<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 SEPTEMBER 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 November 1, 1999, there were 21,340,095 shares of AppliedTheory
Corporation common stock, par value $.01, outstanding.


                    The Index of Exhibits appears on page 36
<PAGE>   2
                            APPLIEDTHEORY CORPORATION


                                TABLE OF CONTENTS




PART I. FINANCIAL INFORMATION
<TABLE>
<CAPTION>
<S>           <C>                                                                                     <C>
Item 1.       Financial Statements (Unaudited):

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

              Statements of Operations for the three and nine months ended
              September 30, 1998 and September 30, 1999................................................4

              Statements of Cash Flows for the nine months ended
              September 30, 1998 and September 30, 1999................................................5

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


Item 2.       Management's Discussion and Analysis of Financial Condition
              and Results of Operations...............................................................12

PART II.      OTHER INFORMATION

Item 1.       Legal Proceedings.......................................................................19

Item 2.       Changes in Securities and Use of Proceeds...............................................19

Item 3.       Defaults Upon Senior Securities.........................................................20

Item 4.       Submission of Matters to a Vote of Security Holders.....................................20

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

Item 6.       Exhibits and Reports on Form 8-K........................................................34

Signatures    ........................................................................................35

Exhibit
Index         ........................................................................................36
</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,         September 30,
                                                                                                     1998                  1999
                                                                                                  ------------         ------------
                                                                                              (Derived from Audited     (Unaudited)
                                                                                              Financial Statements)
                             ASSETS
<S>                                                                                                <C>                     <C>
Current assets
 Cash and cash equivalents                                                                         $  1,786                $  3,290
 Marketable securities                                                                                 --                    51,646
 Accounts receivable, net of allowance for doubtful accounts
  of $157 and $208, respectively                                                                      3,584                   6,108
 Due from related parties                                                                              --                     1,163
 Prepaid expenses and other assets                                                                      255                     896
                                                                                                   --------                --------
     Total current assets                                                                             5,625                  63,103

Property and equipment, net                                                                           4,203                   7,532
Investment, at cost                                                                                    --                     5,000
Other assets                                                                                            690                     996
                                                                                                   --------                --------
     Total assets                                                                                  $ 10,518                $ 76,631
                                                                                                   ========                ========

         LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities
 Accounts payable                                                                                  $  2,149                $  4,303
 Accrued payroll                                                                                        582                   1,586
 Accrued expenses                                                                                     2,473                   2,357
 Deferred revenue                                                                                     1,849                   2,559
 Current portion of long-term debt
   and capital lease obligations                                                                        551                     959
 Preferred stock dividends payable                                                                      420                    --
 Due to related parties                                                                                 850                    --
                                                                                                   --------                --------
     Total current liabilities                                                                        8,874                  11,764

Long-term debt and capital lease obligations                                                          5,979                   5,084
Borrowings from NYSERNet.net, Inc.                                                                    2,957                    --
Other liabilities                                                                                       215                     279
Redeemable preferred stock - 1,000,000 shares
 authorized; Issued and outstanding
 15,000 shares at December 31, 1998 and 0 shares at
 September 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 21,193,576 shares
 at September 30, 1999                                                                                  151                     212
Additional paid-in capital                                                                            6,581                  82,833
Accumulated deficit                                                                                 (15,739)                (23,369)
Accumulated other comprehensive income (loss)                                                          --                      (172)
                                                                                                   --------                --------

     Total stockholders' equity (deficit)                                                            (9,007)                 59,504
                                                                                                   --------                --------

     Total liabilities and stockholders' equity (deficit)                                          $ 10,518                $ 76,631
                                                                                                   ========                ========
</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                   NINE MONTHS ENDED
                                                                  September 30,                        September 30,
                                                        -------------------------------       -------------------------------
                                                            1998               1999               1998               1999
                                                        ------------       ------------       ------------       ------------
<S>                                                     <C>                <C>                <C>                <C>
Net revenues
     Third-party customers                              $      4,178       $      7,447       $     10,033       $     18,250
     NYSERNet.org, Inc. customers and services                 2,010              2,730              6,271              7,487
                                                        ------------       ------------       ------------       ------------

     Total net revenues                                        6,188             10,177             16,304             25,737
                                                        ------------       ------------       ------------       ------------

