill amortization during the period of adjustment and each period thereafter until fully amortized. Once adjusted, there can

be no assurance that there will not be further adjustments for impairment and recoverability in future periods. We have integrated the acquired businesses into our primary iMAP service offerings. Therefore, in evaluating impairment a principal factor we consider is the failure to achieve expected cash flows from operations.

At December 31, 2000, we had cash and cash equivalents of $56,962. On January 2, 2001 we closed a series of debt and equity transactions resulting in gross proceeds of $107,000. Had these transactions closed on December 31, 2000, our cash and cash equivalents position would have been $143,171 after giving effect to transaction fees and repayment and cash collateralization of certain long term debt facilities. Cash in excess of operating requirements is invested in high grade liquid financial instruments with maturities less than 90 days.

In addition to the financings described above which occurred on January 2, 2001, we raised an additional $186,475 of capital during 2000 of which $159,721 was equity and $26,754 was long term debt. The equity was raised primarily through a secondary common stock offering of $119,200 which closed in February of 2000 and a private equity offering of $40,521 which closed in November of 2000. The long term debt was principally in the form of capitalized lease obligations through various vendor financing programs. Payments of debt amortization, including amortization of capital leases amounted to $42,037. All of the long-term fixed asset financing is collateralized by the incremental infrastructure assets deployed to fulfill customer requirements.

For the year ended December 31, 2000, we used $118,605 in operating activities, $85,403 in investing activities and raised $148,668 (net of debt repayments), as described above, through financing activities. Cash used in operating activities was used to fund working capital needs. Specifically, we used approximately $21,000 to fund implementation costs associated with iMAP clients added during the year. Additionally, our accounts receivable balance increased approximately $18,800 as a result of the growth in new iMAP contracts during the year. The accounts receivable balance was $35,312 at December 31, 2000, which includes unbilled accounts receivable of $11,737. During 2000, we wrote-off $2,649 and reserved an additional $1,242 of accounts receivable related to several early-stage companies that were experiencing financial difficulty. At December 31, 2000, our accounts receivable balance is comprised primarily of amounts due from larger, more stable companies with no specific industry or customer concentration. Cash used in investing activities was primarily used to purchase computing hardware and software required to support the increase in our iMAP clients and shared infrastructure. During 2000, the Company purchased $108,611 in property and equipment, compared to $79,858 purchased in 1999. This increase is due to the increase in iMAP clients signed in 2000 as compared to 1999.

Cash will be required in 2001 to fund capital expenditures, which are estimated to be approximately $100,000, as well as to continue to fund operating activities. Included in the capital expenditures estimate is $8,701 related to committed facilities costs. In addition, the cash resources on hand subsequent to the closing of the January 2, 2001 series of transactions, we have the following financing sources available:


	•	In January, we closed a sale-leaseback of certain computing hardware which netted us $17,500 in proceeds.

	•	On January 2, 2001, we closed a $50,000 revolving line of credit led by GE Capital. Availability under this line is based upon accounts receivable balance and our 12 month backlog, which is the committed revenue we expect to obtain from our iMAP contracts over the next 12 months. The line requires that we meet certain financial covenants and is secured by substantially all of our assets. As of February 28, 2001, we used approximately $16,000 of the line. Of the remaining $34,000, an additional $18,000 is currently available.

	•	$41,000 of lease financing for HP products, of which $13,100 has been funded and $16,900 is currently available. Another $11,000 will be made available after the conclusion of the quarter


		ending March 31, 2001, contingent upon the Company achieving certain operating metrics. All commitments expire June 30, 2001.

	•	$20,000 in long-term fixed asset financing from Compaq, of which $6,600 has been funded and $13,400 remains available. This commitment expires June 30, 2001.

	•	$20,000 in long-term fixed asset financing from Sun Microsystems, of which $4,300 has been funded, $6,900 expired on December 31, 2000, and $8,800 remains available. This commitment expires June 30, 2001.

	•	We have entered into an agreement with Acqua Wellington North American Equities Fund Ltd. for the sale of up to $140,000 of common stock, depending on the market price of our common stock over the next 28 months. We may sell these shares at its sole discretion, depending upon its needs. The shares will be sold at a 4% to 6% discount based on the market price of our common stock at the time of the draw. The amount of stock sold in a given draw period is based on the stock price during such draw period. At $3 per share, we could sell $5,000 in stock per draw period. At $10 per share, we could sell $35,000 in stock per draw. Below $3 per share, Acqua Wellington has the option not to purchase our equity. As of March 23, 2001, we had $135,000 available under this line.

We believe that these resources and our existing cash and cash equivalents will be sufficient to fund our operations, including planned levels of capital expenditure for the foreseeable future assuming the successful implementation of our current business model. The majority of the base infrastructure required to provide our iMAP offerings has been purchased. As a result, we expect that our capital expenditures for the next several years will now largely be success-based, consisting of software licenses, hardware and the expansion of existing data center facilities required to implement iMAP offerings for our new customers. These new customer contracts are expected to have an average term of three to five years; however, we anticipate that 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.

In December 2000, we accrued a restructuring charge of $2,110 related to severance costs associated with the involuntary termination of certain employees of USi and non-cancellable lease costs associated with the closing of three sales offices. We anticipate that substantially all of this restructuring accrual will be paid in 2001.

In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 was later amended by the Financial Accounting Standards Board in 1999 and 2000 upon the issuance of SFAS No. 137 and SFAS No. 138. These standards, which we adopted on January 1, 2001, provide a comprehensive and consistent method for the recognition and measurement of derivatives and hedging activities. The adoption of SFAS No. 133 and its amendment did not have a material impact on the consolidated financial statements.

In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements. We adopted the provisions of SAB No. 101 in our consolidated financial statements for the year ended December 31, 2000. The

We are exposed to market risk from changes in interest rates. Market risk is the risk of loss to future earnings, to fair value or to future cash flows that may result from the changes in the price of financial instruments. Changes in the quoted market price of our common stock affects the fair value of our convertible subordinated notes. At December 31, 2000, we had $125,000 of convertible subordinated notes outstanding, bearing interest at 7%, that mature November 1, 2004. The estimated fair value of these notes was $65,625 at December 31, 2000, which represents an 82% decrease in the estimated fair value from December 31, 1999. We continue to manage our exposure to this risk through our regular operating and financing activities. There have been no other significant changes in our interest rate risk and other market risks.

Investing in our common stock involves risk. You should carefully consider the risks and uncertainties described below before making an investment decision. These risks and uncertainties are not the only ones that we face or that may adversely affect our business. If any of the following risks or uncertainties actually occur, our business, financial condition or results of operations could be materially adversely affected. This Form 10K also contains forward-looking statements that involve risks and uncertainties. Our actual results may differ from those described in the forward-looking statements. This could occur because of the risks described below and elsewhere in this Form 10K. Dollar amounts herein are in thousands.

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 as well as expanding our infrastructure and work force to service our growing customer base required substantial capital and other expenditures. As a result, we reported a net loss of $174,960 for the year ended December 31, 2000 and EBITDA of negative $71,179 for the same period. For the year ended December 31, 1999, we reported a net loss of $103,318 and EBITDA of negative $65,533 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 may need additional capital to fund our operations and finance our growth. While we have recently raised a significant amount of additional capital, there can be, however, no assurance that we will not need to raise additional capital or that such efforts will be successful. If we raise additional funds by selling our common stock or securities convertible into common stock, the relative ownership of our existing investors could be diluted or the new investors could obtain terms more favorable than those of our existing investors. If we cannot obtain financing on terms acceptable to us or at all, we may be forced to curtail our planned business expansion.

Our business is difficult to evaluate because we have a limited operating history in a relatively new market.

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. Additionally, our market, the Application Service Provider (or “ASP”) market is relatively new and has not yet received universal acceptance by the enterprises we target. Therefore, it is difficult to evaluate our business and prospects.


	•	limit our ability to fund future working capital, capital expenditures, acquisitions and other general corporate requirements;

	•	limit our ability to borrow additional funds;

	•	require us to dedicate a substantial portion of our cash flow from operations to repaying indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, acquisitions and other general corporate purposes;

	•	make it more difficult for us to satisfy our obligations with respect to our indebtedness;

	•	increase our vulnerability to general adverse economic and industry conditions; and

	•	limit our flexibility in planning for, or reacting to, changes in our business and industry.

Any additional borrowings would further increase the amount of our leverage and the associated risks.

Our ability to make payments on our indebtedness, and to fund planned capital expenditures, development and operating costs will depend on our ability to generate cash in the future through sales of our services. We cannot assure you that our available liquidity will be sufficient to service our indebtedness, or to fund our other cash needs. We may need to refinance all or a portion of our indebtedness, on or before maturity, but we may not be able to do so on commercially reasonable terms, or at all. Without sufficient funds to service our indebtedness, we would have serious liquidity constraints and would need to seek additional financing from other sources, but we may not be able to do so on commercially reasonable terms, or at all.

If we fail to meet covenants or default under our equipment leases or revolving line of credit, our ability to service our clients could be harmed.

We have financed a large percentage of our hardware purchases under various lease and sale-leaseback agreements. We have also entered into a revolving line of credit with General Electric Credit Corp. which is secured by the majority of our unencumbered assets. Some of these agreements and the credit line contain financial covenants and cross-default provisions which, if triggered, could have a material adverse effect on our business and our ability to service our clients.

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 and is now evolving rapidly.

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 continue to grow or to grow at the rate we anticipate.

The growth in demand for outsourced business software applications is now beginning, but the future is still uncertain.

Future demand for and acceptance of outsourced business software applications, including our iMAP offerings is uncertain. While there has been a significant level of initial adoption of the ASP model, we believe that many of our potential customers are still not fully aware of the benefits of outsourced solutions. In addition, the rate of initial adoption may be slowed by performance or financial problems among Application Service Providers. It is possible that our iMAP offerings may never achieve broad market acceptance. If the market for our offerings 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;

	•	expanding our work force;

	•	investing to develop unique service offerings; and

	•	developing and acquiring 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.

The markets we serve are highly competitive and many of our competitors have much greater resources.

Our competitors may include such companies as Accenture, AT&T, Corio, Digex, EDS, IBM, Oracle, Qwest Communications, SAP and Sprint. While we believe that our GSP environment, together with our level of service, support and targeted business focus distinguish us from these competitors, some of these competitors have significantly greater market presence, brand recognition, and financial, technical and personnel resources than we do, and have extensive coast-to-coast Internet networks.

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.

	•	hire our employees

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.

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 service offerings;

	•	attract and retain iMAP clients;

	•	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, although most of our management team has worked together for approximately two years, there can be no assurance that we will be able to successfully execute all elements of our strategy.

Our quarterly operating results may fluctuate due to the nature of our ASP business and other factors affecting our revenues and costs, which could cause our stock price to fall.

