<PAGE>   1
                                  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 JUNE 30, 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  X   No

As of August 1, 1999, there were 21,179,311 shares of AppliedTheory Corporation
common stock, par value $.01, outstanding.


                    The Index of Exhibits appears on page 35
<PAGE>   2
                            APPLIEDTHEORY CORPORATION



                                TABLE OF CONTENTS




<TABLE>
<CAPTION>
<S>                                                                                                   <C>
PART I. FINANCIAL INFORMATION

Item 1.       Financial Statements (Unaudited):

              Balance Sheets as of December 31, 1998 and June 30, 1999.................................3

              Statements of Operations for the three and six months ended
              June 30, 1998 and June 30, 1999..........................................................4

              Statements of Cash Flows for the six months ended
              June 30, 1998 and June 30, 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.......................................................................19

Item 6.       Exhibits and Reports on Form 8-K........................................................33

Signatures    ........................................................................................34

Exhibit Index ........................................................................................35
</TABLE>
<PAGE>   3
PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS


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

<TABLE>
<CAPTION>
                                                                             December 31,              June 30,
                                                                                 1998                    1999
                                                                                 ----                    ----
                                                                         (Derived from Audited        (Unaudited)
                                                                          Financial Statements)
<S>                                                                      <C>                          <C>
                                     ASSETS
Current assets
 Cash and cash equivalents                                                        $  1,786             $  6,992
 Marketable securities                                                                  --               55,123
 Accounts receivable, net of allowance for doubtful
 accounts of $157 and $187, respectively                                             3,584                4,650
 Due from related parties                                                               --                  961
 Prepaid expenses and other assets                                                     255                  746
                                                                                  --------             --------
     Total current assets                                                            5,625               68,472

Property and equipment, net                                                          4,203                6,246
Investment, at cost                                                                     --                5,000
Other assets                                                                           690                1,116
                                                                                  --------             --------
     Total assets                                                                 $ 10,518             $ 80,834
                                                                                  ========             ========

                 LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)

Current liabilities
 Accounts payable                                                                 $  2,149             $  4,439
 Accrued payroll                                                                       582                  761
 Accrued expenses                                                                    2,473                2,983
 Deferred revenue                                                                    1,849                2,050
 Current portion of long-term debt and capital lease obligations                       551                  980
 Preferred stock dividends payable                                                     420                   --
 Due to related parties                                                                850                   --
                                                                                  --------             --------
     Total current liabilities                                                       8,874               11,213

Long-term debt and capital lease obligations                                         5,979                6,589
Borrowings from NYSERNet.net, Inc.                                                   2,957                   --
Other Liabilities                                                                      215                  188
Redeemable preferred stock - 1,000,000 shares authorized; issued
 and outstanding 15,000 shares at December 31, 1998 and 0 shares
 at June 30, 1999; cumulative 14% dividend;
 $100 per share liquidation value                                                    1,500                   --

Stockholders' Equity (Deficit):
Common stock, $.01 par value; 90,000,000 shares authorized;
 issued and outstanding 15,094,336 shares at December 31, 1998
 and 21,147,902 shares at June 30, 1999                                                151                  211
Additional paid-in capital                                                           6,581               82,590
Accumulated deficit                                                                (15,739)             (19,764)
Accumulated other comprehensive income (loss)                                           --                 (193)
                                                                                  --------             --------

     Total stockholders' equity (deficit)                                           (9,007)              62,844
                                                                                  --------             --------

     Total liabilities and stockholders' equity (deficit)                         $ 10,518             $ 80,834
                                                                                  ========             ========
</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                    SIX MONTHS ENDED
                                                                     June 30,                             June 30,
                                                             1998               1999               1998               1999
                                                             ----               ----               ----               ----
<S>                                                      <C>                <C>                <C>                <C>
Net revenues
     Third-party customers                               $      2,680       $      5,970       $      5,855       $     10,803
     NYSERNet.org, Inc. customers and services                  2,102              2,723              4,261              4,757
                                                         ------------       ------------       ------------       ------------

     Total net revenues                                         4,782              8,693             10,116             15,560
                                                         ------------       ------------       ------------       ------------

Costs and expenses
     Cost of revenues                                           2,864              5,789              5,804              9,892
     Sales and marketing                                        1,536              2,644              2,974              4,408
     General and administrative                                 1,159              2,055              2,302              3,869
     Research and development                                      74                 67                120                130
     Depreciation and amortization                                399                791                759              1,407
     Other expenses                                                --                 --                  2                  3
                                                         ------------       ------------       ------------       ------------

