<PAGE>   1
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                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON D.C. 20549


                                    FORM 10-Q


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

                                       OR

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


                        COMMISSION FILE NUMBER 000-25759


                            APPLIEDTHEORY CORPORATION
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)


                       DELAWARE                               16-1491253
           (STATE OR OTHER JURISDICTION OF                  (I.R.S. EMPLOYER
            INCORPORATION OR ORGANIZATION)                IDENTIFICATION  NO.)



                 40 CUTTER MILL ROAD,                             11021
            SUITE 405, GREAT NECK, N.Y.                        (ZIP CODE)
      (ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)

                                (516) 466 - 8422
               REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE

                                 NOT APPLICABLE
         (FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED
                            SINCE LAST REPORT DATE)


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

As of June 1, 1999, there were - 21,146,435 shares of AppliedTheory Corporation
common stock, par value $.01, outstanding


                    The Index of Exhibits appears on page 34

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<PAGE>   2
                            APPLIEDTHEORY CORPORATION



                                TABLE OF CONTENTS




PART I. FINANCIAL INFORMATION

Item 1.       Financial Statements (Unaudited):

              Balance Sheets as of December 31, 1998 and March 31, 1999........3

              Statements of Operations for the three months ended
              March 31, 1998 and March 31, 1999................................4

              Statements of Cash Flows for the three months ended
              March 31, 1998 and March 31, 1999................................5

              Notes to Financial Statements....................................6


Item 2.       Management's Discussion and Analysis of Financial Condition
              and Results of Operations.......................................11

PART II. OTHER INFORMATION

Item 1.       Legal Proceedings...............................................18

Item 2.       Changes in Securities and Use of Proceeds.......................18

Item 3.       Defaults Upon Senior Securities.................................19

Item 4.       Submission of Matters to a Vote of Security Holders.............19

Item 5.       Other Information...............................................20

Item 6.       Exhibits and Reports on Form 8K.................................32

Signatures    ................................................................33

Exhibit Index.................................................................34
<PAGE>   3
PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS


                            APPLIEDTHEORY CORPORATION
                                 BALANCE SHEETS
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)

<TABLE>
<CAPTION>
                                                                            December 31,             March 31,
                                                                                1998                    1999
                                                                                ----                    ----
                                                                       (Derived from Audited        (Unaudited)
                                                                       Financial Statements)
<S>                                                                    <C>                          <C>
                             ASSETS
Current assets
 Cash and cash equivalents                                                    $  1,786               $    813
 Accounts receivable, net of allowance for doubtful accounts
  of $157 and $172, respectively                                                 3,584                  3,888
 Prepaid expenses and other assets                                                 255                    289
                                                                              --------               --------
     Total current assets                                                        5,625                  4,990

Property and equipment, net                                                      4,203                  5,923
Other assets                                                                       690                  1,721
                                                                              --------               --------
     Total assets                                                             $ 10,518               $ 12,634
                                                                              ========               ========

         LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities
 Accounts payable                                                             $  2,149               $  2,988
 Accrued payroll                                                                   582                    866
 Accrued expenses                                                                2,473                  2,579
 Deferred revenue                                                                1,849                  1,790
 Current portion of long-term debt and capital lease obligations                   551                  1,077
 Preferred stock dividends payable                                                 420                    473
 Due to related parties                                                            850                    869
                                                                              --------               --------
     Total current liabilities                                                   8,874                 10,642

Long-term debt and capital lease obligations                                     5,979                  6,767
Borrowings from NYSERNet.net, Inc.                                               2,957                  3,809
Other Liabilities                                                                  215                    198
Redeemable preferred stock - 1,000,000 shares authorized;
 15,000 issued and outstanding; cumulative 14% dividend;
 $100 per share liquidation value                                                1,500                  1,500

Stockholders' Equity (Deficit):
Common stock, $.01 par value; 60,000,000 shares authorized;
 issued and outstanding 15,039,488 shares at December 31,
 1998 and 15,848,708 shares at March 31, 1999                                      150                    159
Common stock - nonvoting, $.01 par value, 5,000,000 shares
 authorized; issued and outstanding 54,848 shares at December
 31, 1998 and 121,473 shares at March 31, 1999                                       1                      1

Additional paid-in capital                                                       6,581                  7,007
Accumulated deficit                                                            (15,739)               (17,449)
                                                                              --------               --------

     Total stockholders' equity (deficit)                                       (9,007)               (10,282)
                                                                              --------               --------

     Total liabilities and stockholders' equity (deficit)                     $ 10,518               $ 12,634
                                                                              ========               ========
</TABLE>


        The accompanying notes are an integral part of these statements.


                                       3
<PAGE>   4
                            APPLIEDTHEORY CORPORATION

                            STATEMENTS OF OPERATIONS
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)
                                   (UNAUDITED)


<TABLE>
<CAPTION>
                                                                       THREE MONTHS ENDED
                                                                            March 31,
                                                                --------------------------------
                                                                    1998                1999
                                                                    ----                ----
<S>                                                             <C>                 <C>
Net revenues
     Third-party customers                                      $      3,175        $      4,833
     NYSERNet.org, Inc. customers and services                         2,159               2,034
                                                                ------------        ------------

     Total net revenues                                                5,334               6,867
                                                                ------------        ------------

Costs and expenses
     Cost of revenues                                                  2,940               4,103
     Sales and marketing                                               1,438               1,764
     General and administrative                                        1,143               1,814
     Research and development                                             46                  63
     Depreciation and amortization                                       360                 616
     Other expenses                                                        2                   3
                                                                ------------        ------------

     Total costs and expenses                                          5,929               8,363
                                                                ------------        ------------

     Loss from operations                                               (595)             (1,496)

Interest income                                                         --                   (18)
Interest expense                                                         142                 180
                                                                ------------        ------------

     NET LOSS                                                           (737)             (1,658)

Preferred stock dividends                                                 52                  52
                                                                ------------        ------------

Net loss attributable to common stockholders                    $       (789)       $     (1,710)
                                                                ============        ============

Basic and diluted loss per common share                         $      (0.07)       $      (0.11)
                                                                ============        ============

Shares used in computing basic and diluted loss per share         10,907,075          15,930,258
                                                                ============        ============
</TABLE>


        The accompanying notes are an integral part of these statements.


                                       4
<PAGE>   5
                            APPLIEDTHEORY CORPORATION

                             STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
                                   (UNAUDITED)


<TABLE>
<CAPTION>
                                                                                 THREE MONTHS ENDED
                                                                                      March 31,
                                                                               ----------------------
                                                                                1998            1999
                                                                                ----            ----
<S>                                                                            <C>            <C>
Cash flows from operating activities
         Net loss                                                              $  (737)       $(1,658)
         Adjustments to reconcile net loss to net cash used in operating
         activities:
              Depreciation and amortization                                        360            616
              Provision for bad debts                                             --               23
              Deferred payment of interest expense to NYSERNet.net, Inc.            51             52
              Loss on sale of property and equipment                                12              3
              Non-cash compensation expense                                        100            313
              Changes in assets and liabilities
                Accounts receivable, net                                          (502)          (326)
                Due to (from) related parties                                     (431)            18
                Prepaid expenses and other assets                                 (240)          (284)
                Accounts payable                                                   589            840
                Accrued payroll                                                     39            284
                Accrued expenses and other liabilities                             358             89
                Deferred revenue                                                   360            (59)
                                                                               -------        -------

              Net cash used in operating activities                                (41)           (89)
                                                                               -------        -------

Cash flows from investing activities
         Purchases of property and equipment                                      (626)          (889)
         Payments received on notes receivable                                    --                1
         Proceeds from sale of property and equipment                                5           --
                                                                               -------        -------

              Net cash used in investing activities                               (621)          (888)
                                                                               -------        -------

Cash flows from financing activities
         Issuance of common stock, net of issuance costs                            59            121
         Borrowings from NYSERNet.net, Inc.                                       --              800
         Proceeds from line of credit borrowings, net                              721             70
         Principal payments on capital leases                                      (53)          (205)
         Security deposit on equipment financing                                  --             (782)
                                                                               -------        -------

              Net cash provided by financing activities                            727              4
                                                                               -------        -------

              Net increase (decrease) in cash and cash equivalents                  65           (973)

Cash and cash equivalents, beginning of period                                     135          1,786
                                                                               -------        -------

Cash and cash equivalents, end of period                                       $   200        $   813
                                                                               =======        =======
</TABLE>


        The accompanying notes are an integral part of these statements.


                                       5
<PAGE>   6
                            APPLIEDTHEORY CORPORATION
                          NOTES TO FINANCIAL STATEMENTS
                                   (UNAUDITED)

NOTE A - NATURE OF OPERATIONS AND BASIS OF PRESENTATION

     AppliedTheory Corporation (formerly AppliedTheory Communications, Inc.) was
     incorporated in the State of New York in November 1995 as a wholly-owned
     subsidiary of NYSERNet.net, Inc. ("NET"), a not-for profit corporation. NET
     is also the sole member of NYSERNet.org, Inc. ("ORG"), a not-for-profit
     corporation (in effect ORG is a wholly-owned subsidiary of NET). As a
     result of certain transactions completed during 1998 (the exercise of
     options for 3,559,335 shares of AppliedTheory Communications, Inc. common
     stock, the private placement of 1,725,000 shares of AppliedTheory
     Communications, Inc. common stock and NET's direct sale of 4,875,000 shares
     of AppliedTheory Communications, Inc. common stock), AppliedTheory
     Corporation is no longer a subsidiary of NET.