Our financial results will also vary over time as our ASP business matures. For our iMAP clients, we recognize all fees, including upfront and monthly fees, over the balance of the contractual relationship. Important factors that could cause our quarterly results and stock price to fluctuate materially include:


	•	the number of clients we obtain in order to scale our business;

	•	the level of service we provide to our clients;

	•	cost of capital associated with the services we provide to our clients;

	•	the loss of or change in our relationship with important clients;

	•	the timing and magnitude of expanding our operations and of other capital expenditures;

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

	•	potential changes in the accounting standards associated with accounting or stock or warrant issuances and for revenue recognition; and

	•	the loss of key members of, or other changes in, our management.

We have rapidly expanded our operations since USi was founded in January 1998. In addition, we expect our business to continue to grow in geographic scope, number of customers 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;

	•	maintain a high level of client service and support;

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

	•	train, manage and integrate 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 our limited operating history. Any inability to expand our network or services or to effectively manage our employee base commensurate with the demand for our services could adversely affect our revenues.

We have built and currently maintain a very sophisticated data center network to provide availability to our clients’ applications over the Internet and private connections. Complex networks are subject to the risk of outages. Over the course of our operating history, portions of our network have experienced network outages lasting from minutes to hours. Each of our clients’ contracts contain service level guarantees which initially provide for revenue credits, and eventually termination of the contract, if access to the client’s application is compromised. The total amount of service fee credits provided to our clients during our operating history due to network outages has not been material.

Factors both in and outside of our control could cause additional outages to our network which could cause a loss in revenue.

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. Depending upon our growth, we may 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, especially if our stock price declines or remains low.

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 most of our vice presidents and other key employees, including our Chief Executive Officer, Andrew A. Stern.

We may not be able to deliver our iMAP offerings 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 systems 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. 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 offerings 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 licenses, marketing and maintenance under agreements with Ariba, BroadVision, Lawson, Microsoft, Oracle, PeopleSoft, Plumtree, and Siebel and package them as part of our iMAP offerings. The license agreements are for terms ranging from one to four years. All the agreements may be terminated upon a breach of the agreement, subject to cure periods. 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, delay or reduce their introduction unless we could find, license and package equivalent technology or require our clients to purchase software licenses directly from vendors.

All but one of our agreements with software vendors are non-exclusive. Our agreement with SiebelNet, Inc., a wholly-owned subsidiary of Siebel Systems, Inc., gives us exclusivity as the Application Service Provider of Siebel enterprise relationship management applications for direct customers of SiebelNet headquartered in North America. This exclusivity could be terminated or altered in the future. 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.

We will need to perform software upgrades for our customers, and any inability to successfully perform these upgrades could cause interruptions or errors in our customers’ software applications, which could increase our costs and delay market acceptance of our services.

Our software vendors from time to time will upgrade their software applications, and at such time we will be required to implement these software upgrades for our customers. Implementing software upgrades can be a complicated and costly process, particularly implementation of an upgrade simultaneously across multiple customers. Accordingly, we cannot assure you that we will be able to perform these upgrades successfully or at a reasonable cost. We may also experience difficulty implementing software upgrades to a large number of customers, particularly if different software vendors release upgrades simultaneously. If we are unable to perform software upgrades successfully and to a large customer base, our customers could be subject to increased risk of interruptions or errors in their business-critical software, our reputation and business would likely suffer and the market would likely delay the acceptance of our services. It will also be difficult for us to predict the timing of these upgrades, the cost to us of these upgrades and the additional resources that we may need to implement these upgrades. Additionally, if we evolve our business model to charge customers for the cost of software upgrades, we may lose prospective customers who choose not to pay for these upgrades. Therefore, any such upgrades could strain our development and engineering resources, require significant unexpected expenses and cause us to miss our financial forecasts or those of securities analysts. Any of these problems could impair our customer relations and our reputation and subject us to litigation.

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.

For the year ended December 31, 2000, sales to SiebelNet accounted for approximately 10.2% of our revenues. We expect sales to SiebelNet to continue to constitute a significant portion of our revenues in the near term. During that period, if our sales to SiebelNet decrease, our business may suffer.

If we cannot obtain additional application software, we will be unable to expand or enhance our iMAP 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 offerings competitive. If we cannot obtain these applications and as a result must discontinue, delay or reduce the availability of our iMAP offerings 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 newly acquired operations.

In August 2000, we acquired the assets of EnableVision, LLC. We cannot be sure that our integration of EnableVision will result in the EnableVision business performing as we expect. 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 under performance could have a material adverse effect on our business, results of operations and financial condition.

From time to time, we may undertake additional acquisitions. If we do, our risks may increase because:


	•	we may pay more for the acquired company than the value we realize from the acquisition;

	•	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.


	•	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.

In August 2000, we invested $5,000 in C3i, Inc., a customer relationship management service company in New York City. In the future, we may make additional investments in joint ventures or other entities over which we do not exercise control. We may make these investments in connection with entering into strategic partnerships with software vendors, systems integrators or Internet Service Providers

or as strategic investments. Our inability to control the entity in which we may invest may have consequences on our ability to receive distributions from such entity or to implement our business plan. Debt agreements, if entered into by a non-controlled entity, may restrict or prohibit such entity from paying distributions to us. Applicable state or local law may also limit the amount that a non-controlled entity is permitted to pay a distribution on its equity interest, and we may not be able to influence the payment of dividends. If any of the other investors in a non-control entity fail to observe their commitments, that entity may not be able to operate according to its business plans or we may be required to increase our level of commitment to give effect to the plan. In addition, our ability to implement a business plan for a non-controlled entity may be limited or non-existent.

Because we have international operations, we face additional risks related to foreign political and economic conditions.

We have established redundant EDC capabilities in Europe and Asia. 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. In recent sessions, the United States Congress has enacted Internet laws regarding children’s privacy, copyrights, taxation and the transmission of sexually explicit material and other similar proposals are continuously being considered. 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.

The outcome of proposals put to a vote of stockholders will be determined by our existing principal stockholders, executive officers and directors.

As of March 23, 2001, our executive officers, directors, existing 5% or greater stockholders and their affiliates, in the aggregate, own shares representing approximately 52% of our outstanding voting capital

stock. As a result, these persons, acting together, are able to control all matters submitted to our stockholders for approval and to control our management and affairs. For example, these people, acting together, control the election and removal of directors and any merger, consolidation or sale of all or substantially all of our assets.

The trading price of our common stock could be subject to significant fluctuations.

The trading price of our common stock has been volatile. Factors such as announcements of fluctuations in our or our competitors’ operating results and market conditions for Internet related and other technology stocks in general have had and could continue to have a significant impact on the trading price of our common stock. In particular, the trading price of the common stock of many Internet related and other technology companies has experienced extreme price and volume fluctuations, which have at times been unrelated to the operating performance of such companies whose stocks were affected. In addition, the trading prices of our common stock could be subject to significant fluctuations in response to variations in our prospects and operating results, which may in turn be affected by changes in interest rates and other factors. There can be no assurance that these factors will not have an adverse effect on the trading prices of our common stock.

The market price of our common stock could be affected by the substantial number of shares that are eligible for future sale.

As of March 23, 2001, we had 143,958,315 shares of common stock issued and outstanding, excluding 13,882,691 shares issuable upon the exercise of warrants and 20,459,553 shares issuable upon the exercise of options granted under our Stock Option Plans and 7,545,272 shares issuable upon conversion of 7% Convertible Subordinated Promissory Notes. We cannot predict the effect, if any, that future sales of the notes or shares of common stock, including common stock issuable upon conversion of the notes, or the availability of the notes or shares of common stock for future sale, will have on the market price of common stock prevailing from time to time.

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 and hardware products in our target markets increases and the functionality of these products further overlap, software and hardware 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 have audited the accompanying consolidated balance sheets of USinternetworking, Inc. (“the Company”) as of December 31, 2000 and 1999, and the related consolidated statements of operations, stockholders’ equity (deficit) and cash flows for the years then ended and for the period from January 14, 1998 (date of inception) through December 31, 1998. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of USinternetworking, Inc. as of December 31, 2000 and 1999, and the consolidated results of its operations and its cash flows for the years then ended and for the period from January 14, 1998 (date of inception) through December 31, 1998, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

(In thousands, except share amounts)



			Common Stock					Additional			Note
								Paid-in			Receivable			Unearned			Accumulated
			Shares			Par Value		Capital			From Officer			Compensation			Deficit

Balance at January 1, 2000				92,065,911		$	92	$	241,861		$	(2,250	)	$	(1,782	)	$	(135,771	)




	Issuance of common stock for cash, net of offering costs of $6,903			15,133,391			15		159,706			—			—			—




	Issuance of restricted stock in connection with employee option conversion program			4,789,406			5		15,815			—			(15,820	)		—




	Issuance of warrants in connection with marketing agreement			80			—		981			—			—			—




	Issuance of common stock upon acquisition of EnableVision, LLC			290,640			—		4,000			—			—			—




	Issuance of common stock upon exercise of stock options			1,458,610			2		3,008			—			—			—




	Issuance of common stock to employee stock purchase plan and employee benefit plan			311,800			—		2,890			—			—			—




	Issuance of common stock upon exercise of warrants			1,047,989			1		1,599			—			—			—




	Repurchase of common stock upon exercise of warrants			(33,956	)		—		(1,600	)		—			—			—




	Stock compensation expense from issuance of common stock options			—			—		16,618			—			—			—




	Amortization of unearned compensation			—			—		—			—			2,573			—




	Comprehensive income:




		Net loss for the year ended December 31, 2000		—			—		—			—			—			(174,960	)




		Other comprehensive income — reclassification adjustment for gains included in net loss		—			—		—			—			—			—




		Total comprehensive income (loss)		—			—					—			—			—

Balance at December 31, 2000				115,063,871		$	115	$	444,878		$	(2,250	)	$	(15,029	)	$	(310,731	)

[Continued from above table, first column(s) repeated]


			Accumulated
			Other			Total
			Comprehensive			Stockholders’
			Income			Equity

Balance at January 1, 2000			$	311		$	102,461




	Issuance of common stock for cash, net of offering costs of $6,903			—			159,721




	Issuance of restricted stock in connection with employee option conversion program			—			—




	Issuance of warrants in connection with marketing agreement			—			981




	Issuance of common stock upon acquisition of EnableVision, LLC			—			4,000




	Issuance of common stock upon exercise of stock options			—			3,010




	Issuance of common stock to employee stock purchase plan and employee benefit plan			—			2,890




	Issuance of common stock upon exercise of warrants			—			1,600




	Repurchase of common stock upon exercise of warrants			—			(1,600	)




	Stock compensation expense from issuance of common stock options			—			16,618




	Amortization of unearned compensation			—			2,573




	Comprehensive income:




