<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
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 July 28, 2000, there were 24,817,489 shares of AppliedTheory Corporation
common stock, par value $.01, outstanding.
The Index of Exhibits appears on page 38
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<PAGE> 2
APPLIEDTHEORY CORPORATION
TABLE OF CONTENTS
<TABLE>
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited):
Consolidated Balance Sheets as of December 31, 1999 and June 30, 2000.........3
Consolidated Statements of Operations for the three and six months ended
June 30, 1999 and June 30, 2000...............................................4
Consolidated Statements of Cash Flows for the six months ended
June 30, 1999 and June 30, 2000...............................................5
Notes to Consolidated Financial Statements....................................6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................................14
Item 3. Quantitative and Qualitative Disclosures about Market Risk...................20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................................21
Item 2. Changes in Securities and Use of Proceeds....................................21
Item 3. Defaults Upon Senior Securities..............................................23
Item 4. Submission of Matters to a Vote of Security Holders..........................23
Item 5. Other Information............................................................24
Item 6. Exhibits and Reports on Form 8K..............................................35
Signatures ................................................................................37
Exhibit Index..............................................................................38
</TABLE>
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
December, 31 June 30,
1999 2000
---- ----
(Derived from Audited (Unaudited)
ASSETS Financial Statements)
<S> <C> <C>
Current assets
Cash and cash equivalents $ 14,834 $ 7,877
Marketable securities 32,727 27,072
Accounts receivable, net of allowance of $231 and $496, respectively 6,714 14,367
Due from related parties 59 217
Prepaid expenses and other assets 2,133 2,999
--------- ----------
Total current assets 56,467 52,532
Property and equipment, net 13,881 30,268
Investment, at cost 5,000 5,250
Goodwill 55,423
Other assets 1,587 3,219
--------- ----------
Total assets $ 76,935 $ 146,692
========= ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 5,025 $ 8,164
Accrued payroll 2,012 2,430
Accrued expenses 4,794 6,399
Deferred revenue 2,476 3,516
Current portion of long-term debt and capital lease obligations 1,215 9,386
--------- ----------
Total current liabilities 15,522 29,895
Long-term debt and capital lease obligations 6,783 6,109
Convertible Debenture 25,316
Other liabilities 421 265
Stockholders' equity
Common stock, $.01 par value; 90,000,000 shares authorized; issued and
outstanding 21,413,362 shares at December 31, 1999
and 24,424,628 shares at June 30, 2000 214 244
Additional paid-in capital 84,052 138,620
Accumulated deficit (29,806) (53,703)
Accumulated other comprehensive loss (251) (54)
--------- ----------
Total stockholders' equity 54,209 85,107
--------- ----------
Total liabilities and stockholders' equity $ 76,935 $ 146,692
========= ==========
</TABLE>
The accompanying notes are an integral part of these statements.
3
<PAGE> 4
APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
-------- --------
1999 2000 1999 2000
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net revenues
Third-party customers $ 5,970 $ 15,225 $ 10,803 $ 28,323
NYSERNet.org, Inc. customers and services 2,723 2,763 4,757 5,487
--------- ---------- ---------- -----------
Total net revenues 8,693 17,988 15,560 33,810
--------- ---------- ---------- -----------
Costs and expenses
Cost of revenues 5,789 12,746 9,892 23,788
Sales and marketing 2,644 7,459 4,408 14,170
General and administrative 2,055 4,864 3,869 9,773
Research and development 67 181 130 347
Depreciation 791 2,626 1,407 4,465
Amortization 2,518 4,797
Other expenses (income) (186) 3 (206)
--------- ---------- ---------- -----------
Total costs and expenses 11,346 30,208 19,709 57,134
--------- ---------- ---------- -----------
Loss from operations (2,653) (12,220) (4,149) (23,324)
Interest income (505) (284) (523) (677)
Interest expense 146 972 326 1,250
--------- ---------- ---------- -----------
NET LOSS (2,294) (12,908) (3,952) (23,897)
Preferred stock dividends 21 73
--------- ---------- ---------- -----------
Net loss attributable to common stockholders $ (2,315) $ (12,908) $ (4,025) $ (23,897)
========= ========== ========== ===========
Basic and diluted loss per common share $ ( 0.12) $ ( 0.54) $ ( 0.23) $ ( 1.02)
========= ========== ========== ===========
Shares used in computing basic and diluted loss
per share 19,440,599 23,841,598 17,695,081 23,472,056
========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
4
<PAGE> 5
APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASHFLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
June 30,
-----------------------------
1999 2000
---- ----
<S> <C> <C>
Cash flows from operating activities
Net loss $ (3,952) $ (23,897)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation 1,407 4,465
Amortization of goodwill 4,797
Amortization of debt discount 589
Provision for bad debts 45 133
Payment of interest expense to NYSERNet.net, Inc. (270)
(Gain) loss on sale of property and equipment 3 (16)
Non-cash compensation expense 627 618
Changes in assets and liabilities, net of effects of business
acquisitions
Accounts receivable (1,111) (5,868)
Due from related parties (1,812) (158)
Prepaid expenses and other assets (920) (827)
Accounts payable 2,290 1,830
Accrued payroll 179 (258)
Accrued expenses and other liabilities 484 (1,252)
Deferred revenue 201 823
--------- ---------
Net cash used in operating activities (2,829) (19,021)
--------- ---------
Cash flows from investing activities
Purchases of property and equipment (2,009) (13,224)
Purchase of marketable securities (55,316) (23,930)
Investment in certain businesses, net of cash acquired (5,000) (11,183)
Proceeds from sale of marketable securities 29,782
Proceeds from sale of property and equipment 5 16
Payments received on notes receivable 3 3
--------- ---------
Net cash used in investing activities (62,317) (18,536)
--------- ---------
Cash flows from financing activities
Issuance of common stock, net of issuance costs 75,442 1,526
Issuance of convertible debenture 30,000
Convertible debenture issue costs (970)
Payment of preferred stock dividends (493)
Redemption of preferred stock (1,500)
Borrowings from NYSERNet.net, Inc. 800
Repayment of borrowings from NYSERNet.net, Inc. (3,487)
Proceeds (payments) from line of credit borrowings, net 70 (170)
Principal payments on capital leases (480) (966)
Proceeds received from long term debt 2,997
Principal payments on long-term debt (1,817)
--------- ---------
Net cash provided by financing activities 70,352 30,600
--------- ---------
Net increase (decrease) in cash and cash equivalents 5,206 (6,957)
Cash and cash equivalents, beginning of period 1,786 14,834
--------- ---------
Cash and cash equivalents, end of period $ 6,992 $ 7,877
========= =========
Supplemental disclosures of noncash investing transactions:
Issuance of common stock for investment in certain businesses $ 47,181
Fixed asset acquisitions financed through capital lease obligations 5,029
</TABLE>
The accompanying notes are an integral part of these statements.
5
<PAGE> 6
APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - NATURE OF OPERATIONS AND BASIS OF PRESENTATION
AppliedTheory Corporation (formerly AppliedTheory Communications, Inc.)
(the "Company") was incorporated in the State of New York in November 1995
as a wholly-owned subsidiary of NYSERNet.net, Inc. ("NET"), a not-for
profit corporation. NET is also the sole member of NYSERNet.org, Inc.
("ORG"), a not-for-profit corporation (in effect, ORG is a wholly-owned
subsidiary of NET). As a result of certain transactions completed during
1998 (the exercise of 3,559,335 stock options, the private placement of
1,725,000 shares and NET's direct sale of 4,875,000 shares it owned of the
Company), and the effect of the Company's initial public offering ("IPO")
in April 1999, Net's ownership percentage declined to less than 50%. In
conjunction with the IPO, the Company reorganized as a Delaware
corporation. On January 28, 1999, AppliedTheory Communications, Inc.
established its wholly owned subsidiary, AppliedTheory Corporation.
AppliedTheory Communications, Inc. merged into AppliedTheory Corporation,
which is the surviving entity.
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries (See Note B). All significant
intercompany transactions have been eliminated in consolidation. These
financial statements for the three and six months ended June 30, 2000 and
1999 and the related footnote information are unaudited and have been
prepared on a basis substantially consistent with the audited financial
statements of the Company as of and for the year ended December 31, 1999
included in our Annual Report on Form 10-K filed with the Securities and
Exchange Commission (SEC). The accompanying unaudited 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 have been reflected. Operating results for
the three month periods ended June 30, 2000 and 1999 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 financial
statements for the year ended December 31, 1999.
NOTE B - ACQUISITIONS
CRL NETWORK SERVICES, INC.
On January 5, 2000, the Company acquired all of the capital stock of CRL
Network Services, Inc. ("CRL") for $9,939,000 in cash and up to
approximately 2,022,291 shares of common stock, par value $.01 per share
of the Company. CRL provides high speed Internet access and data
networking solutions across the United States and owns and operates a Tier
1 network backbone. CRL is now a wholly owned subsidiary of the Company
named AppliedTheory California Corporation whose results are consolidated
beginning on the date of acquisition.
The acquisition was accounted for using the purchase method of accounting.
Accordingly, a portion of the purchase price was allocated to the net
tangible assets acquired based on the estimated fair values. The balance
of the purchase price was recorded as goodwill and is being amortized over
5 years. The acquisition was financed using a portion of the net proceeds
of the Company's IPO.