Costs and expenses
     Cost of revenues                                          3,433              6,818              9,237             16,710
     Sales and marketing                                       1,771              3,688              4,745              8,096
     General and administrative                                1,604              2,958              3,906              6,827
     Research and development                                     22                 66                142                196
     Depreciation and amortization                               422                879              1,181              2,286
     Other expenses                                               (2)              --                 --                    3
                                                        ------------       ------------       ------------       ------------

     Total costs and expenses                                  7,250             14,409             19,211             34,118
                                                        ------------       ------------       ------------       ------------

     Loss from operations                                     (1,062)            (4,232)            (2,907)            (8,381)

Investment income                                               --                 (756)              --               (1,279)
Interest expense                                                 141                129                424                455
                                                        ------------       ------------       ------------       ------------

     NET LOSS                                                 (1,203)            (3,605)            (3,331)            (7,557)

Preferred stock dividends                                         52               --                  157                 73
                                                        ------------       ------------       ------------       ------------

Net loss attributable to common stockholders            $     (1,255)      $     (3,605)      $     (3,488)      $     (7,630)
                                                        ============       ============       ============       ============

Basic and diluted loss per common share                 $      (0.09)      $      (0.17)      $      (0.29)      $      (0.40)
                                                        ============       ============       ============       ============

Shares used in computing basic
  and diluted loss per share                              13,539,735         21,180,152         11,834,585         18,858,416
                                                        ============       ============       ============       ============
</TABLE>

        The accompanying notes are an integral part of these statements.

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

<TABLE>
<CAPTION>
                                                                                                            NINE MONTHS ENDED
                                                                                                               September 30,
                                                                                                        ---------------------------
                                                                                                          1998               1999
                                                                                                        --------           --------
<S>                                                                                                     <C>                <C>
Cash flows from operating activities
         Net loss                                                                                       $ (3,331)          $ (7,557)
         Adjustments to reconcile net loss to net cash used in operating
         activities:
              Depreciation and amortization                                                                1,182              2,286
              Provision for bad debts                                                                       --                   68
              Deferral (payment) of interest expense to NYSERNet.net, Inc., net                              154               (270)
              Loss on sale of property and equipment                                                          14                  3
              Non-cash compensation expense                                                                  341                940
              Changes in assets and liabilities
                Accounts receivable                                                                       (1,022)            (2,592)
                Due to (from) related parties                                                               (505)            (2,012)
                Prepaid expenses and other assets                                                         (1,134)            (1,070)
                Accounts payable                                                                             147              2,154
                Accrued payroll                                                                              616              1,004
                Accrued expenses and other liabilities                                                       272                (51)
                Deferred revenue                                                                             804                711
                                                                                                        --------           --------

              Net cash used in operating activities                                                       (2,462)            (6,386)
                                                                                                        --------           --------

Cash flows from investing activities
         Purchases of property and equipment                                                              (1,185)            (4,174)
         Purchase of marketable securities                                                                  --              (77,258)
         Proceeds from sale or redemption of marketable securities                                          --               25,440
         Purchase of investment                                                                             --               (5,000)
         Payments received on notes receivable                                                              --                  122
         Proceeds from sale of property and equipment                                                          4                  5
                                                                                                        --------           --------

              Net cash used in investing activities                                                       (1,181)           (60,865)
                                                                                                        --------           --------

Cash flows from financing activities
         Issuance of common stock, net of issuance costs                                                   4,895             75,371
         Payment of preferred stock dividends                                                               --                 (493)
         Redemption of preferred stock                                                                      --               (1,500)
         Borrowings from NYSERNet.net, Inc.                                                                  301                800
         Repayment of borrowings from NYSERNet.net, Inc.                                                    --               (3,487)
         Proceeds from (repayment of) line of credit borrowings, net                                         356             (1,190)
         Principal payments on capital leases                                                               (165)              (746)
                                                                                                        --------           --------

              Net cash provided by financing activities                                                    5,387             68,755
                                                                                                        --------           --------

              Net increase (decrease) in cash and cash equivalents                                         1,744              1,504

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

Cash and cash equivalents, end of period                                                                $  1,879           $  3,290
                                                                                                        ========           ========
</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 nine months ended
     September 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 nine month period ended September 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 was declared effective upon completion of the IPO. 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 $75.3 million after deduction of the underwriting
     discount, commissions and other offering costs.