     These financial statements for the three months ended March 31, 1999 and
     1998 and the related footnote information are unaudited and have been
     prepared on a basis substantially consistent with the audited financial
     statements of AppliedTheory Corporation (the "Company") as of and for the
     year ended December 31, 1998 included in the our Registration Statement on
     Form S-1 filed with the Securities and Exchange Commission. The
     accompanying unaudited financial statements of AppliedTheory Corporation
     have been prepared in accordance with generally accepted accounting
     principles for interim financial information, with the instructions to Form
     10-Q and Article 10 of Regulation S-X. All material adjustments, consisting
     of only normal and recurring adjustments, which, in the opinion of
     management, are necessary for fair presentation of the results for the
     interim periods have been reflected. Operating results for the three month
     periods ended March 31, 1999 and 1998 are not necessarily indicative of the
     results that may be expected for any succeeding quarters or for the full
     year. The financial statements and notes thereto should be read in
     conjunction with the Company's audited financial statements for the year
     ended December 31, 1998.

     In conjunction with its Initial Public Offering (the "IPO"), AppliedTheory
     Communications, Inc. reorganized as a Delaware corporation. On January 28,
     1999, AppliedTheory Communications, Inc. established its wholly owned
     subsidiary, AppliedTheory Corporation. AppliedTheory Communications, Inc.
     merged into AppliedTheory Corporation, which is the surviving entity
     effective with the completion of its IPO, on May 5, 1999. On April 12,
     1999, a committee of the Board of Directors of both AppliedTheory entities
     authorized an increase in the number of authorized shares of common stock
     and preferred stock to 90,000,000 and 1,000,000, respectively. All
     non-voting common shares were converted into voting common shares effective
     with the IPO.

     On May 5, 1999, the Company's IPO became effective. Through the IPO,
     5,175,000 shares of the Company's common stock were issued for net proceeds
     of approximately $77.0 million after deduction of the underwriting discount
     and commission.

NOTE B - LOSS PER SHARE

     Basic loss per share is computed using the weighted average number of
     shares of common stock outstanding during the period. Diluted loss per
     share is computed using the weighted average number of shares of common
     stock outstanding, adjusted for the dilutive effect of potential common
     shares issued or issuable pursuant to stock options and stock appreciation
     rights. Potential common shares issued are calculated using the treasury
     method. All potential common shares have been excluded from the computation
     of diluted loss per share


                                       6
<PAGE>   7
                            APPLIEDTHEORY CORPORATION
                          NOTES TO FINANCIAL STATEMENTS
                                   (UNAUDITED)


     as their effect would be antidilutive and accordingly, there is no
     reconciliation of basic and diluted loss per share for the periods
     presented.

NOTE C - SEGMENT AND RELATED INFORMATION

     The Company operates as one business segment, as a provider of Internet
     solutions. The Company had revenues from its major service offerings as
     follows:


<TABLE>
<CAPTION>
                                                        Three Months Ended
                                                             March 31,
                                                  ------------------------------
                                                     1998                1999
                                                  ----------          ----------
<S>                                               <C>                 <C>
Net revenues
  Internet connectivity                           $3,577,439          $4,160,818
  Internet integration and
    enterprise portal development                  1,361,202           2,094,635
  Web hosting                                        395,160             611,218
                                                  ----------          ----------
Total net revenues                                $5,333,801          $6,866,671
                                                  ==========          ==========
</TABLE>


NOTE D - PROPERTY AND EQUIPMENT

     On December 21, 1998, the Company adopted a plan, which was approved by its
     Board of Directors, to close a leased facility, which principally is used
     as a Web-hosting data center. The facility has experienced operational
     difficulties which limited its usability as a Web-hosting site and its
     ability to generate sufficient revenues. In connection with the plan of
     abandonment, the Company recorded a $900,000 charge to operations for the
     year ended December 31, 1998 consisting of (i) a $486,000 write-down of
     equipment and leasehold improvements to management's estimate of their fair
     value, based on the anticipated discounted future cash flows through the
     date of abandonment, of approximately $70,000 in accordance with the
     provisions of SFAS No. 121, "Accounting for the Impairment of Long-Lived
     Assets and for Long-Lived Assets To Be Disposed Of" and (ii) a $414,000
     accrued liability, included in Accrued Expenses, relating to equipment
     leases and facility operating leases, (net of anticipated subrental income)
     expiring in October 2001 and May 2006, respectively, in accordance with the
     provisions of EITF 94-3, "Liability Recognized for Certain Employee
     Termination Benefits and Other Costs to Exit an Activity." This accrued
     liability provides for only those costs subsequent to exiting the facility,
     which is expected to occur in September 1999, and costs prior thereto will
     be recognized during the period they are incurred. The plan calls for the
     Web-hosting customer base served from this abandoned facility and the
     related revenues, which are not significant, to be transitioned to another
     facility. As of March 31, 1999, no amounts have been paid against this
     liability.


                                       7
<PAGE>   8
                            APPLIEDTHEORY CORPORATION
                          NOTES TO FINANCIAL STATEMENTS
                                   (UNAUDITED)


NOTE E - LONG-TERM DEBT

     Line of Credit

     On January 20, 1998, the Company entered into a credit agreement with a
     bank for an aggregate amount of $7,500,000, which expires on January 19,
     2001. The agreement provides for the payment of the unpaid principal
     balance of all amounts advanced on January 19, 2001. Interest is charged
     and payable on a monthly basis as determined by the Company, either on a
     LIBOR plus 50 basis points or a prime rate basis less 200 basis points. The
     credit facility is collateralized by substantially all assets of the
     Company and by a maximum of $5,500,000 of cash and cash equivalents,
     government securities, corporate securities or corporate equities pledged
     by NET.

     The Company had $5,500,000 outstanding under the line of credit as of March
     31, 1999 and, as a result of certain restrictions, had no additional
     availability as of March 31, 1999. The average interest rate on outstanding
     borrowings was 6.1% at March 31, 1999.

     Borrowings from NYSERNet.net, Inc.

     The Company has an unsecured borrowing facility with NET, which provides
     for borrowings to a maximum amount of $6,187,000, less any preferred stock
     issued to NET, for working capital requirements. This borrowing facility
     expires on January 1, 2002. Interest on the loans accrues at the prime rate
     and payments are deferred for five years from the date of each advance or
     January 1, 2002, whichever is earlier. All principal borrowings under this
     agreement are due and payable on January 1, 2002. The Company had principal
     borrowings under this facility of $3,487,000 at March 31, 1999. The Company
     had $1,200,000 available for additional principal borrowings at March 31,
     1999. In addition, the Company has interest payable under this agreement of
     approximately $322,000 at March 31, 1999. On May 5, 1999, the Company paid
     down the line of credit and deferred interest in full with the proceeds
     from the IPO.


     Capital Lease Obligations

     During March 1999, the Company leased approximately $1,449,000 of equipment
     under an agreement accounted for as a capital lease. The obligation for the
     equipment requires the Company to make monthly payments of approximately
     $52,000 through September 2001. In connection with the equipment financing,
     the Company was required to place on deposit $782,000 as additional
     collateral. The security deposit which is included in other assets is
     interest bearing, and may at the sole discretion of the lender, be
     refundable based upon the completion of the Company's IPO.


                                       8
<PAGE>   9
                            APPLIEDTHEORY CORPORATION
                          NOTES TO FINANCIAL STATEMENTS
                                   (UNAUDITED)


NOTE F - REDEEMABLE PREFERRED STOCK

     Holders of shares of the redeemable preferred stock are entitled to receive
     payment for cumulative dividends at the annual rate of $14.00 per share
     (14%) beginning January 1, 1999, based upon a liquidation value of $100 per
     share, payable quarterly. At March 31, 1999, the amount of dividends
     payable on the 14% redeemable preferred stock was $472,500. The Company may
     redeem all or any part of the preferred stock at any time on or after
     December 31, 2001, by resolution of the Company's Board of Directors. At
     any time on or after December 31, 2001, any holder of preferred stock may
     request that the Company redeem some or all of the holder's preferred stock
     within sixty days of such request. On May 5, 1999, the Company paid
     $1,993,000 to fully redeem the preferred stock and accrued dividends in
     full with the proceeds from the IPO.

NOTE G - STOCK OPTIONS

     Certain options and stock appreciation rights were granted in 1998 at
     exercise prices below the fair market value of the Company's stock. The
     Company recorded $100,000 and $313,000 of compensation expense associated
     with these options and stock appreciation rights for the three months ended
     March 31, 1998 and 1999 respectively.

NOTE H - RELATED PARTY TRANSACTIONS

     Transactions with NET and ORG

     The Company has entered into an Internet service provider agreement with
     ORG to serve as ORG's sole source provider for Internet solutions to ORG's
     customer base under contractual arrangements. ORG's customers consist of
     (i) unrelated customers for which ORG serves as a conduit to the sales
     transactions between the Company and these customers and (ii) member
     institutions of ORG for which ORG provides pricing terms below that charged
     by the Company to ORG. The Company's revenues from ORG's customer base for
     the following periods are:


<TABLE>
<CAPTION>
                                                 Three months ended March 31,
                                               ---------------------------------
                                                  1998                   1999
                                               ----------             ----------
<S>                                            <C>                    <C>
Unrelated customers                            $  832,274             $  698,932
Member institutions                             1,118,815              1,119,397
Services to ORG                                   207,948                215,273
                                               ----------             ----------
                                               $2,159,037             $2,033,602
                                               ==========             ==========
</TABLE>


                                       9
<PAGE>   10
                            APPLIEDTHEORY CORPORATION
                          NOTES TO FINANCIAL STATEMENTS
                                   (UNAUDITED)


     During each of the three months ended March 31, 1998 and 1999, the Company
     charged NET approximately $25,000 and ORG $75,000, respectively, in
     management fees.

     The excess of the Company's revenues over amounts charged by ORG to its
     member institutions was approximately $707,000 and $698,000 for the three
     months ended March 31, 1998 and 1999, respectively.

NOTE I - SUBSEQUENT EVENT

     1.   Stock Split

          On April 12, 1999 the Board of Directors approved a 1.5 to 1 stock
          split to be completed upon completion of the Initial Public Offering.
          All per share amounts have been adjusted retroactively.


                                       10
<PAGE>   11
ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS

         You should read and consider the following discussion in conjunction
with our audited financial statements and notes thereto and the "Management's
Discussion and Analysis of Financial Condition and Results of Operations" as of
and for the year ended December 31, 1998 which is included the Registration
Statement Form S-1 (File No. 333-72133), as filed with the Securities and
Exchange Commission in connection with our initial public offering of common
stock.