6
<PAGE> 7
APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Under escrow provisions of the Merger Agreement, the Company has placed in
escrow 285,507 of its common stock, valued at $19.16 per share, issuable to
CRL's former owners to cover various contingencies. 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 June 30, 2000, no shares have been issued since the outcome of
the contingencies was not determinable. In connection with the acquisition
of CRL the Company entered into a put option agreement requiring the
Company, at the option of the shareholders, to repurchase a total of up to
625,000 shares of AppliedTheory common stock in two equal installments, on
the first and second anniversary of the acquisition.
THE CORDADA GROUP, INC.
On May 23, 2000, the Company acquired all of the capital stock of The
Cordada Group, Inc. ("Cordada") for approximately 758,219 shares of common
stock, par value $.01 per share of the Company. Cordada provides
e-Business solutions to businesses ranging from start-ups to Global 500
companies. Cordada is now a wholly owned subsidiary of the Company named
AppliedTheory Seattle Corporation whose results are consolidated beginning
on the date of acquisition.
Under escrow provisions of the Merger Agreement, the Company has placed in
escrow 160,000 shares of its common stock valued at $20.44 per share
issuable to Cordada's former owners to cover various contingencies. Such
amounts will be recorded as additional cost of the acquired company when
the issuance of shares, if any, becomes determinable beyond a reasonable
doubt. At June 30, 2000, no shares have been since the outcome of the
contingencies was not determinable.
The acquisition was accounted for using the purchase method of accounting.
Accordingly, a portion of the purchase price was allocated to the net
tangible assets acquired based on the estimated fair values. The balance
of the purchase price was recorded as goodwill and is being amortized over
5 years. Acquisition costs were financed using a portion of the net
proceeds of the Company's IPO.
The financial statements reflect the preliminary allocation of the
purchase prices of the above acquisitions and are subject to revision upon
final settlement of all purchase price adjustments and the completion of
evaluations and other studies of the fair value of all assets acquired and
liabilities assumed.
Following is the Company's unaudited proforma results for the six months
ending June 30, 1999 and 2000 as if all of the Company's acquisitions
during 2000 occurred on January 1, 1999.
<TABLE>
<CAPTION>
Six months ended
June 30,
1999 2000
-------------- -------------
<S> <C> <C>
(in thousands, except
per share data)
Net revenues $ 24,889 $ 37,275
Net loss (10,347) (29,820)
Basic and diluted net loss per share (0.44) (1.12)
</TABLE>
7
<PAGE> 8
APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE C - COMPREHENSIVE LOSS
Comprehensive loss for the three and six months ended June 30, 1999 and
2000, was as follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
------------------------------ -------------------------
1999 2000 1999 2000
------------ ------------- ------------ ----------
(in thousands) (in thousands)
<S> <C> <C> <C> <C>
Net loss attributable to common
stockholders $(2,294) $ (12,908) $ (3,952) $ (23,897)
Other comprehensive loss:
Unrealized gain (loss) on
marketable securities, net of
income tax (193) 29 (193) 197
-------- ---------- -------- ----------
Comprehensive loss $(2,487) $ (12,879) $ (4,145) $ (23,700)
======= ========== ======== ==========
</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 outstanding, adjusted for the dilutive effect of potential common
shares issued or issuable pursuant to stock options and stock appreciation
rights. Potential common shares issued are calculated using the treasury
method. All potential common shares have been excluded from the
computation of diluted loss per share as their effect would be
antidilutive and accordingly, there is no reconciliation of basic and
diluted loss per share for the periods presented.
NOTE E - SEGMENT AND RELATED INFORMATION
The Company operates as one business segment, as a provider of Internet
solutions. The Company had revenues from its major service offerings as
follows:
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
--------------------------- -------------------------
1999 2000 1999 2000
------------ ----------- ------------ ----------
(in thousands) (in thousands)
<S> <C> <C> <C> <C>
Net revenues
Internet connectivity $4,947 $ 7,864 $ 9,108 $ 15,329
e-Business solutions 2,939 8,079 5,034 14,706
Web hosting 807 2,045 1,418 3,775
------ ------- -------- -------
Total net revenues $8,693 $17,988 $15,560 $33,810
====== ======= ======= =======
</TABLE>
8
<PAGE> 9
APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE F - PROPERTY AND EQUIPMENT
On December 21, 1998, the Company adopted a plan, which was approved by its
Board of Directors, to close a leased facility, which principally is used
as a Web-hosting data center. The facility has experienced operational
difficulties which limited its usability as a Web-hosting site and its
ability to generate sufficient revenues. In connection with the plan of
abandonment, the Company recorded a $900,000 charge to operations for the
year ended December 31, 1998 consisting of (i) a $486,000 write-down of
equipment and leasehold improvements to management's estimate of their fair
value, based on the anticipated discounted future cash flows through the
date of abandonment, of approximately $70,000 in accordance with the
provisions of SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets To Be Disposed Of" and (ii) a $414,000
accrued liability, included in Accrued Expenses at December 31, 1999,
relating to equipment leases and facility operating leases, (net of
anticipated subrental income) expiring in October 2001 and May 2006,
respectively, in accordance with the provisions of EITF 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to
Exit an Activity." This accrued liability provides for only those costs
subsequent to exiting the facility, that was expected to occur in September
1999, and costs prior thereto will be recognized during the period they are
incurred. The plan calls for the Web-hosting customer base served from this
abandoned facility and the related revenues, which are not significant, to
be transitioned to another facility. The closure date has been delayed
pending completion of additional data centers. As of June 30, 2000, the
Company continues to operate this facility due to delays in its closure
requiring a reduction in the liability of $170,000 which was recorded as
other income. This reversal was partially offset by costs and expenses
incurred on the facility for the six month period ended June 30, 2000.
NOTE G - LONG-TERM DEBT
Line of Credit
On January 20, 1998, the Company entered into a credit agreement with a
bank for an aggregate amount of $7,500,000, which expires on January 19,
2001. The agreement provides for the payment of the unpaid principal
balance of all amounts advanced on January 19, 2001. Interest is charged
and payable on a monthly basis as determined by the Company, either on a
LIBOR plus 50 basis points or a prime rate basis less 200 basis points.
The credit facility is collateralized by substantially all assets of the
Company and by a maximum of $5,500,000 of cash and cash equivalents,
government securities, corporate securities or corporate equities pledged
by NET.
In accordance with the terms of the credit agreement, as amended on August
3, 1999, the bank issued a standby letter of credit in the Company's name
for $650,000, expiring July 30, 2000, pursuant to the amended agreement,
collateralizing the Company's obligation to a third party for a real
property lease. The Company's available credit under its line of credit
agreement is effectively reduced by the outstanding amount of the letter
of credit. The letter of credit agreement was renewed during July 2000 to
expire coincident with the line of credit on January 19, 2001.
As a result of the acquisition of The Cordada Group, Inc., the Company
acquired a credit agreement with a bank for $1,000,000, which expires on
July 15, 2000. Interest is charged and payable on a monthly basis at the
bank's prime rate plus 25 basis points (9.75% at June
9
<PAGE> 10
APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
30, 2000). The credit facility is collateralized by Cordada's accounts
receivable and general intangibles. Subsequent to July 15, 2000, the
credit agreement has been extended until August 15, 2000 pending the
execution of a new agreement.
At June 30, 2000 the Company had $5,710,000 outstanding under the lines of
credit and, as a result of certain restrictions, had $650,000 in
additional availability as of June 30, 2000. The average interest rate on
outstanding borrowings was 6.3% at June 30, 2000.
Borrowings from NYSERNet.net, Inc.
The Company has an unsecured borrowing facility with NET, which provides
for borrowings to a maximum amount of $6,187,000, less any preferred stock
issued to NET, for working capital requirements. This borrowing facility
expires on January 1, 2002. Interest on the loans accrues at the prime
rate (9.5% at June 30, 2000) and payments are deferred for five years from
the date of each advance or January 1, 2002, whichever is earlier. All
principal borrowings under this agreement are due and payable on January
1, 2002. The Company had no principal borrowings under this facility at
December 31, 1999 or at June 30, 2000.
Lease Obligations
The following is a summary of future minimum lease payments under capital
leases as of June 30, 2000.
<TABLE>
<CAPTION>
(in thousands)
<S> <C>
Year ending December 31,
2000 $ 1,908
2001 3,333
2002 2,857
2003 780
-------
Total minimum lease payments 8,878
Less amounts representing interest 1,304
-------
Present value of minimum lease obligation $ 7,574
=======
</TABLE>
NOTE H - CONVERTIBLE DEBENTURE
On June 5, 2000 the Company entered into a financing agreement (the
"Financing Agreement") with seven institutional investors and issued $30
million in 5% convertible debt financing (the "Debentures"). Under related
agreements with these investors (the "Investors"), the Company can also
receive up to an additional $33 million over the next five years from the
exercise of warrants and options for the purchase and sale of the Company's
common stock. The maximum investment by the Investors in the Company under
the agreements is an aggregate of $63 million. See our current report on
Form 8-K filed with the SEC on June 20, 2000 for additional information.
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 or paid.
10
<PAGE> 11
APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Principal and interest accrued on the Debentures are convertible into
common stock at the option of the holder. These Debentures are presently
convertible into 1,797,483 shares of common stock at a conversion price of
$16.69 per share at any time until maturity. On June 5, 2001 and at six
month intervals thereafter, ending June 5, 2003, the conversion price will
reset downward if the average trading price during a period defined in the
Debentures is less than AppliedTheory's stock price during the period when
the initial conversion price was set. The Company may require the Investors
to convert the convertible debentures into common stock if the volume
weighted average price of the common stock exceeds $33.38 on each of 60
consecutive trading days.
