<PAGE>
                                  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, 2001

                                       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.)



 1500 BROADWAY, 3RD FLOOR                                       10036
     NEW YORK, N.Y.                                           (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICE)

                                 (212) 398-7070
               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 October 31, 2001, there were 28,977,303 shares of AppliedTheory
Corporation common stock, par value $.01, outstanding.


                      The Exhibit Index appears on page 47

<PAGE>
                            APPLIEDTHEORY CORPORATION


                                TABLE OF CONTENTS


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

        Consolidated Balance Sheets as of December 31, 2000 and September 30, 2001              3

        Consolidated Statements of Operations for the three and nine months ended
        September 30, 2000 and September 30, 2001 ................................              4

        Consolidated Statements of Stockholders' Equity and Comprehensive Income
        (Loss) for the year ended December 31, 2000 and the nine months ended
        September 30, 2001 .......................................................              5

        Consolidated Statements of Cash Flows for the nine months ended
        September 30, 2000 and September 30, 2001 ................................              6

        Notes to Consolidated Financial Statements ...............................              7


Item 2. Management's Discussion and Analysis of Financial Condition
        and Results of Operations ......................................................       18

Item 3. Quantitative and Qualitative Disclosures about Market Risk .....................       28

PART II.  OTHER INFORMATION

Item 1. Legal Proceedings ..............................................................       28

Item 2. Changes in Securities and Use of Proceeds ......................................       30

Item 3. Defaults Upon Senior Securities ................................................       30

Item 4. Submission of Matters to a Vote of Security Holders ............................       30

Item 5. Other Information ..............................................................       31

Item 6. Exhibits and Reports on Form 8K ................................................       45

Signatures .............................................................................       46

Exhibit Index ..........................................................................       47
</TABLE>

<PAGE>
PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

                   APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
                        (IN THOUSANDS, EXCEPT SHARE DATA)

<TABLE>
<CAPTION>
                                                                                    December 31,             September 30,
                                                                                        2000                     2001
                                                                                        ----                     ----
                                                                               (Derived from Audited          (Unaudited)
                                   ASSETS                                      Financial Statements)
<S>                                                                            <C>                           <C>
Current assets
    Cash and cash equivalents                                                              $5,733                $1,492
    Marketable securities                                                                   4,098                   190
    Accounts receivable, net of allowance of $1,031 and $1,209, respectively               15,379                16,146
    Costs in excess of billings                                                               702                 1,170
    Due from related parties                                                                1,436                 1,017
    Prepaid expenses and other current assets                                               1,920                 1,248
                                                                                        ---------             ---------
           Total current assets                                                            29,268                21,263
Property and equipment, net                                                                30,632                25,798
Investment, at cost                                                                         5,250                   760
Goodwill                                                                                   61,946                51,587
Other assets                                                                                3,150                 2,409
                                                                                        ---------             ---------
           Total assets                                                                  $130,246              $101,817
                                                                                        =========             =========

                    LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
    Accounts payable                                                                       $6,028               $15,201
    Lines of credit                                                                           687                 8,385
    Accrued payroll                                                                         3,088                 2,119
    Accrued expenses                                                                        4,385                 2,725
    Deferred revenue                                                                        4,270                 4,971
    Current portion of convertible debentures                                              13,804
    Current portion of long-term debt and capital lease obligations                         4,394                 6,947
                                                                                        ---------             ---------
           Total current liabilities                                                       36,656                40,348
Long-term debt and capital lease obligations                                               11,655                 3,890
Convertible debentures                                                                     13,804                29,925
Other liabilities                                                                             404                   643
Temporary equity                                                                           10,000                10,000
Commitments and contingencies
Stockholders' equity
    Common stock, $.01 par value; 90,000,000 shares authorized;
       issued and outstanding: 25,986,947 shares at December 31, 2000
       and 28,687,154 shares at September 30, 2001                                            260                   287
    Additional paid-in capital                                                            139,900               142,593
    Accumulated deficit                                                                   (82,439)             (125,691)
    Accumulated other comprehensive income (loss)                                               6                  (178)
                                                                                        ---------             ---------
           Total stockholders' equity                                                      57,727                17,011
                                                                                        ---------             ---------
           Total liabilities and stockholders' equity                                    $130,246              $101,817
                                                                                        =========             =========
</TABLE>

        The accompanying notes are an integral part of these statements.

                                       3
<PAGE>


                   APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS
               (IN THOUSANDS, EXCEPT PER SHARE AND SHARE AMOUNTS)
                                   (UNAUDITED)
<TABLE>
<CAPTION>
                                                                    Three months ended                 Nine months ended
                                                                      September 30,                     September 30,
                                                                      -------------                     -------------

                                                                   2000              2001              2000             2001
                                                                   ----              ----              ----             ----
<S>                                                          <C>                <C>                <C>                <C>
Net revenues
     Web hosting                                             $      3,417       $      6,772       $      7,192       $     20,986
     Internet solutions                                             9,474              6,578             24,180             16,543
     Internet connectivity                                          8,075              7,157             23,405             22,092
                                                             ------------       ------------       ------------       ------------

     Total net revenues                                            20,966             20,507             54,777             59,621
                                                             ------------       ------------       ------------       ------------

Costs and expenses
     Cost of revenues                                              14,561             12,761             38,350             38,771
     Sales and marketing                                            7,198              4,474             21,368             16,234
     General and administrative                                     5,709              5,835             15,481             15,889
     Research and development                                         915                498              1,263              1,750
     Depreciation                                                   2,868              3,357              7,333              9,547
     Amortization                                                   3,416              3,708              8,212             11,087
     Other (income) expenses                                           20                (67)              (186)               (89)
     Non-recurring charges                                                                                                   6,202
                                                             ------------       ------------       ------------       ------------

     Total costs and expenses                                      34,687             30,566             91,821             99,391
                                                             ------------       ------------       ------------       ------------

     Loss from operations                                         (13,721)           (10,059)           (37,044)           (39,770)

Interest income                                                      (436)               (21)            (1,113)              (160)
Interest expense                                                      940              1,183              2,190              3,642
                                                             ------------       ------------       ------------       ------------

     Net loss attributable to common stockholders            $    (14,225)      $    (11,221)      $    (38,121)      $    (43,252)
                                                             ============       ============       ============       ============

Basic and diluted loss per common share                      $      (0.57)      $      (0.40)      $      (1.59)      $      (1.59)
                                                             ============       ============       ============       ============

Shares used in computing basic and diluted loss per share      24,822,053         28,327,183         23,924,826         27,193,967
                                                             ============       ============       ============       ============
</TABLE>
        The accompanying notes are an integral part of these statements.


                                       4
<PAGE>


                   APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                         AND COMPREHENSIVE INCOME (LOSS)
          YEAR ENDED DECEMBER 31, 2000 (DERIVED FROM AUDITED FINANCIAL
        STATEMENTS) AND NINE MONTHS ENDED SEPTEMBER 30, 2001 (UNAUDITED)
                        (IN THOUSANDS, EXCEPT SHARE DATA)


<TABLE>
<CAPTION>



                                                                        Common stock                      Additional
                                                                    ----------------------                 paid-in
                                                                      Shares               Amount          capital
                                                                      ------               ------          -------
<S>                                                                 <C>                <C>                <C>
BALANCE, JANUARY 1, 2000                                              21,413,362       $        214       $     84,052
                                                                    ============       ============       ============

Issuance of common stock for acquisitions                              3,828,471                 38             48,327
Issuance of common stock pursuant to exercise of stock options           515,441                  5              1,004
Issuance of common stock pursuant to Employee
Stock Purchase Plan                                                      229,673                  3              1,189
Compensation expense related to stock option plan                                                                1,236
Discount on convertible debenture                                                                                4,092
Unrealized gain (loss) on marketable securities
Net loss
                                                                    ------------       ------------       ------------

Comprehensive loss


BALANCE, DECEMBER 31, 2000                                            25,986,947       $        260       $    139,900
                                                                    ============       ============       ============

Issuance of common stock for acquisitions                                238,874                  3                155
Issuance of common stock pursuant to exercise of stock options           405,827                  4                 59
Issuance of common stock pursuant to Employee
Stock Purchase Plan                                                      537,105                  5                332
Issuance of common stock pursuant to conversion of convertible
debentures, net of debt discount and issuance costs                    1,518,401                 15              1,247
Compensation expense related to stock option plan                                                                  900
Unrealized gain (loss) on marketable securities
Net loss
                                                                    ------------       ------------       ------------

Comprehensive loss


BALANCE, SEPTEMBER 30, 2001                                           28,687,154       $        287       $    142,593
                                                                    ============       ============       ============

</TABLE>



<TABLE>
<CAPTION>
                                                                                        Accumu-
                                                                                         lated
                                                                                         other
                                                                      Accumu-           compre-                             Compre-
                                                                       lated            hensive                          hensive
                                                                      deficit        income  (loss)        Total       income (loss)
                                                                      -------        --------------        -----      -------------
<S>                                                               <C>                <C>               <C>            <C>
BALANCE, JANUARY 1, 2000                                          $    (29,806)      $       (251)     $     54,209
                                                                  ============       ============      ============

Issuance of common stock for acquisitions                                                                    48,365
Issuance of common stock pursuant to exercise of stock options                                                1,009
Issuance of common stock pursuant to Employee
Stock Purchase Plan                                                                                           1,192
Compensation expense related to stock option plan                                                             1,236
Discount on convertible debenture                                                                             4,092
Unrealized gain (loss) on marketable securities                                               257               257            257
Net loss                                                               (52,633)                             (52,633)       (52,633)
                                                                  ------------       ------------      ------------    ------------

Comprehensive loss                                                                                                      $  (52,376)
                                                                                                                       ============

BALANCE, DECEMBER 31, 2000                                        $    (82,439)      $          6      $     57,727
                                                                  ============       ============      ============

Issuance of common stock for acquisitions                                                                       158
Issuance of common stock pursuant to exercise of stock options                                                   63
Issuance of common stock pursuant to Employee
Stock Purchase Plan                                                                                             337
Issuance of common stock pursuant to conversion of convertible
debentures, net of debt discount and issuance costs                                                           1,262
Compensation expense related to stock option plan                                                               900
Unrealized gain (loss) on marketable securities                                              (184)             (184)          (184)
Net loss                                                               (43,252)                             (43,252)       (43,252)
                                                                  ------------       ------------      ------------    ------------

Comprehensive loss                                                                                                    $    (43,436)
                                                                                                                       ============

BALANCE, SEPTEMBER 30, 2001                                       $   (125,691)      $       (178)     $     17,011
                                                                  ============       ============      ============
</TABLE>


        The accompanying notes are an integral part of these statements.

                                        5
<PAGE>
                   APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
                                   (UNAUDITED)

<TABLE>
<CAPTION>
                                                                                               Nine months ended
                                                                                                  September 30,
                                                                                           -------------------------
                                                                                             2000             2001
                                                                                           --------         --------
<S>                                                                                        <C>              <C>
Cash flows from operating activities
         Net loss                                                                          $(38,121)        $(43,252)
         Adjustments to reconcile net loss to net cash used in operating activities
              Depreciation                                                                    7,333            9,547
              Amortization of goodwill                                                        8,212           11,087
              Amortization of debt discount                                                     625              668
              Write-off of debt discount                                                                       2,167
              Provision for bad debts                                                           506            1,131
              Realized loss on marketable securities                                             11            2,933
              Gain (loss) on sale of property and equipment                                       5              (51)
              Compensation expense related to stock option plans                                927              900
              Changes in assets and liabilities, net of acquisitions
                Accounts receivable                                                          (8,829)          (2,659)
                Due from related parties                                                     (1,019)             304
                Prepaid expenses, other current assets and other assets                        (487)           1,535
                Accounts payable                                                                476            9,173
                Accrued payroll, expenses and other liabilities                              (2,442)          (1,626)
                Deferred revenue                                                                908              232
                                                                                           --------         --------
              Net cash used in operating activities                                         (31,895)          (7,911)
                                                                                           --------         --------

Cash flows from investing activities
         Purchases of property and equipment                                                (14,946)          (2,016)
         Purchase of marketable securities                                                  (23,930)
         Proceeds from sales of marketable securities                                        45,093            6,042
         Investment in certain businesses, net of cash acquired                             (10,640)            (456)
         Payments received on notes receivable                                                    4                4
         Proceeds from sale of property and equipment                                            16              218
                                                                                           --------         --------
              Net cash provided by (used in) investing activities                            (4,403)           3,792
                                                                                           --------         --------

Cash flows from financing activities
         Issuance of common stock, net of issuance costs                                      1,559              400
         Issuance of convertible debentures                                                  30,000
         Convertible debenture issue costs                                                   (1,010)            (404)
         Proceeds from line of credit borrowings                                             65,187           47,495
         Payments on line of credit borrowings                                              (65,238)         (45,297)
         Principal payments on long-term debt and capital leases                             (4,398)          (4,647)
         Proceeds received from long-term debt and capital leases                             2,997            2,331
                                                                                           --------         --------
              Net cash (used in) provided by financing activities                            29,097             (122)
                                                                                           --------         --------

              Net decrease in cash and cash equivalents                                      (7,201)          (4,241)

Cash and cash equivalents, beginning of period                                               14,834            5,733
                                                                                           --------         --------

Cash and cash equivalents, end of period                                                   $  7,633         $  1,492
                                                                                           ========         ========

Supplemental disclosures of cash flow information
         Cash paid during the period for interest                                          $  1,065         $  1,531

Non-cash investing and financing transactions
         Fixed asset acquisitions financed through capital lease obligations               $  7,561         $  2,585
         Conversion of convertible debentures to equity                                                        1,263
         Acquired stock in exchange for cancellation of accounts receivable                                      760
         Unrealized holding (loss) gain on available for sale securities                        243             (184)
         Investment in businesses
               Fair value of assets acquired, net of cash acquired                           73,295              614
              Liabilities assumed                                                             7,909
              Issuance of common stock for investment in businesses                          44,746              158
              Issuance of temporary equity for investment in businesses                      10,000
</TABLE>

        The accompanying notes are an integral part of these statements.