     Total costs and expenses                                   6,032             11,346             11,961             19,709
                                                         ------------       ------------       ------------       ------------

     Loss from operations                                      (1,250)            (2,653)            (1,845)            (4,149)

Investment income                                                  --               (505)                --               (523)
Interest expense                                                  141                146                283                326
                                                         ------------       ------------       ------------       ------------

     NET LOSS                                                  (1,391)            (2,294)            (2,128)            (3,952)

Preferred stock dividends                                          53                 21                105                 73
                                                         ------------       ------------       ------------       ------------

Net loss attributable to common stockholders             $     (1,444)      $     (2,315)      $     (2,233)      $     (4,025)
                                                         ============       ============       ============       ============

Basic and diluted loss per common share                  $      (0.13)      $      (0.12)      $      (0.20)      $      (0.23)
                                                         ============       ============       ============       ============

Shares used in computing basic and diluted
 loss per share                                            11,038,208         19,440,599         10,972,642         17,695,081
                                                         ============       ============       ============       ============
</TABLE>

        The accompanying notes are an integral part of these statements.

                                       4
<PAGE>   5
                            APPLIEDTHEORY CORPORATION
                             STATEMENTS OF CASHFLOWS
                                 (IN THOUSANDS)
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                                       SIX MONTHS ENDED
                                                                                            June 30,
                                                                                       1998            1999
                                                                                       ----            ----
<S>                                                                                  <C>            <C>
Cash flows from operating activities
         Net loss                                                                    $ (2,128)      $ (3,952)
         Adjustments to reconcile net loss to net cash used in operating
         activities:
              Depreciation and amortization                                               759          1,407
              Provision for bad debts                                                      --             45
              Deferral (payment) of interest expense to NYSERNet.net, Inc., net           101           (270)
              Loss on sale of property and equipment                                       14              3
              Non-cash compensation expense                                               200            627
              Changes in assets and liabilities
                Accounts receivable                                                      (560)        (1,111)
                Due to (from) related parties                                            (254)        (1,812)
                Prepaid expenses and other assets                                        (694)          (920)
                Accounts payable                                                           91          2,290
                Accrued payroll                                                           281            179
                Accrued expenses and other liabilities                                    463            484
                Deferred revenue                                                          514            201
                                                                                     --------       --------

              Net cash used in operating activities                                    (1,213)        (2,829)
                                                                                     --------       --------

Cash flows from investing activities
         Purchases of property and equipment                                             (840)        (2,009)
         Purchase of marketable securities                                                 --        (55,316)
         Purchase of investment                                                            --         (5,000)
         Payments received on notes receivable                                             --              3
         Proceeds from sale of property and equipment                                       4              5
                                                                                     --------       --------

              Net cash used in investing activities                                      (836)       (62,317)
                                                                                     --------       --------

Cash flows from financing activities
         Issuance of common stock, net of issuance costs                                   43         75,442
         Payment of preferred stock dividends                                              --           (493)
         Redemption of preferred stock                                                     --         (1,500)
         Borrowings from NYSERNet.net, Inc.                                                --            800
         Repayment of borrowings from NYSERNet.net, Inc.                                   --         (3,487)
         Proceeds from line of credit borrowings, net                                   2,026             70
         Principal payments on capital leases                                            (108)          (480)
                                                                                     --------       --------

              Net cash provided by financing activities                                 1,961         70,352
                                                                                     --------       --------

              Net increase (decrease) in cash and cash equivalents                        (88)         5,206

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

Cash and cash equivalents, end of period                                             $     47       $  6,992
                                                                                     ========       ========
</TABLE>

        The accompanying notes are an integral part of these statements.

                                       5
<PAGE>   6
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 Corporation common stock, the
     private placement of 1,725,000 shares of AppliedTheory Corporation common
     stock and NET's direct sale of 4,875,000 shares of AppliedTheory
     Corporation common stock), AppliedTheory Corporation is no longer a
     subsidiary of NET.

     These financial statements for the three months and six months ended June
     30, 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 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 and six month period ended June 30, 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. Further, all
     non-voting common shares were converted into voting common shares and a 1.5
     to 1 stock split were effective upon completion of the Initial Public
     Offering. All per share amounts have been adjusted retroactively.