The Investors also received detachable warrants to purchase up to
$13,000,000 of the Company's common stock. The warrants are presently
exercisable to purchase up to 749,279 shares of AppliedTheory for $17.35
per share. The warrants expire on June 5, 2005. At June 30, 2000 the
Company had a preliminary estimate that the beneficial conversion features
of the Debentures would result in a total non-cash interest charge of
$956,000 over the two month period prior to August 2, 2000 when the
Debentures become convertible. Operating results for the quarter ended June
30, 2000 include interest expense of $430,000 representing a portion of
this estimated non-cash charge.
The Financing Agreement also provides that the Investors have the option
until June 5, 2001 to purchase up to $10,000,000 of the Company's common
stock, or 599,191 shares, at a purchase price of $16.69 per share and that
the Company has the option until June 5, 2001, under certain conditions, to
require the Investors to purchase an additional $10,000,000 of the
Company's common stock, or 599,191 shares, at $16.69 per share. Based on
the preliminary estimate the Company recorded a $4.8 million debt discount
and corresponding increase in additional paid in capital representing the
allocation of proceeds to the detachable warrants and Investor's call
option. The carrying value of the Debentures is being accreted to the face
value of $30 million using the interest method over the life of the
Debentures. The accretion was $159,000 in the quarter ended June 30, 2000.
These estimates are subject to change as a result of the completion of an
independent valuation of the Debentures and related warrants and options.
NOTE I - REDEEMABLE PREFERRED STOCK
Holders of shares of the Company's redeemable preferred stock were
entitled to receive payment for cumulative dividends at the annual rate of
$14.00 per share (14%) beginning January 1, 1999, based upon a liquidation
value of $100 per share, payable quarterly. On May 5, 1999, the Company
paid $1,993,000 to fully redeem the preferred stock and accrued dividends
in full with the proceeds from the IPO.
NOTE J - 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 $314,000 and $309,000 of compensation expense
associated with these options and stock appreciation rights for the three
months ended June 30, 1999 and 2000 and a total of $627,000 and 618,000
for the six months ended June 30, 1999 and 2000, respectively.
11
<PAGE> 12
APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE K - RELATED PARTY TRANSACTIONS
Transactions with NET and ORG
The Company has entered into an Internet service provider agreement with
ORG to serve as ORG's sole source provider for Internet solutions to ORG's
customer base under contractual arrangements. ORG's customers consist of
(i) unrelated customers for which ORG serves as a conduit to the sales
transactions between the Company and these customers and (ii) member
institutions of ORG for which ORG provides pricing terms below that
charged by the Company to ORG. The Company's revenues from ORG's customer
base for the following periods are:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- -------------------------
1999 2000 1999 2000
------------- ----------- ------------ ----------
(in thousands) (in thousands)
<S> <C> <C> <C> <C>
Unrelated customers $ 743 $ 729 $ 1,442 $ 1,481
Member institutions 1,235 1,287 2,355 2,552
Services to ORG 745 747 960 1,454
---------- ---------- -------- ---------
$ 2,723 $ 2,763 $ 4,757 $ 5,487
========== ========== ======== =========
</TABLE>
During each of the three and six months ended June 30, 1999 and 2000, the
Company charged NET approximately $8,000 and ORG approximately $25,000,
respectively, in management fees.
The excess of the Company's revenues over amounts charged by ORG to its
member institutions was approximately $775,000 and $781,000 for the three
months ended June 30, 1999 and 2000, and $1,473,000 and $1,562,000 for the
six months ended June 30, 1999 and 2000, respectively.
NOTE L -INVESTMENT IN PLANNING TECHNOLOGIES, INC.
On April 4, 2000, the Company converted 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 15% 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 owns approximately 8.5% of PTI's
outstanding common stock. The Company continues to account for the
investments under the cost method.
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APPLIEDTHEORY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE M -SUBSEQUENT EVENTS
TEAM TECH INTERNATIONAL, INC. ACQUISITION
On July 1, 2000, the Company acquired all of the capital stock of Team
Tech International, Inc. ("Team Tech") for approximately 444,489 shares of
common stock, par value $.01 per share of the Company. The Merger
Agreement also includes a performance incentive payment clause whereby up
to an additional 538,140 shares of AppliedTheory common stock will be
issued by December 31, 2000 if specific revenue, EBITDA (earnings before
interest, taxes, depreciation and amortization) and balance sheet targets
are satisfied for the quarter ended September 30, 2000. Team Tech provides
Web consulting and e-Business solutions to commercial clients and
government agencies worldwide. Team Tech will be a wholly owned subsidiary
of the Company named AppliedTheory Austin Corporation whose results will
be consolidated beginning on the date of acquisition. For additional
information see our current report on Form 8-K filed with the SEC on July
14, 2000.
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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, 1999 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.
APPLIED THEORY IS AN INTERNET BUSINESS SOLUTIONS PROVIDER.
The Internet has evolved from a data transport mechanism to a business
tool comprised of a set of strategies, technologies, methodologies, and best
practices. AppliedTheory defines an Internet Business Solution as the ability
to apply each of these to a customer's business model. We assist businesses to
use the Internet to increase profit, decrease costs, and meet business
objectives. We strive to have our comprehensive, integrated services give our
customers a single source for all of their Internet needs.
We look for opportunities to help our customers implement high-tech,
high impact critical business applications. Having evolved from one of the
founding institutions of the Internet, today we deploy mission-critical
Internet solutions to over 1,500 customers. We deploy over 700 employees
nationwide toward meeting our customers' expectations.
OUR EXPERTISE IS MOST CLEARLY SHOWN IN OUR EXPERIENCE.
We have developed business-to-business extranets, portals, and
e-business strategies; built corporate intranets; designed Web site user
interfaces; and constructed e-commerce sites from the ground up. We have done
so throughout the country for major businesses, mid-sized companies and
start-ups.
AppliedTheory provides Internet solutions to some of America's leading
companies, including AOL, Eddie Bauer, Carrier and Time Warner. We provide
Internet access, Web Hosting, and customized Internet-enabled solutions to
America's Job Bank, one of the largest employment services on the Web. We built
a custom solution for Hedgeworld, Ltd. (which serves the hedge fund industry by
linking fund managers to site members and integrating future product offerings)
by leveraging their legacy systems and databases with online capabilities. By
integrating numerous technologies, AppliedTheory created a Web-based solution
for the Boston Marathon, giving them the ability to gather, process, and
present data on the Internet, and eliminated concerns raised by previous years'
connectivity limitations.
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OUR EXPERTISE SPANS MANY INDUSTRIES.
- We provide Internet solutions to many of the nation's 3,700 colleges and
universities.
- We develop healthcare applications for medical professionals, supplying
technology to address and meet the demand for online healthcare delivery
systems.
- We assist manufacturers, suppliers and dealerships in the automotive
industry in creating Websites and other Web-based capabilities.
- We have worked to develop teams with the experience and expertise to
efficiently fulfill the special requirements that government institutions
face.
We have also developed various business relationships with major Internet
technology companies, including Microsoft, Sun, Cisco, Concentric, Covad, IDS
Scheer, PTI, Sprint, and Veritect to give our customers leading technology:
- We rely on Cisco for their high-end routers that serve as the core of our
network backbone.
- Sun Microsystems' development, Web, and file servers are the foundation
for our UNIX hosting.
- We are a Microsoft Certified Solutions provider.
- Veritect supplies network security integration expertise and firewall
support.
- Covad Communications provides high-speed DSL services, and the Concentric
Network supplies access to over 150 points-of-presence which bolster our
dial-in service offerings.
- IDS Scheer assists us in business process reengineering.
- Planning Technologies Inc. provides business consulting to our customers.
- Our access services use Sprint's network, data-engineering, national IP
infrastructure and support resources.
WE HAVE ONE SERVICE - INTERNET BUSINESS SOLUTIONS.
AppliedTheory's suite of Internet solutions is based on the strong
foundation of our e- Business solutions. We use a phased approach designed to
develop and implement a comprehensive Internet strategy for our customers. Our
core expertise is derived from our experience in developing
business-to-business and business-to-consumer Web sites.
We believe that no Internet solution is complete without a completely
integrated hosting solution. Therefore, we offer parallel lines of Hosting
services to our customers. Web Hosting solutions include Web site and network
operation, while AIP Hosting Solutions are designed for Applications Service
Providers who want to use our network infrastructure. Each line of Hosting
services offers Managed Application Hosting as a fully outsourced, upgradeable
solution - saving time and greatly reducing capital expenditures, risk of
obsolescence and internal management responsibilities. Our Dedicated Hosting
offering gives customers a dedicated server while they maintain their own
software management.
We provide Security Consulting Services, VPNs, and Managed Firewalls
for network security. We also provide direct connectivity to the global
Internet via a fully redundant, rigorously engineered, high-speed network
backbone.
In 1999, we tripled our sales force and added over 8 new sales offices
in key cities on the east coast of the U.S. Already in 2000, we have expanded
in the west coast, midwest and the southern U.S. while continuing our expansion
on the east coast. In addition, as previously discussed, we have launched a
vertical sales effort to focus on markets such as higher education, the federal
government, state and local governments, healthcare and automotive. We also
intend to extend our vertical market focus to strategic segments where our
solutions have competitive differentiation and the market opportunity is
significant.