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
     stock method. All potential common shares have been

                                       6
<PAGE>   7
     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.

NOTE C - COMPREHENSIVE INCOME (LOSS)

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

<TABLE>
<CAPTION>
                                                Three months ended                Nine months ended
                                                   September 30,                    September 30,
                                              ------------------------         ------------------------
                                                1998            1999             1998            1999
                                              --------        --------         --------        --------
<S>                                           <C>             <C>              <C>             <C>
  Net loss                                    $(1,203)        $(3,605)         $(3,331)        $(7,557)
  Other comprehensive income (loss):
  Unrealized gain (loss) on
   Marketable securities                         --                21             --              (172)
                                              -------         -------          -------         -------
Comprehensive income (loss)                   $(1,203)        $(3,584)         $(3,331)        $(7,729)
                                              =======         =======          =======         =======
</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                Nine months ended
                                                    September 30,                    September 30,
                                              ------------------------          -----------------------
                                                1998            1999              1998           1999
                                               -------         -------          -------         -------
<S>                                            <C>             <C>              <C>             <C>
  Net revenues
  Internet connectivity                        $ 3,834         $ 5,081          $10,929         $14,189
  Internet integration and
  enterprise portal development                  1,981           4,250            4,285           9,284
  Web hosting                                      373             846            1,090           2,264
                                               -------         -------          -------         -------
Total net revenues                             $ 6,188         $10,177          $16,304         $25,737
                                               =======         =======          =======         =======
</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 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 had been 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 September 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.

                                       8
<PAGE>   9
NOTE H - LONG-TERM DEBT

     Line of Credit

     On January 20, 1998, the Company entered into a credit agreement with a
     bank for an aggregate amount of $7,500,000, which expires on January 19,
     2001. The agreement provides for the payment on January 19, 2001 of the
     unpaid principal balance of all amounts advanced on and outstanding at that
     time. 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 $4,240,000 outstanding under the line of credit as of
     September 30, 1999 and, as a result of certain restrictions, has an
     additional $1,260,000 available as of September 30, 1999. The average
     interest rate on outstanding borrowings was 6.2% at September 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 date 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 September 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 nine months ended September 30, 1998 and
     1999 was approximately $141,000, $424,000, $129,000 and $794,000,
     respectively.

                                       9
<PAGE>   10
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.

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 September 30, 1998 and 1999 and a total of $300,000 and
     $941,000 for the nine months ended September 30, 1998 and 1999,
     respectively.

     During the nine months ended September 30, 1999, options with respect to
     924,426 shares of common stock were exercised for aggregate net proceeds of
     approximately $140,000.

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            Nine months ended
                                     September 30,                September 30,
                                  ------------------           -------------------
                                   1998        1999             1998         1999
                                  ------      ------           ------       ------
<S>                               <C>         <C>              <C>          <C>
    Unrelated customers           $  730      $  754           $2,351       $2,196
    Member institutions            1,120       1,265            3,358        3,620
    Services to ORG                  160         711              562        1,671
                                  ------      ------           ------       ------
                                  $2,010      $2,730           $6,271       $7,487
                                  ======      ======           ======       ======
</TABLE>

     During each of the three and nine months ended September 30, 1998 and 1999,
     the Company charged NET approximately $25,000 and $75,000 and ORG $75,000
     and $225,000, respectively, in management fees.

     The excess of the Company's revenues over amounts charged by ORG to its
     member institutions was approximately $701,000 and $783,000 for the three
     months ended September 30, 1998 and 1999 and $2,116,000 and $2,256,000 for
     the nine months ended September 30, 1998 and 1999, respectively.

NOTE L - COMMITMENTS

     During the three months ended September 30, 1999, the Company entered into
     five noncancelable operating leases for new office facilities with terms
     ranging from seven to ten years. Certain of these

                                       10
<PAGE>   11
     operating leases 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 the
     noncancelable operating leases entered into during the quarter ended
     September 30, 1999 are approximately $1,200,000 in 2000, $1,500,000
     annually from 2001 through 2007 and approximately $1,000,000 annually from
     2007 through 2009.