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

                                       6
<PAGE>   7
NOTE C - COMPREHENSIVE INCOME (LOSS)

     Comprehensive income (loss) for the three and six months ended June 30,
     1998 and 1999, was as follows (in thousands):


<TABLE>
<CAPTION>
                                                       Three months ended           Six months ended
                                                             June 30,                    June 30,
                                                        1998          1999          1998          1999
                                                        ----          ----          ----          ----
<S>                                                   <C>           <C>           <C>           <C>
         Net loss                                     $(1,391)      $(2,294)      $(2,128)      $(3,952)
         Other comprehensive income (loss):
           Unrealized loss on
            marketable securities                          --          (193)           --          (193)
                                                      -------       -------       -------       -------
         Comprehensive income (loss)                  $(1,391)      $(2,487)      $(2,128)      $(4,145)
                                                      =======       =======       =======       =======
</TABLE>


NOTE D - 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 (in thousands):

<TABLE>
<CAPTION>
                                                      Three months ended         Six months ended
                                                           June 30,                   June 30,
                                                       1998         1999         1998         1999
                                                       ----         ----         ----         ----
<S>                                                   <C>          <C>          <C>          <C>
         Net revenues
           Internet connectivity                      $ 3,518      $ 4,947      $ 7,095      $ 9,108
           Internet integration and
           enterprise portal development                  943        2,939        2,304        5,034
           Web hosting                                    321          807          717        1,418
                                                      -------      -------      -------      -------
         Total net revenues                           $ 4,782      $ 8,693      $10,116      $15,560
                                                      =======      =======      =======      =======
</TABLE>


NOTE E - MARKETABLE SECURITIES

     Investments classified as marketable securities represent fixed maturity
     instruments (bonds and notes) which are reported at their fair values.
     Unrealized gains and losses on these securities, net of related tax effects
     are included in stockholders' equity as a component of accumulated other
     comprehensive income (loss). The Company categorizes all marketable
     securities as available for sale in order to provide the Company
     flexibility to respond to various factors, including changes in market
     conditions.

     Investment income is recognized when earned. Realized gains and losses on
     sales, maturities and liquidation of investments are determined on a
     specific identification basis. The amortization of premiums and accretion
     of discounts are computed on the straight-line basis. Fair values are based
     on quoted market prices.

                                       7
<PAGE>   8
NOTE F - 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 June 30, 1999, no amounts have been paid against this
     liability. Management currently anticipates that the closure date will be
     delayed approximately four months later than originally planned.

NOTE G - INVESTMENT IN PLANNING TECHNOLOGIES, INC.

     On June 22, 1999, the Company entered into a stock purchase agreement (the
     "Stock Purchase Agreement") with Planning Technologies, Inc. ("PTI"), a
     Georgia corporation which provides consulting and network engineering
     services, along with Grumman Hill Investments III, L.P., and certain
     shareholders of PTI. Pursuant to the Stock Purchase Agreement, the Company
     acquired approximately 10% of the capital stock of PTI on a fully diluted
     basis, as defined in the Stock Purchase Agreement, for $5.0 million. The
     Company's 10% ownership interest in PTI is represented by 2,976,190 shares
     of PTI's Convertible Preferred Stock, which represents approximately 50% of
     PTI's outstanding Convertible Preferred Stock. The investment is being
     accounted for under the cost method.

     The Stock Purchase Agreement provides a definition of service revenues for
     PTI for the year ending December 31, 1999. In the event that PTI's service
     revenues for that period are below thresholds which are described in the
     Stock Purchase Agreement, the Company will receive additional shares of PTI
     Convertible Preferred Stock representing up to 5% of the fully diluted
     capital stock of PTI.

     As a result of its investment in PTI, so long as the Company continues to
     hold at least 25% of the total outstanding Convertible Preferred Stock of
     PTI, the Company will be entitled to designate and elect one director out
     of a total of six seats on the Board of Directors.

     Pursuant to the terms of its investment, during the period beginning June
     30, 2000 and ending December 31, 2000, the Company will have the option to
     purchase all the outstanding capital stock of PTI at a price, which at that
     time is determined to be fair market value.

NOTE H - LONG-TERM DEBT

     Line of Credit

                                       8
<PAGE>   9
     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 June
     30, 1999 and, as a result of certain restrictions, had no additional
     availability as of June 30, 1999. The average interest rate on outstanding
     borrowings was 6.1% at June 30, 1999.

         In accordance with the terms of the credit agreement, amended on August
     3, 1999, the bank issued a standby letter of credit in the Company's name
     for $650,000, expiring July 30, 2000, pursuant to the amended agreement,
     collateralizing the Company's obligation to a third party for a real
     property lease. The Company's available credit under its line of credit
     agreement is effectively reduced by the outstanding amount of the letter of
     credit.