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As part of our expansion strategy we purchased several businesses
through July 31, 2000. On January 5, 2000 we acquired CRL Network Services,
Inc. ("CRL"). CRL provides high speed Internet access and data networking
solutions across the United States and owns and operates a Tier 1 network
backbone. This acquisition allowed us to extend our network footprint, link the
Company's data centers on the east and west coasts, and increase our sales
presence on the west coast. On May 23, 2000 we acquired The Cordada Group, Inc.
("Cordada") and on July 1, 2000 we acquired Team Tech International, Inc.("Team
Tech"). Cordada and Team Tech provide e-Business consulting and managed web
hosting services to customers primarily located in Seattle, Washington and
Austin, Texas, respectively. These e-Business acquisitions allow us to expand
our presence into two more high-tech corridors in the United States and further
leverage our professional service expertise. The acquisition of CRL and Cordada
result in additional revenue and costs in the first and second quarter of 2000
that affect the comparability to the same periods in 1999.
RESULTS OF OPERATIONS
THREE AND SIX MONTHS ENDED JUNE 30, 2000 COMPARED TO THREE AND SIX MONTHS ENDED
JUNE 30, 1999
REVENUE. Total net revenues increased approximately $9.3 million from
$8.7 million in the three months ended June 30, 1999 to $18.0 million in the
three months ended June 30, 2000. Total net revenues increased approximately
$18.2 million from $15.6 million in the six months ended June 30, 1999 to $33.8
million in the six months ended June 30, 2000.
The increase in total net revenues of $18.2 million was driven by $9.7
million in additional e-Business solutions. These services include:
- linking existing databases and legacy systems with the Web; and
- creating open, universal interfaces to business-critical
information and standards-based software used to link with the
systems of suppliers, partners and customers.
The majority of the $9.6 million increase in e-Business solutions was
derived from an additional $6.6 million in services to the New York State
Department of Labor in connection with America's Job Bank. Additionally, during
the same period our revenue from other e-Business solutions customers increased
by $3.0 million to $3.4 million reflecting the continued expansion of this
solution. Our acquisitions of businesses during 2000 contributed $1.0 million
in incremental e-Business solution revenue.
Approximately $6.2 million of the growth during the six months ended
June 30,1999 as compared to the same period in 2000 was from Internet
connectivity revenue. $3.2 million of that growth was attributable to acquired
business and the remaining $3 million increase was due to an increase by the
Company in the number of its connectivity customers, upgrades of service to
higher speed connections and an expansion of special project revenue including
$.5 million for a backbone upgrade.
Web hosting revenue increased by approximately $2.4 million during the
six months ended June 30, 2000. This increase includes $.9 million in new web
hosting revenue from the acquired business. The remainder of the increase
resulted from a $1.5 million increase by the Company in Web monitoring,
management and hosting services for dedicated web hosting customers.
For the six months ended June 30, 2000, as a percentage of total net
revenues, Internet connectivity represented 45%, e-Business solutions
represented 43% and Web hosting represented
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11%. For the six months ended June 30, 1999, as a percentage of total net
revenues, Internet connectivity represented 59%, e-Business solutions
represented 32% and Web hosting represented 9%.
COST OF REVENUE. Cost of revenue increased approximately $7.0 million
from $5.8 million in the three months ended June 30, 1999 to $12.8 million in
the three months ended June 30, 2000. Total cost of revenues increased
approximately $13.9 million from $9.9 million in the six months ended June 30,
1999 to $23.8 million in the six months ended June 30, 2000. The increase in
cost of revenue of $13.9 million was primarily attributable to the factors
below.
- $5.7 million of the increase is attributable to the labor and connection
charges to upgrade our network infrastructure to establish our nationwide
Tier 1 presence and to provide additional capacity to support continued
customer growth;
- the acquired businesses increased Internet connectivity and e-Business
costs of revenue by $3.9 million;
- approximately $2.5 million of the increase was from increased labor and
other professional service costs associated with the expansion of
e-Business solutions provided to the New York State Department of Labor in
connection with America's Job Bank and services provided to other
customers; and
- increased labor costs of $1.2 million support the expansion of web hosting
design and support services.
As a percentage of revenue, cost of revenue increased to 71% in the three
months ended June 30, 2000 from 67% in the three months ended June 30, 1999.
During the six months ended June 30, 2000 cost of revenue increased to 70% of
revenue from 64% of revenue in the six months ended June 30, 1999.
SALES AND MARKETING. For the three months ended June 30, 2000 and
1999, sales and marketing expense was approximately $7.5 million and $2.6
million, respectively. For the six months ended June 30, 2000 and 1999, sales
and marketing expense was approximately $14.2 million and $4.4 million,
respectively. The $9.8 million increase in the six months ended June 30, 2000
reflects a substantial investment in the sales and marketing organizations
necessary to support our expanded customer base and on-going costs to establish
a national sales and marketing program. The largest components of the increase
were $5.9 million in additional salary, commission and related benefit costs;
$1.4 million in increased occupancy costs and other costs to support the
nationwide sales presence. Our marketing program and product management efforts
increased costs by $1.3 million. An acquired business also contributed an
additional $0.6 million in costs. Sales and marketing expense, as a percentage
of revenue, increased to approximately 41% for the three months ended June 30,
2000 from 30% for the three months ended June 30, 1999. During the six months
ended June 30, 2000 sales and marketing increased to 42% of revenue from 28% of
revenue in the six months ended June 30, 1999.
GENERAL AND ADMINISTRATIVE. For the three months ended June 30, 2000
and 1999, general and administrative expenses were approximately $4.9 million
and $2.1 million, respectively. For the six months ended June 30, 2000 and
1999, general and administrative expenses were approximately $9.8 million and
$3.9 million, respectively. The increase in general and administrative expenses
of approximately $5.9 million in the six month period was primarily
attributable to:
- $3.3 million in costs related to salaries and recruiting new personnel;
- $.5 million in additional audit, legal and other professional service
costs;
- $.5 million in increased real estate occupancy costs;
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- $.7 million in additional general and administrative costs from our
merger and acquisition department and costs of abandoned business
acquisitions; and
- other increases necessary to manage the financial, legal and
administrative aspects of our business.
For the quarter ended June 30, 2000, general and administrative
expense increased as a percent of revenue to 27% from 24% for the quarter ended
June 30, 1999. For the six months ended June 30, 2000, general and
administrative expense increased as a percent of revenue to 29% from 25% for
the quarter ended June 30, 1999
RESEARCH AND DEVELOPMENT. Research and development costs are
principally focused in our e-Business solutions and web hosting service
offerings. For the three and six months ended June 30, 2000 and 1999, research
and development expenses have not significantly fluctuated.
DEPRECIATION. For the three months ended June 30, 2000 and 1999,
depreciation expense was approximately $2.6 million and $0.8 million,
respectively. For the six months ended June 30, 2000 and 1999, depreciation
expense was approximately $4.5 million and $1.4 million, respectively. The
increase of $3.1 million in the six months ended June 30, 2000 is primarily
attributable to the acquisition of computer equipment in our upgraded data
centers and equipment used to support the continued expansion of our Internet
Connectivity, Web hosting and e-Business solutions. A portion of the
depreciation expense increase also resulted from additional office furniture
and equipment necessary to support our expanding customer base. Acquired
businesses also contributed an additional $0.4 million in depreciation expense
during the first six months of 2000.
AMORTIZATION. For the three and six months ended June 30, 2000,
amortization expense was approximately $2.5 million and $4.8 million,
respectively. Amortization expense relates to goodwill from businesses acquired
during 2000 and is being amortized over five years.
INTEREST EXPENSE. Interest expense has increased $0.8 million from $0.2
million to $1.0 million for the three months ended June 30, 2000 and 1999,
respectively. Interest expense has increased from $0.3 million to $1.3 million
for the six months ended June 30, 2000 and 1999, respectively. The increase of
$1 million for the six months ended June 30, 2000 is a result of an estimated
$0.4 million non-cash charge for the beneficial conversion features of the $30
million 5% convertible debt issued on June 5, 2000. The convertible debentures
also contributed $0.3 million in debt discount amortization and interest expense
charges during 2000. The new equipment leases and loans during 2000 account for
the remainder of the increase.
INTEREST INCOME. Interest income has decreased from $0.5 million to
$0.3 million for the three months ended June 30, 2000 and 1999, respectively.
However, interest income increased from $0.5 million to $0.7 million for the
six months ended June 30, 2000 and 1999, respectively. These changes are a
result of available proceeds from the IPO and issuance of the debentures.
NET LOSS. Net loss attributable to common stockholders for the quarter
ended June 30, 2000 was approximately $12.9 million, or $0.54 per share,
compared with approximately $2.3 million or $0.12 per share for the quarter
ended June 30, 1999. Net loss attributable to common stockholders for the six
months ended June 30, 2000 was approximately $23.9 million, or $1.02 per share,
compared with approximately $4.0 million or $0.23 per share for the six months
ended June 30, 1999.
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LIQUIDITY AND CAPITAL RESOURCES
On May 5, 1999, we completed our IPO of 5,175,000 shares of common
stock sold at an initial public offering price of $16.00 per share. Gross
proceeds from the offering were $82.8 million, $5.8 million of which was
applied to the underwriting discount and approximately $1.8 million was applied
to expenses related to our offering. As a result, net proceeds from the
offering are approximately $75.2 million.
On June 5, 2000, we issued $30 million in 5% convertible debentures
due June 5, 2003 to seven institutional investors. These debentures are
currently convertible into approximately 1,797,500 shares of common stock at
any time until maturity. After payment of $1.0 million in fees and expenses net
proceeds of $29.0 million were received. See additional discussion in Note H to
the financial statements.