         Certain statements in this Form 10-Q constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. These forward-looking statements involve known and unknown risks,
uncertainties and other factors which may cause our actual results, performance
or achievements, or those of the industry in which we operate, to be materially
different from any expected future results, performance or achievements
expressed or implied by these forward-looking statements. Factors that could
cause or contribute to such differences include, but are not limited to, those
discussed below, as well as those discussed in Part II, Item 5 of this Form 10-Q
and in the Registration Statement of our initial public offering of common
stock.

         Unless the context otherwise requires, references in this Form 10-Q to
"AppliedTheory", the "Company, "we", "our" and "us" refer to AppliedTheory
Corporation.

OVERVIEW

         We are a leading provider of one-stop Internet solutions to the
business mid-market and public sector, offering an extensive array of high
performance, reliable and scalable Internet technology products and services.
Our products and services can be tailored to meet our customers' requirements.
We provide the following products and services, either individually or as part
of a one-stop package:

               -    Internet integration and enterprise portal development,
                    including custom software application development, Web site
                    design and development and upgrading of legacy systems;

               -    Web hosting, consisting of custom hosting solutions and
                    outsourcing, shared server, dedicated server and co-location
                    hosting solutions; and

               -    Internet connectivity, including virtual private network
                    solutions, network and security consulting and dedicated
                    Internet access.

         We market our products and services to the business mid-market and
public sector institutions. We believe these businesses and institutions are
increasingly demanding one-stop solutions for Internet services due to the
difficulty and expense of managing and integrating the products and services of
multiple vendors. Our comprehensive suite of products and services enables our
customers to capitalize on the wide variety of critical data communication
opportunities made possible by the Internet.

         Historically, we have generated our revenues using a small sales force
and have expanded our customer base primarily through word of mouth. We are
rapidly building our sales and marketing efforts nationally to more aggressively
pursue customers. We have targeted 20-30 metropolitan areas throughout the
United States which have high concentrations of businesses


                                       11
<PAGE>   12
and intend to grow our direct sales force by more than 100 over the next two
years. These targeted markets, where we plan to have a physical local presence,
coincide with the planned points of presence, or POPs, of our strategic partner,
IXC Internet Services, Inc.

RESULTS OF OPERATIONS

THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED MARCH 31, 1998

         REVENUE. Total net revenues increased approximately $1.6 million from
$5.3 million in the three months ended March 31, 1998 to $6.9 million in the
three months ended March 31, 1999. Approximately $0.6 million of this growth was
from Internet connectivity revenue, which resulted primarily from the addition
of over 65 new customers from March 31, 1998 to March 31, 1999. Web hosting
revenue increased by approximately $0.2 million during the same period. This
increase resulted primarily from an increase in Web monitoring, management and
hosting services for the New York State Department of Labor in connection with
America's Job Bank. The remaining increase in total net revenues of
approximately $0.8 million was derived from Internet integration and enterprise
portal development services. These services include:

         -     linking existing databases and legacy systems with the Web; and

         -     creating open, universal interfaces to business-critical
               information and standards-based software used to link with the
               systems of suppliers, partners and customers.

         The increase in Internet integration and enterprise portal development
was derived from the expansion of these services to the New York State
Department of Labor in connection with America's Job Bank.

         For the quarter ended March 31, 1999, as a percentage of total net
revenues, Internet connectivity represented 61%, Internet integration and
enterprise portal development represented 31% and Web hosting represented 8%.
For the quarter ended March 31, 1998, as a percentage of total net revenues,
Internet connectivity represented 67%, Internet integration and enterprise
portal development represented 26% and Web hosting represented 7%.

          COST OF REVENUE. Cost of revenue for the three months ended March 31,
1999 totaled approximately $4.1 million compared with approximately $2.9 million
for the three months ended March 31, 1998. Approximately $.55 million of this
increase is attributable to the upgrade of our network to support customer
growth and improve our Internet connectivity services. Additionally,
approximately $.50 million was derived from an increase in labor and other
professional service costs associated with the expansion of Internet integration
and enterprise portal development services provided to the New York State
Department of Labor in connection with America's Job Bank. As a percentage of
revenue, cost of revenue increased to 60% of revenue in the three months ended
March 31, 1999 from 55% of revenue in the three months ended March 31, 1998.

         SALES AND MARKETING. For the three months ended March 31, 1999 and
1998, sales and marketing expense was approximately $1.8 million and $1.4
million, respectively. The $.4 million increase reflects a substantial
investment in the sales and marketing organizations necessary to support our
expanded customer base and our efforts to establish a national sales and
marketing program. This increase also reflects a growth in subscriber
acquisition costs for our Internet connectivity and web hosting products,
related to both increased direct marketing efforts as well as commissions paid
to distribution partners. Sales and marketing expense, as a percentage of
revenue, was approximately 26% for the three months ended March 31, 1999 and
1998.


                                       12
<PAGE>   13
         GENERAL AND ADMINISTRATIVE. For the quarters ended March 31, 1999 and
1998, general and administrative expenses were approximately $1.8 million and
$1.1 million, respectively. The increase in general and administrative expenses
of approximately $0.7 million was primarily attributable to:

         -     compensation expense relating to stock compensation expense;

         -     costs related to recruiting new personnel; and

         -     increases necessary to manage the financial, legal and
               administrative aspects of our business.

         For the quarter ended March 31, 1999, general and administrative
expense increased as a percent of revenue to 26% from 21% for the quarter ended
March 31, 1998.

         RESEARCH AND DEVELOPMENT. Research and development costs are
principally focused in our Internet integration and enterprise portal
development and web hosting service offerings. For the three months ended March
31, 1999 and 1998, research and development expenses have not significantly
fluctuated.

         DEPRECIATION AND AMORTIZATION. For the three months ended March 31,
1999 and 1998, depreciation and amortization expense was approximately $.6
million and $.4 million, respectively. Depreciation and amortization costs have
increased as a result of capital expenditures associated with our Internet
integration and enterprise portal development and web hosting products.

         NET INTEREST EXPENSE. Net interest expense was approximately $.2
million for the three months ended March 31, 1999 and 1998, respectively.

         NET LOSS. Net loss attributable to common stockholders for the quarter
ended March 31, 1999 was $1.7 million, or $0.11 per share, compared with $.79
million or $0.07 per share for the quarter ended March 31, 1998.



LIQUIDITY AND CAPITAL RESOURCES

         We had an accumulated deficit of $17.4 million at March 31, 1999, and
have used $8.8 million in cash in the aggregate to fund operations during the
period since our inception on October 1, 1996 through March 31, 1999. To date,
we have satisfied our cash requirements primarily through the sale of common and
preferred stock and borrowings under credit agreements and equipment financing
arrangements. Our principal uses of cash are to fund operations, for working
capital requirements and for capital expenditures. At March 31, 1999, we had $.8
million in cash and cash equivalents and a working capital deficit of
approximately $5.7 million. The Company used cash in operations of approximately
$89,000 in the quarter ended March 31, 1999 compared to $41,000 for the quarter
ended March 31, 1998. Net cash used in investing activities for the quarter
ended March 31, 1999 and 1998 was approximately $.9 million and $.6 million,
respectively. Net cash provided by financing activities was insignificant in the
quarter ended March 31, 1999 and approximately $.7 million for the quarter ended
March 31, 1998.


                                       13
<PAGE>   14
         Capital expenditures, including capital leases, amounted to
approximately $2.4 million for the quarter ended March 31, 1999 as compared to
$.6 million for the quarter ended March 31, 1998.

         On January 20, 1998, we obtained a secured revolving line of credit
with Fleet National Bank for $7.5 million, which expires on January 19, 2001.
Borrowings under this line are secured by substantially all our assets and by a
maximum of $5.5 million of cash and cash equivalents, government securities and
corporate securities or corporate equities pledged by NYSERNet.net, Inc., a
not-for-profit corporation of which we were formerly a wholly owned subsidiary,
and which is currently one of our principal stockholders. (For further details
of this relationship, please see the discussion in Note A to the Financial
Statements provided in Part I, Item I of this Form 10-Q and in the Registration
Statement for our initial public offering of common stock). At March 31, 1999,
borrowings under this line amounted to $5.5 million. The credit agreement
provides for the payment on January 19, 2001, of the unpaid principal balance of
all amounts advanced. Interest is charged and payable on a monthly basis as
determined by us either at LIBOR plus 50 basis points or at the prime rate less
200 basis points. As of March 31, 1999, as a result of restrictions under the
line of credit, no additional credit was available under this agreement.

         We also have an unsecured revolving borrowing facility with
NYSERNet.net, which provides for borrowings up to a maximum amount of
approximately $6.2 million, less any preferred stock issued to NYSERNet.net.
Interest on the loans accrues at the prime rate (7.75% at March 31, 1999).
Payments are deferred until December 31, 2001. As of March 31,1999, $2.0 million
was available under this borrowing facility. In connection with our initial
public offering, on Form S-1 of 5,175,000 shares of our common stock, par value
$.01 per share, we fully redeemed our outstanding preferred stock and paid down
all outstanding line of credit borrowings to NYSERNet.net.

         We have made capital investments in our network operations center, data
center and other capital assets, excluding assets under capital lease, totaling
$0.9 million and $0.6 million in the three months ended March 31, 1999 and 1998.

         We believe that the net proceeds from our initial public offering,
which closed on May 5, 1999, will be sufficient to meet our anticipated cash
needs for expanding our sales and marketing efforts, expanding our customer
support services, building new distributed data centers, and for other working
capital requirements and general corporate purposes. However, there can be no
assurance regarding the period of time through which our financial resources
will be adequate to support our operations. We may need to raise additional
funds through public or private financing, strategic relationships or other
arrangements. There can be no assurance that additional financing, if needed,
will be available on terms acceptable to us, or at all. Furthermore, any
additional equity financing may be dilutive to stockholders, and debt financing,
if available, may involve restrictive covenants and significant interest
expense. Strategic arrangements, if necessary to raise additional funds, may
require us to relinquish rights to some of our technologies.