     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. On May 5, 1999, the
     Company paid down the line of credit and deferred interest in full with the
     proceeds from the IPO.

     As of June 30, 1999, the Company had no principal borrowings outstanding
     under this facility and had $6,187,000 available for additional principal
     borrowings.

     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 deliver a security deposit by placing on
     deposit $782,000 as additional collateral. The security deposit was fully
     refunded to the Company in June 1999.

     Interest paid for the three and six months ended June 30, 1998 and 1999 was
     approximately $141,000, $283,000, $485,000 and $665,000, respectively.

NOTE I - REDEEMABLE PREFERRED STOCK

     On May 5, 1999, the Company paid approximately $1,993,000 to fully redeem
     all outstanding preferred stock and accrued dividends with a portion of the
     proceeds from the Company's IPO.

                                       9
<PAGE>   10
NOTE J - STOCKHOLDERS' EQUITY

     Certain options were granted in 1998 at exercise prices below the fair
     market value of the Company's stock. The Company recorded compensation
     expense associated with these options of $100,000 and $314,000 for the
     three months ended June 30, 1998 and 1999 and a total of $200,000 and
     $627,000 for the six months ended June 30, 1998 and 1999, respectively.

     During the quarter ended June 30, 1999, options with respect to 2,721
     shares of common stock were exercised for aggregate net proceeds of
     approximately $500.

NOTE K - 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 (in thousands):

<TABLE>
<CAPTION>
                                           Three months ended        Six months ended
                                                 June 30                 June 30,
                                             1998        1999        1998        1999
                                             ----        ----        ----        ----
<S>                                        <C>         <C>         <C>         <C>
         Unrelated customers                $  789      $  743      $1,621      $1,442
         Member institutions                 1,119       1,235       2,238       2,355
         Services to ORG                       194         745         402         960
                                            ------      ------      ------      ------
                                            $2,102      $2,723      $4,261      $4,757
                                            ======      ======      ======      ======
</TABLE>


     During each of the three and six months ended June 30, 1998 and 1999, the
     Company charged NET approximately $25,000 and $50,000 and ORG $75,000 and
     $150,000, respectively, in management fees.

     The excess of the Company's revenues over amounts charged by ORG to its
     member institutions was approximately $708,000 and $775,000 for the three
     months ended June 30, 1998 and 1999 and $1,415,000 and $1,473,000 for the
     six months ended June 30, 1998 and 1999, respectively.

NOTE L - COMMITMENTS

     During July and August 1999, the Company entered into noncancelable
     operating leases for office facilities with terms ranging from seven to ten
     years. Certain operating leases for the office facilities include rent
     holidays and scheduled base rent increases over the term of the lease. The
     total amount of the base rent is charged to expense on the straight-line
     method over the terms of the lease. The Company's total future minimum
     annual lease payments under these noncancelable operating leases are
     approximately $800,000 through 2006 and approximately $650,000 during the
     period from 2007 through 2009.

                                       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 for 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 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

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<PAGE>   12
local presence, coincide with the planned points of presence, or POPs, of our
strategic partner, IXC Internet Services, Inc.

RESULTS OF OPERATIONS

THREE AND SIX MONTHS ENDED JUNE 30, 1999, COMPARED TO THREE AND SIX MONTHS ENDED
JUNE 30, 1998

         REVENUE. Total net revenues were approximately $8.7 million for the
three months ended June 30, 1999, an increase of $3.9 million or 81%, from $4.8
million in the three months ended June 30, 1998. Total net revenues were
approximately $15.6 million for the six months ended June 30, 1999, an increase
of $5.5 million or 54%, from $10.1 million in the six months ended June 30,
1998. Approximately $2.0 million of the growth during the six months ended June
30, 1999 from the same period ended June 30, 1998 was from Internet connectivity
revenue, which resulted primarily from the addition new of customers and from
additional revenue derived from existing customers who upgraded their level of
service. Web hosting revenue increased by approximately $0.7 million during the
same period. This increase resulted from an approximately equal increase in Web
monitoring, management and hosting services for the New York State Department
Labor in connection with America's Job Bank and from our managed dedicated web
hosting product. The remaining increase in total net revenues of approximately
$2.8 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 of Internet integration and enterprise portal development
was primarily derived from the expansion of these services to the New York State
Department of Labor in connection with America's Job Bank as well as from the
addition of contracts for services with other state agencies and commercial
customers.