At June 30, 2000, we had $7.9 million in cash and cash equivalents,
$27.1 million in marketable securities and a $22.6 million working capital
surplus. This represents a $12.6 million decrease in available cash and cash
equivalents and securities from December 31, 1999. Although we have utilized a
portion of the available proceeds from our IPO we have several sources of
additional funds at our disposal. These include liquidation of marketable
securities, drawing from three available lines of credit and, if certain events
occur, exercise of a $10 million put option for additional financing. Our
marketable securities are generally fixed rate short-term investment grade
corporate bonds and notes. At June 30, 2000, all of our investments are due to
mature within eighteen months but could be sold prior to maturity to provide
working capital or finance future acquisitions.
Our principal uses of cash are to fund operations, working capital
requirements and capital expenditures. We had an accumulated deficit of $53.7
million at June 30, 2000, and have used $19.0 million in cash in the aggregate
to fund operations since January 1, 2000 through June 30, 2000.
- Net cash used in operating activities for the six months ended June 30,
2000 and 1999 was approximately $19.0 million and $2.8 million. The
increase of $16.2 million is a result of $19.9 million in increased net
losses from operations in the period and $5 million in unfavorable working
capital changes offset by increased amortization of goodwill of $5 million
and $3.1 million in additional depreciation expense.
- Net cash used in investing activities for the six months ended June 30,
2000 and 1999 was approximately $18.5 million and $62.3 million. The
significant decrease of approximately $43.8 million is a result of
purchasing $55.3 million in marketable securities and investing $5 million
in PTI with IPO proceeds during 1999. During 2000 an additional $11.2
million in property and equipment were purchased, business acquisitions
used $10.9 million and marketable securities transactions provided a $5.9
million in cash for these acquisitions.
- For the six months ended June 30, 2000 and 1999 cash of approximately
$70.4 million and $30.6 million, respectively, was provided by financing
activities. The decrease of approximately $39.8 million results primarily
from the generation of $75.4 million in IPO proceeds during 1999 and the
generation of $33 million in proceeds from the issuance of convertible
debentures and long term debt financing in 2000. These inflows are offset
by repayments of debt consists principally of the repayment of long-term
debt assumed in connection with the business acquired in the first quarter
of 2000 and routine principal payments on existing loans.
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We have made capital investments in our network operations center,
data center and other capital assets totaling $13.2 million and $2.0 million in
the six months ended June 30, 2000 and 1999, respectively. We acquired assets
under capital leases for $5.0 million in the six months ended June 30, 2000.
At June 30, 2000 we have three lines of credit available to provide
working capital.
- The first is a secured revolving line of credit with Fleet National Bank
for $7.5 million which expires on January 19, 2001. Borrowings under this
line are secured by substantially all our assets and by a maximum of $5.5
million of assets pledged by NYSERNet.net. At June 30, 2000, borrowings
under this line amounted to $5.5 million. As of June 30, 2000, as a result
of restrictions under the line of credit, no additional credit was
available under this agreement.
- We also have an unsecured revolving borrowing facility with NYSERNet.net,
which provides for borrowings up to a maximum amount of approximately $6.2
million, less any preferred stock issued to NYSERNet.net. As of June 30,
2000, $6.2 million was available under this borrowing facility.
- As a result of our acquisition of The Cordada Group, Inc., we have a
secured revolving line of credit with Pacific Northwest Bank for $1
million. The line of credit expired on July 15, 2000 but was extended to
August 15, 2000 pending the execution of a new agreement. The credit
facility is collateralized by Cordada's accounts receivable and general
intangibles. At June 30, 2000, borrowings under this line amounted to $0.2
million. As of June 30, 2000, as a result of restrictions under the line
of credit, $0.6 million in additional credit was available under this
agreement.
At June 30, 2000 we had $27.1 million in marketable securities, $7.9
million in cash, $6.8 million in availability under the aforementioned
financing agreements and, if certain events occur, a $10 million put option for
additional financing. We may need to raise additional funds through public or
private financing, strategic relationships or other arrangements. There can be
no assurance that additional financing, if needed, will be available on terms
acceptable to us, or at all. If additional financing is unavailable or delayed
we have developed contingency plans to reduce costs and expenses. 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.
COMMITMENTS
Annual maturities of our debt obligations are as follows: $1.8 million
in 2000, $9.0 million in 2001, $3.2 million in 2002 and $30.1 million in 2003.
Debt maturing in 2001 includes $5.5 million borrowed under the Fleet National
Bank line of credit that expires January 19, 2001. Debt maturing in 2003
includes $30.0 million in convertible debentures maturing on June 5, 2003.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
At June 30, 2000, we had various financial instruments consisting of
variable rate debt and short-term investments entered into for purposes other
than trading. The substantial majority of our outstanding debt obligations have
variable interest rates of LIBOR plus 50 basis points or prime rate less 200
basis points. At June 30, 2000, the carrying
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value of our debt obligations approximate the fair value due to debt discount
recorded on the convertible debenture and the short maturity and/or variable
interest rates of the other debt. The weighted average interest rate of our
debt obligations at June 30, 2000 was approximately 6.6%.
Our investments are generally fixed rate short-term investment grade
corporate bonds and notes. At June 30, 2000, all of our investments are due to
mature within eighteen months and are carried at fair value of $27.1 million.
These investments are subject to interest rate risk, market risk and in some
cases foreign currency risk. Market risk is estimated as the potential loss in
fair value resulting from a hypothetical 10% adverse change in the securities'
quoted market prices, and amounted to $2.7 million at June 30, 2000. We
actively monitor the capital and investing markets in analyzing our capital
raising and investing decisions.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
There have been no material changes to the status of legal proceedings
previously reported in our annual report on Form 10-K filed with the SEC.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On May 5, 1999, we completed our initial public offering, or IPO, of
5,175,000 shares of our common stock. The offering was made pursuant to a
registration statement on Form S-1 (File No. 333-72133) which registered up to
5,175,000 shares of our common stock and was declared effective on April 29,
1999. The offering commenced on April 30, 1999 and all 5,175,000 shares
registered in our offering were sold at an initial public offering price of
$16.00 per share. The managing underwriters were Bear, Stearns & Co. Inc., CIBC
World Markets Corp., Lehman Brothers Inc. and Wit Capital Corporation. Gross
proceeds from the offering were $82.8 million, $5.8 million of which was
applied to the underwriting discount. In total approximately $1.8 million was
applied to expenses incurred for our offering. As a result, net proceeds from
the offering are approximately $75.2 million. Except as discussed herein with
respect to our repayment of a revolving line of credit and redemption of our
preferred stock to NYSERNet.net, none of the net proceeds of our offering were
paid by us, directly or indirectly, to any of our directors, officers or any of
their associates, or to any person or entity owning 10 percent or more of our
equity securities or the equity securities of any of our affiliates.
On May 5, 1999, we paid approximately $3.8 million to repay outstanding
borrowings under our revolving line of credit with NYSERNet.net, including
accrued interest. We also paid approximately $2.0 million to redeem our
outstanding preferred stock, including accrued dividends, all of which was held
by NYSERNet.net. As of June 30, 2000, NYSERNet.net owns approximately 19.4% of
our common stock and has one representative on our board of directors.
On June 22, 1999, the Company purchased 10% of the ownership interests
of Planning Technologies, Inc., ("PTI"), for $5.0 million, by purchasing
approximately 2,976,190 shares of convertible preferred stock of PTI. For
additional information about this investment, please see our current report on
Form 8-K (File No. 000-25749), filed with the SEC on July 7, 1999.
On January 5, 2000, the Company acquired CRL Network Services, Inc.
for up to approximately $9.9 million in cash and up to approximately 2,022,287
unregistered shares of our common stock. For additional information about this
acquisition, please see our current report on Form 8-K (File No. 000-25749),
filed with the SEC on January 20, 2000. On February 2, 2000, the
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Company acquired Y.C. Inc., a Michigan corporation doing business as Customnet
for up to $.6 million in cash and 24,605 unregistered shares of our common
stock.
On May 23, 2000, the Company acquired The Cordada Group, Inc., a
Washington corporation, for up to approximately 758,219 unregistered shares of
our common stock. For additional information about this acquisition, please see
our current report on Form 8-K (File No. 000-25749), filed with the SEC on June
1, 2000. On June 21, 2000, the Company acquired The New Media Group, Inc., a
Virginia corporation, for up to 140,000 unregistered shares of our common stock.
On June 5, 2000, the Company issued $30 million in 5% convertible
debentures (the "Debentures") due June 5, 2003. These Debentures are presently
convertible into 1,797,483 shares of common stock at any time until maturity.
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 or paid. Accrued interest is convertible into shares of common stock.
These Debentures are presently convertible into 1,797,483 shares of common stock
at a conversion price of $16.69 per share at any time until maturity. On June 5,
2001 and at six month intervals thereafter, ending June 5, 2003, the conversion
price will reset downward if the average trading price during a period defined
in the Debentures is less than AppliedTheory's stock price during the period
when the initial conversion price was set. The Company may require the Investors
to convert the convertible debentures into common stock if the volume weighted
average price of the common stock exceeds $33.38 on each of 60 consecutive
trading days. In connection with the issuance of the Debentures, (a) the
investors received detachable warrants to purchase up to $13,000,000 of the
Company's common stock for $17.35 per share; expiring on June 5, 2005, (b) the
Investors have the option expiring June 5, 2001 to purchase up to $10,000,000 of
the Company's common stock, or 599,191 shares, at a purchase price of $16.69 per
share and (c) the Company has the option, under certain conditions, until June
5, 2001 to require the Investors to purchase an additional $10,000,000 of the
Company's common stock, or 599,191 shares, at $16.69 per share. See our current
report on Form 8-K filed with the SEC on June 20, 2000 for additional
information.