YEAR 2000 COMPLIANCE

         Our business operations and revenues are very sensitive to the effects
of Year 2000 problems. These problems may originate within our own systems and
products or within the systems of our third party suppliers or our customers.
Some of our non-information technology systems, such as equipment or machinery,
may also be affected by Year 2000 problems.


                                       14
<PAGE>   15
OUR YEAR 2000 COMPLIANCE PROGRAM

         During the second quarter of 1998, we formed a working group to ensure
that our products and services are Year 2000 compliant. These include:

     -   our commercial product line;

     -   internal software business applications;

     -   hardware;

     -   desktop support;

     -   telephone systems;

     -   office equipment; and

     -   facilities.

         All of these components are undergoing a rigorous Year 2000 readiness
verification process, which includes:

     -   component inventory and assessment, including vendor and third party
         evaluation;

     -   component remediation;

     -   component testing;

     -   system testing; and

     -   contingency planning.

         Testing has not yet been completed, and we plan to continue testing
throughout the rest of the year. As of May 29, 1999, we have identified all of
the components of our business that need to be tested for Year 2000 readiness,
and we expect to complete upgrades and testing in the second quarter of 1999. We
have also sent requests for Year 2000 readiness statements to each of our third
party vendors. Responses received from these parties are currently being
analyzed, and follow-up requests have been sent to those who did not respond to
our initial request. To date, there are no responses that cause concern as far
as achieving compliance.

         Our Total Estimated Costs Associated with Year 2000. We estimate that
we will incur expenses of approximately $45,000 to test and upgrade our products
and applications for Year 2000 readiness. We also expect 500 to 750 additional
hours of labor will be necessary to complete the testing and upgrading. The
costs associated with our internal applications compliance are expected to be
limited to 150 to 250 hours of labor, and the balance of our estimated expenses
in cash and hours of labor will be committed to ensuring the readiness of our
products and services.

YEAR 2000 AND OUR INTERNAL APPLICATIONS

         Our State of Readiness. All of our internally developed systems,
upgrades and applications are Year 2000 ready or are scheduled to be updated in
the near future. Most of our system packages have also been deemed compliant by
our vendors. Even though we will continue to test our systems, we anticipate
full compliance during 1999.

         Contingency Plans. If during our testing in 1999 we find results that
warrant concern, we will dedicate programming staff to procure readiness and to
do re-testing.


                                       15
<PAGE>   16
YEAR 2000 AND OUR SERVICES AND PRODUCTS.

         Our State of Readiness. We expect that any problems related to our
Internet access products will be resolved before the end of 1999. For example,
we are currently changing our dial-up network to a dial-up access service
provided by an affiliate of IXC that has been represented to us as Year 2000
ready.

         We are currently assessing the Year 2000 readiness of the different
operational aspects of our Internet access and value-added services such as mail
and news, and almost all components are Year 2000 ready. Any component that is
found not to be Year 2000 ready will be upgraded and tested further. Any third
party vendor of products that we use for these services that has been noted as
not yet Year 2000 ready had been sent a letter requesting its readiness plans.

         Regarding our security services offerings, while versions 4.0a and
higher of the Gauntlet firewall software program have been tested and are Year
2000 ready, we have recommended that all of our Gauntlet customers upgrade to
version 4.2 or higher. We have sent the Gauntlet version 4.2 or higher to all
our existing Gauntlet customers.

         We deliver Web hosting services through integration of third party
hardware and software. This creates an environment in which our clients may
place and run their Web sites in our data centers. As of March 1, 1999, we had
requested Year 2000 readiness plans from all 40 of our third party vendors for
our Web hosting services. Based on responses, software upgrades have been
applied to those in need, and product testing is underway. We are testing
outside software used by our customers in the same manner as internally designed
software when there is no third party vendor liable for upgrades and patches.

         We expect that our Internet integration and enterprise portal
development services will be for the most part unaffected by the Year 2000
issue. There may be cases where incoming data feeds from customers will need to
be adjusted or slight modifications will need to be made on the Web server.
However, because Internet integration and enterprise portal development is a
fairly new business line, Year 2000 compliance was addressed from its inception.
Additionally, Internet integration and enterprise portal development projects
have been implemented almost exclusively by in-house technical programmers who
have helped to ensure that Year 2000 standards, as well as other programming
standards, were adhered to.

         We have initiated full testing of our entire product line. Test servers
have been built, and web testing is underway. The tests are simulating the
Internet access services and Web hosting services for the two calendar weeks
before and after January 1, 2000. The goal of these tests is to identify any
problematic operations and create a plan for rectifying problems during June and
July 1999, when the second phase of testing will commence.

         Risks of our Products and Services' Year 2000 Issues. The worst case
scenario for our Internet access services would be the unavailability of access
to all customers. Although this risk is unlikely, given the high level of Year
2000 readiness already in place for the components of this product line, it is
possible that we could suffer minor access problems.

         In the case of our Web hosting services, the worst case scenario would
be the inability to access the Web sites we manage. A more likely risk would be
that our service would be unavailable to some sites for time periods of less
than one week. In such cases we may give service credits to our customers whose
service is interrupted.

         Our Web enabling solutions applications may experience problems such as
a customer data feed not being Year 2000 ready or customers failing to make
necessary changes. In such a


                                       16
<PAGE>   17
case, our technical support and operations groups would help customers fix these
problems to the best of our ability.

         Contingency Plans. If our Internet access and value-added services are
not Year 2000 ready, we are prepared to move customers' local loop access
services to other providers or to offer service credits. We do not currently
have any information that would cause us to believe that any of our third party
vendors will experience substantial Year 2000 problems. However, if during the
course of our Year 2000 testing we find that any particular vendor is being
unresponsive, we will attempt to locate a replacement for that vendor.
Additionally, we will communicate with our customers throughout the year in
order to alert them to third party issues that may affect them.

         In the case of our Web hosting services, we will be adding multiple
data centers over the course of 1999 and will be in a position to provide
additional redundancy for our customers' Web sites if they desire.

         If, during the course of the Year 2000 testing of our Internet
integration and enterprise portal development solutions, we discover that a
customer will be required to alter or correct a data feed and that the customer
is unable to do so, we will try to correct the data feed and reform it as
necessary. This correction would likely involve a small amount of additional
labor on our part.

         In any event, we will fully staff our technical support and operations
groups during the last week of December and all of January 2000 to fix any
problems in our systems and help customers to the best of our ability with any
problems they may experience.


                                       17
<PAGE>   18
PART II. OTHER INFORMATION

ITEM 1.           LEGAL PROCEEDINGS

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

ITEM 2.           CHANGES IN SECURITIES AND USE OF PROCEEDS

         On May 5, 1999, we completed our initial public offering of 5,175,000
shares of our common stock, par value $.01 per share. The offering was made
pursuant to a Registration Statement on Form S-1 (File No. 333-72133) which
registered up to 5,175,000 shares of our common stock and was declared effective
on April 29, 1999. The offering commenced on April 30, 1999 and all 5,175,000
shares registered in our offering were sold at an initial public offering price
of $16.00 per share. The managing underwriters were Bear, Stearns & Co. Inc.,
CIBC World Markets Corp., Lehman Brothers Inc. and Wit Capital Corporation.
Gross proceeds from the offering were $82.8 million, $5.8 million of which was
applied to the underwriting discount. As of June 1, 1999, approximately $1.6
million was applied to expenses related to our offering. As a result, net
proceeds from the offering are approximately $75.4 million. Except as discussed
herein with respect to our repayment of a revolving line of credit and
redemption of our preferred stock to NYSERNet.net, none of the net proceeds of
our offering were paid by us, directly or indirectly, to any of our directors,
officers or any of their associates, or to any person or entity owning 10
percent or more of our equity securities or the equity securities of any of our
affiliates.

         On May 5, 1999, we paid approximately $3.8 million to repay outstanding
borrowings under our revolving line of credit with NYSERNet.net, including
accrued interest. We also paid approximately $2.0 million to redeem our
outstanding preferred stock, including accrued dividends, from NYSERNet.net.
NYSERNet.net owns approximately 23.1% of our common stock and has one
representative on our board of directors. We intend to use the remaining $70.0
million of the net proceeds from the offering for general corporate purposes and
working capital requirements, including the following:

         -     to expand our sales and marketing efforts in 20-30 metropolitan
               areas and increase our direct sales force by over 100 employees
               nationally;

         -     to expand our customer support services, and

         -     for working capital requirements and other general corporate
               purposes, including possible acquisitions.

         No portion of the proceeds has been allocated for any specific purpose
referred to above. We have discretionary authority over the use of net proceeds
from the offering. In addition, we intend to use approximately $4.5 million of
the net proceeds from this offering to build new data centers in connection with
the planned construction of the Gemini2000 Network.

         Pending the above uses, we intend to invest the proceeds of the
offering in short-term, interest bearing securities of investment grade.

         During the quarter ended March 31, 1999, proceeds of $121,092 were
generated from the exercise of options for 875,845 shares of our common stock.
There were no significant expenses, underwriting discounts or commissions
attributable to these proceeds. These options had been granted under our 1996
Incentive Stock Option Plan and were exercised by certain employees and
directors. We issued the shares in reliance on the exemption from registration
provided by Rule 701 under the Securities Act of 1933.