                                       6
<PAGE>

                   APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)


NOTE A - NATURE OF OPERATIONS, BASIS OF PRESENTATION, FINANCIAL RESULTS AND
         LIQUIDITY

     AppliedTheory Corporation was incorporated in the State of New York in
     November 1995 and reorganized as a Delaware corporation on January 28,
     1999.

     The Company is a provider of Internet business solutions offering a full
     suite of web hosting, Internet solutions, Internet connectivity and
     security services to give customers a single source for all their Internet
     needs.

     The Company operates as one business segment and follows the requirements
     of Statement of Financial Accounting Standards No. 131 ("SFAS No. 131"),
     "Disclosures About Segments of an Enterprise and Related Information."

     The consolidated financial statements include the accounts of the Company
     and its wholly owned subsidiaries. All significant intercompany
     transactions have been eliminated in consolidation. These financial
     statements for the three and nine months ended September 30, 2000 and 2001
     and the related footnote information are unaudited and have been prepared
     on a basis substantially consistent with the audited consolidated financial
     statements of the Company as of and for the year ended December 31, 2000
     included in our Annual Report on Form 10-K filed with the Securities and
     Exchange Commission (SEC). The accompanying unaudited consolidated
     financial statements of the Company 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 assuming the Company will continue as a
     going concern, have been reflected. Operating results for the three and
     nine month periods ended September 30, 2000 and 2001 are not necessarily
     indicative of the results that may be expected for any succeeding quarters
     or for the full year. The consolidated financial statements and notes
     thereto should be read in conjunction with the Company's audited
     consolidated financial statements for the year ended December 31, 2000.

     During fiscal 2001, the Company has experienced the effects of the economic
     downturn, has experienced a significant decline in liquidity and has not
     been able to obtain additional financing sufficient to cover its ongoing
     cash flow needs. As a result of these factors, there is substantial doubt
     as to the Company's ability to continue as a going concern through the end
     of 2001. The accompanying consolidated financial statements have been
     prepared assuming the Company will continue as a going concern.
     Accordingly, the financial statements do not include any adjustments
     relating to the recoverability and classification of asset carrying amounts
     or the amount and classification of liabilities that might result should
     the Company be unable to continue as a going concern. At September 30,
     2001, the Company had cash and cash equivalents of $1.5 million.
     Consequently, the Company does not expect it will have sufficient liquidity
     or assets to meet its existing obligations as they become due. The Company
     is pursuing various financing arrangements to allow for the execution of
     its business plan. Management believes that if it does not raise additional
     financing or receives an unfavorable resolution of the litigation with the
     former CRL shareholders (see Note L), there will not be sufficient cash
     flows and the Company will be required to seek relief under Chapter 11 of
     the Bankruptcy Code.







                                       7
<PAGE>

                   APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)

NOTE B - ACCOUNTING FOR ACQUISITIONS, INTANGIBLE ASSETS AND GOODWILL, AND THE
         IMPAIRMENT OF LONG LIVED ASSETS

     In connection with the acquisition of CRL Network Services, Inc. ("CRL") in
     January 2000, the Company entered into a put option agreement requiring the
     Company, at the option of the holders, to repurchase a total of up to
     625,000 shares of AppliedTheory common stock in two equal installments at
     $16.00 per share, not to exceed $10,000,000 in the aggregate, on the first
     and second anniversary of the acquisition. The Company has classified the
     redemption price of $10,000,000 as temporary equity. No amounts have been
     paid as of September 30, 2001 (see Note L for further discussion).

     Under escrow provisions of the merger agreement in connection with the
     acquisitions of CRL in 2000, the Company has placed 285,507 shares of its
     common stock in escrow. These shares are issuable to the former owners of
     CRL but may be forfeited, in whole or in part, in the event that various
     contingencies as defined in the merger agreement occur. Such amounts will
     be recorded as additional cost of the acquired company when the number of
     shares to be issued, if any, becomes determinable beyond a reasonable
     doubt. At September 30, 2001, the aforementioned shares held in escrow had
     not been issued since the outcome of the contingencies was not
     determinable.

     In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
     "Business Combinations" and SFAS 142, "Goodwill and Other Intangible
     Assets". The new standards require that all business combinations initiated
     after June 30, 2001 must be accounted for under the purchase method. In
     addition, all intangible assets acquired that are obtained through
     contractual or legal right, or are capable of being sold, transferred,
     licensed, rented or exchanged shall be recognized as an asset apart from
     goodwill. Goodwill and intangibles with indefinite lives will no longer be
     subject to amortization, but will be subject to at least an annual
     assessment for impairment by applying a fair value based test.

     The Company will continue to amortize goodwill existing at September 30,
     2001 under its current method until January 1, 2002 (the adoption date).
     Thereafter, annual and quarterly goodwill amortization of approximately
     $3.7 million and $14.7 million, respectively, will no longer be recognized.
     In accordance with the new standards, by June 30, 2002, the Company will
     perform a transitional fair value based impairment test. If the fair value
     is less than the recorded value at January 1, 2002, the Company will record
     an impairment loss in the March 31, 2002 quarter, as a cumulative effect of
     a change in accounting principle.

     In August 2001, the FASB issued statement of Financial Accounting Standard
     No. 144, "Accounting for the Impairment or Disposal of Long Lived Assets"
     ("SFAS 144"). This statement is effective for fiscal years beginning after
     December 15, 2001 and supersedes SFAS 121, "Accounting for the Impairment
     of Long Lived Assets and for Long Lived Assets to Be Disposed Of", while
     retaining many requirements of such statement. The Company is currently
     evaluating the impact of this statement.

                                       8
<PAGE>
                   APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)

NOTE C - COMPREHENSIVE LOSS

Comprehensive loss for the three and nine months ended September 30, 2000 and
2001, was as follows:

<TABLE>
<CAPTION>

                                             Three months ended                  Nine months ended
                                                September 30,                     September 30,
                                          -------------------------         -------------------------
                                           2000             2001              2000            2001
                                          --------         --------         --------         --------
                                               (in thousands)                     (in thousands)

<S>                                       <C>              <C>              <C>              <C>
Net loss attributable to common           $(14,225)        $(11,221)        $(38,121)        $(43,252)
 stockholders
Other comprehensive (income) loss:
  Unrealized gain (loss) on
     marketable securities, net of
     income tax                                 46              (65)             243             (184)
                                          --------         --------         --------         --------

Comprehensive loss                        $(14,179)        $(11,286)        $(37,878)        $(43,436)
                                          ========         ========         ========         ========
</TABLE>


NOTE D - 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, adjusted for the dilutive effect of potential common shares issued
     or issuable pursuant to stock options, stock appreciation rights, warrants
     and convertible securities. Potential common shares issued are calculated
     using the treasury stock method. All potential common shares have been
     excluded from the computation of diluted loss per share as their effect
     would be antidilutive and, accordingly, there is no reconciliation of basic
     and diluted loss per share for each of the periods presented. Potential
     common shares that were excluded from the computation of diluted loss per
     share consisted of stock options, warrants and convertible debentures
     outstanding of 6,646,000 and 27,021,565 at September 30, 2000 and 2001,
     respectively.


NOTE E - OTHER LIABILITIES

     The Company acquired CRL Network Services, Inc. in January 2000. In the
     fourth quarter 2000, the Company recorded $1.1 million in accrued
     liabilities for planned terminations of certain network and
     facility-related contracts and severance for certain employees in
     connection with the acquisition. Such terminations and severance were
     substantially completed as of September 30, 2001. The Company has charged
     $18,000 and $924,000, respectively, against these liabilities for the three
     and nine months ended September 30, 2001.



                                       9
<PAGE>
                   APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)

NOTE F - LONG-TERM DEBT

     Line of Credit

     On January 20, 2001, the Company renewed a credit agreement with a
     commercial bank for an aggregate amount of $7,500,000 through January 19,
     2002. Interest is charged and payable on a monthly basis as determined by
     the Company, either on the LIBOR plus 40 basis points or a prime rate basis
     less 200 basis points (4.00% on September 30, 2001). The credit facility is
     collateralized by either cash and cash equivalents, government securities,
     corporate securities or corporate equities pledged by NYSERNet.net, Inc.
     ("NET"). NET must post collateral equaling 100% of the draw if the
     collateral is cash and cash equivalents or collateral equaling 130% of the
     draw if the collateral is government securities, corporate securities or
     corporate equities.

     In accordance with the terms of the credit agreement, the bank issued
     standby letters of credit in the Company's name for $1,450,000, expiring
     January 19, 2002, pursuant to the credit agreement, collateralizing the
     Company's obligation to third parties for real property leases. The
     Company's available credit under its line of credit agreement is
     effectively reduced by the outstanding amount of these letters of credit.

     At September 30, 2001, the Company had $4,257,000 outstanding and
     $1,793,000 in availability under this line of credit. The average interest
     rate on outstanding borrowings was 4.00% at September 30, 2001.

     Revolving Credit Agreement

     On July 10, 2001, the Company entered into a one-year revolving credit
     agreement with seven lenders (referred to as the "Investors" in Note G) for
     a principal amount of up to $6,000,000. Based on this initial agreement,
     the total amount that the Company may borrow was limited among other
     restrictions by its borrowing base, which was measured at any time of
     borrowing by multiplying the total value of the Company's eligible account
     receivables by 44.44%. Amounts borrowed under the credit agreement bear
     interest for the first 60 days outstanding at the prime rate plus two
     hundred basis points and thereafter at the prime rate plus four hundred
     basis points.

     At September 30, 2001, the Company had $4,128,000 in outstanding loans
     under this revolving credit agreement. The average interest rate on
     outstanding borrowings was 9.9% at September 30, 2001.

     On October 10, 2001, the Company and the Investors entered into an
     amendment to the revolving credit agreement. That amendment increased the
     maximum principal amount of borrowings under the revolving credit agreement
     to $7,000,000 and permitted the Company to borrow the maximum amount,
     notwithstanding that its borrowing base was insufficient to support that
     amount of borrowing. The Company borrowed $2,872,000 in connection with the
     amendment. None of the other provisions of the revolving credit agreement,
     including the Company's ongoing obligation to satisfy the borrowing base
     requirement, were waived. Borrowings under the revolving credit agreement,
     as amended, are evidenced by promissory notes of the Company and its
     subsidiaries. Such borrowings are secured by intercompany guarantees and
     security interests in all of the assets of the Company and its
     subsidiaries.

                                       10
<PAGE>
                   APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)

     The Company and the lenders have also entered into a security agreement,
     which grants the lenders a first priority lien on the assets of the Company
     to secure the payment in full of all amounts due and payable under the
     aforementioned credit agreement and the convertible debentures (see Note
     G).

     Equipment Financing

     The Company has entered into various equipment financing agreements with
     secured lenders. Borrowings under these agreements are repayable in monthly
     installments with interest at fixed rates ranging from 10.3% to 13.5%
     through June 2003. In connection with these equipment financings, the
     Company was required to place on deposit $382,000 and $385,000 as
     additional collateral. The security deposits are included in "Other assets"
     at September 30, 2001 and earn interest at a rate of approximately 5.0% per
     annum. On September 1, 2001, one half of the $382,000 deposit plus accrued
     interest of approximately $40,000 became refundable. The remaining balance
     will be used for monthly lease payments commencing May 1, 2002.

     Capital Lease Obligations

     The Company leases certain equipment under agreements accounted for as
     capital leases. The obligations for the equipment require the Company to
     make monthly payments through December 2005, with implicit interest rates
     ranging from 10.0% to 22.8%. In connection with the financing, the Company
     was required to maintain a cash deposit of $540,000 as additional
     collateral. This deposit comprises a portion of the total restricted cash
     balance of approximately $576,000 at September 30, 2001.

     The following is a summary of future minimum lease payments under capital
leases as of September 30, 2001.
<TABLE>
<CAPTION>
                                                            (in thousands)
<S>                                                         <C>
         Year ending December 31,
         2001                                                       $1,399
         2002                                                        5,400
         2003                                                        2,809
         2004                                                          232
                                                           --------------

         Total minimum lease payments                                9,840

         Less amounts representing interest                          1,232
                                                           --------------

         Present value of minimum lease obligation                 $ 8,608
                                                           ==============
</TABLE>

                                       11
<PAGE>
                  APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  (UNAUDITED)

NOTE G - CONVERTIBLE DEBENTURES

     On June 5, 2000 the Company entered into a purchase agreement with seven
     institutional investors (the "Investors") and issued $30 million in 5%
     convertible debt financing (the "Debentures"). On January 9, 2001, the
     Company amended the agreements with the Investors whereby the Company and
     the Investors modified certain significant components of the June 5, 2000
     purchase agreement and the accompanying registration rights agreement. The
     amended and restated agreement eliminated the Investors' option to purchase
     up to $10 million of the Company's common stock. It also eliminated the
     Company's option to require the Investors to purchase an additional $10
     million of the Company's common stock. On July 10, 2001, the Company
     entered into an amendment agreement (the "Amendment Agreement"), as further
     discussed below, with the Investors whereby certain provisions of the
     January 9, 2001 amended and restated purchase agreement and related
     documents were modified.