                                       11
<PAGE>   12
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 in the Registration
Statement on Form S-1 (File No. 333-72133), as filed with the Securities and
Exchange Commission in connection with our initial public offering ("IPO") 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.

         We are rapidly building our sales and marketing efforts to more
aggressively pursue customers. During the third quarter of 1999 we increased our
sales force 70% and opened sales offices in 2 new regions. AppliedTheory also
signed leases to open a new data center in Hayward, California and a network
operations center in Columbia, Maryland. We have also signed a lease for new
office facilities in Syracuse, New York, which will provide additional space for
the expansion of our current network

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operations and data center. During the remainder of 1999 and the first quarter
of 2000, we have targeted 10 metropolitan areas throughout the East Coast of the
United States, which have high concentrations of businesses and intend to
continue to grow our direct sales force. These targeted markets are where we
plan to have a physical local presence consisting of a sales office and/or
planned points of presence, ("POPs").

RESULTS OF OPERATIONS

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1999, COMPARED TO THREE AND NINE
MONTHS ENDED SEPTEMBER 30, 1998

         REVENUE. Total net revenues were approximately $10.2 million for the
three months ended September 30, 1999, an increase of $4.0 million or 65%, from
$6.2 million in the three months ended September 30, 1998. Total net revenues
were approximately $25.7 million for the nine months ended September 30, 1999,
an increase of $9.4 million or 58%, from $16.3 million in the nine months ended
September 30, 1998. Approximately $3.3 million of the growth during the nine
months ended September 30, 1999 from the same period ended September 30, 1998
was from Internet connectivity revenue, which resulted primarily from the
addition of new customers and from additional revenue derived from existing
customers who upgraded their level of service. Web hosting revenue increased by
approximately $1.1 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 $5.0 million was derived from
Internet integration and enterprise portal development services. These services
include, but are not limited to:

-    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 nine months ended September 30, 1999, as a percentage of total
net revenues, Internet connectivity represented 55%, Internet integration and
enterprise portal development represented 36% and Web hosting represented 9%.
For the nine months ended September 30, 1998, as a percentage of total net
revenues, Internet connectivity represented 67%, Internet integration and
enterprise portal development represented 26% and Web hosting represented 7%.

         COST OF REVENUE. Cost of revenue 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 $6.8 million (67% of revenue) for the three months ended September
30, 1999, an increase of approximately $3.4 million from the $3.4 million (55%
of revenue) for the three months ended September 30, 1998. Cost of revenue
totaled approximately $16.7 million (65% of revenue) for the nine months ended
September 30, 1999, an increase of approximately $7.5 million from the $9.2
million (57% of revenue) for the nine months ended September 30, 1998. The
increase in both periods is

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primarily attributable to the upgrade of our network to support customer growth,
improve the efficiency and performance of our Internet connectivity services and
building and staffing of our network operations center. Additionally,
approximately $1.3 million of the increase in the three months ended September
30, 1999 and approximately $2.4 million of the increase in the nine months ended
September 30, 1999 from the same periods last year was derived from an increase
in labor and other professional service costs associated with the expansion of
Internet integration and enterprise portal development services.

         SALES AND MARKETING. Sales and marketing expense consists principally
of advertising and marketing programs, including personnel, occupancy and other
professional service expenses consisting of telemarketing services. Sales and
marketing expense was approximately $3.7 million (36% of revenue) for the three
months ended September 30, 1999, an increase of $1.9 million, or 108% from $1.8
million (29% of revenue) for the three months ended September 30, 1998. Sales
and marketing expense was approximately $8.1 million (31% of revenue) for the
nine months ended September 30, 1999, an increase of $3.4 million, or 71% from
$4.7 million (29% of revenue) for the nine months ended September 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 $3.0 million (29% of revenue) for the
three months ended September 30, 1999, an increase of $1.4 million, or 84% from
$1.6 million (26% of revenue) for the three months ended September 30, 1998.
General and administrative expense was approximately $6.8 million (27% of
revenue) for the nine months ended September 30, 1999, an increase of $2.9
million, or 75% from $3.9 million (24% of revenue) for the nine months ended
September 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 nine months
ended September 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
$.9 million (9% of revenue) for the three months ended September 30, 1999, an
increase of $.5 million, or 108% from $.4 million (7% of revenue) for the three
months ended September 30, 1998. Depreciation and amortization was approximately
$2.3 million (9% of revenue) for the nine months ended September 30, 1999, an
increase of $1.1 million, or 94% from $1.2 million (7% of revenue) for the nine
months ended September 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

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<PAGE>   15
and office furniture for personnel supporting our national expansion.