                                       18
<PAGE>   19
ITEM 3.           DEFAULTS UPON SENIOR SECURITIES

         Not applicable

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


         On February 26, 1999, a special meeting of the stockholders of
AppliedTheory Communications, Inc. was held pursuant to a notice, dated February
16, 1999, which was mailed on February 16, 1999 to all stockholders. The meeting
was called in order to solicit the stockholders' approval of the reincorporation
of AppliedTheory Communications, Inc. as a Delaware corporation, to be effected
through a merger between AppliedTheory Communications, Inc., a New York
corporation, and its wholly owned subsidiary, AppliedTheory Corporation, a
Delaware corporation that is also the registrant. The Board of Directors of both
of these corporations approved this merger on February 25, 1999. The
stockholders approved this merger. Holders of the following shares were present
in person or by proxy at this meeting and the following votes were cast in favor
of the merger:



         Common stock: 15,941,673 shares outstanding, 15,670,173 shares present
         and voting in favor of approving the reincorporation merger,
         representing 99% of the common stock outstanding;

         Preferred stock: 15,000 shares outstanding, 15,000 shares present and
         voting in favor of approving the reincorporation merger, representing
         100 % of the preferred stock outstanding.



         On April 15, 1999, a special meeting of the stockholders of
AppliedTheory Communications, Inc. was held pursuant to a notice dated April 5,
1999, which was mailed to all stockholders. The meeting was called in order to
solicit the stockholders' approval of the 1999 Stock Option Plan which was
adopted by the Board of Directors of AppliedTheory Communications on March 8,
1999, as well as of the 1999 Employee Stock Purchase Plan, which was adopted by
the Board of Directors of AppliedTheory Communications, Inc. on March 16, 1999.
Both the 1999 Stock Option Plan and the 1999 Employee Stock Purchase Plan
received stockholders' approval at this meeting. Holders of the following shares
were present in person or by proxy at this meeting and votes were cast in the
following manner:



         Common Stock: 15,970,179 shares outstanding, 14,985,749 shares present
         and voting in favor of approving the 1999 Stock Option Plan and the
         1999 Employee Stock Purchase Plan, representing 94 % of the common
         stock outstanding; and

         Preferred stock: 15,000 shares outstanding, 15,000 shares present and
         voting in favor of approving the 1999 Stock Option Plan and the 1999
         Employee Stock Purchase Plan, representing 100 % of the preferred stock
         outstanding.


                                       19
<PAGE>   20
ITEM 5.           OTHER INFORMATION

RISK FACTORS

         From time to time, in both written and in oral statements by our senior
management, we express expectations and other statements regarding future
performance. These forward-looking statements are inherently uncertain and you
must recognize that these events could turn out to be different than such
expectations and statements. We discuss key factors impacting current and future
performance in the Registration Statement for our initial public offering and in
other filings with the Securities and Exchange Commission. In addition, you
should consider the following risk factors as well as any other information in
this Quarterly Report in evaluating our business and us. Any investment in our
common stock involves a high degree of risk.

WE HAVE A LIMITED OPERATING HISTORY AND MAY SUCCESSFULLY IMPLEMENT OUR BUSINESS
PLAN.

         We have a limited operating history, and our business model is still in
development. We were incorporated in 1995 and commenced operations in late 1996.
As an early stage Internet company we are subject to expenses and difficulties
associated with implementing our business plan that are not typically
encountered by more mature companies. The risks associated with implementing our
business plan relate to:

               -    building out our operations infrastructure;

               -    expanding our sales structure and marketing programs;

               -    increasing awareness of our brand;

               -    providing services to our customers that are reliable and
                    cost-effective;

               -    responding to technological development or service offerings
                    by competitors; and

               -    attracting and retaining qualified personnel.

         If we are not successful in implementing our business plan, our
business or future financial or operating results could suffer.

WE HAVE A HISTORY OF SIGNIFICANT LOSSES AND EXPECT THESE LOSSES TO INCREASE IN
THE FORESEEABLE FUTURE.

         We have incurred significant net losses and negative cash flows in each
quarterly and annual period since inception and expect to continue to do so for
the foreseeable future. At March 31, 1999, we had an accumulated deficit of
approximately $17.4 million. We incurred net losses of $1.7 million and $.79
million in the three months ended March 31, 1999 and 1998, respectively. In
connection with our expansion plans, we anticipate making significant
investments in sales and marketing, new distributed data centers, customer
support and personnel. As a result of our expansion plans, we expect our net
losses and negative cash flows from operations on a quarterly and annual basis
to increase in the foreseeable future. Our ability to achieve profitability is
dependent in large part upon the successful completion of the Gemini2000 Network
over which we have no control, and the successful implementation of our
nationwide expansion strategy. The Gemini 2000 Network is the first
coast-to-coast, next generation Internet backbone network which is designed to
carry both research and commercial traffic. We are deploying this network
together with IXC Communications, Inc., an affliate of one of our significant
stockholders. We cannot assure you that we will achieve or sustain revenue
growth or profitability on either a quarterly or annual basis.


                                       20
<PAGE>   21
TO DATE, MOST OF OUR REVENUES HAVE BEEN DERIVED FROM CUSTOMERS LOCATED IN NEW
YORK STATE AND WE MAY NOT SUCCESSFULLY EXECUTE OUR NATIONWIDE GROWTH STRATEGY.

         To date, most of our revenues have been derived from customers located
in New York State. Our business strategy is to become a leading national
provider of advanced Internet technology solutions to the business mid-market
and select public sector organizations. The risks we may encounter in executing
our nationwide growth strategy include the possibility that:

               -    our products and services are not accepted beyond our
                    current market;

               -    there are significant delays in the roll-out of the
                    Gemini2000 Network or our new data centers;

               -    the technology upon which the Gemini2000 Network is based is
                    overtaken;

               -    we fail to successfully implement our sales and marketing
                    strategy on a national scale;

               -    we fail in our efforts to build a national sales force;
                    and/or

               -    we fail to develop a nationally recognized brand.

OUR RAPID GROWTH STRATEGY IS LIKELY TO PLACE A SIGNIFICANT STRAIN ON OUR
RESOURCES.

         Our future success depends in large part on our ability to manage any
achieved growth in our business. For our nationwide growth strategy to succeed,
we will need:

               -    to expand our business with new and current customers;

               -    to develop and offer successful new products and services;

               -    to retain key employees and hire new employees; and

               -    to ensure that any future business we may develop or acquire
                    will perform in a satisfactory manner.

         These activities are expected to place a significant strain on our
resources. Also, we cannot guarantee that any of these will occur or that we
will succeed in managing the results of any success in our nationwide growth
strategy.

OUR ANNUAL AND QUARTERLY OPERATING RESULTS ARE SUBJECT TO SIGNIFICANT
FLUCTUATIONS. AS A RESULT, PERIOD-TO-PERIOD COMPARISONS OF OUR RESULTS OF
OPERATIONS ARE NOT NECESSARILY MEANINGFUL AND SHOULD NOT BE RELIED UPON AS
INDICATIONS OF FUTURE PERFORMANCE.

         We have experienced significant fluctuations in our results of
operations on a quarterly and annual basis. We expect to continue to experience
significant fluctuations in our future quarterly and annual results of
operations due to a variety of factors, many of which are outside of our
control, including:

               -    demand for and market acceptance of our services;

               -    customer retention;

               -    the timing and success of our marketing efforts;

               -    the timing and magnitude of capital expenditures, including
                    costs relating to the expansion of operations;

               -    the timely expansion of existing facilities and completion
                    of new facilities;

               -    the ability to increase bandwidth as necessary;

               -    fluctuations in bandwidth used by customers;

               -    introductions of new services or enhancements by us and our
                    competitors;


                                       21
<PAGE>   22
               -    increased competition in our markets;

               -    growth of Internet use and establishment of Internet
                    operations by mainstream enterprises; and

               -    changes in our and our competitors' pricing policies.

A RELATIVELY LARGE PORTION OF OUR EXPENSES ARE FIXED IN THE SHORT-TERM. AS A
RESULT, OUR RESULTS OF OPERATIONS WILL BE PARTICULARLY SENSITIVE TO FLUCTUATIONS
IN REVENUE.

         A relatively large portion of our expenses are fixed in the short-term,
particularly in respect of data and telecommunications costs, depreciation, real
estate interest expense and personnel. Because we will be required to incur
these fixed expenses, irrespective of our revenue, our future results of
operations are particularly sensitive to fluctuations in revenue.

THE EXPECTED CONTINUED GROWTH IN THE MARKET FOR OUR PRODUCTS AND SERVICES MAY
NOT MATERIALIZE OR MAY MATERIALIZE IN A MANNER WE HAVE NOT ANTICIPATED.

         Our market is new and rapidly evolving. Whether, and the manner in
which, the market for our products and services will continue to grow is
uncertain. The market for our products and services may be inhibited for a
number of reasons, including:

               -    the reluctance of businesses to outsource their Internet
                    integration, enterprise portal development, Web hosting and
                    Internet connectivity needs;

               -    our failure to successfully market our products and services
                    to new customers; and

               -    the inability to maintain and strengthen our brand
                    awareness.

OUR SUCCESS DEPENDS IN LARGE PART ON THE CONTINUED GROWTH OF THE INTERNET
MARKET.

         Our business would be hurt if Internet usage does not continue to grow.
Internet usage may be inhibited for a number of reasons, including:

               -    access costs;

               -    inadequate network infrastructure;

               -    security concerns;

               -    uncertainty of legal and regulatory issues concerning use of
                    the Internet;

               -    inconsistent quality of service; and

               -    lack of availability of cost-effective, high-speed service.

         If Internet usage grows, the Internet infrastructure may not be able to
support the demands placed on it or the Internet's performance and reliability
may decline. Similarly, Web sites have experienced interruptions in their
service as a result of outages and other delays occurring throughout the
Internet network infrastructure. If these outages or delays occur frequently,
use of the Internet as a commercial or business medium could, in the future,
grow more slowly or decline. This could hurt our business.

WE OPERATE IN AN EXTREMELY COMPETITIVE MARKET AND MAY NOT BE ABLE TO COMPETE
EFFECTIVELY.

         The Internet-based services market is extremely competitive and many of
our competitors are more established and have greater financial resources than
us. In addition, there are no substantial barriers to entry in this market. We
also expect that competition will intensify in the future. Many of our
competitors have greater market presence, engineering and marketing


                                       22
<PAGE>   23
capabilities and financial, technological and personnel resources than we do. As
a result, as compared to us our competitors may:

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

               -    adapt more swiftly to new or emerging technologies and
                    changes in customer requirements;

               -    take advantage of acquisitions and other opportunities more
                    effectively; and

               -    more effectively leverage existing relationships with
                    customers or exploit a more recognized brand name to market
                    and sell their services.