We have used and intend to use the remaining proceeds from our initial
public offering and the proceeds from the sale of the 5% Convertible Debentures
due June 5, 2003 to fund the Company's operations, for general corporate
purposes and working capital requirements, including the following:
- to expand our sales and marketing efforts in approximately 20 metropolitan
areas;
- to continue to increase the size of our sales force;
- to expand our customer support services;
- for working capital requirements and other general corporate purposes; and
- for possible acquisitions.
No portion of the proceeds from our IPO or Debenture issuance has been
allocated for any specific purpose referred to above. We have discretionary
authority over the use of net proceeds from the offerings. In addition, we
intend to use a portion of the net proceeds from these offerings to add
additional data center capacity.
Pending the above uses, we have invested the proceeds of the offerings
in short-term, interest bearing investment grade securities.
During the three months ended June 30, 2000, proceeds of approximately
$879,000 were generated from the exercise of options for 387,274 shares of our
common stock. There were no significant expenses, underwriting discounts or
commissions attributable to these proceeds. These
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options had been granted under our 1996 Incentive Stock Option Plan and were
exercised by certain employees and directors. During the three months ended
June 30, 2000, proceeds of approximately $558,000 were generated from issuances
under our Employee Stock Purchase Plan of 63,996 shares of our common stock.
There were no significant expenses, underwriting discounts or commissions
attributable to these proceeds. The shares issued pursuant to our 1996 Option
Plan 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
On May 25, 2000, the annual meeting of the stockholders of
AppliedTheory Corporation was held pursuant to a notice dated April 11, 2000,
which was mailed to all stockholders. The meeting was called in order to elect
one director to the Board of Directors and to ratify the appointment of Grant
Thornton LLP as independent certified public accountants for the Company. The
stockholders elected Dr. George Sadowsky as a Class I director whose term will
expire at the 2003 annual meeting of stockholders. The terms of each of the
current Class II directors, Dominick DeAngelo, and Dr. Shelly A. Harrison expire
at the 2001 annual meeting of stockholders. The terms of each of the current
Class III directors, James T. Kelsey and Dr. Richard Mandelbaum expire at the
2002 annual meeting of stockholders.
The election of a Class I Director and the appointment of Grant
Thornton LLP as independent certified public accountants for the Company
received stockholders' approval at this meeting. Holders of the following
shares were present in person or by proxy at this meeting and votes were cast
in the following manner:
Election of Class I Director: 23,542,234 shares of Common Stock
outstanding, 18,088,960 shares present and voting in favor of the
election of Dr. George Sadowsky as a Class I director, representing 77
% of the common stock outstanding.
Ratification of Grant Thornton LLP as independent certified public
accountants: 17,991,166 shares present and voting in favor of the
ratification, representing 76 % of the common stock outstanding.
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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.
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 operations infrastructure;
- expanding our sales structure and marketing programs;
- increasing awareness of our brand;
- providing services to our customers that are reliable and
cost-effective;
- responding to technological development or service offerings by
competitors; and
- attracting and retaining qualified personnel.
If we are not successful in implementing our business plan, our
business or future financial or operating results could suffer.
WE HAVE A HISTORY OF SIGNIFICANT LOSSES AND EXPECT THESE LOSSES TO INCREASE IN
THE FORESEEABLE FUTURE.
We have incurred significant net losses and negative cash flows from
operations in each quarterly and annual period since inception and expect to
continue to do so for the foreseeable future. At June 30, 2000 and December 31,
1999 and 1998, we had an accumulated deficit of approximately $53.7 million,
$29.8 million and $15.7 million, respectively. We incurred net losses of $23.9
million in the six months ended June 30, 2000 and $14.1 million, $7.1 million
and $6.1 million in the three years ended December 31, 1999, 1998 and 1997,
respectively. In connection with our expansion plans, we anticipate making
significant investments in sales and marketing, customer support and personnel.
As a result of our expansion plans, we expect our net losses and negative cash
flows from operations on a quarterly and annual basis to be significant in the
foreseeable future. Our ability to achieve profitability is dependent in large
part upon the successful implementation of our expansion strategy. We cannot
assure you that we will achieve or sustain revenue growth or profitability on
either a quarterly or annual basis.
PRIOR TO 2000, MOST OF OUR REVENUES HAVE BEEN DERIVED FROM CUSTOMERS LOCATED IN
NEW YORK STATE AND WE MAY NOT SUCCESSFULLY OPERATE ON A NATIONWIDE BASIS.
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Prior to 2000, most of our revenues have been derived from customers
located in New York State. Our business strategy is to become a leading
national provider of advanced Internet technology solutions to mid-sized
businesses, mid-sized departments of larger businesses, and specifically
targeted vertical markets. The risks we may encounter in operating on a
nationwide basis include the possibility that:
- our solutions are not accepted beyond our current market;
- there are significant delays in the completion of any new data
centers or any existing data centers; and/or
- we fail to develop a nationally recognized brand.
OUR RAPID GROWTH STRATEGY IS LIKELY TO PLACE A SIGNIFICANT STRAIN ON OUR
RESOURCES.
Our future success depends in large part on our ability to manage any
achieved growth in our business. For our nationwide operating plan to succeed,
we will need:
- to expand our business with new and current customers;
- to develop and offer successful new products and services;
- to retain key employees and hire new employees; and
- to ensure that any future business we may develop or acquire will
perform in a satisfactory manner.
These activities are expected to place a significant strain on our
resources. Also, we cannot guarantee that any of these will occur or that we
will succeed in managing the results of any success in our nationwide operating
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 Internet access
industry;
- potential unfavorable legislative and regulatory developments;
- growth of Internet use and establishment of Internet operations
by mainstream enterprises; and
- changes in our pricing policies and our competitors' pricing
policies.
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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.
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 e-Business, Web
hosting and Internet connectivity needs;
- our failure to successfully market our products and services to
new customers; and
- the inability to maintain and strengthen our brand awareness.
OUR SUCCESS DEPENDS IN LARGE PART ON THE CONTINUED GROWTH OF THE INTERNET
MARKET.
Our business will be hurt if Internet usage does not continue to grow.
Internet usage may be inhibited for a number of reasons, including:
- access costs;
- inadequate network infrastructure;
- security concerns;
- uncertainty of legal and regulatory issues concerning use of the
Internet;
- inconsistent quality of service; and
- lack of availability of cost-effective, high-speed service.
If Internet usage grows, the Internet infrastructure may not be able
to support the demands placed on it or the Internet's performance and
reliability may decline. Similarly, Web sites have experienced interruptions in
their service as a result of outages and other delays occurring throughout the
Internet network infrastructure. If these outages or delays occur frequently,
use of the Internet as a commercial or business medium could, in the future,
grow more slowly or decline. This could hurt our business.
WE OPERATE IN AN EXTREMELY COMPETITIVE MARKET AND MAY NOT BE ABLE TO COMPETE
EFFECTIVELY.
The Internet-based services market is extremely competitive and many
of our competitors are more established and have greater financial resources
than us. In addition, there are no substantial barriers to entry in this
market. We also expect that competition will intensify in the future. Many of
our competitors have greater market presence, engineering and marketing
capabilities and financial, technological and personnel resources than we do.
As a result, as compared to us our competitors may:
- develop and expand their network infrastructures and service
offerings more efficiently or more quickly;
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- adapt more swiftly to new or emerging technologies and changes in
customer requirements;
- take advantage of acquisitions and other opportunities more
effectively; and
- more effectively leverage existing relationships with customers
or exploit a more recognized brand name to market and sell their
services.
Our current and prospective competitors, both in New York State and
nationally, generally may be divided into the following three groups:
- Internet access, VPNs and security providers including GTE
Internetworking, Verio Inc., Qwest Communications International
Inc., Sprint Corporation, AT&T Corp., UUNET Technologies, Inc.,
Concentric Network Corp., Cable & Wireless plc, WorldCom, Inc.
and other national and regional providers;
- Web and application hosting companies including Digex, Inc.,
Frontier Global Center, GTE Internetworking, Globix Corporation,
PSINet Inc., Exodus Communications, Inc. and other companies; and
- e-Business solution companies including Razorfish Inc., IBM
Global Services, Andersen Consulting, US Internetworking Inc.,
Scient Corp., Cambridge Technology Partners, Inc., Whittman-Hart
Inc., Oracle Corporation, the Big 5 accounting firms, EDS
Corporation and other companies.
We believe that we may also face competition from other large computer
hardware and software companies and other media, technology and
telecommunications companies.
The number of businesses providing Internet-related services is
rapidly growing. We are aware of other companies, in addition to those named
above, that have entered into or are forming joint ventures or consortia to
provide services similar to those provided by us. Others may acquire the
capabilities necessary to compete with us through acquisitions.
WE COULD ENCOUNTER SIGNIFICANT PRICING PRESSURE AS A RESULT OF INCREASED
COMPETITION AND INDUSTRY CONSOLIDATION.
As a result of increased competition and consolidation in the
industry, we could encounter significant pricing pressure, which in turn could
result in significant reductions in the average selling price of our services.
We may not be able to offset such price reductions even if we obtain an
increase in the number of our customers, derive higher revenue from enhanced
services or manage to reduce our costs. Increased price or other competition
could erode our market share and could significantly hurt our business. We
cannot assure you that we will have the financial resources, technical
expertise or marketing and support capabilities to continue to compete
successfully in that environment.
