I think i figured it out.  I just had to remove the download statement in the application_startup:

app.Download(false);

When i navigate to the external xap, UXShell automatically downloads and initializes the xap.  pretty cool.

More composite app questions:

I've got a composite app (ClientUIOutlookNavApp1) with 2 external apps (App1 & App2).  In fiddler, the external apps always download each time i run ClientUIOutlookNavApp1 even when they have not changed.  Why doesn't UXShell load App1 and App2 from local storage? 

here's the startup code in ClientUIOutlookNavApp1.  any suggestions much appreciated!

public partial class App : Application
    {

        // define the ApplicationID used to reference this application from UXShell or other containers
        public static string ApplicationID = "ClientUIOutlookNavApp1";
        public static string DataFolder = "/ClientUIOutlookNavApp1;component/Assets/Data/";
        public static string ImagesFolder = "/ClientUIOutlookNavApp1;component/Assets/Images/";

        public App()
        {
            this.Startup += this.Application_Startup;
            this.Exit += this.Application_Exit;
            this.UnhandledException += this.Application_UnhandledException;

            InitializeComponent();
            InitializeShell();
        }

        private void InitializeShell()
        {        
            UXShell shell = new UXShell();
            shell.RootApplication = UXShell.CreateApplicationFromType(typeof(App), ApplicationID, ApplicationID);
            shell.CheckForUpdates = true;  
            shell.AutoInstallOnDownload = true;
            shell.AutoInstallUpdates = true;
            //shell.InstallStorageScope = StorageScope.Site;          
            this.ApplicationLifetimeObjects.Add(shell);      
        }

        private void Application_Startup(object sender, StartupEventArgs e)
        {
           
            // create a new ApplicationPackage that represents App1

            ApplicationPackage app1 = new ApplicationPackage()
            {
                ID = "App1",
                Name = "App1",
                Source = new Uri("App1.xap", UriKind.RelativeOrAbsolute),
                EnableMetadataDiscovery = true,
                MainType = "App1.MainPage",
                VirtualPathIdentity = "/App1",
                Size = -1 // auto detect the file size at runtime
            };
            

            // add the application to the UXShell
            UXShell.Current.Applications.Add(app1);

            ApplicationPackage app2 = new ApplicationPackage()
            {
                ID = "App2",
                Name = "App2",
                Source = new Uri("App2.xap", UriKind.RelativeOrAbsolute),
                EnableMetadataDiscovery = true,
                Size = -1 // auto detect the file size at runtime
            };
            
            // add the application to the UXShell
            UXShell.Current.Applications.Add(app2);
          
            this.RootVisual = new MainPage();        
        }

        private void Application_Exit(object sender, EventArgs e)
        {

        }

        private void Application_UnhandledException(object sender, ApplicationUnhandledExceptionEventArgs e)
        {
            // If the app is running outside of the debugger then report the exception using
            // the browser's exception mechanism. On IE this will display it a yellow alert 
            // icon in the status bar and Firefox will display a script error.
            if (!System.Diagnostics.Debugger.IsAttached)
            {
                e.Handled = true;

                // Displays a user-friendly error page to the primary navigation (UXFrame) of the application
                Deployment.Current.Dispatcher.BeginInvoke(delegate { DisplayErrorToNavigationFrame(e); });
            }
        }

        private void DisplayErrorToNavigationFrame(ApplicationUnhandledExceptionEventArgs e)
        {
            UXFrame frame = UXFrame.GetPrimaryNavigator(this.RootVisual);

            if (frame != null)
            {
                frame.Navigate(new Uri("/Error", UriKind.Relative), e);
            }
            else
            {
                ReportErrorToDOM(e);
            }
        }

        private void ReportErrorToDOM(ApplicationUnhandledExceptionEventArgs e)
        {
            try
            {
                string errorMsg = e.ExceptionObject.Message + e.ExceptionObject.StackTrace;
                errorMsg = errorMsg.Replace('"', '\'').Replace("\r\n", @"\n");

                System.Windows.Browser.HtmlPage.Window.Eval("throw new Error(\"Unhandled Error in Silverlight Application " + errorMsg + "\");");
            }
            catch (Exception)
            {
            }
        }
    }