         Our current and prospective competitors, both in New York State and
nationally, generally may be divided into the following three groups:

               -    Internet service providers including Concentric Network
                    Corp., Exodus Communications, Inc., Globix Corporation,
                    AboveNet Communications, Inc., PSINet Inc., UUNET
                    Technologies, Inc., Frontier Global Center, GTE
                    Internetworking, Digex, Inc., Verio Inc. and other national
                    and regional providers;

               -    telecommunications companies, such as AT&T Corp., Cable &
                    Wireless plc, Sprint Corporation, MCI WorldCom, Inc., Qwest
                    Communications International Inc., regional
                    telecommunications companies and various cable companies;
                    and

               -    network and system integrators, including IBM Corporation,
                    Oracle Corporation, the Big 5 accounting firms, EDS
                    Corporation and similar entities.

         We believe that we may also face competition from other large computer
hardware and software companies and other media, technology and
telecommunications companies.

         The number of businesses providing Internet-related services is rapidly
growing. We are aware of other companies, in addition to those named above, that
have entered into or are forming joint ventures or consortia to provide services
similar to those provided by us. Others may acquire the capabilities necessary
to compete with us through acquisitions.

WE COULD ENCOUNTER SIGNIFICANT PRICING PRESSURE AS A RESULT OF INCREASED
COMPETITION AND INDUSTRY CONSOLIDATION.

         As a result of increased competition and consolidation in the industry,
we could encounter significant pricing pressure, which in turn could result in
significant reductions in the average selling price of our services. We may not
be able to offset such price reductions even if we obtain an increase in the
number of our customers, derive higher revenue from enhanced services or manage
to reduce our costs. Increased price or other competition could erode our market
share and could significantly hurt our business. We cannot assure you that we
will have the financial resources, technical expertise or marketing and support
capabilities to continue to compete successfully in that environment.


                                       23
<PAGE>   24
OUR REVENUES ARE HEAVILY DEPENDENT ON TWO CUSTOMERS. IF WE LOSE EITHER OF THESE
CUSTOMERS, IF EITHER OF THEM REDUCE THE AMOUNT OF WORK THEY DO WITH US, OR IF WE
FAIL TO DIVERSIFY OUR CUSTOMER BASE, OUR BUSINESS WILL SUFFER.

         We currently derive a substantial portion of our total revenue from two
customers - NYSERNet.org, Inc., a not-for-profit corporation that is also
affiliated with one of our major stockholders, and the New York State Department
of Labor. The loss of either of these customers could significantly hurt our
business. For the three months ended March 31, 1999 and 1998, revenue from
NYSERNet.org, Inc. represented approximately 30% and 40%, respectively, of our
total revenue. For the three months ended March 31, 1999 and 1998, revenue under
the agreement with the New York State Department of Labor represented 34% and
27%, respectively, of our total revenue.

         Our current agreement to provide services through NYSERNet has an
initial term of three years, ending October 1, 2001, and is automatically
renewable for successive one-year terms. While the agreement only allows
termination by either party under special circumstances, it is still possible
that NYSERNet could terminate the agreement or cease working with us. Our
contract with the New York State Department of Labor is for the development and
maintenance of the America's Job Bank Web site. This agreement is subject to
cancellation by the New York State Department of Labor upon 15 days notice.

         We cannot assure you that revenue from these two customers or from
other customers that have accounted for significant revenue in past periods,
individually or as a group, will continue, or if continued, will reach or exceed
historical levels in any future period. In addition we may not succeed in
diversifying our customer base in future periods.

OUR BUSINESS MODEL ASSUMES THAT WE WILL USE THE GEMINI2000 NETWORK FOR THE
DELIVERY OF OUR SERVICES. IF IXC DOES NOT COMPLETE THIS NETWORK, OUR BUSINESS
COULD SUFFER.

         Our business model assumes that we will use IXC's Gemini2000 Network
for the delivery of our services. While we believe that we could transfer our
business to another network supplier if this network were not available, we may
not find an alternate network which would provide comparable technology at a
competitive cost. At this time, IXC has not completed construction of the
network. In addition, on February 4, 1999, IXC announced that it had hired an
investment bank to advise it on strategic alternatives. We are unable to predict
the result of this process or the impact it may have on us. Any failure by IXC
to complete construction of, or deploy and maintain, the Gemini2000 Network
could hurt our business. While IXC has publicly announced its intention to
complete construction of the Gemini2000 Network, we do not have a written
agreement with them which requires them to do so.

OUR BUSINESS AND EXPANSION MODELS ASSUME THAT WE WILL BE ABLE TO EASILY SCALE
THE NETWORK INFRASTRUCTURE WE USE TO ACCOMMODATE INCREASING NUMBERS OF CUSTOMERS
AND INCREASED TRAFFIC. HOWEVER, THE SCALABILITY OF THE GEMINI2000 NETWORK IS
UNPROVEN.

         Due to its limited deployment, the ability of the Gemini2000 Network to
connect and manage a large number of customers or a large quantity of traffic at
high transmission speeds is unproven. This network's ability to be scaled up to
meet our expected customer usage levels while maintaining superior performance
is also unproven. As the number of our customers grows or as network usage
increases, we many need to make additional investments to expand and adapt our
network infrastructure and maintain adequate data transmission speeds. Any
future expansion and adaptation of our telecommunications and hosting facility
infrastructure could require substantial financial, operational, technical and
management resources. Further, additional network capacity many not be available
from IXC or other third-party suppliers as it is needed by


                                       24
<PAGE>   25
us, and, as a result, our network may not be able to achieve or maintain a
sufficiently high capacity for data transmission. Any failure on our part to
achieve or maintain high data transmission capacity could significantly reduce
customer demand for our services and hurt our business. If we are required to
expand our network significantly and rapidly due to increased usage, additional
stress will be placed upon our network hardware, traffic management systems and
hosting facilities.

WE COULD EXPERIENCE SYSTEM FAILURES AND CAPACITY CONSTRAINTS, WHICH WOULD AFFECT
OUR ABILITY TO COMPETE.

         Interruptions in service to our customers could hurt our business. To
succeed, we must be able to operate our network management infrastructure 24
hours per day, seven days per week, without interruption. Our operations depend
upon our ability to protect our network infrastructure, our equipment and
customer data against damage from human error or "acts of God." Even if we take
precautions, the occurrence of a natural disaster or other unanticipated
problems could result in interruptions in the services we provide to our
customers.

         At this time, we do not have a formal disaster recovery plan. Although
we have attempted to build redundancy into our network and hosting facilities,
our network is currently subject to various single points of failure. For
example, a problem with one of our routers or switches could cause an
interruption in the services we provide to some of our customers. Any
interruptions in service could:

         -     cause end users to seek damages for losses incurred;

         -     require us to spend more money replacing existing equipment,
               expanding facilities or adding redundant facilities;

         -     cause us to spend money on existing or new equipment and
               infrastructure earlier than we plan;

         -     damage our reputation for reliable service;

         -     cause existing end-users and resellers to cancel our contracts;
               or

         -     make it more difficult for us to attract new end-users and
               partners.

         Any of these results could hurt our business.

         Failure of the national telecommunications network and Internet
infrastructure to continue to grow in an orderly manner could result in service
interruptions. While the national telecommunications network and Internet
infrastructure have historically developed in an orderly manner, there is no
guarantee that this will continue as the network expands and more services,
users and equipment connect to the network. Failure by our telecommunications
providers to provide us with the data communications capacity we require could
cause service interruptions, which could hurt our business.

WE ARE DEPENDENT ON NETWORKS BUILT AND OPERATED BY OTHERS. IF WE DO NOT HAVE
CONTINUED ACCESS TO A RELIABLE NETWORK, OUR BUSINESS WILL SUFFER.

         In delivering our services, we rely on networks, which are built and
operated by others. We do not have control over these networks, nor can we
guarantee that we will continue to have access on terms that fit our business
needs.

         Our use of the infrastructure of other communications carriers presents
risks. Our success partly depends upon the capacity, scalability, reliability
and security of the network infrastructure provided to us by telecommunications
network suppliers, including IXC, Bell Atlantic Corp. and Sprint Corporation.
Our nationwide expansion plans require rapid expansion


                                       25
<PAGE>   26
of network capacity, which we expect will be satisfied through the completion of
the Gemini2000 Network. Without this expanded capacity, our ability to execute
our business strategy could be hurt. In addition, future expansion and
adaptation of our network infrastructure may require substantial financial,
operational and management resources. We may not be able to expand or adapt our
network infrastructure on a timely basis and at a commercially reasonable cost
to meet additional demand, changing customer requirements or evolving industry
standards. In addition, if demand for usage of our network were to increase
faster than projected or were to exceed our current forecasts, the network could
experience capacity constraints which would hurt its performance.

         We also depend on our telecommunications suppliers to provide
uninterrupted and error-free service through their telecommunications networks.
If these suppliers greatly increased the prices for their services or if the
telecommunications capacity available to us was insufficient for our business
purposes, and we were unable to use alternative networks or pass along any
increased costs to our customers, it could hurt our business.

OUR NETWORK AND SOFTWARE ARE VULNERABLE TO SECURITY BREACHES AND SIMILAR THREATS
WHICH COULD RESULT IN OUR LIABILITY FOR DAMAGES AND HARM OR REPUTATION.

         Despite the implementation of network security measures, the core of
our network infrastructure is vulnerable to computer viruses, break-ins and
similar disruptive problems caused by Internet users. This could result in our
liability for damages, and our reputation could suffer, thereby deterring
potential customers from working with us. Security problems caused by third
parties could lead to interruptions and delays or to the cessation of service to
our customers. Furthermore, inappropriate use of the network by third parties
could also jeopardize the security of confidential information stored in our
computer systems and in those of our customers.