     The Debentures earn interest at 5% per annum, payable semi-annually in June
     and December, and mature on June 5, 2003. At the Company's option, interest
     can be accrued, paid in cash, paid in common stock, or take the form of PIK
     interest (interest paid in kind and added to the principal of the
     Debentures). At September 30, 2001, the outstanding principal balance of
     the Debentures (including PIK interest) was $29,925,000 and interest
     accrued on the Debentures was $505,000.

     Under the Amendment Agreement the Investors are granted the right to
     convert the Debentures, in whole or in part, into shares of common stock
     from time to time. The Debentures' conversion prices and amounts are as
     follows:

<TABLE>
<CAPTION>
        Conversion Price                                    Conversion Amount
        ----------------                                    -----------------
<S>                           <C>
               $0.90          for the first $6,500,000 of principal, plus PIK interest and accrued but
                              unpaid interest thereon

               $1.22          for the next $6,500,000 of principal, plus PIK interest and accrued but
                              unpaid interest thereon

               $1.80          for the next $6,500,000 of principal, plus PIK interest and accrued but
                              unpaid interest thereon

               $2.70          for the next $6,500,000 of principal, plus PIK interest and accrued but
                              unpaid interest thereon


               $3.60          for the aggregate principal amount of the Debentures outstanding in excess
                              of $26,000,000 plus PIK interest and accrued but unpaid interest thereon
</TABLE>


     Unless otherwise specified by the Investor, the Debentures submitted for
     conversion shall be converted at the lowest conversion price available to
     the Investor with respect to such Debentures. The outstanding principal
     amount of a Debenture, together with accrued interest, that is so converted
     shall be convertible into shares of the Company's common stock. Based on
     these conversion prices, the Debentures are presently convertible into
     approximately 22.4 million shares of common stock at any time until
     maturity. During the three and nine months ended September 30, 2001,
     $419,000 and $1,263,000, respectively, of the convertible


                                       12
<PAGE>
                  APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  (UNAUDITED)

     debentures' principal, net of debt discount and issuance costs, was
     converted into 957,043 and 1,518,401 shares, respectively, of common stock
     under the conversion terms of the prior agreements.

     Upon the occurrence of an event of default and until such event of default
     is cured, amounts due and outstanding under the Debentures bear interest at
     the per annum rate equal to the lower of the Citibank Prime Rate per annum
     plus six (6%) percent or the highest rate permitted by law. The Investors
     have the option to receive such interest in the form of cash, PIK interest
     or common stock. The Investors may also require the Company to repurchase
     the Debentures at 120% of the outstanding principal amounts of the
     Debentures if the Company defaults in its obligations to them under any
     agreements between the Investors and the Company.

     Subject to limited exceptions, the right to convert the Debentures
     terminates upon the closing of a relevant sale of the Company as defined in
     the Amendment Agreement. In the event of a change of control transaction,
     the Investors are entitled to convert their Debentures into common stock
     and receive the same consideration as the common stock holders. Also, in
     the event that the Company enters into a sale of the Company (as defined in
     the Amendment Agreement), the Company is obligated to pay to the Investors
     a percentage of the consideration paid by the acquirer in such a
     transaction. Such payments shall be applied, as to each Investor, first, to
     redeem the Debentures. The consideration from such a sale of the Company
     shall be paid to the Investors as follows: 100% of the first $10,000,000;
     60% of the next $20,000,000; 20% of the next $20,000,000; and 10% of
     amounts above $50,000,000. After the Debentures have been redeemed and/or
     converted in full, the Investors may continue to be entitled to receive
     part of the consideration resulting from each sale of the Company based on
     the terms set forth in the Amendment Agreement.

     Additionally, the Amendment Agreement terminated the Investors' warrants to
     purchase up to $13,000,000 of the Company's common stock under the prior
     agreements. Based on an independent valuation of the Debentures and related
     warrants and options, the Company had originally recorded a $3.9 million
     debt discount and corresponding increase in additional paid in capital
     representing the allocation of proceeds to the detachable warrants and
     Investors' call option. The carrying value of the Debentures was being
     accreted to the face value of $30 million using the interest method over
     the life of the Debentures. Due to the termination of the warrants and call
     option, the Company wrote off the unamortized portion of the debt discount
     of $2.4 million in June 2001. In addition, the Company assigned a value of
     $250,000 to certain features in the Amendment Agreement. The net of these
     two amounts of approximately $2.2 million was included in non-recurring
     charges on the consolidated statements of operations for the nine months
     ended September 30, 2001. For the three and nine months ended September 30,
     2001, accretion totaled $31,000 and $668,000 respectively.


NOTE H - STOCK OPTIONS

     Certain options and stock appreciation rights were granted in 1998 and 1999
     at exercise prices below the fair market value of the Company's stock. The
     Company recorded $309,000 and $300,000 of compensation expense associated
     with these options and stock appreciation rights for the three months ended
     September 30, 2000 and 2001 and a total of $927,000 and $900,000 for the
     nine months ended September 30, 2000 and 2001, respectively.

                                       13
<PAGE>
                  APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  (UNAUDITED)

NOTE I - RELATED PARTY TRANSACTIONS

     Transactions with NET and ORG

     The Company has a resale agreement with NYSERNet.org, Inc. ("ORG") to serve
     as ORG's provider for Internet services and network management 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. In addition, the Company provides services to ORG
     principally related to network operations and development. The Company's
     revenues from ORG's customer base and services to ORG for the following
     periods are:

<TABLE>
<CAPTION>
                              Three Months Ended            Nine Months Ended
                                 September 30,                 September 30,
                           ---------------------------     -----------------------
                             2000          2001             2000          2001
                           -------------   -----------     -----------  ----------
                                  (in thousands)                 (in thousands)
<S>                        <C>            <C>            <C>            <C>
Unrelated customers        $   800        $   724        $ 2,280        $ 2,824
Member institutions          1,456          2,304          4,009          6,648
Services to ORG              1,428            584          2,882          2,051
                           -------        -------        -------        -------
                           $ 3,684        $ 3,612        $ 9,171        $11,523
                           =======        =======        =======        =======
</TABLE>
     During the three months ended September 30, 2000 and 2001, the Company
     charged NET and ORG approximately $100,000 and $0, respectively, in
     management fees. During the nine months ended September 30, 2000 and 2001,
     the Company charged NET and ORG approximately $200,000 and $50,000,
     respectively, in management fees.


NOTE J - INVESTMENT IN PLANNING TECHNOLOGIES, INC. AND RED HAT, INC.

     On June 22, 1999, the Company and certain other shareholders of Planning
     Technologies, Inc. ("PTI"), a Georgia Corporation, entered into a stock
     purchase agreement (the "Stock Purchase Agreement") with PTI which provided
     consulting and network engineering services. 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 million. At December 31, 1999, the Company's 10% ownership interest
     in PTI was represented by 2,976,190 shares of PTI's Convertible Preferred
     Stock.

     On April 4, 2000, the Company converted its 2,976,190 shares of PTI's
     Convertible Preferred Stock into common shares and received 1,816,173
     additional shares of common stock in exchange for the termination of the
     Stock Purchase Agreement. This increased the Company's ownership percentage
     to 16% of PTI's common stock on a fully diluted basis. The Company also
     invested an additional $250,000 in PTI in connection with the
     reorganization of PTI in exchange for 564,498 shares of common stock. After
     the reorganization the Company owned approximately 8.5% of PTI's
     outstanding common stock. The Company accounted for the investment under
     the cost method.

                                       14
<PAGE>
                  APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  (UNAUDITED)

     On February 26, 2001, PTI merged with Red Hat, Inc. ("RHAT"), a company
     publicly traded on the Nasdaq Stock Market. As a result of the merger, the
     Company converted its 5,356,861 shares of PTI into 521,769 shares of common
     stock of RHAT and recorded a realized loss of $1.7 million based on the
     investment's fair value of $3.6 million on February 26, 2001. On June 28
     and June 29, 2001, the Company sold a total of 467,497 shares of RHAT
     resulting in proceeds of $2.0 million and a realized loss of $1.3 million.
     The realized loss was included in non-recurring charges on the consolidated
     statements of operations for the nine months ended September 30, 2001. The
     fair value of the remaining shares of $0.2 million was classified as an
     available for sale marketable security and the unrealized loss of $0.2
     million, net of taxes, on the investment was included in stockholders'
     equity as a component of accumulated other comprehensive income (loss) at
     September 30, 2001.


NOTE K - STOCK PURCHASE AGREEMENT

     On February 22, 2001, the Company completed a stock purchase arrangement
     with Crescent International Ltd., an investment fund managed by GreenLight
     (Switzerland) SA of Geneva, Switzerland, that provides the Company with
     financing ability of up to $30 million to fund operations and
     infrastructure requirements. The arrangement provides that Crescent will
     buy up to $30 million worth of AppliedTheory common stock, should the
     Company choose to sell.

     The Company did not anticipate selling its common stock under this
     agreement, and therefore, wrote-off its financing costs pursuant to the
     agreement of $0.3 million in June 2001. This amount was included in
     non-recurring charges on the consolidated statements of operations for the
     nine months ended September 30, 2001. As of October 20, 2001, the Company
     terminated its agreement with Crescent International Ltd.


NOTE L - LEGAL PROCEEDINGS AND CONTINGENCIES

     Qui Tam Action

     In June 2000, the Company was notified by the U.S. Attorney for the Western
     District of New York that a relator had filed a qui tam action under seal
     against the Company and NYSERNet.net ("NYSERNet"). The complaint alleged
     that the National Science Foundation was fraudulently induced to provide a
     grant of $2.45 million to NYSERNet, a portion of which was paid by NYSERNet
     to the Company for services rendered. The complaint seeks treble damages
     related to the alleged overpayment for services provided by the Company to
     NYSERNet, as well as certain other penalties and forfeitures under the
     False Claims Act. On January 19, 2001, the Company received a redacted copy
     of the amended complaint in this action. In addition to the original
     allegations, this amended complaint alleged that NYSERNet and the Company
     failed to disclose the transfer of alleged program income in violation of
     the False Claims Act. Furthermore, the amended complaint alleged that the
     Company conspired with NYSERNet to engage in the fraudulent conduct
     described above and seeks unspecified millions of dollars in treble damages
     as a result. Although the Department of Justice has not yet determined
     whether or not it will join in this action, the Company believes that these
     allegations are without merit and intends to contest them.

                                       15
<PAGE>
                  APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  (UNAUDITED)

     CRL Network Services, Inc. Litigation

     On December 13, 2000, James G. Couch filed a complaint in New York State
     court seeking approximately $9,650,000 in damages against the Company due
     to an alleged anticipatory breach of a put option agreement between the
     Company, Mr. Couch and others dated January 5, 2000 pursuant to which Mr.
     Couch, as part of the consideration for his sale to the Company of the
     capital stock of CRL Network Services, Inc., was granted two put options,
     exercisable on January 5, 2001 and January 5, 2002, respectively, pursuant
     to which Mr. Couch may require the Company to re-purchase shares of its
     common stock from Mr. Couch at specified times and in specified
     circumstances. On January 2, 2001, the Company answered the complaint and
     asserted affirmative defenses and counterclaims for fraud, indemnification
     and breach of contract for which the Company seeks compensatory and
     punitive damages. Mr. Couch served an amended complaint on January 8, 2001
     asserting claims of actual and anticipatory breach of the Put Option
     Agreement, and a reply to the Company's answer and counterclaims. On
     January 29, 2001, the Company answered the amended complaint and asserted
     affirmative defenses and counterclaims for fraud, violations of the
     California Corporation Code, indemnification and breach of contract for
     which the Company seeks compensatory and punitive damages. In addition, the
     Company is pursuing indemnification claims under an escrow agreement
     against Mr. Couch in an arbitration proceeding. On February 15, 2001, Mr.
     Couch filed a motion to dismiss the Company's counterclaim for violations
     of the California Corporations Code and to stay the Company's counterclaims
     for indemnification and breach of contract pending the completion of an
     arbitration between the parties concerning the Company's claims against Mr.
     Couch under the escrow agreement. The Company cross-moved to stay the
     entire litigation, including Mr. Couch's claims, pending completion of this
     arbitration. On March 9, 2001, Mr. Couch filed a motion for partial summary
     judgment seeking entry of judgment in his favor on all his claims, striking
     the Company's fraud defense to the extent it seeks a rescission remedy, and
     striking the Company's claim for punitive damages. Oral argument for Mr.
     Couch's motion filed on February 15, 2001, the Company's cross-motion
     thereto, and Mr. Couch's motion filed on March 9, 2001 took place on April
     5, 2001. On July 23, 2001, the court ruled on the parties' motions. The
     court granted Mr. Couch's motion to dismiss the Company's counterclaim for
     violations of the California Corporations Code. The court granted Mr.
     Couch's motion to stay the Company's counterclaims for indemnification and
     breach of contract and the Company's cross-motion to stay the entire
     litigation pending the completion of an arbitration between the parties
     concerning the Company's claims against Mr. Couch under the escrow
     agreement. The court held in abeyance Mr. Couch's motion for partial
     summary judgment on his breach of contract claim pending the determination
     of the arbitration, denied Mr. Couch's motion to strike the Company's fraud
     defense to the extent it seeks a rescission remedy, and granted Mr. Couch's
     motion to strike the Company's claim for punitive damages. The Company has
     filed a notice of appeal from the adverse aspects of the ruling, and Mr.
     Couch has filed a cross-appeal. The Company has received an interim
     decision from the arbitration panel granting some of our claims and denying
     others. This litigation is still in the preliminary stage, and therefore,
     no opinion as to likelihood of an unfavorable outcome can be made. However,
     if an unfavorable outcome does occur requiring the Company to pay cash to
     redeem the shares owned by the former CRL shareholders, the Company may not
     have sufficient financial resources to meet the obligation. At September
     30, 2001, the Company has $10 million recorded as temporary equity in
     connection with these put options.