         For the six months ended June 30, 1999, as a percentage of total net
revenues, Internet connectivity represented 59%, Internet integration and
enterprise portal development represented 32% and Web hosting represented 9%.
For the six months ended June 30, 1998, as a percentage of total net revenues,
Internet connectivity represented 70%, Internet integration and enterprise
portal development represented 23% and Web hosting represented 7%.

         COST OF REVENUE. Cost of revenue consists principally of backbone and
Internet access costs, including charges from local exchange carriers and
personnel costs to operate our network and data centers and provide Internet
Integration and enterprise portal development services. Cost of revenue totaled
approximately $5.8 million (67% of revenue) for the three months ended June 30,
1999, an increase of approximately $2.9 million from the $2.9 million (60% of
revenue) for the three months ended June 30, 1998. Cost of revenue totaled
approximately $9.9 million (63% of revenue) for the six months ended June 30,
1999, an increase of approximately $4.1 million from the $5.8 million (57% of
revenue) for the six months ended June 30, 1998. The increase in both periods is
primarily attributable to the upgrade of our network to support customer growth
and improve the efficiency and performance of our Internet connectivity
services. Additionally, approximately $1.1 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.

                                       12
<PAGE>   13
         SALES AND MARKETING. Sales and marketing expense consists principally
of advertising and marketing programs, including personnel, occupancy and other
professional service expenses. Sales and marketing expense was approximately
$2.6 million (30% of revenue) for the three months ended June 30, 1999, an
increase of $1.1 million, or 73% from 1.5 million (31% of revenue) for the three
months ended June 30, 1998. Sales and marketing expense was approximately $4.4
million (28% of revenue) for the six months ended June 30, 1999, an increase of
$1.4 million, or 47% from $3.0 million (30% of revenue) for the six months ended
June 30, 1998. These increases reflect a substantial investment in the sales and
marketing organizations necessary to support our expanded customer base,
advertising campaigns and efforts to establish national sales and marketing
programs.

         GENERAL AND ADMINISTRATIVE. General and administrative expense consists
principally of costs relating to personnel, including customer support,
occupancy, general operating costs and professional fee expenses. General and
administrative expense was approximately $2.1 million (24% of revenue) for the
three months ended June 30, 1999, an increase of $.9 million, or 75% from $1.2
million (25% of revenue) for the three months ended June 30, 1998. General and
administrative expense was approximately $3.9 million (25% of revenue) for the
six months ended June 30, 1999, an increase of $1.6 million, or 69% from $2.3
million (23% of revenue) for the six months ended June 30, 1998. The increase in
general and administrative expenses 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.

         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 and six months
ended June 30, 1999 and 1998, research and development expenses have not
significantly fluctuated.

         DEPRECIATION AND AMORTIZATION. Depreciation and amortization consist
principally of depreciation of computer equipment, office furniture and
leasehold improvements. Depreciation and amortization expense was approximately
$.8 million (9% of revenue) for the three months ended June 30, 1999, an
increase of $.4 million, or 100% from $.4 million (8% of revenue) for the three
months ended June 30, 1998. Depreciation and amortization was approximately $1.4
million (24% of revenue) for the six months ended June 30, 1999, an increase of
$.6 million, or 75% from $.8 million (8% of revenue) for the six months ended
June 30, 1998. 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, as well as computer equipment and
office furniture for personnel supporting our national expansion.

         INTEREST INCOME. Interest income was approximately $.5 million for the
three and six months ended June 30, 1999 and insignificant for the same periods
in 1998. The increase is a result of the investment on May 5, 1999 of the net
proceeds from the Company's IPO.

         INTEREST EXPENSE. Interest expense was approximately $.2 million for
the three months ended June 30, 1999 and 1998, and approximately $.3 million for
the six months ended June 30, 1999 and 1998.

         NET LOSS. Net loss attributable to common stockholders for the quarter
ended June 30, 1999 was $2.3 million, or $0.12 per share, compared with $1.4
million, or $.13 per share, for the quarter ended June 30, 1998. Net loss
attributable to common stockholders for the six months ended June 30, 1999 was
$4.0

                                       13
<PAGE>   14
million, or $.23 per share compared with $2.2 million, or $.20 per share for the
six months ended June 30, 1998.

LIQUIDITY AND CAPITAL RESOURCES.