		Net loss for the year ended December 31, 2000		—			(174,960	)




		Other comprehensive income — reclassification adjustment for gains included in net loss		(311	)		(311	)

		Total comprehensive income (loss)		—			(175,271	)

Balance at December 31, 2000			$	—		$	116,983

(In thousands, except share amounts)



			Common Stock						Additional			Note
									Paid-in			Receivable
			Shares			Par Value			Capital			From Officer

Balance at January 14, 1998				—		$	—		$	—		$	—




	Issuance of common stock to founder upon inception			1,406,250			1			3			—




	Issuance of 53,333 shares of $.01 par value Series A Convertible Preferred Stock for cash, net of offering costs of $205			—			—			31,795			—




	Issuance of 1,667 shares of Series A Convertible Preferred Stock on May 28, 1998 in exchange for $1,000 note			—			—			1,000			—




	Issuance of warrants to purchase common stock associated with various acquisitions and financing commitments			—			—			2,830			—




	Dividends accrued on Series A Convertible Preferred Stock			—			—			(1,503	)		—




	Accretion of common stock subject to repurchase to fair value			—			—			(3,904	)		—




	Accretion of Series B Convertible Redeemable Preferred Stock to fair value			—			—			(237	)		—




	Net loss for the period January 14, 1998 through December 31, 1998			—			—			—			—

Balance at December 31, 1998				1,406,250		$	1		$	29,984		$	—




	Dividends accrued on Series A and Series B Convertible Redeemable Preferred Stock			—			—			(2,328	)		—




	Accretion of Series B Convertible Redeemable Preferred Stock and common stock subject to repurchase to fair value			—			—			(24,037	)		—




	Conversion of 55,000 shares of Series A and 59,279 shares of Series B Convertible Redeemable Preferred Stock to common stock			69,523,934			70			62,173			—




	Reclassification of common stock subject to repurchase to common stock			3,023,438			3			28,849			—




	Issuance of common stock upon initial public offering, net of offering costs of $12,072			15,525,000			16			132,812			—




	Issuance of common stock upon exercise of stock options			1,681,610			2			3,231			(2,250	)




	Issuance of common stock upon exercise of warrants			1,113,977			1			3,085			—




	Issuance of common stock to employee benefit plan			54,738			—			600			—




	Issuance of restricted common stock			141,750			—			2,009			—




	Repurchase of common stock			(404,786	)		(1	)		(3,022	)		—




	Amortization of unearned compensation			—			—			—			—




	Stock compensation expense from issuance of common stock options			—			—			8,505			—




	Comprehensive income:			—			—			—			—




	Net loss for the year ended December 31, 1999.			—			—			—			—




	Other comprehensive income- unrealized gain on marketable securities			—			—			—			—




		Total comprehensive income (loss)		—			—			—			—

Balance at December 31, 1999.				92,065,911		$	92		$	241,861		$	(2,250	)

[Continued from above table, first column(s) repeated]


									Accumulated		Total
									Other		Stockholders’
			Unearned			Accumulated			Comprehensive		Equity
			Compensation			Deficit			Income		(Deficit)

Balance at January 14, 1998			$	—		$	—		$	—	$	—




	Issuance of common stock to founder upon inception			—			—			—		4




	Issuance of 53,333 shares of $.01 par value Series A Convertible Preferred Stock for cash, net of offering costs of $205			—			—			—		31,795




	Issuance of 1,667 shares of Series A Convertible Preferred Stock on May 28, 1998 in exchange for $1,000 note			—			—			—		1,000




	Issuance of warrants to purchase common stock associated with various acquisitions and financing commitments			—			—			—		2,830




	Dividends accrued on Series A Convertible Preferred Stock			—			—			—		(1,503	)




	Accretion of common stock subject to repurchase to fair value			—			—			—		(3,904	)




	Accretion of Series B Convertible Redeemable Preferred Stock to fair value			—			—			—		(237	)




	Net loss for the period January 14, 1998 through December 31, 1998			—			(32,453	)		—		(32,453	)

Balance at December 31, 1998			$	—		$	(32,453	)	$	—	$	(2,468	)




	Dividends accrued on Series A and Series B Convertible Redeemable Preferred Stock			—			—			—		(2,328	)




	Accretion of Series B Convertible Redeemable Preferred Stock and common stock subject to repurchase to fair value			—			—			—		(24,037	)




	Conversion of 55,000 shares of Series A and 59,279 shares of Series B Convertible Redeemable Preferred Stock to common stock			—			—			—		62,243




	Reclassification of common stock subject to repurchase to common stock			(633	)		—			—		28,219




	Issuance of common stock upon initial public offering, net of offering costs of $12,072			—			—			—		132,828




	Issuance of common stock upon exercise of stock options			—			—			—		983




	Issuance of common stock upon exercise of warrants			—			—			—		3,086




	Issuance of common stock to employee benefit plan			—			—			—		600




	Issuance of restricted common stock			(2,009	)		—			—		—




	Repurchase of common stock			—			—			—		(3,023	)




	Amortization of unearned compensation			860			—			—		860




	Stock compensation expense from issuance of common stock options			—			—			—		8,505




	Comprehensive income:			—			—			—		—




	Net loss for the year ended December 31, 1999.			—			(103,318	)		—		(103,318	)




	Other comprehensive income- unrealized gain on marketable securities			—			—			311		311

		Total comprehensive income (loss)		—			—			—		(103,007	)

Balance at December 31, 1999.			$	(1,782	)	$	(135,771	)	$	311	$	102,461

USinternetworking, Inc., (the “Company”) was incorporated on January 14, 1998 principally to provide clients the ability to use leading business software applications through the Company’s Internet-based network. The Company is an “Internet Managed Application Provider.^SM” The Company’s iMAP services integrate Internet communications, data center management, packaged software applications, implementation and support to meet the technology needs of businesses in a number of areas. These areas include sales force automation, customer support, e-commerce, and human resource and financial systems. The Company also makes its infrastructure available to clients who want to run their own applications in a highly reliable and secure Internet environment and provides information technology consulting services.

The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Intercompany transactions and balances have been eliminated.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

The Company considers all money market accounts and all other investments with a maturity of three months or less when purchased to be cash equivalents.

Available-for-sale securities are carried at fair value with the unrealized gains and losses, net of tax, reported as other comprehensive income. Realized gains and losses and declines in value judged to be other than temporary on available-for-sale securities are included in investment income. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in investment income.

At December 31, 1999, available-for-sale securities consisted principally of corporate and government agency obligations.

Accounts receivable includes unbilled amounts related to revenue which has been recorded either as deferred revenue or earned revenue in accordance with the Company’s stated revenue recognition policy. At December 31, 2000 and 1999, accounts receivable included $11,737 and $3,050 of unbilled accounts receivable, respectively.

Direct costs related to the implementation of software under iMAP contracts are deferred and expensed ratably over the term of the related contract. Costs related to the issuance of debt are deferred and expensed over the term of the debt using the interest method.

The Company capitalizes the costs associated with the purchase of licenses for major business process application software used in providing iMAP services. The licenses specify the maximum number of users permitted to utilize the license in connection with the Company’s service, and whether the licenses may be later transferred to subsequent users by the Company. All amounts are non-refundable, regardless of the actual number of users assigned a license in connection with iMAP services.

Transferable licenses are amortized over their estimated useful life of three years. Non-transferable licenses are amortized over the lesser of the minimum contract period for iMAP clients subject to these licenses, or three years. Amortization commenced in January 1999, the date that transferable and non-transferable licenses were first available to generate revenue, and the average amortization period is expected to be three years.

The Company also purchases maintenance services from its software vendors under agreements that require annual payments for software maintenance, including technical support and software upgrades. These payments are included in prepaid expenses and amortized ratably over the annual service period.

Property and equipment is stated at cost less accumulated depreciation. Depreciation is computed for owned assets using the straight-line method over estimated useful lives of the assets. Assets under capital leases are amortized using the straight-line method over the lesser of the lease term or the estimated useful life of the assets.

Estimated useful lives for furniture and equipment range from five to seven years. Computer hardware and software, is depreciated over three to five years. Buildings are depreciated over twenty-five years, and leasehold improvements are depreciated over the term of the related lease.

The Company expenses advertising as incurred. Advertising expense totaled approximately $963, $2,439, and $700 in 2000, 1999, and for the period from January 14, 1998 (date of inception) through December 31, 1998, respectively.

Long-lived assets, consisting principally of software licenses, property and equipment and goodwill, are evaluated for possible impairment through a review of undiscounted expected future cash flows. If the sum of the undiscounted expected future cash flows is less than the carrying amount of the asset, an impairment loss is recognized.

At December 31, 1999, the Company had liabilities for the purchase of fixed assets for which the Company had outstanding commitments to finance on a long-term basis. The Company executed these financings early in 2000, and therefore in 1999 classified as long-term a portion of the liabilities based on the terms of the subsequent financings.

The Company generates revenue from iMAP services and information technology services. Revenues from professional IT services are recognized as services are provided. iMAP revenues consist of fees for the Company’s iMAP services.

iMAP service fees are recognized ratably over the term of the contract, which have terms of up to five years. Payments received in advance of revenue recognition, even if non-refundable, are recorded as deferred revenue. Amounts included in deferred revenue are generally recognized as revenue within 12 months. Some contracts permit termination without cause by the clients. Contracts permitting termination without cause generally provide for termination payments to the Company that will be recognized as revenue when collectibility is assured.

The Company incurs product research and development costs related to expanding its portfolio of iMAP solutions. These costs primarily include labor costs associated with the testing of new product offerings, including the evaluation of the functionality of hardware and software applications in an iMAP environment. Product research and development costs are expensed as incurred.

The Company amortizes goodwill arising from purchase business combinations on a straight-line basis over its estimated useful life ranging from three to five years.

The Company records compensation expense for all stock-based compensation plans using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB No. 25”). Under APB No. 25, if the exercise price of the Company’s employee stock-based awards equals or exceeds the estimated fair value of the underlying stock on the date of grant, no compensation expense is generally recognized.

Financial Accounting Standards Board Statement No. 123, Accounting for Stock-Based Compensation (“Statement No. 123”), encourages companies to recognize expense for stock-based awards based on their estimated fair value on the date of grant. Statement No. 123 requires the disclosure of pro forma net income or loss in the notes to the financial statements if the fair value method is not elected. The Company supplementally discloses in Note 15 to these consolidated financial statements the pro forma information as if the fair value method had been adopted.

The Company uses the liability method in accounting for income taxes. Under this method, deferred income tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.

In 2000 and 1999, the Company’s Board of Directors approved the following stock splits of common stock, options and warrants:

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 all of these stock splits.

Certain amounts in the 1999 consolidated financial statements have been reclassified to conform to the 2000 presentation.