                                       16
<PAGE>
                  APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                                  (UNAUDITED)

     On September 21, 2001, James G. Couch filed a complaint in the Delaware
     Court of Chancery seeking the appointment of a receiver for the
     Corporation. On October 15, 2001, the Company answered the complaint and
     asserted certain affirmative defenses.

     On September 21, 2001, James G. Couch filed a complaint in New York State
     court against the Company, a group of investors led by the Palladin Group,
     L.P., Danny Stroud, the Company's president, and certain other unnamed
     persons seeking to set aside as a fraudulent conveyance the transactions
     that the Company entered on July 10, 2001, including the security interest
     granted by the Company to such investors (see Note G). On October 22, 2001,
     the Company answered the complaint and asserted certain affirmative
     defenses.

     Insurance Coverage

              The Company received notice in September 2001 that its insurance
     carrier does not intend to renew the Company's comprehensive general
     liability insurance coverage beyond November 30, 2001. Management is
     actively pursuing to obtain other comprehensive insurance coverage.


              There can be no assurance whether these matters will be determined
     in a manner that is favorable to the Company or, if adversely determined,
     that such determination would not have a material adverse effect upon the
     Company's business, financial condition or results of operations.

              The Company is not involved in any other legal proceedings or
     contingencies which it believes would, if adversely determined, have a
     material adverse effect upon its business, financial condition or results
     of operations.



                                       17
<PAGE>

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, 2000 which is included in Form 10-K (File
No. 000-25759), as filed with the SEC .

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

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

OUR COMPANY

         Industry veteran AppliedTheory combines its knowledge base with the
ability to build, integrate and manage Internet business solutions for
corporations wanting to remain competitive in an increasingly complex economy.
We offer a comprehensive and fully integrated suite of managed web hosting,
Internet solutions and connectivity and security services, which enable us to
provide a variety of outsourced managed hosting services options for large
enterprise business needs.

         We help businesses use the Internet to increase profit, decrease costs
and meet business objectives.

MANAGED HOSTING SERVICES AND THE LIFE-CYCLE SUPPORT MODEL

         Today, companies are looking beyond their own resources to meet their
Internet solutions objectives and to fulfill their web hosting requirements.
These companies need to ensure the long-term success of their critical, hosted
applications, such as e-commerce, benefits management, process management, or
any other traditional information technology function that is being migrated to
the Internet environment. Each of these areas makes an important contribution to
the success of an organization's business plan. We believe - and our experience
has shown - that companies often want the cost savings and flexibility of
managed hosting and outsourcing these applications.

         The more critical and more complex the application, the more these
companies might require full support for the life cycle of that application.
Thus, fully integrated Internet solutions become the pathway to a hosting
solution and vice versa. We call this self-perpetuating process our "life cycle
support."

WE FOCUS ON INTEGRATED INTERNET BUSINESS SOLUTIONS

         Our customers' successful Internet business strategies have become as
complicated as they are critical. We have found that our business, organization
and government customers view the Internet as a tool to achieve a business
strategy. We believe our intensely customer-focused, life-cycle support approach
helps support established business models.

                                       18
<PAGE>
         We believe the high percentage of customers that are buying complex
solutions from us, and the high degree of retention of our customers, along with
repeat business validates our integrated, web-centric, life-cycle customer
service model. An increasing number of our new proposals are quoting a complex
mix of services, including managed web hosting.

         We use a phased approach designed to develop and implement
comprehensive Internet solutions for our customers. Our core expertise is
derived from our experience in developing business-to-business and
business-to-consumer web-centric solutions.

         We believe that no business-critical Internet solution is viable
without a completely integrated hosting solution; therefore, we offer parallel
lines of hosting services to our customers. Our web hosting solutions include
web site development, managed application support, security and network
operations.

         Each of our managed hosting service offerings is available as a fully
outsourced, upgradeable solution. The managed application hosting solution is
designed to allow its user to save time and greatly reduce capital expenditures,
risk of obsolescence and internal management responsibilities.

         In addition, we provide dedicated server and co-location hosting
services, security consulting services, virtual private networks (VPNs) and
managed firewalls for network security. We also provide direct connectivity to
the global Internet via a redundant, rigorously engineered, high-speed network
backbone.

WE PARTNER WITH OUR CUSTOMERS

         We have found that enterprise customers are increasingly less likely to
consider facilities-based hosting and knowledge-based development, integration
and management services to be mutually exclusive. As large-scale, web-based
business applications become more complex, companies and organizations are
requiring that their Internet outsourcing company be a partner that has both the
technology and the knowledge to scale and grow with their needs.

OUR EXPERTISE IS EVIDENT IN OUR HANDS-ON EXPERIENCE

         AppliedTheory deploys Internet solutions to more than 1,200 customers.
Our customer satisfaction is reflected in our low churn rate of less than 3/4%
per month and reflects the dedication of our more than 400 employees nationwide.

         We have developed business-to-business networks, web sites, portals and
e-business strategies; built internal corporate networks; migrated existing or
legacy software and data processing and storage systems to the Internet;
designed web site user interfaces; and constructed e-commerce sites from the
ground up for major businesses and mid-sized companies nationwide.

-        We provide Internet solutions to some of America's leading companies,
         including AOL Time Warner, Eddie Bauer, United Parcel Service and
         Ingersoll-Rand.

-        The New York State Department of Labor awarded AppliedTheory a
         five-year $82 million contract extension in November 2000 to continue
         to manage and host America's Job Bank, which we believe is the world's
         largest online employment database. We created the original site design
         and continue to operate and manage the site. We have also expanded
         contracts with other top-tier customers including Carrier Corporation,
         the U.S. Department of State and the Denver Broncos.
                                       19
<PAGE>

-        In addition to the NYS Department of Labor and U.S Department of State,
         our government work has further expanded as a result of a General
         Services Administration ("GSA") contract that was entered into during
         2001. This contract qualifies the Company to sell e-business services
         directly to Federal agencies. The GSA is one of three central
         management agencies of the Federal Government. In addition, we have
         added the State of Hawaii as a customer and are working with the U.S.
         Forest Service on the redesign of their web operations.

-        In the third quarter we also entered into a three-year contract with
         New York City Health and Hospitals Corporation (NYCHHC), a $4.1 billion
         organization that oversees the public hospital system in all five city
         boroughs. We are providing them with managed Internet services,
         security, and connectivity for their entire user community, including
         doctors, hospital administrators, and technical staff throughout the
         city.

OUR EXPERTISE SPANS MANY INDUSTRIES

         AppliedTheory's concentration on providing mission-critical
applications to key industries makes us highly knowledgeable in numerous
vertical markets, including:

-        EDUCATION - We provide Internet solutions to many of the nation's
         colleges and universities.

-        HEALTHCARE - We develop healthcare applications for medical
         professionals, supplying technology to address and meet the demand for
         online healthcare delivery systems.

-        GOVERNMENT - We have worked to develop teams of software engineers and
         consultants with the experience and expertise to efficiently fulfill
         the special requirements that governmental institutions face.

STRONG ALLIANCES EXPAND OUR CAPABILITIES

         To ensure our customers have access to today's leading technology, we
have developed various business relationships with major Internet technology
companies, including:

-  AT&T - We utilize AT&T's national IP network, peering and co-location
   services to supply the majority of our network infrastructure.

-  Cisco - Their high-end routers and switches serve as the core of our
   network backbone and web hosting infrastructure.

-  Compaq - Their development, web and file servers are the foundation for
   our NT and Linux hosting product line.

-  EDS - They supply high-end and large scale technology project
   management support.

-  Microsoft - We are a Microsoft Certified Solutions provider.


-  Pivot Technologies - They provide our customers with network security
   integration expertise and firewall support.

-  Sprint - We utilize Sprint's national IP infrastructure to provide
   certain peering relationships.


-  Sun Microsystems - Their development, web and file servers are the
   foundation for our UNIX hosting product line.

WE CONTINUE TO EXECUTE OUR BUSINESS PLAN

         We have been able to increase our repeat business and add valuable new
customers during the first three quarters of 2001. We continue to focus our core
business on fast-growing, high-margin outsourced and managed hosting and have
created a more efficient, streamlined delivery machine which allows us to
produce long-term recurring

                                       20
<PAGE>
revenue. We believe that the recurring revenue realized from our managed hosting
services offering is an important element of our business strategy.

         We have developed certain standard managed hosting configurations. This
streamlines our service delivery and shortens the time to implement the service.
We are continuing to mine certain vertical market segments and build upon our
experience base. By continuing to leverage our success, we maximize the
opportunity to re-use solutions or parts of solutions. Our library of
experienced software code and solutions models is rapidly expanding.

         We have continued to concentrate on high-margin outsourced and managed
hosting revenue. In addition, we have ongoing initiatives to reduce our costs of
delivery and have made concerted efforts across the Company to streamline sales,
marketing and administrative costs. The combination of these strategic measures
has resulted in improved gross margins and a lower EBITDA loss on a quarterly
basis during the year. These initiatives will affect our growth rate which we
believe is a prudent trade off given the current market conditions.

         We will continue to look for targeted, strategic acquisitions, with a
view towards make-versus-buy. We find that these strategic acquisitions resonate
with our business model, and their teams bring new ideas, new skills and, of
course, new customers. However, although we continue to have long-term
aspirations for expansion through acquisitions, we don't expect to complete any
acquisitions during 2001 as a result of the currently existing market
conditions.


RESULTS OF OPERATIONS

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THREE AND NINE MONTHS
ENDED SEPTEMBER 30, 2000

REVENUES

         The following table and discussion highlights the revenues of the
Company:


<TABLE>
<CAPTION>

                                       Three months ended                                Nine months ended
                                          September 30,                                    September 30,
                                ------------------------------------          -----------------------------------
                                  2000          2001          Change          2000            2001         Change
                                ------         ------         ------          ------         ------        ------
                                                 (in millions)                    (in millions)
<S>                             <C>            <C>            <C>             <C>            <C>           <C>
Net revenues
   Web hosting                  $  3.4         $  6.8         $  3.4          $  7.2         $ 21.0        $ 13.8
  Internet solutions               9.5            6.6           (2.9)           24.2           16.5          (7.7)
  Internet connectivity            8.1            7.1           (1.0)           23.4           22.1          (1.3)
                                ------         ------         ------          ------         ------        ------
Total net revenues              $ 21.0         $ 20.5         $ (0.5)         $ 54.8         $ 59.6        $  4.8
                                ======         ======         ======          ======         ======        ======

Percent of total revenue
   Web hosting                      16%            33%                                           13%           35%
  Internet solutions                45             32                                            44            28
  Internet connectivity             39             35                                            43            37
                                ------         ------                                        ------        ------
Total net revenues                 100%           100%                                          100%          100%
                                ======         ======                                        ======        ======
</TABLE>

          Total net revenues decreased 2%, or approximately $0.5 million, from
$21.0 million in the three months ended September 30, 2000 to $20.5 million in
the three months ended September 30, 2001. Total net revenues increased 8%, or
approximately $4.8 million, from $54.8 million in the nine months ended
September 30, 2000 to $59.6 million in the nine months ended September 30, 2001.

                                       21
<PAGE>


         As the table above illustrates, revenue from web hosting has become a
more significant component of our total revenue as we continue to place more of
a business emphasis on the higher-margin outsourced and managed web hosting
services. Our web hosting revenue growth of 191% illustrates the dramatic
expansion of these services from the nine months ended September 30, 2000 to the
nine months ended September 30, 2001.

         WEB HOSTING REVENUE increased by approximately $3.4 million and $13.8
million, from $3.4 million and $7.2 million for the three and nine months ended
September 30, 2000, respectively, to $6.8 million and $21.0 million for the
three and nine months ended September 30, 2001, respectively. These services
include:

   -   fully managed application hosting including equipment, monitoring,
       security and maintenance services;

   -   co-located and shared web hosting services in our state of the art web
       hosting centers; and

   -   event solutions consisting of managed hosting, integration services, and
       a software suite of web-based event tools known as CyberCentral(TM).

         The continued expansion of our web hosting customer base and product
line accounted for $4.2 million of the increase for the nine months ended
September 30, 2001 in comparison to the same period in 2000. In addition,
approximately $2.0 million of the increase was the result of revenue from our
event solutions, CyberCentral(TM). An increase in the managed web hosting
services provided to the New York Department of Labor in connection with
America's Job Bank provided an additional $7.6 million in hosting revenue during
the nine months ended September 30, 2001.