         INTEREST INCOME. Interest income was approximately $.8 million for the
three months ended September 30, 1999 and $1.3 million for the nine months ended
September 30, 1999. Interest income was insignificant for the same periods in
1998. The increase is a result of the return on funds invested since May 5, 1999
representing the net proceeds from the Company's IPO.

         INTEREST EXPENSE. Interest expense was approximately $.1 million for
the three months ended September 30, 1999 and 1998, and approximately $.4
million for the nine months ended September 30, 1999 and 1998.

         NET LOSS. Net loss attributable to common stockholders for the quarter
ended September 30, 1999 was $3.6 million, or $0.17 per share, compared with
$1.2 million, or $.09 per share, for the quarter ended September 30, 1998. Net
loss attributable to common stockholders for the nine months ended September 30,
1999 was $7.6 million, or $.40 per share compared with $3.5 million, or $.29 per
share for the nine months ended September 30, 1998.

LIQUIDITY AND CAPITAL RESOURCES.

         We had an accumulated deficit of $23.4 million at September 30. 1999,
and have used $15.1 million in cash in the aggregate to fund operations during
the period since our inception on October 1, 1996, through September 30, 1999.
Until the successful completion of our initial public offering, we had 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 September 30, 1999, we have $3.3 million in
cash and cash equivalents and working capital of approximately $51.3 million.
The Company used approximately $6.3 million of cash in operations during the
nine months ended September 30, 1999, compared to $2.5 million for the nine
months ended September 30, 1998. Net cash used in investing activities for the
nine months ended September 30, 1999 and 1998 was approximately $60.9 million
and $1.2 million, respectively. The increase of approximately $59.7 million is
associated with the purchase of marketable securities and an investment using
net proceeds of our IPO which closed on May 5, 1999. Net cash provided by
financing activities was approximately $68.8 in the nine months ended September
30, 1999 and approximately $5.4 million for the nine months ended September 30,
1998. This increase of approximately $63.4 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 $5.6 million for the nine months ended September 30, 1999, as
compared to $1.2 million for the nine months ended September 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. At
September 30, 1999, borrowings under this line amounted to $4.2 million and a
standby letter of credit in the Company's name for $650,000 that expires July
30, 2000. As of September 30, 1999, as a result of restrictions under

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<PAGE>   16
the line of credit, additional credit of $1.3 million was available under this
agreement.

         We also have an unsecured revolving borrowing facility with
NYSERNet.net, which provides for borrowings up to a maximum amount of
approximately $6.2 million, less any preferred stock issued to NYSERNet.net. As
of September 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 and availability under
the aforementioned financing agreements, will be sufficient to meet our
anticipated cash needs for expanding our sales and marketing efforts, expanding
our customer support services, building new distributed data centers, and for
other working capital requirements and general corporate purposes. However,
there can be no assurance regarding the period of time through which our
financial resources will be adequate to support our operations. We may need to
raise additional funds through public or private financing, strategic
relationships or other arrangements. There can be no assurance that additional
financing, if needed, will be available on terms acceptable to us, or at all.
Furthermore, any additional equity financing may be dilutive to stockholders,
and debt financing, if available may involve restrictive covenants and
significant interest expense. Strategic arrangements, if necessary to raise
additional funds, may require us to relinquish rights to some of our
technologies.

YEAR 2000 COMPLIANCE

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

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.

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<PAGE>   17
         As of November 1, 1999, all product lines and internal systems have
been tested or are in the process of being tested. All AppliedTheory Internet
connectivity and Unix Web hosting products and services have been tested and are
deemed to be compliant. NT Web hosting products are in final testing, with no
problems reported to date. Scheduled maintenance and system upgrades necessary
before year-end will be fully tested for compliance. Custom developed code for
our customers have been completely tested. 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. Internal systems are
in final stages of acceptance testing and will be completed by December 1, 1999.