         We rely upon encryption and authentication technology listed from third
parties to provide the security and authentication necessary to effect secure
transmission of confidential information. Although we intend to continue to
implement industry-standard security measures, in the past some of these
standards have occasionally been circumvented by third parties. Therefore, we
cannot assure you that the measures we implement will not be circumvented. The
costs and resources required to eliminate computer viruses and alleviate other
security problems may result in interruptions, delays or cessation of service to
our customers, which could hurt our business.

OUR BRAND IS NOT WELL KNOWN, AND FAILURE TO DEVELOP BRAND RECOGNITION COULD HURT
OUR BUSINESS.

         To successfully execute our strategy, we must strengthen our brand
awareness. While many of our competitors have well-established brands in
Internet services, to date, our market presence has been limited principally to
New York State. We have generated our existing revenue primarily through a small
sales force and word of mouth. In order to build our brand awareness, our
marketing efforts must succeed, and we must provide high quality services. We
expect to increase our marketing budget substantially as part of our brand
building efforts. We cannot assure you that these investments will succeed as
planned. If we do not build our brand awareness, our ability to realize our
strategic and financial objectives could be hurt.

IF WE DO NOT RESPOND EFFECTIVELY AND ON A TIMELY BASIS TO RAPID TECHNOLOGICAL
CHANGE, OUR BUSINESS COULD SUFFER.

         If we do not successfully use or develop new technologies, introduce
new services or enhance our existing services on a timely basis, or new
technologies or enhancements used or


                                       26
<PAGE>   27
developed by us do not gain market acceptance, our business could be hurt. The
Internet industry is characterized by rapidly changing technology, industry
standards, customer needs and competition, as well as by frequent new product
and service introductions. Our future success will depend, in part, on our
ability to accomplish all of the following in a timely and cost-effective
manner, all while continuing to develop our business model and rolling-out our
services on a national level:

         -     effectively use and integrate leading technologies;

         -     continue to develop our technical expertise;

         -     enhance our products and current networking services;

         -     develop new products and services that meet changing customer
               needs;

         -     have the market accept our services;

         -     advertise and market our products and services; and

         -     influence and respond to emerging industry standards and other
               changes.

         We cannot assure you that we will successfully use or develop new
technologies, introduce new services or enhance our existing services on a
timely basis, or that new technologies or enhancements used or developed by us
will achieve market acceptance. Our pursuit of necessary technological advances
may require substantial time and expense. In addition, we cannot assure you
that, if required, we will successfully adapt our network and services to
alternate access devices and conduits.

         If our services do not continue to be compatible and interoperable with
products and architectures offered by other industry members, our ability to
compete could be impaired. Our ability to compete successfully is dependent, in
part, upon the continued compatibility and interoperability of our services with
products and architectures offered by various other members of the industry.
Although we intend to support emerging standards in the market for Internet
access, we cannot assure you that we will be able to conform to new standards in
a timely fashion and maintain a competitive position in the market. Our services
rely on the continued widespread commercial use of Transmission Control
Protocol/Internetwork Protocol, commonly known as TCP/IP, which is an industry
standard to facilitate the transfer of data. Alternative open protocol and
proprietary protocol standards could emerge and become widely adopted. A
resulting reduction in the use of TCP/IP could render our services obsolete and
unmarketable. Our failure to anticipate the prevailing standard or the failure
of a common standard to emerge could hurt our business.

WE DERIVE SIGNIFICANT REVENUE FROM CONTRACTS WITH GOVERNMENT AGENCIES. THESE
CONTRACTS OFTEN ARE SUBJECT TO A COMPLEX PROCUREMENT PROCESS, REQUIRE COMPLIANCE
WITH VARIOUS GOVERNMENT REGULATIONS AND POLICIES AND MAY BE SUBJECT TO
UNILATERAL TERMINATION OR MODIFICATION BY THE GOVERNMENT. IN ADDITION, CHANGES
IN GOVERNMENT FUNDING AND OTHER POLICY DECISIONS COULD JEOPARDIZE OUR CONTRACTS
WITH GOVERNMENT AGENCIES.

         Contracts with various government agencies accounted for approximately
50% of our revenues in the quarter ended March 31, 1999. Government contracts
are often subject to a competitive bidding process, which is governed by
applicable federal and state statutes and regulations. The procurement process
for government contracts is complex and can be very time consuming.

         Because of our contracts with governmental agencies, we are required to
comply with various government regulations and policies. For instance, we are
required to maintain employment policies relating to equal opportunity, and we
are subject to audit by the government to confirm our compliance with these
policies. If we fail to comply with regulations which apply


                                       27
<PAGE>   28
to government contractors, we may face sanctions, including substantial fines
and disqualification from being awarded government contracts in the future.

         Contracts with governmental agencies are subject to the risk of
unilateral termination by the government for its convenience and reductions in
services, or modifications in contractual terms, due to changes in the
government's requirements or to budgetary restraints.

         In addition, the government may not continue to fund the projects and
programs with which we work. Even if funding continues, we may not obtain this
funding. We cannot assure you that we will be able to procure additional
government contracts, that we will be able to retain our existing government
contracts or, if retained, that these contracts will be fully funded.

WE MAY BE EXPOSED TO RISKS ASSOCIATED WITH ACQUISITIONS, INCLUDING INTEGRATION
RISKS AND RISKS ASSOCIATED WITH METHODS OF FINANCING AND THE IMPACT OF
ACCOUNTING TREATMENT. COMPLETED ACQUISITIONS MAY NOT ENHANCE OUR BUSINESS.

         A component of our strategy is to acquire network assets,
Internet-related technologies and businesses complementary to our operations.
Any future acquisitions would be accompanied by the risks commonly encountered
in acquisitions, including:

         -     the difficulty of assimilating the operations and personnel of
               acquired companies;

         -     the potential disruption of our business;

         -     the inability of our management to maximize our financial and
               strategic position by the incorporation of an acquired technology
               or business into our service offerings;

         -     the difficulty of maintaining uniform standards, controls,
               procedures and policies; and

         -     the potential loss of key employees of acquired businesses, and
               the impairment of relationships with employees and customers as a
               result of changes in management.


         We cannot assure you that any completed acquisition will enhance our
business. If we proceed with one or more significant acquisitions in which the
consideration consists of cash, a substantial portion of our available cash,
including proceeds of this offering, could be used to consummate the
acquisitions. If we were to consummate one or more acquisitions in which the
consideration consisted of stock, our stockholders could suffer significant
dilution of their interest in us. In addition, we could incur or assume
significant amounts of indebtedness in connection with acquisitions.
Acquisitions required to be accounted for under the purchase method could result
in significant goodwill and/or amortization charges for acquired technology.

WE ARE DEPENDENT ON OUR HARDWARE AND SOFTWARE SUPPLIERS TO PROVIDE US WITH THE
PRODUCTS AND SERVICES WE NEED TO SERVE OUR CUSTOMERS.

         We rely on outside vendors to supply us with computer hardware,
software and networking equipment. These products are available from only a few
sources. We purchase virtually all of these products from Sun Microsystems,
Inc., Compaq Computer Corporation and Cisco Systems, Inc. We cannot assure you
that we will be able to obtain the products and services that we need on a
timely basis and at affordable prices.

         We have in the past experienced delays in receiving shipments of
equipment purchased for resale. To date, these delays have not adversely
affected us, but we cannot guarantee that we will not be adversely affected by
delays in the future. We may not be able to obtain computer equipment on the
scale and at the times required by us at an affordable cost. Our suppliers may
enter into exclusive arrangements with our competitors or stop selling us their
products or


                                       28
<PAGE>   29
services at commercially reasonable prices. If our sole or limited source
suppliers do not provide us with products or services, our business, financial
condition and results of operations may be significantly hurt.

WE OPERATE IN AN UNCERTAIN REGULATORY AND LEGAL ENVIRONMENT. NEW LAWS AND
REGULATIONS COULD HARM OUR BUSINESS.

         We are not currently subject to direct regulation by the Federal
Communications Commission or any other governmental agency, other than
regulations applicable to businesses in general. However, in the future, we may
become subject to regulation by the FCC or another regulatory agency. Our
business could suffer depending on the extent to which our activities are
regulated or proposed to be regulated.

         While there are currently few laws or regulations which specifically
regulate Internet communications, laws and regulations directly applicable to
online commerce or Internet communications are becoming more prevalent. There is
much uncertainty regarding the market-place impact of these laws. In addition,
various jurisdictions already have enacted laws covering intellectual property,
privacy, libel and taxation that could affect our business by virtue of their
impact on online commerce. Further, the growth of the Internet, coupled with
publicity regarding Internet fraud, may lead to the enactment of more stringent
consumer protection laws. If we become subject to claims that we have violated
any laws, even if we successfully defend against these claims, our business
could suffer. Moreover, new laws that impose restrictions on our ability to
follow current business practices or increase our costs of doing business could
hurt our business.

WE MAY BE SUBJECT TO LEGAL LIABILITY FOR DISTRIBUTING OR PUBLISHING CONTENT OVER
THE INTERNET, WHICH COULD BE COSTLY FOR US TO DEFEND.

         It is possible that claims will be made against online services
companies and Internet access providers in connection with the nature and
content of the materials disseminated through their networks. Several private
lawsuits are pending which seek to impose liability upon online services
companies and Internet access providers as a result of the nature and content of
materials disseminated over the Internet. If any of these actions succeed, we
might be required to respond by investing substantial resources in connection
with this increased liability or by discontinuing some of our service or product
offerings. Also, any increased attention focused upon liability issues relating
to the Internet could also have a negative impact on the growth of Internet use.
Although we carry general liability insurance, it may not be adequate to
compensate us or it may not cover us in the event we become liable for
information carried on or disseminated through our networks. Any costs not
covered by insurance that we incur as a result of liability or asserted
liability for information carried on or disseminated through our networks could
hurt our business.