         INTERNET SOLUTIONS REVENUE decreased by approximately $2.9 million and
$7.7 million, from $9.5 million and $24.2 million for the three and nine months
ended September 30, 2000, respectively, to $6.6 million and $16.5 million for
the three and nine months ended September 30, 2001, respectively. These services
include:

   -   linking existing databases and legacy systems with the web;

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

   -   developing business-to-business and business-to-consumer web sites.

         The Internet solutions revenue related to the services provided to the
New York State Department of Labor in connection with America's Job Bank
decreased $8.5 million during the nine months ended September 30, 2001 in
comparison to the same period in 2000. This decrease was primarily due to a
shift in focus to more managed web hosting services provided to America's Job
Bank as discussed above. However, offsetting the decrease, was an increase in
revenue from our other Internet solutions customers obtained organically and
through acquisitions which increased by $0.8 million, reflecting the continued
diversification and expansion of our customer base. During the nine months ended
September 30, 2001, revenue from customers other than the New York State
Department of Labor was 55% of total Internet solutions revenue, up from 34%
during the same period in 2000.

         INTERNET CONNECTIVITY REVENUE decreased by approximately $1.0 million
and $1.3 million, from $8.1 million and $23.4 million for the three and nine
months ended September 30, 2000, respectively, to $7.1 million and $22.1 million
for the three and nine months ended September 30, 2001, respectively. These
services include:

                                       22
<PAGE>

   -   providing high-speed broadband internet connections to businesses and
       institutions at speeds ranging from OC-3 to fractional T-1;

   -   nationwide dial access through over 480 points-of-presence;

   -   digital subscriber line (DSL) services; and

   -   infrastructure and connectivity engineering special projects provided to
       NET.

         The decrease in connectivity revenues resulted principally from the
integration of the CRL legacy network in early 2001 in which we closed various
unprofitable points of presence (POP) and experienced higher than normal churn.
In addition, we have seen increased price competition and have had to lower
prices as certain contracts renewed. We expect this trend to continue for the
foreseeable future as Internet connectivity becomes more commoditized.


COSTS AND EXPENSES

         The following table and discussion highlights the costs and expenses of
the Company:

<TABLE>
<CAPTION>
                                               Three months ended                    Nine months ended
                                                    September 30,                      September 30,
                                   --------------------------------         --------------------------------
                                   2000          2001        Change          2000         2001        Change
                                   -----        -----         -----         -----         -----        -----
                                             (in millions)                             (in millions)
<S>                                <C>          <C>           <C>           <C>           <C>          <C>
Cost of revenues                   $14.6        $12.8         $(1.8)        $38.4         $38.8        $ 0.4
Sales and marketing                  7.2          4.5          (2.7)         21.4          16.2         (5.2)
General and  administrative          5.7          5.8           0.1          15.5          15.9          0.4
Research and development             0.9          0.5          (0.4)          1.3           1.8          0.5
Depreciation                         2.9          3.4           0.5           7.3           9.5          2.2
Amortization                         3.4          3.7           0.3           8.2          11.1          2.9
Other                                0.0         (0.1)         (0.1)         (0.3)          6.1          6.4
                                   -----        -----         -----         -----         -----        -----
 Total costs and expenses          $34.7        $30.6         $(4.1)        $91.8         $99.4        $ 7.6
                                   =====        =====         =====         =====         =====        =====
</TABLE>

         COST OF REVENUES. Cost of revenue decreased approximately $1.8 million
from $14.6 million in the three months ended September 30, 2000 to $12.8 million
in the three months ended September 30, 2001. Total cost of revenues increased
approximately $0.4 million from $38.4 million in the nine months ended September
30, 2000 to $38.8 million in the nine months ended September 30, 2001. For the
nine months ended September 30, 2001 our cost of revenues remained relatively
flat versus the same period in the prior year even though our revenue increased
nearly $5 million. This improvement in gross profit and margin was due to our
ability to more efficiently manage our connectivity costs in 2001 by integrating
the CRL legacy network and consolidating our network operations facilities to
eliminate duplicate costs. In addition, we were able to further lower network
infrastructure costs by renegotiating various pricing arrangements with our
major vendors. Offsetting some of the cost reductions described above were
increased labor costs to support the expansion of our web hosting services.

         As a percentage of revenue, cost of revenues decreased to 62% in the
three months ended September 30, 2001 from 69% in the three months ended
September 30, 2000. During the nine months ended September 30, 2001, cost of
revenues decreased to 65% of revenue from 70% of revenue in the nine months
ended September 30, 2000. These improved gross margins for the three and nine
months ended September 30, 2001 can be attributed to our revenue strategy that
focuses on high-end, integrated managed hosting services as well as our
continuing ongoing initiatives to reduce the cost of delivery as described in
more detail above.

                                       23
<PAGE>

         SALES AND MARKETING. For the three months ended September 30, 2000 and
2001, sales and marketing expense were approximately $7.2 million and $4.5
million, respectively. For the nine months ended September 30, 2000 and 2001,
sales and marketing expense was approximately $21.4 million and $16.2 million,
respectively. The $5.2 million decrease in the nine months ended September 30,
2001 was primarily attributable to the factors below.

   -   $3.3 million in decreased costs associated with our streamlined marketing
       program and product management efforts;

   -   $1.4 million in decreased sales salaries, commissions and related benefit
       costs; and

   -   $0.3 million in decreased occupancy costs and other costs that support
       our sales presence.

         As a percentage of revenue, sales and marketing expense decreased to
22% in the three months ended September 30, 2001 from 34% in the three months
ended September 30, 2000. During the nine months ended September 30, 2001, sales
and marketing expense decreased to 27% of revenue from 39% of revenue in the
nine months ended September 30, 2000. The reduction in these percentages for the
three and nine months ended September 30, 2001 reflects our better use of
marketing resources, an improved expense management and an increase in sales
force productivity.

         GENERAL AND ADMINISTRATIVE. For the three months ended September 30,
2000 and 2001, general and administrative expenses were approximately $5.7
million and $5.8 million, respectively. For the nine months ended September 30,
2000 and 2001, general and administrative expenses were approximately $15.5
million and $15.9 million, respectively. The increase in general and
administrative expenses of approximately $0.4 million in the nine-month period
was primarily attributable to:

   -   $0.9 million increase in costs related to salaries of new personnel;

   -   $0.6 million increase in bad debt expense;

   -   $0.5 million increase in legal costs related to certain litigation (see
       Part II, Item 1 - Legal Proceedings);

   -   $1.0 million decrease in recruiting costs;

   -   $0.2 million decrease in travel costs;

   -   $0.2 million decrease in other professional service fees; and

   -   other decreases representing a concerted and continued effort by the
       entire Company to reduce administrative costs.

         For the quarter ended September 30, 2001, general and administrative
expense increased as a percent of revenue to 28% from 27% for the quarter ended
September 30, 2000. This increase as a percentage of revenue resulted primarily
from legal fees incurred with respect to certain litigation as referred to
above. The Company expects these costs to continue for the foreseeable future
and as a result, our EBITDA losses and cash flow position may be negatively
impacted. For the nine months ended September 30, 2001, general and
administrative expense decreased as a percentage of revenue to 27% from 28% for
the quarter ended September 30, 2000.

         RESEARCH AND DEVELOPMENT. Research and development costs are
principally focused in our web hosting and Internet solutions service offerings.
For the three months ended September 30, 2000 and 2001, research and

                                       24
<PAGE>
development costs were approximately $0.9 million and $0.5 million,
respectively. For the nine months ended September 30, 2000 and 2001, research
and development costs were approximately $1.3 million and $1.8 million,
respectively. The increase in research and development costs of approximately
$0.5 million in the nine-month period was primarily attributable to salaries and
related costs to develop and design web hosting and Internet solutions products,
such as Delta Edge(TM), which we believe is the first content distribution
technology to accelerate Internet delivery of dynamic data with real-time
changes.

         DEPRECIATION. For the three months ended September 30, 2000 and 2001,
depreciation expense was approximately $2.9 million and $3.4 million,
respectively. For the nine months ended September 30, 2000 and 2001,
depreciation expense was approximately $7.3 million and $9.5 million,
respectively. The increase of $2.2 million in the nine months ended September
30, 2001 is primarily attributable to the acquisition of equipment and leasehold
improvements to support our web hosting customer base and equipment used to
support the expansion of our network infrastructure. A portion of the
depreciation expense increase also resulted from additional office furniture and
equipment necessary to support our expanded office space.

         AMORTIZATION. For the three months ended September 30, 2000 and 2001,
amortization expense was approximately $3.4 million and $3.7 million,
respectively. For the nine months ended September 30, 2000 and 2001,
amortization expense was approximately $8.2 million and $11.1 million,
respectively. Amortization expense relates to goodwill from businesses acquired
during 2000 and is being amortized generally over five years.

         INTEREST EXPENSE. Interest expense has increased $0.2 million from $1.0
million for the three months ended September 30, 2000 to $1.2 million for the
three months ended September 30, 2001. Interest expense has increased $1.5
million from $2.2 million for the nine months ended September 30, 2000 to $3.7
million for the nine months ended September 30, 2001. The increase of $1.5
million for the nine months ended September 30, 2001 is mainly the result of the
debt discount amortization and interest expense charges on the $30 million 5%
convertible debentures issued on June 5, 2000. Interest expense from new
equipment leases and loans account for the remainder of the increases.

         NET LOSS. Net loss attributable to common stockholders for the quarter
ended September 30, 2000 was approximately $14.2 million, or $0.57 per share,
compared with approximately $11.2 million or $0.40 per share for the quarter
ended September 30, 2001. Net loss attributable to common stockholders for the
nine months ended September 30, 2000 was approximately $38.1 million, or $1.59
per share, compared with approximately $43.3 million or $1.59 per share for the
nine months ended September 30, 2001. Our loss per share for the nine months
ended September 30, 2001 was impacted by the following non-recurring, non-cash
adjustments which resulted in our loss per share increasing from $1.36 to $1.59:

   -   A realized loss of $1.7 million for the conversion of the PTI shares to
       Red Hat, Inc. shares in the first quarter of 2001.

   -   A realized loss of $1.3 million on the sale of the Red Hat, Inc. shares
       in the second quarter of 2001.

   -   A write-off of $1.0 million for the financing costs incurred pursuant to
       the Crescent stock purchase agreement and other potential financing
       arrangements in the second quarter of 2001.

   -   A net write-off of $2.2 million for the unamortized portion of the debt
       discount with respect to the convertible debentures which resulted from
       the termination of the stock purchase warrants pursuant to an amendment
       agreement on July 10, 2001.



                                       25
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

         At September 30, 2001, we had $1.5 million in cash and cash
equivalents, of which $0.6 million is restricted, $0.2 million in marketable
securities and a $19.1 million working capital deficit. We have utilized the
available proceeds from our IPO and the issuance of 5% convertible debentures.
Details of our credit facilities are discussed below:

   -   On July 10, 2001, we entered into a one-year revolving credit agreement
       with seven lenders for a principal amount of up to $6.0 million. The
       original agreement stated that the total amount that we may borrow is
       limited by our borrowing base, which was to be measured at any time of
       borrowing by multiplying the total value of our eligible account
       receivables by 44.44%. Amounts borrowed under the credit agreement bear
       interest for the first 60 days outstanding at the prime rate plus two
       hundred basis points and thereafter at the prime rate plus four hundred
       basis points. At September 30, 2001, the Company had loans outstanding
       totaling $4.1 million under this revolving credit agreement. On October
       10, 2001, the Company entered into an amendment to the revolving
       credit agreement. That amendment increased the maximum principal amount
       of borrowings under the revolving credit agreement to $7.0 million and
       permitted the Company to borrow the maximum amount, notwithstanding that
       its borrowing base was insufficient to support that amount of borrowing.
       The Company borrowed $2.9 million in connection with the amendment on
       October 10, 2001.

   -   On January 20, 2001, the Company renewed a credit agreement with a
       commercial bank for an aggregate amount of $7.5 million through January
       19, 2002. However, there can be no assurances that this credit facility
       will be able to be renewed past that date. Interest is charged and
       payable on a monthly basis as determined by the Company, either on the
       LIBOR plus 40 basis points or a prime rate basis less 200 basis points.
       The credit facility is collateralized by either cash and cash
       equivalents, government securities, corporate securities or corporate
       equities pledged by NET (see Note F to the financial statements). In
       accordance with the terms of the credit agreement, the bank issued
       standby letters of credit in the Company's name for $1.4 million expiring
       January 19, 2002, pursuant to the credit agreement, collateralizing the
       Company's obligation to third parties for real property leases. The
       Company's available credit under its line of credit agreement is
       effectively reduced by the outstanding amount of these letters of credit.
       At September 30, 2001, the Company had $4.3 million outstanding and $1.8
       million in availability under this line of credit.

         Our principal uses of cash are to fund operations, working capital
requirements and capital expenditures. We had an accumulated deficit of $125.7
million at September 30, 2001, and have used $7.9 million in cash in the
aggregate to fund operations during the first three quarters of 2001.

   -   Net cash used in operating activities for the nine months ended September
       30, 2000 and 2001 was approximately $31.9 million and $7.9 million,
       respectively. The decrease in cash used of $24.0 million was principally
       a result favorable working capital changes of $18.4 million, increased
       amortization of goodwill of $2.9 million, additional depreciation expense
       of $2.2 million, write-off of debt discount of $2.2 million, increase in
       realized loss on marketable securities of $2.9 million, and additional
       bad debts of $0.6 million, offset by increased net losses from operations
       of $5.1 million.