In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 was later amended by the Financial Accounting Standards Board in 1999 and 2000 upon the issuance of SFAS No. 137 and SFAS No. 138. These standards, which the Company adopted on January 1, 2001, provide a comprehensive and consistent method for the recognition and measurement of derivatives and hedging activities. The adoption of SFAS No. 133 and its amendments did not have a material impact on the consolidated financial statements.

In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements. The Company adopted the provisions of SAB No. 101 in its consolidated financial statements for the year ended December 31, 2000. The adoption of this pronouncement did not have any impact on the Company’s revenue recognition policies, financial position or results of operations.

On September 8, 1998, the Company acquired all of the outstanding common stock of I.I.T. Holding, Inc. (IIT), a provider of Internet and intranet consulting, integration and support services principally to commercial companies located throughout the United States and South America. The initial purchase price consisted of cash of $12,887 and warrants to purchase 112,500 shares of common stock for $7.11 per share valued at $40. Direct acquisition costs of $395 were also incurred. The acquisition was accounted for using the purchase method of accounting, and the results of operations of IIT are included in the accompanying consolidated statements of operations commencing September 8, 1998. At the acquisition date, $14,132 of goodwill was recorded and is being amortized over its estimated useful life of five years.

Additional contingent consideration was payable to the former shareholders of IIT to the extent that defined amounts of revenue, earnings before interest, income taxes, depreciation and amortization (EBITDA), and employee retention percentages (as related to the operations of IIT) in 1998 were exceeded. At December 31, 1998, the Company determined that the amount of additional consideration

due to the sellers was $2,327, and therefore recorded that amount as due to former shareholders of acquired businesses and as additional goodwill. The contingent consideration was paid in May 1999.

On October 2, 1998, the Company acquired all of the outstanding common stock of Advanced Communication Resources, Inc. (ACR), a New York based systems integrator focused on the financial services industry. The initial purchase price aggregated $6,050, consisting of cash of $2,500, a $3,500 secured promissory note due in January 1999 bearing interest at 8.25%, and warrants to purchase 140,625 shares of common stock for $7.11 per share valued at $50. Direct acquisition costs of $339 were also incurred. The acquisition was accounted for using the purchase method of accounting, and the results of operations of ACR are included in the accompanying consolidated statements of operations commencing October 2, 1998. At the acquisition date, $5,291 of goodwill was recorded and is being amortized over its estimated useful life of five years.

Additional contingent consideration was payable to the former shareholders of ACR to the extent that defined amounts of revenue, EBITDA, and employee retention percentages (as related to the operations of ACR) in 1998 were exceeded. At December 31, 1998, the Company determined that the amount of additional consideration due to the sellers was $5,000, and therefore recorded that amount as due to former shareholders of acquired businesses and as additional goodwill. The contingent consideration was paid in January 1999.

On October 8, 1999, the Company purchased the assets of Conklin & Conklin, Inc. (“Conklin”), a comprehensive provider of Lawson financial and human resources system implementation services and a certified reseller of Lawson software licenses. The initial purchase price aggregated $11,200, and consisted of cash of $7,700, assumed liabilities of $1,500, and a $2,000 secured note due on October 8, 2001. Additional contingent cash consideration of up to $4,600 will be payable to the extent that specified financial milestones are achieved through December 31, 2001, and any such payment will result in the recording of additional goodwill. The acquisition was accounted for as a purchase, and goodwill of approximately $9,400 was recorded at the acquisition date, and is being amortized over its estimated useful life of five years. The results of operations of Conklin are included in the accompanying consolidated statements of operations commencing October 8, 1999.

On September 1, 2000, the Company acquired assets of EnableVision LLC, a provider of Lawson financial and human resources system implementation services. The purchase price aggregated $6,000, consisting of $2,000 in cash and $4,000 million in restricted stock of the Company. The acquisition was accounted for as a purchase, and goodwill of approximately $6,000 was recorded at the acquisition date and is being amortized over its estimated useful life of three years. The results of operations of EnableVision are included in the accompanying consolidated statements of operations commencing September 1, 2000.

The following combined unaudited pro forma consolidated results of operations of the Company give effect to the acquisition of EnableVision and Conklin as though they occurred on January 1, 1999. The

results are not necessarily indicative of what would have occurred had these transactions been consummated as of the beginning of the period, or of future operations of the Company.

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

Basic loss per share is based upon the average number of shares of common stock outstanding during the periods. The computation excludes 4,787,060, 141,750 and 3,023,438 shares of unvested restricted common stock and common stock subject to repurchase for 2000, 1999 and 1998, respectively.

Diluted 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 unvested restricted common stock, convertible preferred stocks, stock options and warrants in the 1998 period; and unvested restricted common stock, stock options and warrants in the 2000 and 1999 periods.

The Company acquired equipment totaling $65,184, $15,812 and $5,188 under leases classified as capital leases for the years ended December 31, 2000 and 1999 and for the period from January 14, 1998

(date of inception) through December 31, 1998, respectively. The Company also acquired $3,000 and $7,500 of equipment in 1999 and 1998 that was included in accounts payable and short-term obligations expected to be refinanced at December 31, 1999 and 1998, respectively.

Interest paid was approximately $21,376, $5,902 and $368 for the years ended December 31, 2000 and 1999 and for the period from January 14, 1998 (date of inception) through December 31, 1998, respectively.

In December 1998, $22,095 of notes payable and a $1,000 loan from an officer of the Company were converted into Series B Convertible Redeemable Preferred Stock.

In 1998, the Company purchased all of the capital stock of IIT and ACR for approximately $27,800. In conjunction with these acquisitions, assets with a fair market value of approximately $30,800 were acquired and liabilities of approximately $3,000 were assumed.

In July 1998, the Company sold 1,406,250 shares of common stock to an executive officer for $5. The common stock at the date of issuance had an appraised estimated fair value of $0.71 per share, or $1,000. The difference between the estimated fair value of the common stock of $1,000 and the amount paid of $5 ($995) was recorded as unearned compensation and is being amortized over the 22 month period in which it is earned.

During 1999, the Company issued 141,750 shares of restricted common stock as compensation to executive officers valued at a price of $14.17 per share. The restricted common stock at the date of issuance had an aggregate quoted market value of $2,009, which was recorded as stockholders’ equity.

These investments are classified as current as the Company views its available-for-sale investments as available for use in its current operations.

In December 2000, the Company accrued a restructuring charge of $2,110. The restructuring charge consisted of accrued severance costs of $727 related to the involuntary termination of three employees of the Company and non-cancelable lease obligations of $1,383 related to the closing of three sales offices. The Company anticipates that substantially all of the restructuring costs will be paid by December 31, 2001. The accrued restructuring charge of $2,110 is included in other accrued expenses in the accompanying 2000 consolidated balance sheet.

Substantially all property and equipment is collateralized under financing arrangements.

The Company has entered into capital lease agreements to acquire certain equipment. Property and equipment includes the following amounts for leases that have been capitalized.

Amortization of leased property is included in depreciation and amortization expense.

Future minimum payments under capital lease obligations consist of the following at December 31, 2000:

The Company entered into an interest rate swap agreement for a notional amount of $4,750. The effective date of the interest rate swap is January 1, 2000 and it expires on December 29, 2003. Under the terms of the swap, the Company will pay a fixed rate of 9.8% per annum and the Company will receive a variable rate of LIBOR plus 2.2%. The Company has designated the swap as a cash flow hedge and the net interest rate differential to be paid or received is being recognized as an adjustment to interest expense. Changes in the fair value of the swap as a result of changes in market interest rates are not recognized.

In 1999, the Company issued $125,000 (principal amount at maturity) of convertible subordinated notes, due November 1, 2004. Interest accrues at 7% per annum, payable semi-annually on May 1 and November 1 of each year, commencing May 1, 2000. A holder may, at any time prior to maturity, convert the principal amount into shares of common stock at a conversion price of $16.57 per share. The Company has the option to redeem the notes after November 5, 2002 through October 31, 2003 for 101.75% of the principal amount.

The following methods and assumptions were used by the Company in estimating its fair value disclosures of its significant financial instruments:

The carrying amounts reported for cash and cash equivalents approximate fair value.

The carrying amounts of accounts receivable and accounts payable and accrued expenses approximate fair value because of the short-term nature of those transactions.

The fair values of the long-term debt are estimated using a discounted cash flow analysis, based on the Company’s incremental borrowing rates for similar types of borrowing arrangements at December 31, 2000 and 1999.

The fair values of the convertible subordinated notes are estimated using quoted market rates as of December 31, 2000 and 1999.

The carrying amounts and fair values of the Company’s financial instruments follows:

On November 8, 2000, the Company entered into a common stock purchase agreement, pursuant to which it sold its common stock totaling 3,126,038 shares to Acqua Wellington North American Equities Fund, Ltd. (“Acqua Wellington”) in exchange for cash proceeds of $10,000. On November 13, 2000, the Company entered into a subsequent common stock purchase agreement with Acqua Wellington under which the Company may, at its discretion, sell up to $140,000 of registered common stock from time to time over the succeeding 28-month period. The common stock can be sold during periods consisting of 18 trading days. In addition, the Company may grant to Acqua Wellington an option to purchase up to an equal amount of common stock during the same 18 trading day periods. The amount of common stock sold in a given 18 day period is dependent upon the average weighted market price of the Company’s common stock during this period. Acqua Wellington has the option not to purchase the Company’s common stock if the stock price falls below $3 per share. Acqua Wellington purchases the common stock at a discount to the then current market price, ranging from 4% to 6%, depending on the Company’s market capitalization at the time the Company requires Acqua Wellington to purchase its common stock. On February 15, 2001, the Company completed the first sale of its common stock under the November 13, 2000 agreement, issuing 1,612,755 shares to Acqua Wellington in exchange for cash proceeds of $5,000.

On November 13, 2000, the Company entered into common stock purchase agreements with eighteen investors consisting of several existing stockholders, the Company Chairman Christopher R. McCleary, Chief Executive Officer Andrew A. Stern and eight new strategic investors (the “Investors”). Under these agreements, the Investors committed to purchase $122,500 of the Company’s common stock, at a purchase price of $3.40 per share, which was determined based on the average of the closing price of the common

stock for the preceding 20 days. In connection with these financing transactions, in November 2000, the Company issued 9,007,353 shares of common stock to the Investors for cash proceeds of $30,625. The Company also issued warrants to the Investors to purchase 3,152,574 shares of common stock at an exercise price of $4.08 per share. The number of shares subject to the warrant may be adjusted to prevent dilution and each warrant will expire five years after its issuance.