         We had an accumulated deficit of $19.8 million at June 30. 1999, and
have used $11.6 million in cash in the aggregate to fund operations during the
period since our inception on October 1, 1996, through June 30, 1999. Until the
successful completion of our initial public offering, 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 June 30, 1999, we have $6.9 million in cash and
cash equivalents and working capital of approximately $57.3 million. The Company
used approximately $2.8 million of cash in operations during the six months
ended June 30, 1999, compared to $1.2 million for the six months ended June 30,
1998. Net cash used in investing activities for the six months ended June 30,
1999 and 1998 was approximately $62.3 million and $.8 million, respectively. The
increase of approximately $61.5 million is associated with the purchase of
marketable securities and an investment using net proceeds of our initial public
offering ("IPO") which closed on May 5, 1999. Net cash provided by financing
activities was approximately $70.3 in the six months ended June 30, 1999 and
approximately $2.0 million for the six months ended June 30, 1998. This increase
of approximately $68.3 million consists principally of $75 million in net
proceeds received from issuance of 5,175,000 shares of our common stock in
connection with our IPO, less repayment of all outstanding borrowings from
NYSERNet.net, Inc., including deferred interest of approximately $3.5 million
and redemption of preferred stock including dividends payable of approximately
$1.9 million.

         Capital expenditures, including capital leases, amounted to
approximately $3.5 million for the six months ended June 30, 1999, as compared
to $.8 million for the six months ended June 30, 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 on Form S-1 for our IPO.) At June 30, 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
June 30, 1999, as a result of restrictions under the line of credit, no
additional credit was available under this agreement. In accordance with the
terms of this credit agreement, as amended on August 3, 1999, the bank issued a
standby letter of credit in the Company's name for $650,000 that expires July
30, 2000.

         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 and payments are deferred until
December 31, 2001. As of June 30, 1999, approximately $6.2 million was available
under this borrowing facility. In connection with our IPO, we fully redeemed our
outstanding preferred stock and paid down all outstanding line of credit
borrowings to NYSERNet.net.

         We believe that the net proceeds from our IPO, will be sufficient to
meet our anticipated cash needs for expanding our sales and marketing efforts,
expanding our customer support services, building

                                       14
<PAGE>   15
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.

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.

         As of June 30, 1999, all product lines and internal systems are being
tested. Although we anticipate testing to continue throughout the year, all
major components are expected to be compliant by the end of September 1999.
Based on requested Year 2000 readiness statements from each of our third party
vendors, software upgrades have been applied where appropriate. To date, there
are no responses from vendors 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.

                                       15
<PAGE>   16
YEAR 2000 AND OUR INTERNAL APPLICATIONS

         Our State of Readiness. All of our internally developed systems,
upgrades and applications are Year 2000 ready or in the process of being tested.
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
complete re-testing. Additionally, certain major applications will be run in
test during January 2000 and manually checked for accuracy prior to release.

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 a third party that has been represented to us as Year 2000 ready.

         We are in the midst of full testing of our entire product line. Test
servers have been built, and web hosting, access and software 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 plus
software. Software testing is ensuring date processing does not cause any
problems. The goal of these tests is to identify any problematic operations and
create a plan for rectifying problems. We are in the final stages of the first
phase and to date have not uncovered any significant problems. The second phase
of testing will commence in mid-August of 1999.

         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

                                       16
<PAGE>   17
programmers who have helped to ensure that Year 2000 standards, as well as other
programming standards, were adhered to.

         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 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 plan on adding new data
centers and additional data center capacity in our existing data centers over
the course of 1999 and plan to provide additional redundancy for our customers'
Web sites if they so desire when the new data centers and expansion are
completed.

         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 July 15, 1999, approximately $1.7
million was applied to expenses related to our offering. As a result, net
proceeds from the offering are approximately $75.3 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. On June 22, 1999, the Company
purchased Convertible Preferred Stock of Planning Technologies, Inc. for $5.0
million. For additional information about this investment, please see our report
on Form 8-K (File No. 000-25749), filed with the Securities and Exchange
Commission on July 7, 1999. We intend to use the remaining $65.0 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 build a new network operation center;
         -        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 a portion 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 June 30, 1999, proceeds of approximately $500
were generated from the exercise of options for 2,721 shares of our common
stock. There were no significant expenses, underwriting discounts or commissions
attributable to these proceeds. These options had been granted

                                       18
<PAGE>   19
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.

ITEM 3.           DEFAULTS UPON SENIOR SECURITIES

         Not applicable

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



         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.