   -   For the nine months ended September 30, 2000, cash of approximately $4.4
       million was used in investing activities. For the nine months ended
       September 30, 2001, cash of approximately $3.8 million was provided by
       investing activities. The increase in the net cash provided by investing
       activities of approximately $8.2 million was primarily associated with
       the decrease in the investments in acquired companies of $10.2 million
       and the decrease in purchases of property and equipment of $12.9 million,
       offset by the decrease in net proceeds from the sale of marketable
       securities of $15.1 million.

                                       26
<PAGE>

   -   For the nine months ended September 30, 2000, cash of approximately $29.1
       million was provided by financing activities. For the nine months ended
       September 30, 2001, cash of approximately $0.1 million was used in
       financing activities. This decrease in cash provided of approximately
       $29.2 million consists principally of the issuance of convertible
       debentures in June 2000 of $29.0 million, net of $1.0 million in issuance
       costs.

   -   Our accounts payable increased substantially during the three months
       ended September 30, 2001 due to the lack of availability of cash
       equivalents or additional financing to discharge these liabilities. We
       have negotiated settlements or payment arrangements with certain vendors
       and are continuing to make additional arrangements or settlements with
       other vendors in an effort to improve liquidity.

         We may need up to $10 million during the next year to satisfy
obligations under a put option agreement in connection with our acquisition of
CRL Network Services, Inc. Payment of these obligations is subject to the
resolution of certain legal proceedings described in Part II, Item 1 - "Legal
proceedings" of this quarterly report. In addition, the agreements relating to
the 5% convertible debentures and the revolving credit agreement contain certain
restrictions on our ability to redeem common shares pursuant to this put option
agreement. If an unfavorable outcome does occur requiring us to pay cash to
redeem the shares owned by the former CRL shareholders, we may not have
sufficient financial resources to meet the obligation and may be in default
under the terms of the convertible debenture and revolving credit agreements.

         We have made capital investments in our web hosting centers, network
and other capital assets totaling $11.6 million and $16.8 million in the years
ended December 31, 1999 and 2000 and $4.6 million in the nine months ended
September 30, 2001. We acquired assets under capital leases for $1.5 million in
1999, $7.7 million in 2000, and $2.6 million in the nine months ended September
30, 2001.

         At September 30, 2001 we had $0.2 million in marketable securities and
$1.5 million in cash, of which $0.6 million is restricted. In addition to these
amounts and the aforementioned sources of funds at our disposal, we will need to
renew our $7.5 million bank line of credit and our $7.0 million revolving credit
agreement in 2002 and raise additional funds through public or private
financing, strategic relationships, the sale of non-strategic assets or other
arrangements to complete the execution of our business plan. Additional
financing is subject to certain restrictions within the convertible debenture
agreements and there can be no assurance that additional financing 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 and sell certain non-core
assets. In response to current market conditions and as part of our ongoing
corporate strategy, we are pursuing several initiatives intended to increase
liquidity and better position ourselves under current market conditions. We have
completed the consolidation of duplicate network operations facilities and are
continuing the ongoing initiatives to reduce non-essential personnel and
controllable costs such as travel and capital expenditures. In October 2001, we
reduced our total workforce by approximately 16%, and even though the full
benefits of this reduction will not be felt until the 1st quarter of 2002, this
measure along with the other initiatives described above continue to reduce our
working capital requirements.

         We believe that in order to achieve our long-term growth objectives and
maintain and enhance our competitive position, additional financial resources
will be required. We may not be able to secure such financial resources on
commercially reasonable terms. If we are unable to obtain adequate financing or
receive an unfavorable resolution of the litigation with the former CRL
shareholders (see Note L to the financial statements), we will be required to
significantly reduce and/or possibly suspend our operations and will be required
to seek relief under Chapter 11 of the Bankruptcy Code.


                                       27
<PAGE>
 COMMITMENTS

         As of September 30, 2001, our operating lease obligations were $1.5
million, $4.1 million and $3.1 million for 2001, 2002 and 2003, respectively,
and $12.0 million thereafter. Our purchase commitments under various
telecommunication agreements was $5.0 million, $5.5 million and $5.0 million for
2001, 2002 and 2003, respectively, and $9.5 million thereafter.

         Annual maturities of our debt obligations are as follows: $1.4 million
in 2001, $14.3 million in 2002 and $33.2 million in 2003. The debt maturing in
2001 represents capital lease and other equipment financing obligations. The
debt maturing in 2002 includes $4.3 million in bank line of credit obligations,
$4.1 million in revolving credit loans and $5.9 million in capital lease and
other equipment financing obligations. The debt maturing in 2003 includes $29.9
million in convertible debentures maturing on June 5, 2003 and $3.3 million in
capital lease and other equipment financing obligations. The convertible
debentures can be converted into stock at any time until maturity, at the option
of the investors.

         The Company is not current with its required payments under certain
capital lease and debt obligations. However, the Company has not received formal
notice of an event of default and is currently negotiating alternative payment
or other arrangements with the lenders.


ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

         At September 30, 2001, we had various financial instruments consisting
of variable rate debt, short-term investments and convertible debentures entered
into for purposes other than trading. The substantial majority of our
outstanding debt obligations excluding the convertible debentures have variable
interest rates. At September 30, 2001, the carrying value of our debt
obligations approximate the fair value due to the short maturity and/or variable
interest rates of a majority of the debt. The weighted average interest rate of
our debt obligations at September 30, 2001 was 7.0%.

         Our investments are generally common stock securities. At September 30,
2001, all of our investments are classified as available for sale and are
carried at fair value of $0.2 million. These investments are subject to market
risk which is estimated as the potential loss in fair value resulting from a
hypothetical 10% adverse change in the securities' quoted market prices. A
change of this nature would not have a material impact on our financial position
at September 30, 2001. We actively monitor the capital and investing markets in
analyzing our capital raising and investing decisions.


PART II. OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS

         The Company is periodically involved in certain disputes, claims and
threatened with or named as a defendant in lawsuits. Some of these disputes,
lawsuits and threatened litigation include claims asserting alleged breach of
agreements and some of them relate to unresolved issues of law arising out of or
relating to the developing nature of the Internet and on-line services
industries. See, for example, "Risk Factors -- Legal liability for distributing
or publishing content over the Internet " in Item 5 of this Form 10-Q.

         In June 2000, the Company was notified by the U.S. Attorney for the
Western District of New York that a relator had filed a qui tam action under
seal against the Company and

                                       28
<PAGE>
NYSERNet.net ("NYSERNet"). The complaint alleged that the National Science
Foundation was fraudulently induced to provide a grant of $2.45 million to
NYSERNet, a portion of which was paid by NYSERNet to the Company for services
rendered. The complaint seeks treble damages related to the alleged overpayment
for services provided by the Company to NYSERNet, as well as certain other
penalties and forfeitures under the False Claims Act. On January 19, 2001, the
Company received a redacted copy of the amended complaint in this action. In
addition to the original allegations, this amended complaint alleged that
NYSERNet and the Company failed to disclose the transfer of alleged program
income in violation of the False Claims Act. Furthermore, the amended complaint
alleged that the Company conspired with NYSERNet to engage in the fraudulent
conduct described above and seeks unspecified millions of dollars in treble
damages as a result. Although the Department of Justice has not yet determined
whether or not it will join in this action, the Company believes that these
allegations are without merit and intends to contest them.

         On December 13, 2000, James G. Couch filed a complaint in New York
State court seeking approximately $9,650,000 in damages against the Company due
to an alleged anticipatory breach of a put option agreement between the Company,
Mr. Couch and others dated January 5, 2000 pursuant to which Mr. Couch, as part
of the consideration for his sale to the Company of the capital stock of CRL
Network Services, Inc., was granted two put options, exercisable on January 5,
2001 and January 5, 2002, respectively, pursuant to which Mr. Couch may require
the Company to re-purchase shares of its common stock from Mr. Couch at
specified times and in specified circumstances. On January 2, 2001, the Company
answered the complaint and asserted affirmative defenses and counterclaims for
fraud, indemnification and breach of contract for which the Company seeks
compensatory and punitive damages. Mr. Couch served an amended complaint on
January 8, 2001 asserting claims of actual and anticipatory breach of the Put
Option Agreement, and a reply to the Company's answer and counterclaims. On
January 29, 2001, the Company answered the amended complaint and asserted
affirmative defenses and counterclaims for fraud, violations of the California
Corporation Code, indemnification and breach of contract for which the Company
seeks compensatory and punitive damages. In addition, the Company is pursuing
indemnification claims under an escrow agreement against Mr. Couch in an
arbitration proceeding. On February 15, 2001, Mr. Couch filed a motion to
dismiss the Company's counterclaim for violations of the California Corporations
Code and to stay the Company's counterclaims for indemnification and breach of
contract pending the completion of an arbitration between the parties concerning
the Company's claims against Mr. Couch under the escrow agreement. The Company
cross-moved to stay the entire litigation, including Mr. Couch's claims, pending
completion of this arbitration. On March 9, 2001, Mr. Couch filed a motion for
partial summary judgment seeking entry of judgment in his favor on all his
claims, striking the Company's fraud defense to the extent it seeks a rescission
remedy, and striking the Company's claim for punitive damages. Oral argument for
Mr. Couch's motion filed on February 15, 2001, the Company's cross-motion
thereto, and Mr. Couch's motion filed on March 9, 2001 took place on April 5,
2001. On July 23, 2001, the court ruled on the parties' motions. The court
granted Mr. Couch's motion to dismiss the Company's counterclaim for violations
of the California Corporations Code. The court granted Mr. Couch's motion to
stay the Company's counterclaims for indemnification and breach of contract and
the Company's cross-motion to stay the entire litigation pending the completion
of an arbitration between the parties concerning the Company's claims against
Mr. Couch under the escrow agreement. The court held in abeyance Mr. Couch's
motion for partial summary judgment on his breach of contract claim pending the
determination of the arbitration, denied Mr. Couch's motion to strike the
Company's fraud defense to the extent it seeks a rescission remedy, and granted
Mr. Couch's motion to strike the Company's claim for punitive damages. The
Company has filed a notice of appeal from the adverse aspects of the ruling, and
Mr. Couch has filed a cross-appeal. The Company has received an interim decision
from the arbitration panel granting some of our claims and denying others. This
litigation is still in the preliminary stage, and therefore, no opinion as to
likelihood of an unfavorable outcome can be made. However, if an unfavorable
outcome does occur requiring the Company to pay cash to redeem the shares owned
by the former CRL shareholders, the Company may not have sufficient financial

                                       29
<PAGE>
resources to meet the obligation. At September 30, 2001, the Company has $10
million recorded as temporary equity in connection with these put options.

         On September 21, 2001, James G. Couch filed a complaint in the Delaware
Court of Chancery seeking the appointment of a receiver for the Corporation. On
October 15, 2001, the Company answered the complaint and asserted certain
affirmative defenses.

         On September 21, 2001, James G. Couch filed a complaint in New York
State court against the Company, a group of investors led by the Palladin Group,
L.P., Danny Stroud, the Company's president, and certain other unnamed persons
seeking to set aside as a fraudulent conveyance the transactions that the
Company entered on July 10, 2001, including the security interest granted by the
Company to such investors (see Note G to the financial statements). On October
22, 2001, the Company answered the complaint and asserted certain affirmative
defenses.

         There can be no assurance whether these matters will be determined in a
manner that is favorable to the Company or, if adversely determined, that such
determination would not have a material adverse effect upon the Company's
business, financial condition or results of operations.

         The Company is not involved in any other legal proceedings which it
believes would, if adversely determined, have a material adverse effect upon its
business, financial condition or results of operations.


ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

         As of September 30, 2001, the Company has used the proceeds from its
IPO on May 5, 1999 and convertible debentures issued on June 5, 2000 to fund its
operations, working capital requirements, acquisitions and capital expenditures.

         During the three and nine months ended September 30, 2001, proceeds of
approximately $15,000 and $63,000, respectively, were generated from the
exercise of options for 110,000 and 405,827 shares, respectively, of our common
stock. There were no significant expenses, underwriting discounts or commissions
attributable to these proceeds. These options had been granted under our
Incentive Stock Option Plans and were exercised by certain employees and
directors. During the three and nine months ended September 30, 2001, proceeds
of approximately $0 and $337,839, respectively, were generated from the issuance
of 0 and 537,105 shares, respectively, of our common stock under our Employee
Stock Purchase Plan. The shares issued pursuant to our 1996 and 1999 Option
Plans and our Employee Stock Purchase Plan were registered through our
registration statement on Form S-8 (File No. 333-83177), which we filed with the
SEC 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.



                                       30

<PAGE>
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 our annual report on Form 10-K (Commission File No. 000-25759) filed with the
SEC 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.

IF OUR FINANCIAL CONDITION DOES NOT PROMPTLY IMPROVE SUBSTANTIALLY, WE MAY HAVE
TO SEEK RELIEF UNDER CHAPTER 11 OF THE BANKRUPTCY CODE OR MAY BE FORCED INTO
BANKRUPTCY PROCEEDINGS.