The Company has authorized the issuance of up to 1,000,000 shares of preferred stock, par value $.01 per share, of which 110,000 has been designated Series A Convertible Preferred Stock (“Series A”) and 115,000 has been designated Series B Convertible Redeemable Preferred Stock (“Series B”). During 1998, the Company issued 55,000 shares of Series A for a total aggregate purchase price of $33,000, and 59,279 shares of Series B for a total aggregate purchase price of $62,200, including $22,100 of Series B issued upon conversion of notes payable. Upon the conversion of notes payable with a face value of $9,095 into Series B, unamortized debt discount of approximately $1,350 was recorded as additional interest expense.

In April 1999, the Company completed an initial public offering of 15,525,000 shares of common stock which resulted in net proceeds of $132,828, 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 69,523,934 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. (See Note 12.) The holders of the Series A and Series B preferred stock were entitled to receive cumulative quarterly dividends which were paid at the closing of the initial public offering.

The Company sold 3,023,438 shares of common stock to three officers in 1998 that required the Company to repurchase the common stock at fair value in the event of disability or death. These agreements were amended on February 25, 1999 to void the repurchase obligation upon death or disability upon the closing of an initial public offering of the common stock.

The Company initially recorded the common stock subject to repurchase at an amount equal to the consideration received of $1,010. The common stock subject to repurchase was accreted to its estimated fair value during all periods the common stock was subject to repurchase through charges to additional paid-in capital. The estimated value per share of $1.39 at December 31, 1998 was determined through an independent appraisal of the Company’s common stock. Additional accretion in 1999 prior to the April initial public offering was recorded based on valuations consistent with the expected initial public offering price. As a result of the initial public offering in April 1999, these shares were no longer subject to mandatory repurchase by the Company, and their accreted value at that date of $28,219 was reclassified to stockholders’ equity.

The Company has outstanding warrants to purchase common stock at December 31, 2000, as follows:

The Company at December 31, 2000 has reserved 26,984,245 shares of common stock for future issuance upon the exercise of stock options eligible for granting or previously granted under the 1998 Stock Option Plan and the 2000 Board Approved Plan (see Note 15), 7,545,272 shares of common stock issuable upon the conversion of the subordinated notes and 4,424,972 shares of common stock issuable upon the exercise of outstanding warrants.

Effective October 18, 2000, the Company adopted the USinternetworking, Inc. 2000 Board Approved Plan (“the 2000 Plan”), which is administered by the Board of Directors. The 2000 Plan provides for the granting of non-qualified options to purchase an aggregate of up to 5,000,000 shares of common stock to eligible employees.

Effective July 2, 1998, the Company adopted the 1998 Stock Option Plan of USinternetworking, Inc. (“the Plan”) which is also administered by the Board of Directors. The Plan, as amended, provides for the granting of either qualified or non-qualified options to purchase an aggregate of up to 25,160,063 shares of common stock to eligible employees, officers, directors and consultants of the Company.

During 2000 and 1999, the Company granted options to purchase common stock when the quoted market price of common stock was equal to, less than, or in excess of the exercise price of the granted options. The following table summarizes the weighted-average fair values and exercise prices of granted stock options:

Options granted in 1998 had a fair value at the date of grant of less than $0.01 per share.

Exercise prices for options outstanding as of December 31, 2000 ranged from $1.17 to $85.31 as follows:

Most options granted vest immediately at the date of grant. Most of the shares of common stock purchased pursuant to these options will be subject to the Company’s right to repurchase them at the option exercise price upon the termination of the holder’s employment or business relationship with the Company. The repurchase right will lapse with respect to one-third or one-quarter of the shares purchasable upon exercise of an option on the first anniversary of the date of grant of the option. The repurchase right with respect to 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 expire either 5 or 10 years from the date of issuance. At December 31, 2000, the weighted- average remaining contractual life of outstanding options is 7.8 years.

Certain options granted in 1999 are exercisable at prices less than the fair market value of the Company’s common stock at the date of grant. The Company will record stock compensation expense of approximately $30,614 as a result of these 1999 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. For 2000 and 1999, the Company recorded non-cash stock compensation expense of $9,094 and $8,500, respectively, related to these grants.

During 1999, the Company issued for no consideration 141,750 shares of common stock to four officers. The common stock vests over a maximum four year period from the date of issuance. The common stock at the issuance date had an aggregate fair value of $2,009, which is being recognized as compensation expense over the vesting period.

In November 2000, the Company offered its employees a voluntary option to surrender and cancel certain outstanding stock option agreements in exchange for awards of restricted stock. Under the terms of the arrangement, each employee that elected to participate agreed to cancel all stock options issued during a specified period. In conjunction with this arrangement, the Company cancelled stock option agreements for the purchase of 8,347,125 shares of common stock and issued 4,271,058 shares of restricted nonvested common stock. The common stock vests over periods up to 48 months. The common stock at the grant date had an aggregate fair value of $13,881, which is being recognized as compensation expense over the vesting period.

During 2000, the Company issued for no consideration 572,000 shares of common stock to certain executives as a retention bonus. The common stock vests over a four year period from the date of issuance. The common stock at the issuance date had an aggregate fair value of $2,065, which is being recognized as compensation expense over the vesting period.

The Company recognized stock compensation expense of $1,170 in 2000 and $453 in 1999 related to all restricted stock grants. At December 31, 2000, 443,426 shares of common stock issued in connection with these grants are vested, and 4,339,617 shares are unvested.

For the year ended December 31, 1998, pro forma net loss and loss per share information required by Statement No. 123 was determined using the minimum value method. The minimum value method calculates the fair value of options as the excess of the estimated fair value of the underlying stock at the date of grant over the present value of both the exercise price and the expected dividend payments, each discounted at the risk-free rate, over the expected life of the option. In determining the estimated fair value of granted stock options under the minimum value method, the risk-free interest rate was assumed to be 5.50%, the dividend yield was estimated to be 0% and the expected life of granted options was assumed to be four years.

The grant-date fair value of all options granted during 1998 using the minimum value method was less than $0.01, thus no pro forma information has been presented. The exercise price at the grant-date of all options granted through December 31, 1998 was greater than the market value of the underlying common stock on the grant date, as determined by independent appraisal. As a result, the Company has not recognized compensation expense related to these options.

For the years ended December 31, 2000 and 1999, pro forma net loss and loss per share information required by Statement No. 123 has been determined as if the Company had accounted for its stock-based

awards using the fair value method. The fair value of these awards was estimated at the date of grant using the Black-Scholes option pricing model with the following assumptions:

The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s stock-based awards have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock-based awards.

For purposes of pro forma disclosures, the estimated fair value of the awards is amortized to expense over the period the employees earn the right to retain the shares obtained upon exercise of the stock options or upon the issuance of restricted common stock. The Company’s pro forma net loss is $305,562 and $116,800 for the years ended December 31, 2000 and 1999, respectively. Pro forma basic and diluted loss per share attributable to common stock holders is $3.14 and $2.15 for the years ended December 31, 2000 and 1999, respectively.

At December 31, 2000, the Company has a U.S. federal net operating loss carryforward of $295,000. This carryforward begins to expire in 2018. The amount available to be used in any given year will be limited by operation of certain provisions of the Internal Revenue Code. The Company also has state net operating loss carryforwards available, the utilization of which will be similarly limited. The Company has established a valuation allowance with respect to these federal and state loss carryforwards.

Significant components of the Company’s deferred tax assets and liabilities at December 31 are as follows:

The reconciliation of the reported income tax expense to the amount that would result by applying the U.S. federal statutory rate of 35% to the net loss is as follows:

The Company conducts a significant amount of its operations from leased facilities under operating leases that have terms of up to seven years and that generally contain renewal options of two to three years and rent escalation clauses. Future minimum payments under noncancellable operating leases with initial terms of one year or more consist of the following at December 31, 2000:

The Company incurred rent expense of $7,848, $3,182, and $718 in 2000, 1999, and 1998, respectively.

The Company established a defined contribution benefit plan effective July 1, 1998. The plan covers substantially all employees who have 30 days of service with the Company. Participants may contribute from 1% to 15% of their annual compensation to the plan. The Company makes matching contributions of common stock up to 6% of the participant’s contributions pursuant to the terms of the plan. No contributions were made by the Company in 1998. The Company contributed to the plan 172,520 and 54,738 shares of common stock with fair values of $1,669 and $600 for the years ended December 31, 2000 and 1999, respectively.

In September 1999, the Company loaned $2,250 to an officer to purchase 843,750 shares of common stock pursuant to a stock option exercise. Additionally, the Company loaned the same officer $1,900 to fund the officer’s tax liability resulting from the exercise of the options described above. In July 2000, the Company consolidated both loans plus accrued interest of $99 into one full recourse note totaling $4,249, bearing interest at 9% per annum, and payable within 90 days on demand. The Company has classified the portion that represents the stock option exercise, or $2,250, as a reduction of stockholders’ equity at December 31, 2000.

The Company is organized into two business units that offer unique software solutions. These operating segments are as follows:


	•	Enterprise Applications — provides financial and human resource management, customer relationship management and procurement business process needs; and

	•	E-Business Services — provides e-business (B2B) and (B2C) solutions, Enterprise Portal solutions, and AppHost solutions.

Both business units utilize 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, Europe and Asia.

The Company evaluates the performance of its operating segments based on contribution margin, or revenues less variable direct costs. This contribution margin excludes an allocation of network and infrastructure costs, selling, general and administrative costs, product research and development costs, non-cash stock compensation expense, and depreciation and amortization.

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 consolidated financial statements.

The following table sets forth information on the Company’s reportable segments.

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

Revenues from one customer of the Company’s Enterprise Applications segment accounted for approximately 10% and 16% of the Company’s consolidated revenue for the years ended December 31, 2000 and 1999, respectively.

On January 2, 2001, the Company issued the remaining 27,022,059 shares of common stock to the Investors for net cash proceeds of $86,209 and warrants to purchase 9,457,721 shares of common stock at an exercise price of $4.08 per share. On January 2, 2001, the Company entered into a revolving credit facility with CS First Boston and GE Capital Corporation to borrow up to $50,000 for general corporate purposes and to refinance certain existing indebtedness. The credit facility bears interest at the election of the Company at either the prime rate or LIBOR plus variable margin percentages and is due on January 2, 2004. The amount which can be borrowed against the facility is based on a percentage of eligible accounts receivable and 12-month contract backlog. This facility has certain financial covenants and is secured by substantially all assets of the Company not otherwise encumbered.

On January 2, 2001, the Company borrowed $15,000 under this revolving credit facility. The proceeds were used to early retire $7,905 of existing debt, working capital, finance transaction related expenses and for general corporate purposes. In the first quarter of 2001, the Company will record an extraordinary loss on the early extinguishment of debt of approximately $931 related to the debt retirement.

The following is a summary of the quarterly results of operations for the years ended December 31, 2000 and 1999:

Gross profit is defined as revenue less direct cost of services and network and infrastructure costs.