         Our Total Estimated Costs Associated with Year 2000. As of November 15,
1999, we estimate approximately 100 to 150 hours of internal labor hours and an
insignificant amount of additional expense will be necessary to complete testing
and upgrading.

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. The AppliedTheory Internet connectivity
products are Year 2000 ready. The current Dial product, which is not compliant,
is being transitioned to a new dial up service provided by a third party,
Concentric Networks. The Concentric product is Y2K compliant. Customer
transition will be completed by December 15, 1999.

         Testing on our NT Web hosting product is being targeted for completion
by November 15, 1999. The tests are simulating the Web hosting services for the
two calendar weeks before and after January 1, 2000. Software testing is also
being done to ensure 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. No problems have been identified to date in testing.

         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 has 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 which we use 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.

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<PAGE>   18
         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. All critical third party
vendors are compliant. 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. Each individual application has been appropriately tested. There may be
cases where incoming data feeds from customers will need to be adjusted or
slight modifications will need to be made on the Web server. However, because
Internet integration and enterprise portal development is a fairly new business
line, Year 2000 compliance was addressed from its inception. Additionally,
Internet integration and enterprise portal development projects have been
implemented almost exclusively by in-house technical programmers who have helped
to ensure that Year 2000 standards, as well as other programming standards, were
adhered to.

         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 have communicated, and will communicate with our customers
throughout the year in order to alert them to third party issues that may affect
them.

         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.

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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 ("IPO") 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 October 30, 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 23.0% 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 $64.5 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 and add additional data center
capacity.

         Pending the above uses, we have invested the proceeds of the offering
in short-term, interest bearing securities of investment grade.

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<PAGE>   20
         During the quarter ended September 30, 1999, proceeds of approximately
$18,000 were generated from the exercise of options for 45,674 shares of our
common stock. There were no significant expenses, underwriting discounts or
commissions attributable to these proceeds. These options had been granted under
our 1996 Incentive Stock Option Plan and were exercised by certain employees and
directors. The shares we issued pursuant to the exercise of these options were
registered through our Form S-8 (File No.333-83177), which we filed with the
Securities and Exchange Commission on July 19, 1999.

ITEM 3.           DEFAULTS UPON SENIOR SECURITIES

         Not applicable.

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

         Not applicable.

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;

-        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.

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<PAGE>   21
         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 September 30, 1999, we had an
accumulated deficit of approximately $23.4 million. We incurred net losses of
$3.6 million and $1.2 million in the three months ended September 30, 1999 and
1998, respectively, and a year to date net loss of approximately $7.6 million
for the nine months ended September 30, 1999 compared with a net loss of
approximately $3.5 million for the nine months ended September 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 implementation of our regional and
nationwide expansion strategy. 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 completion of our new data centers;
     -   we fail to successfully implement our sales and marketing strategy on a
         national scale;
     -   we fail in our efforts to build a national sales force; and/or
     -   we fail to develop a nationally recognized brand.

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

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

     -   to expand our business with new and current customers;
     -   to develop and offer successful new products and services;
     -   to retain key employees and hire new employees; and
     -   to ensure that any future business we may develop or acquire will
         perform in a satisfactory manner.

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

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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;

-    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;

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<PAGE>   23
-    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, PSINet Inc., UUNET Technologies, Inc.,
Frontier Global Center, GTE Internetworking, Digex, Inc., Verio Inc. and other
national and regional providers;

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

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

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

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

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

                                       23
<PAGE>   24
         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 REDUCES THE AMOUNT OF WORK IT DOES 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 nine months ended September 30, 1999, revenue from
NYSERNet.org, Inc. represented approximately 27% and 29% of our total revenue
compared to 32% and 38% for the three and nine months ended September 30, 1998,
respectively. Revenue under the agreement with the New York State Department of
Labor for the three and nine months ended September 30, 1999 represented 43% and
38%, respectively, of our total revenue compared to 33% and 28% for the three
and nine months ended September 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.

         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,

                                       24
<PAGE>   25
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 THE 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 may 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 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;

                                       25
<PAGE>   26
-    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
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.

                                       26
<PAGE>   27
     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.

                                       27
<PAGE>   28
     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 nine months ended September 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.