         If our financial condition continues to deteriorate and we are unable
to promptly restructure our indebtedness, reduce our losses, and obtain
additional financing, we may be forced to seek relief under Chapter 11 of the
Bankruptcy Code, or may be forced into bankruptcy. Chapter 11 would permit us to
remain in control of our business, protected by a stay of all creditor action,
while we attempt to negotiate and confirm a plan of reorganization with our
creditors. If we commence a case under Chapter 11, we may experience a
deterioration in our customer relationships, a reduction in orders, the loss of
suppliers, and an erosion of employee morale. We may be unsuccessful in our
attempts to confirm a plan of reorganization with our creditors. Many Chapter 11
cases are unsuccessful, and virtually all involve substantial expense and damage
to the business. If we seek relief under Chapter 11 and are unsuccessful in
obtaining confirmation of a plan of reorganization, our assets would be
liquidated. In a bankruptcy case, all other creditors would be paid prior to our
shareholders.

WE HAVE A LIMITED OPERATING HISTORY AND MAY NOT 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 web hosting and network infrastructure;

         -        expanding our sales structure and marketing programs;

         -        increasing awareness of our brand;

         -        providing services to our customers that are reliable and
                  cost-effective; - responding to technological development or
                  service offerings by competitors; and

         -        attracting and retaining qualified personnel.

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

WE HAVE A HISTORY OF NET LOSSES AND EXPECT THESE LOSSES TO CONTINUE IN THE
FORESEEABLE FUTURE.

         We have incurred net losses and have experienced negative cash flows in
each quarterly and annual period since inception and expect to continue to do so
for the foreseeable future. At September 30, 2001 and December 31, 2000 and
1999, we had an accumulated deficit of approximately $125.7 million, $82.4
million and $29.8 million, respectively. We incurred net losses


                                       31
<PAGE>
of $43.3 million for the nine months ended September 30, 2001 and $52.6 million,
$14.1 million and $7.1 million for the years ended December 31, 2000, 1999 and
1998, respectively. As a result of executing our business plan, we expect our
net losses and negative cash flows on a quarterly and annual basis to continue
in the foreseeable future. Our ability to achieve profitability is dependent in
large part upon the successful implementation of our business plan. We cannot
assure you that we will achieve or sustain revenue growth or profitability on
either a quarterly or annual basis.

WE WILL NEED ADDITIONAL FUNDS WHICH, IF AVAILABLE, COULD RESULT IN DILUTION OF
THE HOLDINGS OF EXISTING SHAREHOLDERS OR AN INCREASE IN OUR INTEREST EXPENSE. IF
THESE FUNDS ARE NOT AVAILABLE, OUR BUSINESS COULD BE HURT.

         We intend to use our available cash and existing financing arrangements
to fund our operations, working capital requirements and capital expenditures.
We will need to raise additional funds to become current with our vendors and
other obligations, and to convince potential investors and our current and
potential future customers of our long-term viability and to fund losses until
we become EBITDA and cash flow positive. Any additional financing is subject to
certain restrictions within the convertible debenture agreements and there can
be no assurance that additional financing will be available on terms acceptable
to us, or at all. If additional funds are not available, our business could be
detrimentally impacted. Also, if we are required to pay cash to redeem the
shares owned by the former CRL shareholders, we will not have sufficient
financial resources to meet that obligation. In addition, we will need to raise
additional funds through public or private debt or equity financing in order to:

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

         -        develop new products;

         -        respond to unanticipated competitive pressures; or

         -        achieve profitability.

         When 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.

WE MAY NOT BE ABLE TO GENERATE THE NECESSARY AMOUNT OF CASH TO SERVICE OUR
EXISTING FINANCIAL OBLIGATIONS.

         In addition to the 5% convertible debentures due June 5, 2003, we also
have other financial obligations, including a contested obligation to certain
former shareholders of CRL Network Services, Inc., pursuant to a put option
agreement entered into between the Company and those shareholders as part of the
consideration for the Company's acquisition of CRL Network Services, Inc. We
cannot assure you that our business will generate sufficient cash flow from
operations or that additional equity or debt financing will be available on
commercially reasonable terms or at all to enable us to fulfill our financial
obligations or fund our other liquidity needs. If we are unable to generate
sufficient cash flow for those needs, we may be unable to meet our obligations
and may need to renegotiate or refinance all or a portion of our obligations
under those


                                       32
<PAGE>
agreements. We cannot assure you that we would be able to renegotiate or
refinance our obligations under those agreements on commercially reasonable
terms or at all, which could cause us to default on our obligations and impair
our liquidity and our business.

OUR 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 business plan to succeed, we will need
to:

         -        expand our business with new and current customers;

         -        develop and offer successful new products and services;

         -        retain key employees and hire new employees; and

         -        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 business plan.

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;

         -        economic conditions including those in the technology sector;

         -        potential unfavorable legislative and regulatory developments;

         -        growth of Internet use and establishment of Internet
                  operations, including the providing of Internet solutions,
                  managed hosting and related services by mainstream
                  enterprises; and

         -        changes in our pricing policies 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,
amortization, real estate occupancy costs, 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.


                                       33
<PAGE>
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
                  solutions and Web hosting 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 will be hurt if demand for Internet and related services
does not continue to grow. This demand may be inhibited for a number of reasons,
including:

         -        general economic conditions;

         -        access costs;

         -        inadequate network infrastructure;

         -        security concerns;

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

         -        inconsistent quality of service; and

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

         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. This could hurt our business.

A PORTION OF OUR GROWTH DEPENDS ON OUR ABILITY TO EXPAND WEB HOSTING CAPACITY TO
MEET ANTICIPATED DEMAND.

         Continuing to expand web hosting center capacity is critical to
achieving the goals of our business plan. This expansion is likely to include
the need to add new hardware and software, and may include the opening of
additional web hosting centers. We intend to add web hosting center capacity in
the future as justified by customer demand. Our ability to do so successfully
depends on:

         -        anticipating and planning for future demand levels;

         -        having access to sufficient capital; and

         -        locating and securing satisfactory web hosting center sites
                  and implementing the build-out of these and existing sites,
                  all of which may require significant lead time.

         If we are unable to expand our capacity effectively, our growth may
suffer and we may not be able to adequately meet the demands of existing
customers.

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
we do. 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


                                       34
<PAGE>
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 and web hosting
                  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 generally may be divided into
the following three groups:

         -        Web hosting companies including Digex, Inc., Verio, Inc.,
                  Genuity, Globix Corporation, PSINet Inc., Exodus
                  Communications, Inc. and other companies;

         -        Internet solution companies including Razorfish Inc., IBM
                  Global Services, Accenture, US Internetworking Inc., Scient
                  Corp., Cambridge Technology Partners, Inc., Whittman-Hart
                  Inc., Oracle Corporation, the Big 5 accounting firms, EDS
                  Corporation and other companies; and

         -        Internet connectivity, VPNs and security providers including
                  Genuity, Verio Inc., Qwest Communications International Inc.,
                  Sprint Corporation, AT&T Corp., UUNET Technologies, Inc., XO
                  Communications, Cable & Wireless plc, WorldCom, Inc. and other
                  national and regional providers.

         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 continues
to grow. We are aware of other companies, in addition to those named above, that
have entered into or are forming joint ventures or consortia to provide services
similar to those provided by us. Others may acquire the capabilities necessary
to compete with us through acquisitions.

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

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

OUR REVENUES ARE HEAVILY DEPENDENT ON TWO CONTRACTS. IF WE LOSE EITHER OF THESE
CONTRACTS, IF THERE IS A REDUCTION IN THE AMOUNT OF WORK GENERATED FROM EITHER
OF THEM, OR IF WE FAIL TO DIVERSIFY OUR CUSTOMER BASE, OUR BUSINESS WILL SUFFER.

         We currently derive a substantial portion of our total revenue from
contracts with two customers; NYSERNet.org, Inc. ("NYSERNet"), a not-for-profit
corporation that is affiliated with one of our major stockholders, and the New
York State Department of Labor. The loss of either of these contracts could
significantly hurt our business. For the nine months ended September 30, 2001,
revenue from NYSERNet.org, Inc. represented approximately 19% of our total
revenue. For


                                       35
<PAGE>
the years ended December 31, 2000, 1999 and 1998 revenue from NYSERNet.org, Inc.
represented approximately 18%, 27% and 37% of our total revenue, respectively.
Revenue under the agreement with the New York State Department of Labor for the
nine months ended September 30, 2001 represented 28% of our total revenue.
Revenue under the agreement with the New York State Department of Labor for the
years ended December 31, 2000, 1999 and 1998 represented 28%, 39% and 28% of our
total revenue, respectively.

         We have an agreement with NYSERNet to provide NYSERNet and its
customers with services. Under this agreement we provide services to
approximately 140 different customers affiliated with NYSERNet. Each of these
customers makes individual buying decisions resulting in separate agreements. In
March 2000 we extended and expanded these services through an agreement with
NYSERNet to upgrade and maintain a minimum of 10 full OC-3 connections for
NYSERNet and its customers. This agreement extends until October 2005 and it is
estimated that we will receive approximately $40 million for our services over
the term of the agreement. While these agreements only allow termination by
either party under special circumstances, it is still possible that NYSERNet
could terminate the agreement or cease working with us.

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

         On November 30, 2000, we executed a five year $82 million contract with
the New York State Department of Labor for the development and maintenance of
the America's Job Bank Web site. Although this contract is initiated by the New
York State Department of Labor, the contract includes separate maintenance of
America's Job Bank Web sites for 50 different states and territories. Each of
these states and territories makes an individual buying decision and may
terminate its affiliation with America's Job Bank annually. The America's Job
Bank agreement is subject to cancellation upon 15 days notice by the New York
State Department of Labor.

         We cannot be assured 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.

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 and web hosting management
infrastructure 24 hours per day, seven days per week, without interruption. Our
operations depend upon our ability to protect our network and web hosting
infrastructure, our equipment and customer data against damage from human error,
war, terrorism 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.

         Although we have attempted to build redundancy into our network and
hosting facilities by establishing a redundant, rigorously engineered backbone
connected to our four web hosting centers, 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:


                                       36
<PAGE>
         -        cause end users to seek damages for losses incurred;

         -        require us to spend more money and dedicate more resources to
                  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 coverage, capacity, scalability,
reliability and security of the network infrastructure provided to us by
telecommunications network suppliers, including AT&T Corp., Sprint Corporation,
Verizon Communications, Pacific Bell, Worldcom, Inc. and Broadwing, Inc. Our
expansion plans require additional network resources. Without these resources,
our ability to execute our business strategy could be hurt. In addition, future
expansion and adaptation of our network and web hosting infrastructure may
require substantial financial, operational and management resources. We may not
be able to expand or adapt our network or web hosting 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 and web hosting facilities were to increase faster than
projected or were to exceed our current forecasts, the network could experience
capacity constraints which would hurt its performance.

         The consolidation of network providers could adversely affect our
peering and transit arrangements if peering criteria becomes more restrictive or
cost prohibitive. We also depend on our telecommunications suppliers to provide
uninterrupted and error-free service through their telecommunications networks.
If these suppliers greatly increase the price for their services or if the
telecommunications capacity available to us is insufficient for our business
purposes, and we are unable to use alternative networks or pass along any
increased costs to our customers, our business could suffer.

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

         Despite the implementation of network security measures, the core of
our network infrastructure is vulnerable to computer viruses, break-ins and
similar disruptive problems caused by


                                       37
<PAGE>
Internet users. This could result in our being liable 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 purchased 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 AS WELL KNOWN AS SOME OF OUR COMPETITORS, 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, prior to
2000, our market presence was limited principally to New York State. In order to
build our brand awareness, our marketing efforts must succeed, and we must
provide high quality services. 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. Our industry is characterized by rapidly
changing technology, industry standards, customer needs and competition, as well
as by frequent new product and service introductions. Our future success will
depend, in part, on our ability to accomplish all of the following in a timely
and cost-effective manner, all while continuing to develop our business model
and rolling-out our services on a national level:

         -        effectively use and integrate leading technologies;

         -        continue to develop our technical expertise;

         -        enhance our products and current networking services;

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

         -        have the market accept our services;

         -        advertise and market our products and services; and

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

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


                                       38
<PAGE>
the industry. Although we intend to support emerging standards in the market for
Internet solutions, 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/Internet 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
39% of our total revenue for the nine months ended September 30, 2001, and 36%
and 53% of our total revenue for years ended December 31, 2000 and 1999,
respectively. 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 employment
opportunities, 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.

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. ALSO, COMPLETED ACQUISITIONS MAY NOT ENHANCE OUR BUSINESS.

         A component of our strategy is to acquire web hosting and Internet
solutions companies and other businesses complementary to our operations. In the
28 months ending September 30, 2001 we have acquired or invested in several
companies. In the future, we may acquire additional companies that complement
our existing business model and growth strategies. 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;

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

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


                                       39
<PAGE>
         -        the potential loss of key employees from acquired businesses,
                  and the impairment of relationships with the employees and
                  customers of an acquired business as a result of changes in
                  management; and

         -        the inaccuracy of financial data of acquired companies.

         We cannot assure you that any completed acquisition will enhance our
business. If we consummate additional acquisitions in which any significant
portion of the consideration consists of cash, a significant portion of our
available cash could be used to consummate the acquisitions. If we consummate
one or more acquisitions in which any significant portion of the consideration
consists 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. The purchase price of future
acquisitions will most likely be significantly greater than the fair value of
the acquired net assets. Our acquisitions to date have been accounted for under
the purchase method. Under SFAS 141, all future acquisitions are required to be
accounted for under the purchase method and could result in significant goodwill
and/or impairment charges for acquired technology based on SFAS 142.