We have audited the accompanying consolidated balance sheets of I.I.T. Holding, Inc. and subsidiaries as of December 31, 1996 and 1997, and September 7, 1998, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for the years ended December 31, 1996 and 1997, and for the period from January 1, 1998 through September 7, 1998. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the 1996 and 1997 financial statements of International Information Technology IIT, C.A., a wholly-owned subsidiary, which statements reflect total assets of $68,247 and $76,361 as of December 31, 1996 and 1997, respectively, and total revenues of $3,336 and $147,797 for the period from March 6, 1996 (inception) through December 31, 1996 and for the year ended December 31, 1997, respectively. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to data included for International Information Technology IIT, C.A., is based solely on the report of the other auditors.

In our opinion, based on our audits and the report of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of I.I.T. Holding, Inc. and subsidiaries as of December 31, 1996 and 1997, and September 7, 1998 and the consolidated results of their operations and their cash flows for the years ended December 31, 1996 and 1997, and for the period from January 1, 1998 through September 7, 1998, in conformity with accounting principles generally accepted in the United States.

We have audited the accompanying balance sheets of International Information Technology IIT, C.A., at December 31, 1997 and for the period from March 5, 1996 (date of inception) through December 31, 1996, and the related statements of operations, changes in stockholders’ equity and cash flows for the years then ended (not presented separately herein). These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with U.S. generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of International Information Technology IIT, C.A. at December 31, 1997 and for the period from March 5, 1996 (date of inception) through December 31, 1996, and the results of its operations and its cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.

At December 31, 1997 and 1996, the accompanying financial statements have been prepared assuming that the Company will continue its ongoing operations, despite of the negative stockholder’s equity, which shows uncertainty about the Company’s ability to continue in operation. These financial statements do not include any adjustments that could result as a consequence of this uncertainty.

I.I.T. Holding, Inc. and subsidiaries (“the Company”) provides internet consulting, integration, and support services to commercial companies in the United States and South America. I.I.T. Holding, Inc. was formed in February 1998 when the shareholders of International Information Technology Inc. and International Information Technology IIT, C.A., enterprises under common control, exchanged their stock for 100% of the stock of I.I.T. Holding, Inc. The accompanying consolidated financial statements for all periods presented include the combined financial position and results of operations of the companies previously under common control. All significant intercompany transactions have been eliminated in preparation of the consolidated financial statements.

The financial information for a Venezuelan subsidiary includes financial information converted from Venezuelan Bolivares to U.S. Dollars.

Assets and liabilities were converted at the rate in effect at the balance sheet date and the statement of operations was converted at the average rate during the periods.

The preparation of the consolidated financial statements in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.

For purposes of the statement of cash flows, the Company considers all highly-liquid instruments, including certificates of deposit, purchased with a maturity of three months or less to be cash equivalents.

Financial instruments that subject the Company to concentrations of credit risk consist primarily of accounts receivable. The Company grants credit in the normal course of business to its clients. As part of this ongoing procedure, the Company monitors the creditworthiness of its clients. The Company does not believe that it is subject to any unusual credit risk beyond the normal credit risk inherent in its business.

For the period ended September 7, 1998, two customers accounted for 24% ($1,042,674), and 10% ($457,784) of total revenue, and three customers accounted for 38% ($508,212), 13% ($177,874) and 10% ($139,758) of accounts receivable at September 7, 1998.

For the year ended December 31, 1997, three clients accounted for 33% ($927,964), 17% ($478,042), and 11% ($309,321) of total revenues, and three clients accounted for 44% ($279,055), 16% ($101,474), and 11% ($69,764) of accounts receivable at December 31, 1997. For the year ended December 31, 1996, three clients accounted for 57% ($425,803), 29% ($216,637), and 11% ($82,173) of total revenues, and three clients accounted for 42% ($94,710), 24% ($54,120), and 11% ($24,805) of accounts receivable at December 31, 1996.

The Company expenses advertising costs as incurred. Advertising expense was approximately $73,000 and $30,000 in 1997 and 1996, respectively. Advertising expense was approximately $27,000 for the period ended September 7, 1998.

In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (SFAS No. 130). SFAS No. 130 establishes standards for reporting and displaying comprehensive income and its components. SFAS No. 130 only impacts display as opposed to actual amounts recorded. Comprehensive income includes net income and all other non-owner changes in equity that are excluded from net income, such as foreign currency translation adjustments. SFAS No. 130 was adopted in 1998.

In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information (SFAS No. 131). This Statement requires that public business enterprises report certain information about operating segments in complete sets of financial statements of the enterprise and in condensed financial statements of interim periods issued to shareholders. It also requires that public business enterprises report certain information about their product and services, the geographic areas in which they operate, and their major customers. The Company adopted the provisions of SFAS No. 131 in 1998 which did not have a significant impact on the Company’s definition of operating segments and related disclosures.

The Company has entered into various capital leases for computer equipment during 1997. Computer equipment acquired under capital lease obligations was approximately $44,000. Depreciation expense was $11,116 and $6,000 for the period ended September 7, 1998 and for the year ended December 31, 1997, respectively.

Future lease payments under capital and operating leases are summarized as follows:

Rent expense was $47,476, $32,000 and $17,000 for the period ended September 7, 1998, and for the years ended December 31, 1997 and 1996, respectively.

The Company has established a defined contribution benefit plan effective January 1, 1998. The plan covers substantially all employees of the Company who are 21 years of age or older. Participants may contribute up to 15% of their annual compensation to the plan, and the Company matches up to 3% of annual compensation. In 1998, the Company recorded contributions to the plan of $37,502.

The note payable, which matured in 1997, was due to a financing organization, and required monthly installments of $552, including interest at 9.90%.

Upon reorganization in February 1998, the Company was authorized to issue 100 shares of common stock with a par value of $5.00 per share. At September 7, 1998, 95 shares were issued and outstanding.

In August 1997, the sole stockholder of the Company transferred 473 shares of the outstanding common stock to management employees for no consideration. An independent appraisal was obtained which estimated the fair value of the shares on the date of transfer at $1,002,316. This transfer was treated as a contribution to additional paid-in capital by the sole stockholder, with an offsetting charge to compensation expense. In 1997, the Company recorded compensation expense of $1,002,316 relating to the transfer of these shares.

Deferred income tax assets and liabilities are determined based upon differences between financial reporting and the tax basis of assets and liabilities and are measured using the enacted tax rate and laws that will be in effect when the differences are expected to reverse.

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of net deferred income taxes are as follows:

At September 7, 1998 the Company’s U.S. subsidiary has net operating loss carryforwards of approximately $359,000 available to offset future taxable income of the U.S. operations. These carryforwards begin to expire in 2012.

The Company’s Venezuelan subsidiary had cumulative net operating losses in the amount of $110,000 through December 31, 1997. These net operating losses resulted in net deferred tax assets of approximately $23,000 and $5,000 at December 31, 1997 and 1996, respectively. Management has determined that it is more likely than not that these net operating losses will not be utilized; therefore, a full valuation allowance was recorded against these deferred tax assets at December 31, 1997 and 1996. During the period from January 1, 1998 through September 7, 1998, the subsidiary utilized approximately $92,000 of the net operating loss carryforward, and increased the valuation allowance by approximately $2,500 to $25,500, which fully offsets the net deferred tax asset of $25,500 at September 7, 1998. The remaining net operating loss carryforward of approximately $18,000 will expire in 2000.

The Company is engaged in one business segment. This segment includes providing internet consulting, integration, and support services principally to commercial companies located throughout the United States and South America. The following table presents information regarding geographic segments for the period from January 1, 1998 through September 7, 1998 and the years ended December 31, 1997 and 1996. There were no service transfers between the United States and South America. Operating profit (loss) is total service revenue less cost of service revenue, general and administrative expenses, sales and marketing and depreciation.

Some older computer programs were written using two digits rather than four to define the applicable year. As a result, those computer programs have time-sensitive software that recognize a date using “00” as the year 1900 rather than the year 2000. This could cause a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities.

The Company is assessing the modifications or replacement of its software that may be necessary for its computer systems to function properly with respect to the dates in the year 2000 and thereafter. The Company does not believe that the cost of either modifying existing software or converting to new software will be significant or that the year 2000 issue will pose significant operational problems for its computer systems.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

The information with respect to directors and executive officers required by this Item 10 is incorporated in this report by reference to the information set forth under the caption “Directors and Executive Officers” in our definitive Proxy Statement for our 2000 Annual Meeting of Stockholders, which will be filed with the Commission no later than April 9, 2001.

The information required by this Item 11 is incorporated in this report by reference to the information set forth under the caption “Executive Compensation” in our definitive Proxy Statement which will be filed with the Commission no later than April 9, 2001. The sections entitled “Compensation Committee Report on Executive Compensation” and “Performance Graph” in the Proxy Statement are not incorporated herein by reference. Information relating to certain filings on Forms 3, 4 and 5 is contained in the Proxy Statement under the caption “Section 16(a) Beneficial Ownership Reporting Compliance.”

The information required by this Item 12 is incorporated in this report by reference to the information set forth under the caption “Security Ownership of Certain Beneficial Owners and Management” in our definitive Proxy Statement which will be filed with the Commission no later than April 9, 2001.

The information required by this Item 13 is incorporated in this report by reference to the information set forth under the caption “Certain Relationships and Related Transactions” in our definitive Proxy Statement which will be filed with the Commission no later than April 9, 2001.

All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instruction or are inapplicable and have therefore been omitted.


(a)	Filed herewith.

(b)	Incorporated by reference to the Company’s Registration Statement on Form S-1, as amended (Reg. No. 333-70717)

(c)	Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 1999 filed by the Company on November 15, 1999.

(d)	Incorporated by reference to the Company’s Registration Statement on Form S-1, as amended (Reg. No. 333-93299).

(e)	Not filed, in accordance with Instruction No. 2 to Item 601 of Regulation S-K, because the contract is substantially identical to Exhibit 10.20 except as to the parties thereto and the principal amount of the note.

(f)	Confidential treatment obtained as to certain portions.

(g)	Incorporated by reference to the Company’s Registration Statement on Form S-1, as amended (Reg. No. 333-95543).

(h)	Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2000 filed by the Company on November 14, 2000.

(i)	Incorporated by reference to the Company Current Report on Form 8-K for the event dated November 13, 2000 filed by the Company on November 22, 2000.

(j)	Confidential treatment requested as to certain portions.

We filed a Current Report on Form 8-K dated February 18, 2000 under which we filed a press release relating to the announcement of our cooperative marketing agreement with AT&T.

We filed a Current Report on Form 8-K dated March 6, 2000 under which we filed a press release relating to our Board of Directors approval of a three for two stock split of our common stock for all shareholders of record at the close of business on March 14, 2000.

We filed a Current Report on Form 8-K dated April 24, 2000 under which we filed a press release relating to the election of Ken Sichau to the board of directors.