OUR REVENUES ARE HEAVILY DEPENDENT ON TWO CUSTOMERS. IF WE LOSE EITHER OF THESE
CUSTOMERS, IF EITHER OF THEM REDUCES THE AMOUNT OF WORK IT DOES WITH US, OR IF
WE FAIL TO DIVERSIFY OUR CUSTOMER BASE, OUR BUSINESS WILL SUFFER.
We currently derive a substantial portion of our total revenue from
contracts with two customers - NYSERNet.org, Inc., a not-for-profit corporation
that is also affiliated with one of our major stockholders, and the New York
State Department of Labor. The loss of either of these customers could
significantly hurt our business. For the six months ended June 30, 2000,
revenue from NYSERNet.org, Inc. represented approximately 16% of our total
revenue. For the years ended December 31, 1999, 1998 and 1997, revenue from
NYSERNet.org, Inc. represented approximately 27%, 37%, and 47% of our total
revenue, respectively. Revenue under the agreement with the New York State
Department of Labor for the six months ended June 30, 2000 represented 37% of
our
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total revenue. Revenue under the agreement with the New York State Department
of Labor for the years ended December 31, 1999, 1998 and 1997 represented 39%,
28%, and 16% of our total revenue, respectively.
We have an agreement with NYSERNet to provide NYSERNet and its
customers with services. Under this long term agreement we provide services to
approximately 140 different customers affiliated with NYSERNet. Each of these
customers makes individual buying decisions resulting in separate agreements.
As the initial agreements with NYSERNet's customers expire some customers began
contracting directly with us. The initial master agreement has an original term
of three years, ending October 1, 2001, and is automatically renewable for
successive one-year terms. 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 network backbone 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 concluded 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 2002, we will enhance 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.
Our contract with the New York State Department of Labor is 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 49 different
states and territories. Each of these states and territories make individual
buying decisions and may terminate their 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 assure you that revenue from these two customers, or from
other customers that have accounted for significant revenue in past periods,
individually or as a group, will continue, or if continued, will reach or
exceed historical levels in any future period. In addition, we may not succeed
in diversifying our customer base in future periods.
WE COULD EXPERIENCE SYSTEM FAILURES AND CAPACITY CONSTRAINTS, WHICH WOULD
AFFECT OUR ABILITY TO COMPETE.
Interruptions in service to our customers could hurt our business. To
succeed, we must be able to operate our network management infrastructure 24
hours per day, seven days per week, without interruption. Our operations depend
upon our ability to protect our network infrastructure, our equipment and
customer data against damage from human error or "acts of God." Even if we take
precautions, the occurrence of a natural disaster or other unanticipated
problems could result in interruptions in the services we provide to our
customers.
At this time, we do not have a formal disaster recovery plan. Although
we have attempted to build redundancy into our network and hosting facilities
by establishing a fully redundant, rigorously engineered national Tier 1
backbone connected to three different data 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:
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- 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, Bell Atlantic Corp., Pacific Bell 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 infrastructure may require substantial
financial, operational and management resources. We may not be able to expand
or adapt our network infrastructure on a timely basis and at a commercially
reasonable cost to meet additional demand, changing customer requirements or
evolving industry standards. In addition, if demand for usage of our network
were to increase faster than projected or were to exceed our current forecasts,
the network could experience capacity constraints which would hurt its
performance.
The current 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 increased the prices
for their services or if the telecommunications capacity available to us was
insufficient for our business purposes, and we were unable to use alternative
networks or pass along any increased costs to our customers, 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 Internet users. This could result in our
being liable for damages, and our reputation could suffer,
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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 in
Internet services, to date, our market presence has been limited principally to
New York State. We have generated our existing revenue primarily through a
small sales force and word of mouth. In order to build our brand awareness, our
marketing efforts must succeed, and we must provide high quality services. We
expect to increase our marketing budget substantially as part of our brand
building efforts. We cannot assure you that these investments will succeed as
planned. If we do not build our brand awareness, our ability to realize our
strategic and financial objectives could be hurt.
IF WE DO NOT RESPOND EFFECTIVELY AND ON A TIMELY BASIS TO RAPID TECHNOLOGICAL
CHANGE, OUR BUSINESS COULD SUFFER.
If we do not successfully use or develop new technologies, introduce
new services or enhance our existing services on a timely basis, or new
technologies or enhancements used or developed by us do not gain market
acceptance, our business could be hurt. The Internet industry is characterized
by rapidly changing technology, industry standards, customer needs and
competition, as well as by frequent new product and service introductions. Our
future success will depend, in part, on our ability to accomplish all of the
following in a timely and cost-effective manner, all while continuing to
develop our business model and rolling-out our services on a national level:
- effectively use and integrate leading technologies;
- continue to develop our technical expertise;
- enhance our products and current networking services;
- develop new products and services that meet changing customer
needs;
- have the market accept our services;
- advertise and market our products and services; and
- influence and respond to emerging industry standards and other
changes.
We cannot assure you that we will successfully use or develop new
technologies, introduce new services or enhance our existing services on a
timely basis, or that new technologies or enhancements used or developed by us
will achieve market acceptance. Our pursuit of necessary technological advances
may require substantial time and expense. In addition, we cannot assure you
that, if required, we will successfully adapt our network and services to
alternate access devices and conduits.
If our services do not continue to be compatible and interoperable
with products and architectures offered by other industry members, our ability
to compete could be impaired. Our
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ability to compete successfully is dependent, in part, upon the continued
compatibility and interoperability of our services with products and
architectures offered by various other members of the industry. Although we
intend to support emerging standards in the market for Internet 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/Internetwork Protocol, commonly known as TCP/IP, which is an industry
standard to facilitate the transfer of data. Alternative open protocol and
proprietary protocol standards could emerge and become widely adopted. A
resulting reduction in the use of TCP/IP could render our services obsolete and
unmarketable. Our failure to anticipate the prevailing standard or the failure
of a common standard to emerge could hurt our business.
WE DERIVE SIGNIFICANT REVENUE FROM CONTRACTS WITH GOVERNMENT AGENCIES. THESE
CONTRACTS OFTEN ARE SUBJECT TO A COMPLEX PROCUREMENT PROCESS, REQUIRE
COMPLIANCE WITH VARIOUS GOVERNMENT REGULATIONS AND POLICIES AND MAY BE SUBJECT
TO UNILATERAL TERMINATION OR MODIFICATION BY THE GOVERNMENT. IN ADDITION,
CHANGES IN GOVERNMENT FUNDING AND OTHER POLICY DECISIONS COULD JEOPARDIZE OUR
CONTRACTS WITH GOVERNMENT AGENCIES.
Contracts with various government agencies accounted for approximately
53% of our revenues in year ended December 31, 1999 and 43% in the six months
ended June 30, 2000. Government contracts are often subject to a competitive
bidding process, which is governed by applicable federal and state statutes and
regulations. The procurement process for government contracts is complex and
can be very time consuming.
Because of our contracts with governmental agencies, we are required
to comply with various government regulations and policies. For instance, we
are required to maintain employment policies relating to equal opportunity, and
we are subject to audit by the government to confirm our compliance with these
policies. If we fail to comply with regulations which apply to government
contractors, we may face sanctions, including substantial fines and
disqualification from being awarded government contracts in the future.
Contracts with governmental agencies are subject to the risk of
unilateral termination by the government for its convenience and reductions in
services, or modifications in contractual terms, due to changes in the
government's requirements or to budgetary restraints.
In addition, the government may not continue to fund the projects and
programs with which we work. Even if funding continues, we may not obtain this
funding. We cannot assure you that we will be able to procure additional
government contracts, that we will be able to retain our existing government
contracts or, if retained, that these contracts will be fully funded.
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 network assets,
Internet-related technologies, e-Business companies and other businesses
complementary to our operations. In the 14 months ending June 30, 2000 we have
acquired or invested in several companies. In the future, we intend to 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;
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- 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;
- 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 one or more 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. Acquisitions required to be accounted for under the
purchase method could result in significant goodwill and/or amortization
charges for acquired technology.
WE ARE DEPENDENT ON OUR HARDWARE AND SOFTWARE SUPPLIERS TO PROVIDE US WITH THE
PRODUCTS AND SERVICES WE NEED TO SERVE OUR CUSTOMERS.
We rely on outside vendors to supply us with computer hardware,
software and networking equipment. These products are available from only a few
sources. We purchase virtually all of these products from Sun Microsystems,
Inc., Compaq Computer Corporation and Cisco Systems, Inc. We cannot assure you
that we will be able to obtain the products and services that we need on a
timely basis and at affordable prices.
We have in the past experienced delays in receiving shipments of
equipment purchased for resale. To date, these delays have not adversely
affected us, but we cannot guarantee that we will not be adversely affected by
delays in the future. We may not be able to obtain computer equipment on the
scale and at the times required by us at an affordable cost. Our suppliers may
enter into exclusive arrangements with our competitors or stop selling us their
products or services at commercially reasonable prices. If our sole or limited
source suppliers do not provide us with products or services, our business,
financial condition and results of operations may be significantly hurt.
WE OPERATE IN AN UNCERTAIN REGULATORY AND LEGAL ENVIRONMENT. NEW LAWS AND
REGULATIONS COULD HARM OUR BUSINESS.