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 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 on Form S-1
(Commission File No. 333-72133) filed with the Securities and Exchange
Commission and in our other filings and reports. 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;

                                       19
<PAGE>   20
         -        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 from
operations in each quarterly and annual period since inception and expect to
continue to do so for the foreseeable future. At June 30, 1999, we had an
accumulated deficit of approximately $19.8 million. We incurred net losses of
$2.3 million and $1.4 million in the three months ended June 30, 1999 and 1998,
respectively, and a year to date net loss of approximately $4.0 million for the
six months ended June 30, 1999 compared with a net loss of approximately $2.3
million for the six months ended June 30, 1998. 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 with IXC Communications, Inc., an
affiliate 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.

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:

                                       20
<PAGE>   21
         -        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;
         -        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;

                                       21
<PAGE>   22
         -        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 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

                                       22
<PAGE>   23
         -        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.

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 and six months ended June 30, 1999, revenue from
NYSERNet.org, Inc. represented approximately 31% of our total revenue compared
to 44% and 42% for the three and six months ended June 30, 1998, respectively.
Revenue under the agreement with the New York State Department of Labor for both
the three and six months ended June 30, 1999 represented 35% of our total
revenue compared to 22% and 25% for the three and six months ended June 30,
1998, respectively.

         We have an agreement with NYSERNet to provide NYSERNet and its
customers with services. This agreement 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.

         On June 14, 1999, we concluded a contract with NYSERNet to enhance,
operate and maintain NYSERNet's next generation Internet backbone network
(NYSERNet2000). We completed construction of the network in April 1999. Under
the terms of the contract, which extends until 2002, we will enhance and
maintain the first OC-12 research network backbone in New York State. We will
receive $5.2 million for our services over the term of the contract.

                                       23
<PAGE>   24
         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 was 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. Any failure by IXC or Cincinnati Bell, Inc. after its announced merger
with IXC to complete construction of, or deploy and maintain, the Gemini2000
Network could hurt our business. While IXC had previously 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 MODEL ASSUMES THAT WE WILL USE THE GEMINI2000 NETWORK FOR THE
DELIVERY OF OUR SERVICES. IF PROBLEMS OCCUR AS A RESULT OF A CHANGE OF OWNERSHIP
OF IXC INTERNET SERVICES, INC. AND THE GEMINI2000 NETWORK, OUR BUSINESS COULD
SUFFER.

         On July 21, 1999, Cincinnati Bell, Inc. announced its intention to
merge with IXC Communications Inc., parent of a major stockholder of the Company
and owner of the Gemini2000 Network. Our business model assumes we will use this
network for delivery of our services. As noted above, any failure by IXC (or
Cincinnati Bell and IXC after their merger) to complete construction of, or
deploy and maintain, the Gemini2000 Network could hurt our business.

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. Furthermore, additional network capacity many not be
available from IXC or other third-party suppliers as it is needed by 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

                                       24
<PAGE>   25
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 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

                                       25
<PAGE>   26
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 OUR 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 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.

                                       26
<PAGE>   27
         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 three and six months ended June 30, 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 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.

                                       27
<PAGE>   28
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 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.

                                       28
<PAGE>   29
         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 completing a Year 2000 readiness review that included
assessment, implementation, testing and contingency planning. After evaluating
our internally developed 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. We sought
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 throughout 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.

                                       29
<PAGE>   30
         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.

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. control approximately 26.7%, 23.0% and 13.4%, 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

                                       30
<PAGE>   31
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.

         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 are available for resale in the public
market as a result of our registering a Form S-8 with the Securities and
Exchange Commission on July 19, 1999 (File No. 333-83177) in order to register
the shares issued and issuable upon the exercise of options granted under the
1996 Incentive Stock Option Plan, or granted and to be granted under our 1999
Stock Option Plan and our 1999 Employee Stock Purchase Plan.

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.

                                       31
<PAGE>   32
         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.

         As a result of our re-offer prospectus filed on Form S-8 with the
Securities and Exchange Commission on July 19, 1999, approximately 21.3% of the
shares of our outstanding common stock no longer qualify as "restricted
securities" under Rule 144 of the Securities Act and, under the Securities Act,
these shares may be freely re-offered and re-sold. However, stockholders who
sell shares of our common stock under this re-offer prospectus must comply with
the volume of sale limitations imposed under Rule 144(e) of the Securities Act.
In addition, holders of 94.0% of the shares covered by the re-offer prospectus
are parties 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 during the 180-day lock-up period.