We filed a Current Report on Form 8-K dated July 26, 2000 under which we filed a press release relating to the election of Andrew A. Stern as Chief Executive Officer of the Company, and a press release in connection with the Company’s second quarter financial results.

We filed a Current Report on Form 8-K dated October 26, 2000 under which we filed a press release relating to the Company’s third quarter conference call.

We filed a Current Report on Form 8-K dated November 22, 2000 under which we filed a press release relating to the Company signing commitments for over $300 million in equity and commercial credit facilities from financial and strategic investors and lenders.

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 March 29, 2001.


	By:	/s/ANDREW A. STERN



	Andrew A. Stern
	Chief Executive Officer and Director
	(Principal Executive Officer)

Pursuant to the requirements of the Securities Act of 1934, as amended, this Registration Statement has been signed by the following persons in the capacities and on the dates indicated.


PART I
	Item 1. Business
	Item 2. Properties
	Item 3. Legal Proceedings
	Item 4. Submission of Matters to a Vote of Security Holders
Part II
	Item 5. Market for Registrant’s Common Equity and Related Shareholder Matters
	Item 6. Selected Historical Consolidated Financial Data
	Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 7A. Quantitative and Qualitative Disclosures About Market Risk
	Item 8. Financial Statements and Supplemental Data
	Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
PART III
	Item 10. Directors and Executive Officers of the Registrant
	Item 11. Executive Compensation
	Item 12. Security Ownership of Certain Beneficial Owners and Management
	Item 13. Certain Relationships and Related Transactions
PART IV
	Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
SIGNATURES
Employment Agreement - Christopher R. McCleary
Consent of Ernst & Young LLP
Consent of Ernst & Young LLP
Consent of Bassan & Associados S.C.






PART I.




	Item 1.	Business	1




	Item 2.	Properties	10




	Item 3.	Legal Proceedings	10




	Item 4.	Submission of Matters to a Vote of Security Holders	11




PART II.




	Item 5.	Market for Registrant’s Common Equity and Related Stockholder Matters	11




	Item 6.	Selected Consolidated Financial Data	14




	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17




	Item 8.	Financial Statements and Supplemental Data	35




	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	73




PART III.
Items 10., 11., 12. and 13. are incorporated by reference from USinternetworking Inc.’s




		definitive Proxy Statement which will be filed with the Securities and Exchange Commission, pursuant to Regulation 14A, on or about April 9, 2001	73




PART IV.




	Item 14.	Exhibits, Financial Statement Schedules, and Reports on Form 8-K	73




SIGNATURES			77


		High		Low

Year Ended December 31, 1999:




	Second Quarter (from April 9, 1999)	$	26.67	$	10.22




	Third Quarter		18.64		6.36




	Fourth Quarter		46.59		11.28




Year Ended December 31, 2000:




	First Quarter	$	66.67	$	28.67




	Second Quarter		40.81		15.94




	Third Quarter		21.88		6.50




	Fourth Quarter		6.25		2.28




Year Ended December 31, 2001:




	First Quarter (through March 23, 2001)	$	5.19	$	1.22


			Period from
			January 14, 1998
			(date of inception)
			through			Year ended			Year ended
			December 31, 1998			December 31, 1999			December 31, 2000


			(in thousands, except per share data)




Statement of Operations Data:




Revenue			$	4,122		$	35,513		$	109,544




Costs and expenses:




	Direct cost of services			3,425			23,570			69,609




	Network and infrastructure costs			2,186			16,239			26,718




	Selling, general and administrative			25,239			63,999			101,944




	Non-cash stock compensation expense			231			10,351			20,998




	Depreciation and amortization			3,180			22,480			52,687

		Total costs and expenses		34,261			136,639			271,956

Operating loss				(30,139	)		(101,126	)		(162,412	)




Other income (expense):




	Interest income			367			4,115			8,813




	Interest expense			(2,681	)		(6,307	)		(21,361	)

Net loss			$	(32,453	)	$	(103,318	)	$	(174,960	)

Net loss attributable to common stockholders			$	(38,097	)	$	(129,683	)	$	(174,960	)

Basic and diluted loss per common share attributable to common stockholders(a)			$	(27.09	)	$	(1.95	)	$	(1.80	)


	Actual			Actual		Actual		Pro forma
	December 31,			December 31,		December 31,		December 31,
	1998			1999		2000		2000(b)


	(in thousands)




Balance Sheet Data:




Cash and cash equivalents	$	43,802		$	112,302	$	56,962	$	143,171




Available-for-sale securities		—			31,707		—		—




Working capital		22,551			117,166		2,506		79,515




Total assets		106,516			325,454		418,783		510,390




Current portion of long-term debt and capital lease obligations		3,262			18,421		43,822		57,622




Short-term obligations expected to be refinanced		5,282			2,117		—		—




Long-term debt, capital lease obligations, and convertible subordinated notes, excluding current portion		8,659			168,671		193,425		186,720




Series B Convertible Redeemable Preferred Stock		62,242			—		—		—




Common stock subject to repurchase		4,145			—		—		—




Stockholders’ (deficit) equity		(2,467	)		102,461		116,983		201,495






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


AARP Services, Inc. AllBooks4Less.com Amadeus Global Travel Distribution S.A. American Cancer Society Blue Cross Blue Shield of Michigan Cystic Fibrosis Foundation		General Growth Properties GMAC Home Services Hershey Foods HPdirect, Inc. Legg Mason Liberty Financial Companies Providian Bancorp Services Rand McNally & Company				Rohm & Haas Company Senco Products, Inc. Sony Electronics Inc.’s eMarker Business Sunburst Hospitality XL Capital


Name	Age		Position

Christopher R. McCleary		48	Chairman of the Board




Andrew A. Stern		43	Chief Executive Officer and Director




Harold C. Teubner, Jr.		54	Executive Vice President and Chief Operating Officer




Gary J. Rogers		50	Senior Vice President, Worldwide Marketing and Sales




Mary T. Weaver		47	Senior Vice President and Chief Administrative Officer




Mark J. McEneaney		37	Senior Vice President and Chief Financial Officer




Stephen E. McManus		51	President — E-Business Services Unit and Director




Michael S. Harper		35	President and General Manager of Enterprise Application Business Unit




William T. Price		39	Vice President, Secretary and General Counsel




Frank A. Adams(1)		55	Director




Cathy M. Brienza		52	Director




Michael C. Brooks(1)		56	Director




Benjamin Diesbach(1)		54	Director




William F. Earthman(1)		49	Director




R. Dean Meiszer(2)		44	Director




David J. Poulin(2)		42	Director




Ray A. Rothrock(2)		46	Director




John H. Wyant		54	Director




Joseph R. Zell		41	Director


(1)	Member of the compensation committee

(2)	Member of the audit committee


(a)	In March 2000, we approved a three for two stock split of common stock, options and warrants, for holders of record as of March 14, 2000. The per share data has been restated to retroactively reflect the stock split.

(b)	On January 2, 2001 we completed additional financing including the sale of 27,022,059 shares of common stock for gross proceeds of $91,875. In addition, the Company borrowed $15,000 under a new revolving credit facility with GE Capital Corporation. After giving effect to transaction fees and repayment and cash collateralization of certain long-term debt facilities, the Company received net proceeds of $86,209 from these transactions. The pro forma information at December 31, 2000 reflects both of these transactions. See notes 11 and 21 to the Company’s Consolidated Financial Statements for further information.


												Period from
									Eight			January 1,
									months			1998
			Year ended December 31,						ended			to
									August 31,			September 7,
			1996			1997			1997			1998


			(in thousands, except per
			share data)




Statement of Operation Data:




Revenue			$	747		$	2,812		$	1,499		$	4,406

Costs and expenses




	Cost of revenue			519			1,881			1,112			2,976




	Selling, general and administrative expenses			204			1,844			1,260			1,809




	Depreciation and amortization			14			30			15			28

		Total costs and expenses		737			3,755			2,387			4,813

Operating (loss) income				10			(943	)		(888	)		(407	)




Interest expense				(3	)		(9	)		(1	)		(17	)

Income (loss) before income taxes				7			(952	)		(889	)		(424	)




Provision (benefit) for income taxes				15			(58	)		(58	)		—

Net loss			$	(8	)	$	(894	)	$	(831	)	$	(424	)

Basic and diluted loss per common share attributable to common stockholders			$	(84.21	)	$	(9,410.53	)	$	(8,747.37	)	$	(4,464.37	)



	As of
	December 31,

	1996		1997


	(in thousands)




Balance Sheet Data:




Cash and cash equivalents	$	70	$	14




Working capital		14		41




Total assets		348		769




Long-term debt and capital lease obligations, excluding current position		11		16




Stockholder’s equity		45		132


		Year ended		Year ended		Period ended
		December 31, 2000		December 31, 1999		December 31, 1998

iMAP		$	92,908	$	21,743	$	69




Professional IT services			16,636		13,770		4,053

	Total revenue	$	109,544	$	35,513	$	4,122


Enterprise Applications		$	48,792	$	17,928	$	2,138




E-Business Services			60,752		17,585		1,984

	Total revenue	$	109,544	$	35,513	$	4,122






Consolidated Financial Statements of USinternetworking, Inc.




	Report of Independent Auditors	36




	Consolidated Balance Sheets as of December 31, 2000 and 1999	37




	Consolidated Statements of Operations for the years ended December 31, 2000 and 1999 and for the period January 14, 1998 (date of inception) through December 31, 1998	38




	Consolidated Statement of Stockholders’ Equity for the year ended December 31, 2000	39




	Consolidated Statements of Stockholders’ Equity (Deficit) for the period January 14, 1998 (date of inception) through December 31, 1998 and the year ended December 31, 1999	40




	Consolidated Statements of Cash Flows for the years ended December 31, 2000 and 1999 and for the period January 14, 1998 (date of inception) through December 31, 1998	41




	Notes to Consolidated Financial Statements	42




Consolidated Financial Statements of I.I.T. Holding, Inc. and Subsidiaries




	Report of Independent Auditors	62




	Report of Independent Auditors	63




	Consolidated Balance Sheets as of December 31, 1997, 1996 and September 7, 1998	64




	Consolidated Statements of Operations for the years ended December 31, 1997 and 1996 for the period from January 1, 1998 through September 7, 1998	65




	Consolidated Statements of Stockholders’ Equity for the years ended December 31, 1997 and 1996 and for the period from January 1, 1998 through September 7, 1998	66




	Consolidated Statements of Cash Flows for the years ended December 31, 1997 and 1996 and for the period from January 1, 1998 through September 7, 1998	67




	Notes to Consolidated Financial Statements	68


									For the period from
									January 14, 1998
									(date of inception)
			Year ended December 31,						through
									December 31,
			2000			1999			1998

Revenue			$	109,544		$	35,513		$	4,122




Costs and expenses:




	Direct cost of services			69,609			23,570			3,425




	Network and infrastructure costs			26,718			16,239			2,186




	General and administrative			27,615			22,052			19,426




	Sales and marketing			68,943			36,595			5,123




	Product research and development			3,276			5,352			690




	Restructuring charge			2,110			—			—




	Non-cash stock compensation expense:




		Direct cost of services		3,146			1,638			—




		Network and infrastructure costs		4,821			2,526			—




		General and administrative		7,266			2,904			231




		Sales and marketing		5,724			3,259			—




		Product research and development		41			24			—

				20,998			10,351			231




	Depreciation and amortization			52,687			22,480			3,180

		Total costs and expenses		271,956			136,639			34,261

Operating loss				(162,412	)		(101,126	)		(30,139	)

Other income (expense):




	Interest income			8,813			4,115			367




	Interest expense			(21,361	)		(6,307	)		(2,681	)

				(12,548	)		(2,192	)		(2,314	)

		Net loss		(174,960	)		(103,318	)		(32,453	)




Dividends accrued on Series A and Series B Convertible Preferred Stock				—			(2,328	)		(1,503	)




Accretion of common stock subject to repurchase to fair value				—			(23,938	)		(3,904	)




Accretion of Series B Convertible Redeemable Preferred Stock to fair value				—			(99	)		(237	)

		Net loss attributable to common stockholders	$	(174,960	)	$	(129,683	)	$	(38,097	)

Basic and diluted loss per common share attributable to common stockholders			$	(1.80	)	$	(1.95	)	$	(27.09	)


Date of record		Description

March 14, 2000		3 for 2 stock split
December 3, 1999		3 for 2 stock split
April 8, 1999		1 for 8 reverse stock split


	December 31,
	1999

Corporate commercial paper	$	8,959




Corporate bonds		10,548




Municipal bonds		12,200

	$	31,707






2001		$	27,199




2002			27,290




2003			10,272




2004			2

	Total minimum lease payments		64,763




Amounts representing interest			(3,723	)

Present value of capital lease obligations			61,040




Current portion			(21,802	)

Capital lease obligations, non-current		$	39,238






2001		$	22,020




2002			13,472




2003			2,273




2004			567




2005			6,545




2006 and thereafter			6,518

	Total	$	51,395



	December 31, 2000				December 31, 1999

	Carrying Value		Fair Value		Carrying Value		Fair Value

Cash and cash equivalents	$	56,962	$	56,962	$	112,302	$	112,302




Available-for-sale securities		—		—		31,707		31,707




Long-term debt		51,207		51,802		44,873		45,912




Convertible subordinated notes		125,000		65,625		125,000		362,188


Number of Shares		Exercise Price		Expiration Date

	1,174,004	$	1.52		September 2008
	18,394	$	3.00		December 2004
	3,152,574	$	4.08		December 2005
	80,000	$	20.44		June 2005

	4,424,972



											For the period from
	Year ended December 31,										January 1, 1998
											(date of inception)
											through
	2000					1999					December 31, 1998

				Weighted					Weighted					Weighted
				Average					Average					Average
	Number of			Exercise		Number of			Exercise		Number of			Exercise
	Options			Price		Options			Price		Options			Price

Outstanding at beginning of year		11,919,073		$	6.77		3,785,062		$	1.17		—		$	—




Granted		22,175,739			25.98		10,735,674			7.57		3,845,532			1.17




Exercised		(1,494,549	)		2.04		(1,681,269	)		1.93		—			—




Cancelled		(10,900,643	)		24.52		—			—		—			—




Forfeited		(227,181	)		5.50		(920,394	)		2.53		(60,470	)		1.17

Outstanding and exercisable at end of year		21,472,439		$	17.38		11,919,073		$	6.77		3,785,062		$	1.17


	Number of		Weighted Average		Weighted Average
	Shares		Exercise Price		Fair Value

2000

Market price equal to exercise price on grant date		20,413,118	$	26.94	$	22.68




Market price greater than exercise price on grant date		689,871	$	6.38	$	22.33




Exercise price greater than market price on grant date		1,072,750	$	20.32	$	3.30




1999

Market price equal to exercise price on grant date		5,226,081	$	11.08	$	9.11




Market price greater than exercise price on grant date		5,509,593	$	3.82	$	9.43


			Weighted Average		Weighted Average
			Exercise Prices		Remaining Contractual
Range of	Options		of Options		Life of Options
Exercise Prices	Outstanding		Outstanding		Outstanding

$ 1.17-$ 1.49		1,691,707	$	1.19		7.6
$ 2.31-$ 3.25		2,620,321		2.67		7.6
$ 3.56-$ 5.00		316,651		3.96		4.8
$ 6.50-$ 9.72		2,786,261		8.19		8.4
$10.13-$15.00		1,932,856		12.06		8.6
$15.50-$23.00		3,732,894		19.20		9.6
$23.50-$35.11		8,245,685		30.40		6.9
$35.46-$48.00		119,364		41.98		8.5
$56.87-$85.31		26,700		61.12		7.8

		21,472,439


			2000			1999

Deferred tax assets:




	Net operating loss carryforwards		$	116,754		$	42,583




	Deferred revenue			8,099			2,514




	Start-up and organizational costs capitalized for tax purposes			1,796			2,566




	Book over tax amortization			1,033			—




	Allowance for doubtful accounts			706			215




	Restructuring charges			692			—




	Accrued vacation			170			493




	Accrued compensation			—			230




	Non-cash compensation expense			8,305			3,543




	Other			218			168

		Total deferred tax assets		137,773			52,312

Deferred tax liabilities:




	Stock options			3,543			1,822




	Tax over book depreciation			12,696			279




	Prepaid maintenance contracts			3,589			958




	Other			18			174

		Total deferred tax liability		19,846			3,233

Net future income tax benefit				117,927			49,079




Valuation allowance for net deferred tax assets				(117,927	)		(49,079	)

Net deferred tax assets			$	—		$	—






2001	$	6,704




2002		6,332




2003		4,951




2004		3,329




2005		2,241




Thereafter		722

	$	24,279



	2000

	Q1			Q2			Q3			Q4

Revenue	$	17,790		$	26,223		$	28,268		$	37,263




Gross profit		450			2,714			3,008			7,045




Net loss		(39,646	)		(41,973	)		(47,752	)		(45,589	)




Basic and diluted net loss per share		(0.42	)		(0.43	)		(0.49	)		(0.44	)



	1999

	Q1			Q2			Q3			Q4

Revenue	$	4,392		$	6,683		$	9,777		$	14,661




Gross profit		(1,702	)		(2,044	)		(660	)		110




Net loss		(17,691	)		(23,595	)		(27,767	)		(34,265	)




Basic and diluted net loss per share		(31.03	)		(0.29	)		(0.31	)		(0.37	)


								For the period
		Year ended December 31,						January 1, 1998
								through
		1996			1997			September 7, 1998

Consulting revenue		$	747,023		$	2,812,011		$	4,405,560




Cost of revenue			519,261			1,881,031			2,976,499

Gross profit			227,762			930,980			1,429,061




Operating expenses:




	General and administrative		131,037			778,342			1,803,611




	Sales and marketing		73,305			62,943			4,632




	Stock compensation expense		—			1,002,316			—




	Depreciation		13,556			30,253			27,580

			217,898			1,873,854			1,835,823

Income (loss) from operations			9,864			(942,874	)		(406,762	)




Interest expense			(2,917	)		(8,977	)		(17,353	)

Income (loss) before provision for income taxes			6,947			(951,851	)		(424,115	)




Provision (benefit) for income taxes			14,832			(58,372	)		—

Net loss		$	(7,885	)	$	(893,479	)	$	(424,115	)


			Capital Leases		Operating Leases

Four months ended December 31, 1998			$	3,703	$	14,884




	1999			13,503		54,454




	2000			5,844		39,165




	2001			—		517

		Total minimum lease payments		23,050	$	109,020

Less amounts representing interest				4,651

Present value of minimum lease payments (including current portion of $9,803)			$	18,399


		United States			South America			Total

Consulting revenue:	1998	$	3,896,502		$	509,058		$	4,405,560
	1997		2,664,214			147,797			2,812,011
	1996		743,687			3,336			747,023




Depreciation:	1998	$	21,819		$	5,761		$	27,580
	1997		26,919			3,334			30,253
	1996		12,720			836			13,556




Operating profit (loss):	1998	$	(382,361	)	$	(24,401	)	$	(406,762	)
	1997		(844,036	)		(98,838	)		(942,874	)
	1996		39,481			(29,617	)		9,864




Interest expense:	1998	$	5,420		$	11,933		$	17,353
	1997		4,782			4,195			8,977
	1996		2,345			572			2,917




Identifiable assets:	1998	$	1,646,768		$	158,262		$	1,805,030
	1997		692,702			76,361			769,063
	1996		279,616			68,247			347,863


Exhibit
No.		Description

	3.1(d)	Second Amended and Restated Certificate of Incorporation of the Company.
	3.2(d)	Amended and Restated Bylaws of the Company.


Name	Title	Date

/s/ CHRISTOPHER R. MCCLEARY Christopher R. McCleary	Chairman of the Board
/s/ MARK J. MCENEANEY Mark J. McEneaney	Senior Vice President and Chief Financial Officer
/s/ STEPHEN E. MCMANUS Stephen E. McManus	President — E-Business Services Unit and Director
/s/ FRANK A. ADAMS Frank A. Adams	Director
/s/ CATHY M. BRIENZA Cathy M. Brienza	Director
/s/ MICHAEL C. BROOKS Michael C. Brooks	Director
Benjamin Diesbach	Director
/s/ WILLIAM F. EARTHMAN William F. Earthman	Director
/s/ R. DEAN MEISZER R. Dean Meiszer	Director
/s/ DAVID J. POULIN David J. Poulin	Director
/s/ RAY A. ROTHROCK Ray A. Rothrock	Director
/s/ JOHN H. WYANT John H. Wyant	Director
/s/ JOSEPH R. ZELL Joseph R. Zell	Director



					Additions

			Balance at		Charged to Costs		Charged to Other	Deductions —			Balance at End
Description			Beginning of Period		and Expenses		Accounts — Describe	Describe			of Period

Year Ended December 31, 2000:




	Deducted from assets accounts:




		Allowance for doubtful accounts	$	543	$	3,891		$	2,649	(1)	$	1,785




	Accrued liabilities:




		Other accrued liabilities — restructuring charge	$	0	$	2,110		$	0		$	2,110

Year Ended December 31, 1999:




	Deducted from asset accounts:




		Allowance for doubtful accounts	$	142	$	415		$	14	(1)	$	543

Period from January 14, 1998 (date of inception) through December 31, 1998:




	Deducted from asset accounts:




		Allowance for doubtful accounts	$	0	$	142		$	0	(1)	$	142