We are not currently subject to direct regulation by the Federal
Communications Commission or any other governmental agency, other than
regulations applicable to businesses in general. However, in the future, we may
become subject to regulation by the FCC or another regulatory agency. Our
business could suffer depending on the extent to which our activities are
regulated or proposed to be regulated.
While there are currently few laws or regulations which specifically
regulate Internet communications, laws and regulations directly applicable to
online commerce or Internet communications are becoming more prevalent. There
is much uncertainty regarding the market-place impact of these laws. In
addition, various jurisdictions already have enacted laws covering intellectual
property, privacy, libel and taxation that could affect our business by virtue
of their impact on online commerce. Further, the growth of the Internet,
coupled with publicity regarding Internet fraud, may lead to the enactment of
more stringent consumer protection laws. If we become
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subject to claims that we have violated any laws, even if we successfully
defend against these claims, our business could suffer. Moreover, new laws that
impose restrictions on our ability to follow current business practices or
increase our costs of doing business could hurt our business.
WE MAY BE SUBJECT TO LEGAL LIABILITY FOR DISTRIBUTING OR PUBLISHING CONTENT
OVER THE INTERNET, WHICH COULD BE COSTLY FOR US TO DEFEND.
It is possible that claims will be made against online 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 NEED ADDITIONAL FUNDS WHICH, IF AVAILABLE, COULD RESULT IN DILUTION OF
YOUR SHAREHOLDINGS OR AN INCREASE IN OUR INTEREST EXPENSE. IF THESE FUNDS ARE
NOT AVAILABLE, OUR BUSINESS COULD BE HURT.
We have and intend to use the remaining proceeds from our initial
public offering and the proceeds from the sale of the 5% Convertible Debentures
due June 5, 2003 to fund the expansion of our sales and marketing efforts, to
expand our customer support services, for making investments or acquisitions
and for general corporate and working capital purposes. Our business plan
includes aggressive expansion through acquisitions funded mostly with stock but
requiring some cash expenses and consideration. While we believe that the
remaining proceeds from our initial public offering and sale of Debentures will
be sufficient for these purposes, we may 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; or
- respond to unanticipated competitive pressures.
If additional funds become necessary, additional financing may not be
available on terms favorable to us or available at all. If adequate funds are
not available or are not available on acceptable terms when needed, our
business could be hurt.
If additional funds are raised through the issuance of equity
securities, the percentage ownership of our then current stockholders may be
reduced, and the new equity securities may have rights, preferences or
privileges senior to those of the holders of our common stock. If additional
funds are raised through the issuance of debt securities, these securities
would have some rights, preferences and privileges senior to those of the
holders of our common stock, and the terms of this debt could impose
restrictions on our operations and result in significant interest expense to
us.
SIGNIFICANT STOCKHOLDERS AND CURRENT MANAGEMENT CONTROL APPROXIMATELY 64% OF
OUR COMMON STOCK, AND THESE PARTIES MAY HAVE CONFLICTS OF INTEREST.
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Broadwing, NYSERNet.net, Inc. and Grumman Hill control approximately
24.6%, 19.4% and 12.3%, respectively, of our outstanding common stock at June
30, 2000. In addition, our executive officers and directors may be deemed to
beneficially own in the aggregate approximately 8% 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. Broadwing, Grumman Hill and NYSERNet.net each have one representative on
our board of directors. Grumman Hill has a significant equity interest in
Broadwing. NYSERNet.net, NYSERNet.org, 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.
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 would particularly impact 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. In the past, following periods of volatility in the market
price of a company's securities, securities class action litigation has often
been instituted against the company in question. If we become subject to
securities litigation, we could incur substantial costs and experience a
diversion of management's attention and resources.
Also, a substantial number of shares of common stock issuable upon
exercise of outstanding stock options are available for resale in the public
market as a result of our filing a registration statement on Form S-8 with the
Securities and Exchange Commission on July 19, 1999 (File No. 333-83177) in
order to register the shares issued and issuable upon the exercise of options
granted under our 1996 Incentive Stock Option Plan, or granted and to be
granted under our 1999 Stock Option Plan and our 1999 Employee Stock Purchase
Plan.
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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.
The market price of our common stock could drop as a result of future
sales of a large number of shares of our common stock in the market.
As a result of our re-offer prospectus filed on Form S-8 with the
Securities and Exchange Commission on July 19, 1999, 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,
stockholders who sell shares of our common stock under this re-offer prospectus
must comply with the volume of sale limitations imposed under Rule 144(e) of
the Securities Act.
As a result of filing Form S-3 with the Securities and Exchange
Commission and subsequent effectiveness of the registration statement,
approximately 839,881 shares of our outstanding common stock will no longer
qualify as "restricted securities" under Rule 144 of the Securities Act and,
under the Securities Act, these shares may be freely re-offered and re-sold. In
addition, if certain parties convert the 5% Convertible Debentures into common
stock or exercise warrants to purchase common stock, or the Company or holder
exercise their option to convert a promissory note for common stock up to an
additional 4,109,498 shares of our common stock would be registered and freely
tradable.
Therefore, through the S-8 re-offer prospectus and S-3 registration
statement, 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 June 30, 2000, an additional 54% of the shares of our common
stock continue to be restricted securities. Certain of the holders of these
restricted securities have registration rights with respect to these
restricted shares and with respect to any after-acquired shares. Also, under
Rule 144 these shares become freely tradable in the future.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8K
(a.) EXHIBITS.
The following Exhibits are filed or incorporated by reference herewith:
Exhibit 10.54 Amendment No. 2 to Resale Agreement between
AppliedTheory Corporation and NYSERNet.org, Inc.
dated April 18, 2000
Exhibit 10.55 Loan Agreement between FINOVA Capital Corporation
and AppliedTheory Corporation dated May 30, 2000.
Exhibit 11.1 Calculation of Basic and diluted loss per share
and weighted average shares used in calculation
for the three months ended June 30, 2000.
Exhibit 11.2 Calculation of Basic and diluted loss per share
and weighted average shares used in calculation
for the six months ended June 30, 2000.
Exhibit 27.1 Financial Data Schedule for the three months ended
June 30, 2000, which is submitted electronically to
the Securities and Exchange Commission for
information only.
Exhibit 27.2 Financial Data Schedule for the six months ended
June 30, 2000, which is submitted electronically to
the Securities and Exchange Commission for
information only.
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(b.) REPORTS ON FORM 8K.
On January 20, 2000 and March 20, 2000, we filed a current report
on Form 8-K and a current report on Form 8-K/A that included
information relating to an agreement and plan of merger dated December
3, 1999 to purchase CRL Network Services, Inc. The current report on
Form 8-K/A included CRL's financial statements and pro forma financial
information. AppliedTheory agreed to acquire all of the capital stock
of CRL for up to $10 million in cash and up to 2,031,250 shares in
AppliedTheory common stock. The acquisition was consummated on January
5, 2000.
On June 1, 2000, we filed a current report on Form 8-K that
included information relating to an agreement and plan of merger dated
May 15, 2000 to purchase The Cordada Group, Inc. ("Cordada").
AppliedTheory agreed to acquire all of the capital stock of Cordada
for up to 758,219 shares in AppliedTheory common stock. The
acquisition was consummated on May 23, 2000.
On June 20, 2000, we filed a current report on Form 8-K that
included information relating to a purchase agreement with seven
investors for the issuance of $30 million in 5% convertible debentures
due June 5, 2003. Under the Purchase Agreement and related agreements
with the Investors, AppliedTheory can also receive up to an additional
$33,000,000 over the next five years from the exercise of warrants and
options for the purchase and sale of AppliedTheory common stock, par
value $.01 ("Common Stock"). The additional $33,000,000 in financing
is available from three sources. First, pursuant to the Purchase
Agreement, the Investors received warrants for the purchase of
additional shares of Common Stock, for up to $13,000,000. Second, the
Purchase Agreement contains an Investor call option, pursuant to which
the Investors can purchase additional warrants to purchase Common
Stock, for a purchase price of approximately $10,000,000. Finally, the
Purchase Agreement contains a put option, pursuant to which
AppliedTheory can compel the Investors to purchase additional warrants
to purchase Common Stock, for a purchase price of approximately
$10,000,000 under certain circumstances.
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APPLIEDTHEORY CORPORATION
FORM 10-Q
JUNE 30, 2000
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned thereto duly authorized.
AppliedTheory Corporation
Date: August 11, 2000 by: /s/ Richard Mandelbaum
------------------------------------------
Richard Mandelbaum
Chairman of the Board,
Chief Executive Officer, and Director
(Principal Executive Officer)
Date: August 11, 2000 and: /s/ David Buckel
------------------------------------------
David Buckel
Sr. Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
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EXHIBIT INDEX
The following Exhibits are filed or incorporated by reference herewith:
Exhibit 10.54 Amendment No. 2 to Resale Agreement between
AppliedTheory Corporation and NYSERNet.org, Inc.
dated April 18, 2000
Exhibit 10.55 Loan Agreement between FINOVA Capital Corporation
and AppliedTheory Corporation dated May 30, 2000.
Exhibit 11.1 Calculation of Basic and diluted loss per share and
weighted average shares used in calculation for the
three months ended June 30, 2000.
Exhibit 11.2 Calculation of Basic and diluted loss per share and
weighted average shares used in calculation for the
six months ended June 30, 2000.
Exhibit 27.1 Financial Data Schedule for the three months ended
June 30, 2000, which is submitted electronically to
the Securities and Exchange Commission for
information only.
Exhibit 27.2 Financial Data Schedule for the six months ended
June 30, 2000, which is submitted electronically to
the Securities and Exchange Commission for
information only.
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