OUR COMPUTER SYSTEMS AND THOSE OF OUR BUSINESS PARTNERS MAY NOT BE YEAR 2000
COMPLIANT, WHICH MAY CAUSE SYSTEM FAILURES AND DISRUPTIONS OF OPERATIONS.

         The risks posed by the Year 2000 issue could hurt our business in a
number of significant ways. Many currently installed computer systems and
software products accept only two digit entries in the date code field and will
not distinguish 21st century dates from 20th century dates. This may result in
system failures or miscalculations causing disruptions of operations, including
a temporary inability to process transactions, send invoices or engage in
similar normal business activities.

         We are currently conducting a Year 2000 readiness review including
assessment, implementation, testing and contingency planning. After evaluating
our internally developed


                                       29
<PAGE>   30
software, we believe that this software is Year 2000 compliant. However, we
utilize software and hardware developed by third parties both for our network
and for our internal information systems. Therefore, we are still in the process
of seeking assurances from our vendors that their products are Year 2000
compliant. To date, we have not received any responses from our vendors that
lead us to believe that we will be unprepared for the year 2000.

         We expect to continue assessing and testing our internal information
technology systems during this year. However, we may experience material
unanticipated problems and costs caused by undetected errors or defects in our
systems.

         In addition, Year 2000 issues may also impact other entities with which
we do business, including those responsible for maintaining telephone and
Internet communications. If these entities fail to take preventative or
corrective actions in a timely manner, the Year 2000 issue could hurt our
business in ways which are not now quantifiable.

         We do not have any information regarding the Year 2000 status of our
customers, most of whom are private companies. If our customers experience Year
2000 problems which result in business interruptions or otherwise impact their
operations, we could experience a decrease in the demand for our services, which
could hurt our business.

         To date, we have not incurred and do not foresee any significant
expenses associated with our Year 2000 plan. Apart from the risk that we may not
achieve Year 2000 compliance, we believe that a loss of revenues, which could be
significant, would arise if our major customers or providers fail to achieve
Year 2000 readiness.

WE MAY NEED ADDITIONAL FUNDS WHICH, IF AVAILABLE, COULD RESULT IN DILUTION OF
YOUR SHAREHOLDINGS OR AN INCREASE IN OUR INTEREST EXPENSE. IF THESE FUNDS ARE
NOT AVAILABLE, OUR BUSINESS COULD BE HURT.

         We intend to use the proceeds from our recently completed initial
public offering to fund the expansion of our sales and marketing efforts, build
our new data centers, expand our customer support services and for working
capital and general corporate purposes. While we believe that the proceeds from
this offering will be sufficient for these purposes, we may need to raise
additional funds through public or private debt or equity financings in order
to:

         -     take advantage of anticipated opportunities or acquisitions of
               complementary assets, technologies or businesses;

         -     develop new products; or

         -     respond to unanticipated competitive pressures.

         If additional funds become necessary, additional financing may not be
available on terms favorable to us or available at all. If adequate funds are
not available or are not available on acceptable terms when needed, our business
could be hurt.

         If additional funds are raised through the issuance of equity
securities, the percentage ownership of our then current stockholders may be
reduced, and the new equity securities may have rights, preferences or
privileges senior to those of the holders of our common stock. If additional
funds are raised through the issuance of debt securities, these securities would
have some rights, preferences and privileges senior to those of the holders of
our common stock, and the terms of this debt could impose restrictions on our
operations and result in significant interest expense to us.


                                       30
<PAGE>   31
SIGNIFICANT STOCKHOLDERS AND CURRENT MANAGEMENT CONTROL APPROXIMATELY 74% OF OUR
COMMON STOCK, AND THESE PARTIES MAY HAVE CONFLICTS OF INTEREST.

         IXC Internet Services, Inc., NYSERNet.net, Inc. and Grumman Hill
Investments, L.P. own approximately 28.0%, 23.1% and 14.0%, respectively, of our
outstanding common stock. In addition, our executive officers and directors may
be deemed to beneficially own in the aggregate approximately 74% of our
outstanding common stock, including shares of our common stock owned by IXC,
NYSERNet.net and Grumman Hill that may be deemed to be owned by some of our
officers and directors as a result of their relationships with these entities.
Accordingly, IXC, NYSERNet.net, Grumman Hill and our officers and directors,
whether acting alone or together, are able to exert considerable influence over
any stockholder vote, including any vote on the election or removal of directors
and any merger, consolidation or sale of all or substantially all of our assets,
and control our management and affairs. Such control could discourage others
from initiating potential merger, takeover or other change in control
transactions. As a consequence, our business could be hurt. IXC, Grumman Hill
and NYSERNet.net each have one representative on our board of directors. In
addition, three of our directors and/or executive officers are also directors of
NYSERNet.net and NYSERNet.org, Inc., a not-for-profit corporation that is also
affiliated with NYSERNet.net. Two of our executive officers are executive
officers of NYSERNet.net and/or NYSERNet.org. Grumman Hill has a significant
equity interest in IXC. NYSERNet.net, NYSERNet.org, IXC, Grumman Hill and our
officers and directors may have conflicts of interest among themselves, and
their interests could conflict with the interests of our other stockholders.

WE ARE DEPENDENT ON KEY PERSONNEL AND OPERATE IN AN INDUSTRY WHERE IT IS
DIFFICULT TO ATTRACT AND RETAIN QUALIFIED PERSONNEL.

         We expect that we will need to hire additional personnel in all areas
of our business. The competition for personnel throughout our industry is
intense. At times, we have experienced difficulty in attracting qualified new
personnel. If we do not succeed in attracting new, qualified personnel or
retaining and motivating our current personnel, our business could suffer. We
are also dependent on the continued services of our key personnel, including our
senior management. We have entered into employment agreements with Richard
Mandelbaum, Lawrence B. Helft, James D. Luckett, Denis J. Martin, Mark A. Oros
and David A. Buckel. We have also secured key man insurance policies on the
lives of Messrs. Mandelbaum, Oros and Martin.

OUR STOCK PRICE MAY BE VOLATILE.

         Pursuant to our initial public offering, we began offering our common
stock to the public on April 30, 1999, and the public market for our common
stock is not well-established. We cannot assure you that an active trading
market will develop or be sustained, nor can we provide you with any guarantees
as to how liquid that market might become. Further, we cannot guarantee that the
price of our common stock will not decline. Stock prices of technology
companies, especially Internet-related companies, have been highly volatile. The
current trading price of our common stock may not be indicative of prices that
will prevail in the trading market. Various factors could cause the market price
of our common stock to fluctuate substantially. These factors may include:

         -     variations in our revenue, earnings and cash flow;

         -     announcements of new service offerings, technological innovations
               or price reductions by us, our competitors or providers of
               alternative services; and

         -     changes in analysts' recommendations or projections and general
               economic and market conditions.


                                       31
<PAGE>   32
         In the past, following periods of volatility in the market price of a
company's securities, securities class action litigation has often been
instituted against the company in question. If we become subject to securities
litigation, we could incur substantial costs and experience a diversion of
management's attention and resources.

         Also, a substantial number of shares of common stock issuable upon
exercise of outstanding stock options will also become available for resale in
the public market at prescribed times. We intend to register under the
Securities Act the shares of common stock reserved for issuance under our stock
option plans.

OUR STOCK PRICE MAY BE AFFECTED BY THE AVAILABILITY OF SHARES FOR FUTURE SALE.
THE FUTURE SALE OF LARGE AMOUNT OF OUR STOCK, OR THE PERCEPTION THAT THESE SALES
COULD OCCUR, COULD NEGATIVELY AFFECT OUR STOCK PRICE

         The market price of our common stock could drop as a result of future
sales of a large number of shares of common stock in the market after the
offering.

         While approximately 75% of our common stock are subject to restrictions
under Rule 144 of the Securities Act of 1933, holders of approximately 74% of
these restricted shares have registration rights with respect to these and any
after-acquired shares. These shares are currently subject to lock-up agreements
which are further discussed in the Registration Statement for our initial public
offering and under which the holders of these shares have agreed not to sell or
otherwise dispose of any of their shares. However, under Rule 144 and as a
result of registration rights, these shares may become freely tradable and
affect the market for our stock.

ITEM 6.           EXHIBITS AND REPORTS ON FORM 8K

         (a.)     EXHIBITS.

         The following Exhibits are filed or incorporated by reference herewith:

         Exhibit 11.1      Calculation of basic and diluted loss per share
                           and weighted average shares used in calculation for
                           the three months ended March 31, 1999.

         Exhibit 11.2      Calculation of Basic and diluted loss per share
                           and weighted average shares used in calculation for
                           the three months ended March 31, 1998.

         Exhibit 27.1      Financial Data Schedule, which is submitted
                           electronically to the Securities and Exchange
                           Commission for information only.


         (b.)     REPORTS ON FORM 8K.

              None.


                                       32
<PAGE>   33
                            APPLIEDTHEORY CORPORATION
                                    FORM 10-Q
                                 MARCH 31, 1999




                                   SIGNATURES

         Pursuant to the requirements of the Securities and Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned thereto duly authorized.

                              AppliedTheory Corporation

Date:      June 11, 1999      by:     /s/  Richard Mandelbaum
                                    --------------------------------------------
                                    Richard Mandelbaum
                                    Chairman of the Board,
                                    Chief Executive Officer, and Director
                                    (Principal Executive Officer)

Date:      June 11, 1999      and:    /s/  David Buckel
                                    --------------------------------------------
                                    David Buckel
                                    Vice President and Chief Financial Officer
                                    (Principal Financial and Accounting Officer)


                                       33
<PAGE>   34
                                  EXHIBIT INDEX

         The following Exhibits are filed or incorporated by reference herewith:

Exhibit 11.1.     Calculation of basic and diluted loss per share and weighted
                  average shares used in calculation for the three months ended
                  March 31, 1999.

Exhibit 11.2.     Calculation of Basic and diluted loss per share and weighted
                  average shares used in calculation for the three months ended
                  March 31, 1998.

Exhibit 27.1.     Financial Data Schedule, which is submitted electronically to
                  the Securities and Exchange Commission for information only.


                                       34