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<PAGE>   29
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

                                       29
<PAGE>   30
any other governmental agency, other than regulations applicable to businesses
in general. However, in the future, we may become subject to regulation by the
FCC or another regulatory agency. Our business could suffer depending on the
extent to which our activities are regulated or proposed to be regulated.

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

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

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

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

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

         We are currently 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

                                       30
<PAGE>   31
undetected errors or defects in our systems.

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

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

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

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

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

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

         -        develop new products; or

         -        respond to unanticipated competitive pressures.

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

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

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,

                                       31

<PAGE>   32
NYSERNet.net and Grumman Hill that may be deemed to be owned by some of our
officers and directors as a result of their relationships with these entities.
Accordingly, IXC, NYSERNet.net, Grumman Hill and our officers and directors,
whether acting alone or together, are able to exert considerable influence over
any stockholder vote, including any vote on the election or removal of directors
and any merger, consolidation or sale of all or substantially all of our assets,
and control our management and affairs. Such control could discourage others
from initiating potential merger, takeover or other change in control
transactions. As a consequence, our business could be hurt. IXC, Grumman Hill
and NYSERNet.net each have one representative on our board of directors. In
addition, three of our directors and/or executive officers are also directors of
NYSERNet.net and NYSERNet.org, Inc., a not-for-profit corporation that is also
affiliated with NYSERNet.net. Two of our executive officers are executive
officers of NYSERNet.net and/or NYSERNet.org. Grumman Hill has a significant
equity interest in IXC. NYSERNet.net, NYSERNet.org, IXC, Grumman Hill and our
officers and directors may have conflicts of interest among themselves, and
their interests could conflict with the interests of our other stockholders.

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

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

OUR STOCK PRICE MAY BE VOLATILE.

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

         -        variations in our revenue, earnings and cash flow;

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

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

         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.

                                       32
<PAGE>   33
         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.

         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 which ended October 31, 1999.

         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.

                                       33
<PAGE>   34
ITEM 6.           EXHIBITS AND REPORTS ON FORM 8K

(a.)          EXHIBITS.

         The following Exhibits are filed or incorporated by reference herewith:

         Exhibit 10.1      Amendment No. 8 to Agreement between AppliedTheory
                           Corporation and the New York State Department of
                           Labor, dated August 17, 1999.

         Exhibit 10.2      Lease Agreement between 224 Harrison Associates,
                           LLC and AppliedTheory Corporation, dated September
                           17, 1999.

         Exhibit 10.3      Lease Agreement between Hayward Point Eden I
                           Limited Partnership and AppliedTheory Corporation,
                           dated September 3, 1999.

         Exhibit 11.1      Calculation of basic and diluted loss per share
                           and weighted average shares used in calculation for
                           the three months ended September 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 September 30, 1998.

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

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

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


(b.)          REPORTS ON FORM 8-K.

                  None.

                                       34
<PAGE>   35
                            APPLIEDTHEORY CORPORATION
                                    FORM 10-Q
                               SEPTEMBER 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:      November 15, 1999            by:     /s/ Richard Mandelbaum
                                           -------------------------------------
                                           Richard Mandelbaum
                                           Chairman of the Board,
                                           Chief Executive Officer,
                                              and Director
                                           (Principal Executive Officer)

Date:      November 15, 1999           and:    /s/ David Buckel
                                           ------------------------------------
                                           David Buckel
                                           Vice President and
                                              Chief Financial Officer
                                           (Principal Financial and
                                              Accounting Officer)

                                       35
<PAGE>   36
                                  EXHIBIT INDEX

         The following Exhibits are filed or incorporated by reference herewith:

Exhibit 10.1      Amendment No. 8 to Agreement between AppliedTheory Corporation
                  and the New York State Department of Labor, dated August 17,
                  1999

Exhibit 10.2      Lease Agreement between 224 Harrison Associates, LLC and
                  AppliedTheory Corporation, dated September 17, 1999.

Exhibit 10.3      Lease Agreement between Hayward Point Eden I Limited
                  Partnership and AppliedTheory Corporation, dated September 3,
                  1999.

Exhibit 11.1.     Calculation of basic and diluted loss per share and
                  weighted average shares used in calculation for the three
                  months ended September 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 September 30, 1998.

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

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

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


                                       36