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 a significant portion of these products from Sun
Microsystems, Inc., Compaq Computer Corporation, Cisco Systems, Inc., Microsoft
Corporation and Oracle Corporation. 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 ("FCC") or any other governmental agency, other than
regulations applicable to businesses in general. However, in the future, we may
become subject to regulation by the FCC or another regulatory agency. Our
business could suffer depending on the extent to which our activities are
regulated or proposed to be regulated.

         While there are currently few laws or regulations that 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


                                       40
<PAGE>
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 service
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.

WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS OR TO CONTINUE
USING INTELLECTUAL PROPERTY THAT WE LICENSE FROM OTHERS.

         We rely on a combination of copyright, trademark, service mark and
trade secret laws and contractual restrictions to establish and protect certain
of our proprietary rights. We have no patented technology that would bar
competitors from our market. Despite our efforts to protect our proprietary
rights, unauthorized parties may attempt to copy or otherwise obtain and use our
data or technology.

         We also rely on certain technologies licensed from third parties. We
cannot be sure these licenses will remain available to us on commercially
reasonable terms or at all. The loss of such technology may require us to obtain
substitute technology of lesser quality or performance standards or at greater
cost which could harm our business.

SIGNIFICANT STOCKHOLDERS AND CURRENT MANAGEMENT CONTROL APPROXIMATELY 49% OF OUR
COMMON STOCK, AND THESE PARTIES MAY HAVE CONFLICTS OF INTEREST.

         Broadwing Communications, Inc. ("Broadwing"), NYSERNet.net, Inc. and
Grumman Hill Investments III, L.P. ("Grumman Hill") control approximately 16.6%,
16.5% and 10.2%, respectively, of our outstanding common stock at September 30,
2001. In addition, our executive officers may be deemed to beneficially own in
the aggregate approximately 5.9% of our outstanding common stock. Accordingly,
Broadwing, 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. In addition, Grumman Hill has a
representative on our board of directors. NYSERNet.net, Broadwing, 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.


                                       41
<PAGE>
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 certain
executive officers. We have also secured key man insurance policies on the lives
of Messrs. Mandelbaum and Martin.

OUR STOCK PRICE MAY BE VOLATILE.

         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;

         -        changes in analysts' recommendations or projections; and

         -        changes in general economic and market conditions.

         In addition, the U.S. equity markets in general have periodically had
significant price corrections, trading volume fluctuations and prolonged periods
of decline. These events have impacted the stock prices for Internet-related,
technology and telecommunications companies. Specifically, recent events have
adversely affected the market price of our common stock in a significant manner
that potentially could result in the delisting of our common stock from the
Nasdaq Stock Market. 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.

INDUSTRY CONSOLIDATION COULD MAKE IT MORE DIFFICULT TO COMPETE.

         Companies offering Internet, data and communications services are
increasingly consolidating. As a company with a limited operating history, we
may not be able to successfully compete with businesses that have combined, or
will combine, to produce companies with substantially greater financial, sales
and marketing resources, larger customer bases, extended networks and
infrastructures and more established relationships with vendors, distributors
and partners than we have. In addition, this consolidation trend could prevent
or hinder our ability to further grow our operations through acquisitions. With
these heightened competitive pressures, there is a significant risk that the
value of our common stock will decline.

WE HAVE A SIGNIFICANT AMOUNT OF DEBT.

         We are leveraged, and we may seek additional debt funding in the
future. As of September 30, 2001, we had approximately $49.1 million of
outstanding debt and an accumulated deficit of $125.7 million. We may not be
able to generate sufficient revenue to fund our operations or to repay our debt.
Our existing substantial leverage poses, and any future leverage would pose, the
risk that:

         -        we may be unable to repay our debt;


                                       42
<PAGE>
         -        we may be unable to obtain additional financing; and

         -        we may be more vulnerable during economic downturns, less able
                  to withstand competitive pressures and less flexible in
                  responding to changing business and economic conditions.

         Additionally, our outstanding debt may impose significant restrictions
on how we can conduct our business. The debt may prohibit or limit our ability
to incur additional debt and may materially and adversely affect our ability to
finance future operations or capital needs or conduct additional business
activities. Any future debt that we may incur would also likely impose
restrictions on us. If we fail to comply with any of these restrictions, we
would be in default and, as a result, the holders of the applicable debt could
demand that we pay the debt, including interest, immediately. This would create
a significant risk that the value of our common stock will decline.

         Also, our large amount of debt negatively impacts our shareholders in
many ways, including:

         -        increasing the likelihood that we may be forced to seek relief
                  under Chapter 11 or that we may be forced into bankruptcy
                  proceedings;

         -        reducing funds available to support our business operations
                  and for other corporate purposes because portions of our cash
                  flow from operations must be dedicated to the payment of
                  principal and interest on our debt;


         -        impairing our ability to obtain additional financing for
                  working capital, capital expenditures, acquisitions or general
                  corporate purposes;

         -        increasing our vulnerability to increases in interest rates;

         -        placing us at a competitive disadvantage because we may be
                  substantially more leveraged than certain of our competitors;
                  and

         -        hindering our ability to adjust rapidly to changing market
                  conditions and making us more vulnerable to a downturn in
                  general economic conditions.

DELISTING OF OUR SHARES ON THE NASDAQ NATIONAL MARKET MAY LIMIT YOUR ABILITY TO
DISPOSE OF YOUR SHARES.

         On May 23, 2001, Nasdaq formally notified us of our failure, for more
than 30 consecutive business days, to maintain the $1.00 minimum bid price
required by Nasdaq Marketplace Rule 4310(c)(4). Pursuant to Nasdaq Marketplace
Rule 4310(c)(8)(B), Nasdaq had given the Company 90 calendar days, or until
August 21, 2001 to regain compliance with Rule 4310(c)(4). Nasdaq notified us
that, if we were unable to demonstrate compliance with Rule 4310(c)(4) on or
before August 21, 2001, Nasdaq would provide us with written notification that
our common stock will be delisted. As of August 21, 2001, we did not regain
compliance with Rule 4310(c)(4), and therefore, requested a hearing and a stay
of the delisting of our common stock. However, on September 27, 2001, our
hearing scheduled for October 4, 2001 was rendered moot and our hearing file was
closed as Nasdaq formally informed us that they implemented a moratorium on the
minimum bid price and public float requirements for continued listing on the
Nasdaq Stock Market. Under the moratorium, the continued listing requirements
will be suspended until January 2, 2002, at which time the 30 and 90-day periods
provided by Marketplace Rule 4310(c)(8)(B) would start anew.

         If our common stock is delisted from the Nasdaq National Market,
trading in our common stock, if any, would have to be conducted in the
over-the-counter market (also known as the pink sheet market). In such an event,
an investor could find it more difficult to dispose of, or to obtain accurate
quotations as to the market value of our common stock.

         In addition, if our common stock were to become delisted from trading
on the Nasdaq National Market and the trading price were to remain below $5.00
per share, trading in our common stock may also be subject to the requirements
of certain rules promulgated under the Securities


                                       43
<PAGE>
Exchange Act of 1934, as amended, which require additional disclosures by
broker-dealers in connection with any trades involving a stock defined as a
"penny stock." The additional burdens imposed upon broker-dealers by these
requirements could discourage broker-dealers from facilitating trades in our
common stock, which could severely limit the market liquidity of our common
stock and the ability of our shareholders to trade our common stock.

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

         On May 5, 1999, we completed our initial public offering, or IPO, of
5,175,000 shares of our common stock pursuant to a registration statement on
Form S-1 (File No. 333-72133). In addition to our IPO as a result of our
re-offer prospectus filed on Form S-8 with the Securities and Exchange
Commission ("SEC") on July 19, 1999 (File No. 333-83177), approximately
4,500,000 shares of our outstanding common stock no longer qualify as
"restricted securities" under Rule 144 of the Securities Act of 1933 and, under
the Securities Act, these shares may be freely re-offered and re-sold. However,
affiliates 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. 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 filing a registration statement on Form S-8
with the SEC on July 19, 1999 (File No. 333-83177) in order to register the
shares issued and issuable upon the exercise of options granted under our 1996
Incentive Stock Option Plan and our 1999 Stock Option Plan as well as shares
issued under our 1999 Employee Stock Purchase Plan. Amendment No. 1 to this
registration statement on Form S-8 was filed with the SEC on August 29, 2001 in
order to register an additional 2,000,000 shares issuable upon the exercise of
options under our 1999 Stock Option Plan.

         As a result of filing of a registration statement on Form S-3 with the
SEC on October 24, 2000 (File No. 333-48518), 211,000 shares of our common stock
were issued and these shares may be freely re-offered and re-sold. Also, as a
result of filing of a registration statement on Form S-3 with the SEC on October
25, 2000 (File No. 333-48578), approximately 839,881 shares of our outstanding
common stock will no longer qualified 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. Furthermore, due to the registration statement on Form
S-3 with the SEC that was filed on April 4, 2001 (File No. 333-54420), if
certain parties convert the 5% convertible debentures into common stock up to an
additional 22,333,333 shares of our common stock would be registered and freely
tradable. As a result of filing a registration statement on Form S-3 with the
SEC on May 18, 2001 (File No. 333-61254), approximately 280,759 shares of our
common stock may be freely re-offered and re-sold.

         Therefore, through the S-8 re-offer prospectus, a separate S-8
registration statement and the S-3 registration statements, as a result of
registration rights and under Rule 144, a large number of shares of our common
stock may become freely tradable and affect the market for our stock.

         As of September 30, 2001, an additional 27% of the shares of our common
stock continue to be restricted securities. Certain of the holders of these
restricted securities have registration rights with respected to these
restricted shares and with respect to any after-acquired shares. Also, under
Rule 144 these shares are or may become freely tradable in the future.


                                       44
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

         (a.)     EXHIBITS.

         The following exhibits are filed or incorporated by reference herewith:

<TABLE>
<S>                        <C>
         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, 2001.

         Exhibit 11.2      Calculation of Basic and diluted loss per share and
                           weighted average shares used in calculation for the
                           nine months ended September 30, 2001.

         Exhibit 10.78     Amendment No. 1, dated as of October 10, 2001, to the
                           Revolving Credit Agreement and the Security
                           Agreement, both dated as of July 10, 2001, by and
                           among AppliedTheory Corporation, the subsidiaries
                           named therein, and the lenders named therein.
</TABLE>

         Exhibit 99.1 Press release issued by AppliedTheory Corporation on
November 13, 2001.

         (b.)     REPORTS ON FORM 8-K.

                  On July 26, 2001, we filed a current report on Form 8-K that
         included information relating to an amendment agreement, a revolving
         credit agreement and a security agreement between the Company and seven
         institutional investors dated July 10, 2001. The amendment agreement
         modified certain provisions of the $30,000,000 in 5% convertible
         debentures under the January 9, 2001 amended and restated purchase
         agreement and related documents. Based on the revolving credit
         agreement, the investors agreed to loan the Company and its
         subsidiaries up to $6,000,000. Under the security agreement, the
         investors received a security interest in the assets of the Company to
         secure the Company's obligations to them, including their obligations
         under the revolving credit loans and the convertible debentures.

                  On August 28, 2001, we filed a current report on Form 8-K that
         included information relating to an August 22, 2001 Nasdaq staff
         determination letter that stated the Company had failed to comply with
         the $1.00 minimum bid price required for continued listing of its
         common stock on the Nasdaq National Market or to regain compliance with
         that rule, and as a result, the Nasdaq staff had determined to delist
         AppliedTheory's common stock from the Nasdaq National Market. The
         Company had requested a hearing before a Nasdaq Listing Qualifications
         Panel to review the staff determination. The hearing was scheduled for
         October 4, 2001, whereby the Company intended to request additional
         time to bring itself into compliance with the $1.00 minimum bid price
         requirement and that the Panel reconsiders the Nasdaq staff
         determination to delist AppliedTheory's common stock from the Nasdaq
         National Market. However, on September 27, 2001, Nasdaq suspended its
         $1.00 minimum bid price requirement for all its listed companies until
         January 2, 2002. As a result, the hearing scheduled for October 4, 2001
         was canceled and our common stock was not delisted from the Nasdaq
         National Market.


                                       45
<PAGE>
                            APPLIEDTHEORY CORPORATION
                                    FORM 10-Q
                               SEPTEMBER 30, 2001

                                   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.

<TABLE>
<S>                                         <C>
                                            AppliedTheory Corporation

Date:      November 10, 2001                   by:    /s/  Danny E. Stroud
                                                    ----------------------------------------------
                                                    Danny E. Stroud
                                                    President and Chief Executive Officer
                                                    (Principal Executive Officer)


Date:      November 10, 2001                   and:   /s/  Angelo A. Gencarelli III
                                                    ----------------------------------------------
                                                    Angelo A. Gencarelli III
                                                    Sr. Vice President and Chief Financial Officer
                                                    (Principal Financial and Accounting Officer)
</TABLE>


                                       46
<PAGE>
                                  EXHIBIT INDEX

         The following exhibits are filed or incorporated by reference herewith:

<TABLE>
<S>                        <C>
    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, 2001.

    Exhibit 11.2           Calculation of Basic and diluted loss per share and
                           weighted average shares used in calculation for the
                           nine months ended September 30, 2001.

    Exhibit 10.78          Amendment No. 1, dated as of October 10, 2001, to the
                           Revolving Credit Agreement and the Security
                           Agreement, both dated as of July 10, 2001, by and
                           among AppliedTheory Corporation, the subsidiaries
                           named therein, and the lenders named therein.

    Exhibit 99.1           Press release issued by AppliedTheory Corporation on
                           November 13, 2001.
</TABLE>


                                       47