         Upon effectiveness of the re-offer prospectus, an additional 54.2% of
the shares of our common stock continue to be restricted securities. The holders
of these shares are also parties to the lock-up agreements described above and
in the registration statement for our initial public offering. The holders of
these restricted shares have registration rights with respected to these
restricted shares and with respect to any after-acquired shares and these
registration rights could be exercised after expiration of the 180-day lock-up
period. Also, under Rule 144 these shares become freely tradable in the future.

         Therefore, through the re-offer prospectus, as a result of registration
rights and under Rule 144, large amounts of the shares of our common stock may
become freely tradable and affect the market for our stock.

                                       32
<PAGE>   33
ITEM 6.           EXHIBITS AND REPORTS ON FORM 8K

         (a.) EXHIBITS.

         The following Exhibits are filed or incorporated by reference herewith:

<TABLE>
<CAPTION>
<S>                        <C>
         Exhibit 10.1      Master Service Agreement between AppliedTheory
                           Corporation and NYSERNet.org, Inc. dated June 14, 1999.

         Exhibit 10.2      Amendment No. 6 to Agreement between AppliedTheory
                           Corporation and the New York State Department of Labor,
                           dated August 11, 1998.

         Exhibit 10.3      Amendment No. 7 to Agreement between AppliedTheory
                           Corporation and the New York State Department of Labor,
                           dated July 1, 1999.

         Exhibit 10.4      Sublease Agreement between AppliedTheory Corporation
                           and Time Square Studios LTD, dated July 20, 1999

         Exhibit 11.1      Calculation of basic and diluted loss per share and
                           weighted average shares used in calculation for the three
                           months ended June 30, 1999.

         Exhibit 11.2      Calculation of Basic and diluted loss per share and
                           weighted average shares used in calculation for the three
                           months ended June 30, 1998.

         Exhibit 11.3      Calculation of Basic and diluted loss per share and
                           weighted average shares used in calculation for the six
                           months ended June 30, 1999.

         Exhibit 11.4      Calculation of Basic and diluted loss per share and
                           weighted average shares used in calculation for the six
                           months ended June 30, 1998.

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

         (b.) REPORTS ON FORM 8-K.

                  On July 7, 1999, we filed a Current Report on Form 8-K that
         included information relating to our investment on June 22, 1999 of
         $5.0 million in Planning Technologies, Inc. through the purchase of
         approximately 10% of the fully diluted capital stock of that company.
         We did not file any financial statements with that report.

                                       33
<PAGE>   34
                            APPLIEDTHEORY CORPORATION
                                    FORM 10-Q
                                  JUNE 30, 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: August 16, 1999         by:     /s/ Richard Mandelbaum
                                    --------------------------------------------
                                    Richard Mandelbaum
                                    Chairman of the Board,
                                    Chief Executive Officer, and Director
                                    (Principal Executive Officer)

Date: August 16, 1999         and:    /s/ David Buckel
                                    --------------------------------------------
                                    David Buckel
                                    Vice President and Chief Financial Officer
                                    (Principal Financial and Accounting Officer)

                                       34
<PAGE>   35
                                  EXHIBIT INDEX

         The following Exhibits are filed or incorporated by reference herewith:

<TABLE>
<CAPTION>
<S>               <C>
Exhibit 10.1      Master Service Agreement between AppliedTheory Corporation and
                  NYSERNet.org, Inc. dated June 14, 1999.

Exhibit 10.2      Amendment No. 6 to Agreement between AppliedTheory Corporation
                  and the New York State Department of Labor, dated August 11, 1998

Exhibit 10.3      Amendment No. 7 to Agreement between AppliedTheory Corporation
                  and the New York State Department of Labor, dated July 1, 1999.

Exhibit 10.4      Sublease Agreement between AppliedTheory Corporation and Time
                  Square Studios LTD, dated July 20, 1999

Exhibit 11.1.     Calculation of basic and diluted loss per share and weighted
                  average shares used in calculation for the three months ended
                  June 30, 1999.

Exhibit 11.2.     Calculation of Basic and diluted loss per share and weighted
                  average shares used in calculation for the three months ended
                  June 30, 1998.

Exhibit 11.3.     Calculation of Basic and diluted loss per share and weighted
                  average shares used in calculation for the six months ended
                  June 30, 1999.

Exhibit 11.4.     Calculation of Basic and diluted loss per share and weighted
                  average shares used in calculation for the six months ended
                  June 30, 1998.

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

                                       35